1 Oct 2014

Forever blowing bubbles?

Ruben Z writes:*

The Netherlands perform above average in most in most standard of living indices and on the international stage is characterised by the entrenched protestant work ethic and its renowned socio-economic model. However, this seemingly ideal society is not the product of some sort of organic economic miracle but over time was induced and sustained by a heavily regulated real estate market and the widespread indulgence in mortgages by the average consumer. How could this practise pose a threat to the long-term prospects of this country?

First of all, there is a significant difference in the market price between agricultural and housing land values. For that reason, the Dutch state has the effective power to create wealth due to the monopoly over land classification. This has the practical outcome that the local governments are incentivised by perverse stimuli of larger real estate or construction corporations to allocate more building lots for at times megalomaniac and bombastic housing projects. In practice, the excessive profits make it lucrative and worth to engage in abnormal risks to build as much as possible considering that the costs are significantly lower than the colluded market price (Dutch).

Nonetheless, the Dutch consumer has greatly benefited from the availability of housing and lifted itself to a supposed higher living standard by intuitively concluding mortgages. By now mortgages have been ingrained in the dominant socio-economic culture and the entire Dutch political system is dependent on the state-sponsored abundance of cheap credit. The average Dutch consumer at this point is trapped in the deceptive narrative of their own making that the price of real estate can only increase in the future. While this is generally a self-fulfilling prophecy (due to the high demand for houses and restricted quantity of building sites), the risks of an external shock or decline in the housing price will put a large share of the nation in debt (it's impossible to avoid debt through default or bankruptcy). The pressure does not come from price fluctuations or decreases but easy access to mortgages that allow people to live above their means or simply to finance short-term wants and desires, to the point where an artificial middle-class is threatened by their debts. This speculative and fragile market sustains a prevalent culture of temporary luxurious and unnecessary consumption instead of long-term private investments that could actually accommodate growth and increased productivity. The fluctuation in income for each household is disrupted and fuel greater exacerbations if the increased income of good times is not smoothed by saving for lesser times. As a consequence, the consumerism and pressure to spend is worsened by the mortgage culture due to the disproportional inflow of income that in turn is further likely to enhance the environmental degradation and heighten the ecological footprint.

As seen in the figure, this has the effect that gradually less people will inhabit each residence in the Netherlands because mortgages allow individuals to afford the prospective housing by themselves and therefore depend less on the traditional household or other social conventions of income (and house) sharing. (Average occupancy is 2.2 people per household.) While this affirms the Western trend towards a more individualistic society, this could potentially be disastrous for the prospects of common goods because these segregated individuals are less dependent on another. Moreover, as this trend continues, more scarce resources and valuable land has to be sacrificed to satisfy the increasing demand for housing. For that reason, on the long term it would make more sense to allocate land and mortgages to more communitarian and sustainable housing. Nevertheless the perverse incentives and prevalent short-termism of the financial sector, the governmental decision-makers and the consumer make this a distant ideal to strife for.

Bottom Line: The artificial creation of wealth and elevation of living standards by mortgages as practised in the Dutch housing-market could fuel short-term growth but on the long-term could be abysmal due to unsustainable levels of consumption, the potential burst of the housing-bubble, the individualisation of the national economy and the disproportional sacrifice of scarce resources.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.

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