Member Corner

A survey of housing finance in other countries sheds light on the distortion that government subsidies for housing can cause in national economies. Professors at New York University’s Stern School of Business have pointed out that one thing that Spain and the United States have in common is a “massive misallocation of their economy’s resources to construction. The oversupply is contributing to the substantial unemployment rate in Spain and the U.S.” 

They further point out that the government’s programs to subsidize housing—which includes support through the GSEs—come with a significant price:

These programs come at a cost that is overlooked in the public debate: They make housing relatively cheaper and other goods relatively more expensive. This, in turn, leads to more consumption of housing, more investment in housing and construction, but less business investment and less consumption of non-housing goods and services. The consensus among economists is that investment in residential real estate is substantially less productive (at the margin) than is capital investment by businesses outside the real estate sector (e.g., plant, equipment, inventories), investment in social infrastructure capital (e.g., highways, bridges, airports, water and sewage systems), or human capital (e.g., more and better education and training). In other words, every additional dollar that is spent on residential construction instead of on business or other investment reduces economic growth.

And the distortion is substantial: “Careful research has found that all of the incentives for more house has led to a housing stock that is 30 percent larger than would be the case if all of the incentives were absent, and that U.S. GDP is 10 percent smaller than it could be.”

The international context offers a further cautionary lesson on the hazards of subsidizing housing and relying on residential construction as a source of national economic growth. The financial journalist Felix Salmon has contrasted the divergent paths that the Spanish and German economies have taken in recent years, and he traces that divergence to a difference in government housing policy:

The difference between Germany and Spain, when you get down to it, is that Germans work for companies which provide goods and services that the rest of the world wants. In doing so, they make good money, which they save up. That’s how they became rich. The Spanish, by contrast, have massive unemployment, and most of the country’s GDP growth in recent years has come from the construction industry. Their main export is tourism, if that counts as an export, and the main way that Spaniards have become rich in recent years is by sitting back and watching the value of their real estate grow exponentially.

The lesson that he draws from this contrast is that “the U.S., going forwards, needs to be less like Spain and more like Germany. So let’s not subsidize housing. That way lies fiscal disaster.”