Land-based wealth an illusion

Inflationary pressures are the immediate impetus for interest rate increases.  Aside from short-term movements, those pressures emanate from an imbalance between savings and current levels of consumption.  Savings that are too low in the long run reduce the capacity of the economy to produce income and mean lower growth and consumption.

Australia's real level of household savings has been declining for more than 20 years in a trend that has gathered pace.

In spite of these lower savings levels, according to Treasury data, household wealth is continuing to increase.  Treasury estimates aggregate private wealth in 2005 nominal dollars at $6076 billion, or at $305,500 a person.  In real 2003-04 dollars, wealth is estimated to have grown fourfold since 1975, as illustrated here.

In per capita terms, the real growth has been 2½-fold over the same period.

Obviously there is an inconsistency between private wealth and real savings levels.  The answer lies in housing, which accounts for nearly 60 per cent of private wealth.

Much of the wealth represented by housing is illusory.  It is created by government rationing of land.  This causes inflation in land prices.

The building component of new house prices has changed little in real terms over the past 30 years.  However, over the same period, the land component has outpaced general inflation by between tenfold (Adelaide) and twofold (Melbourne).  This is nothing to do with real land shortages -- urban land comprises only 0.3 per cent of the national land stock.  It is caused by increasingly stringent zoning rules that have reduced the supply of land that can be developed and boosted prices in new and established houses.

The interest rate rise is designed to curb some particularly strong house price rises that have been seen over the past year or so.

While this represents a sound response to an immediate problem, the issue is much longer term.  Land supply constraints are inflating house prices.  This is creating an illusion of wealth and affecting savings levels.  More importantly, it is pricing non-home owners out of the market.

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