Tuesday, February 22, 2011

Free market or govt role? It depends on social goals

Feb 21, 2011

DESPITE the strong stance of the Washington Consensus against government intervention, it is not a logical inevitability that governments will mess up the distribution of goods and services. It is merely a tendency that governments generate a degree of inefficiency. Inefficiency is not in itself a condemnation, while efficiency should be seen as an advantage rather than a definitive end, as there are inevitably other social goals that must be considered. Similarly, the efficiency of the free market is not proof it is the 'correct' method of economic distribution.

One good example of this principle is Singapore's housing system. In most countries, the housing market is dominated by the free market. The government usually acts to supplement the market by providing for low-income households, or to promote home ownership through legislation or tax advantages.

Unlike most other countries, Singapore does not emphasise the role of the free market in the provision and distribution of flats. For new flats, the Housing Board has relied on queueing, and, since 2002, the Build-to-Order ballot system.

This is highly reminiscent of the heyday of central planning. The rationale for indulging in central planning in this case is to avoid price volatility in the housing market and to make sure low-income households are not left out.

The high degree of control the Government wields also allows it to use housing policy for social ends. For example, the Government incentivises marriage by making new HDB flats eligible only for married couples or two or more singles above age 35. Similarly, HDB has to maintain a certain ethnic ratio in its estates so as to promote racial integration.

Try as you will, there are precious few arguments you can throw against the Singaporean model. Housing is affordable, despite qualms about a lengthy mortgage period. The flats are well-built and well-furnished, neighbourhoods are convenient, and the aesthetics agreeable.

The housing system also does well at differentiating between high-income and low-income homes by providing varying degrees of luxury. One initiative in recent years is the provision of upscale HDB flats that are completely different from the austere flats of old. Pinnacle@Duxton is an example: out of reach of most Singaporeans and offering material comfort comparable to that in a private condominium. Recently, the HDB introduced Waterfront@Punggol to remake the heartland, and announced plans to revitalise Yishun as an 'exciting place to live'. Hence, the Singaporean housing system does manage to offer choice, and avoids, for the most part, the grey lack of character that plagues other public housing.

Despite the significant expenditure necessary to sustain the carefully controlled housing market, Singapore invests less per capita on housing than most other countries, possibly because of highly developed economies of scale. Ownership rates, at about 90 per cent overall, are higher than almost any other country. Singapore's model seems to match the results which free housing markets achieve, with the additional benefit of stability in the housing market.

Yet, the Singaporean public housing system is also a good illustration of how a policy approach inevitably comes with its own set of disadvantages. One major issue is how finely tuned the system is. The Government has to let house prices rise with inflation to protect the homeowners' investments, yet ensure the rise is in line with wages so flats remain affordable.

Furthermore, as the resident population rises, given limited land supply, demand growth will outstrip the Government's ability to supply flats. Prices will rise, forcing the Government to increase its subsidy to maintain affordability. As it faces these difficulties, the Government is also not excused from the need to pay attention to consumers' demands, or to respond to rising demand for housing, even if it does not adopt a free market system.

Another issue is the inflexibility of the system. Each policy introduces complications within a contained system, and can cause unintended distortions. For example, most young people, who have just graduated from university and earn rather average wages, are forced by prohibitive rents to live with their parents. The Government's restrictions on public rental, mainly introduced to enforce owner-occupation of HDB flats, inflate the rent by depressing supply. Median rent for a three-room HDB flat is about $1,600 a month. Assuming you earn the median wage of about $3,000 a month, the cost of rent would be over half your budget.

This has repercussions that extend beyond housing, and the consequences need to be taken into consideration. It reinforces the cultural norm of children staying with their parents until marriage. The lack of privacy at home may be a deterrent to dating, thus reducing marriage rates and hence fertility rates. More importantly, it is an indirect restriction on personal freedom. Either way, the point is that the mass of regulation the Government imposes has unintended side effects, which may be socially undesirable.

But it is highly misleading to think that there can be absolutely better policy. Rather, there are some policies that offer advantages which are more generally prized. Hence, most arguments against government, citing inefficiency compared to the free market, miss the point. Instead, what critics of housing policy or government intervention in general should be concerned about is whether the policy offers the 'right' advantages, and this depends on understanding the goals we hope to achieve. The only important question that remains is the normative one of what we want. If we accept that different markets have different desired social outcomes, we can no longer insist dogmatically on free markets.

In the specific context of housing, is there an economic case for government intervention? In a small market like Singapore's, it is highly possible that monopolies may occur in housing. Singapore's current approach avoids the possibility of deadweight loss to private monopoly. More rigid house prices also serve as a buffer against volatility, providing stability in housing investments.

To the extent that we prize stability and low prices in our housing markets, it is likely that government involvement in the housing market offers advantages that outweigh the flaws.

The writer has just graduated from Raffles Institution. This essay first appeared on Very Fine Commentary, an online journal written by and for junior college students.

[This is remarkably well-argued paper, more so that the author is so young. ]

No comments: