Australia must increase housing supply to improve affordability

The intent underpinning the federal government’s First Home Loan Deposit Scheme is well placed, but good intentions do not necessarily translate to good policy.

The winning sound bite the government hopes would echo across the media is, ‘We are helping young people buy their first home sooner.’

This is an outcome worth striving for. Home ownership remains an integral part of the Australian dream. It is a widely held aspiration that represents the stability and freedom of reaching adulthood, delivering both long-term social and economic benefits. The only problem is, these housing subsidies worsen housing affordability in the long run, pushing home ownership further out of reach for aspiring home buyers.

There are two parts to the story.

One, the federal government is trying to improve affordability by adding to the demand for housing. And two, state and local governments have failed to address the fundamental issue that chronically restricts the supply of housing: onerous zoning and planning regulations.

Based on first principles, when you add to the demand for housing but do nothing to expand supply, the only direction for prices to go is up.

Researchers from the Reserve Bank of Australia conducted an analysis in 2018 that found zoning laws (such as minimum lot sizes, maximum building heights, and planning approvals processes) have contributed to 40 per cent of house prices in Sydney and Melbourne. In dollar terms, zoning laws added up to $489,000 to the price of a detached house in Sydney, $324,000 in Melbourne, $206,000 in Perth, and $159,000 in Brisbane.

‘The effect of zoning has increased dramatically over the past two decades, likely due to existing restrictions binding more tightly as demand has risen,’ the study stated.

Furthermore, recent research from the Organisation for Economic Development (OECD) cited such planning restrictions as the primary reason why Australia has such an unusually high in-elasticity of supply for housing. In other words, changes in the price of housing have little impact on the quantity of housing supplied. The Productivity Commission, International Monetary Fund, Grattan Institute, and Centre for Independent Studies all agree planning is the problem. The evidence is overwhelming.

So, in the face of this long-running issue, the federal government decided to throw more fuel on the fire. To his credit, Treasurer Josh Frydenberg has acknowledged state and local government’s role in relaxing planning regulations to increase housing supply. But will he acknowledge his government’s role in exacerbating the affordability problem?

With a federal election looming over Frydenberg’s head, of course not.

Meanwhile, the media too often focuses on tax concessions like abolishing negative gearing and reducing the capital gains discount. Although the Grattan Institute has recommended this, other studies show such policies will only make a minor difference to house prices (and as discussed by AMP Capital’s chief economist Shane Oliver, could introduce other problems like tax distortions).

Allowing Aussies to access their super early to buy a first home was also recently floated (notably by Liberal MP Tim Wilson). Again, this would not solve the problem. It would have the same effect as the federal government’s subsidies of bidding up house prices. Ultimately, these policy proposals should be secondary to fixing the supply side of the market. This is what will make the biggest difference to improving affordability in the long run.

All levels of government have a responsibility.

The federal government should resist expanding schemes that serve only to inflate the demand for housing. Meanwhile, state and local governments should aggressively pursue supply side reform by cutting planning red tape. It has also been recommended that the federal government provide incentive payments to support this process (the major think tanks seem to be in agreement on this one). Committing to this process would make housing supply more responsive to demand, bringing the dream of home ownership back into arm's reach for aspiring home buyers.

For now, at least, the government took the easy route, which was crystal clear in their federal budget largesse – pursuing uninspired pre-election policies aimed at winning votes.

The problem is, by improving housing access for some prospective buyers in the short-term, housing becomes more expensive for everyone else in the long term. This was a clear case of a short-sighted government picking winners and losers, making the problem worse (despite some of their rhetoric).

Prices will continue to rise as demand outstrips supply, kicking the can down the road to the next election cycle. If long-term reform is not tackled head-on, the situation will only get worse for aspiring home buyers.

So much for the land of the ‘fair go’.