It may be a strange thing to say, but the housing collapse is not all a bad thing. Certainly there is a mess to clear up. But the mess would be even larger had the boom continued. In a nutshell the housing boom involved a collassol waste of resources. It is a good thing that we have stopped.
I have commented before on how the bubble in house prices was fairly obvious even while it was still going on. The rise and rapid fall in house prices gets a lot of attention but the waste of resources. This doesn’t get the attention is deserves. Understandably most of the discussion is focused on the consequences of the bubble for the public budget and the banks. In the long term these issues will be resolved — however painfully. But we will still be left with a legacy of a decade of bad investment.
The reason for this bad investment is now fairly obvious: people respond to prices. And People responded to the rapid run up in house prices by devoting more national resources to housing construction. Landowners sold more land for development; builders built more houses and punters bought them. All thought that they were behaving sensibly because the price kept rising.
The graph shows the the size of housing construction as a percentage of GDP in several countries, including Ireland over the last decade (double click on it for a larger version). It is clear that Ireland was an outlier. At its peak, housing construction was 14% of our GDP compared to an average of 6% for the OECD as a whole. That means that an extra 8% of our national effort, on an annual basis, was devoted to housing construction. Formally speaking this is counted as “Investment” in GDP. Although it is fairly obvious now that much of this was not investment in the usual sense of the word i.e. was not going to enhance productive capacity in the future.
Nevertheless this expenditure contributed to GDP (one seventh of GDP at its height). People directly involved in the construction industry obviously benefited. But everybody else did also as the income generated trickled down to the rest of the economy.
When the bubble burst, it became obvious that property wasn’t the good investment it had appeared to be. Thus construction halted almost over night. And therefore, 8% of our GDP disappeared almost overnight. This loss tricked down to the rest of the economy in just the way that the construction boom had trickled down to everyone else. When 8% of your economy disappears over night, you notice the pain. That, in a nutshell, is where our recession came from.
Note that we would have this recession when our bubble burst even without the international credit crunch. The international problems just make our own more difficult to deal with.
But note also, that the bursting of the bubble, though painful now, is ultimately a good thing. As long as it continued, we would be wasting more and more of our resources in the unproductive investment in housing. Stopping that waste is a good thing in the long run. Our resources can now be put to better use elsewhere. Unfortunately in the very short term, the two main “better uses” seem a bit troublesome. Ideally the government should take advantage of the crash in construction to speed up the development of much needed public infrastructure. But of course, the government hasn’t got the cash to fund such a plan at the moment. The other way in which our resources could be better put to use is in export earning industries. This would be useful as we will need to foreign earnings to pay back the foreign borrowing made during the bubble (more on this in a future post). Will only be able to stimulate exports if we can cut our domestic costs.
