The Unassuming Economist

Below are extracts from a report written by IMF colleagues: Krzysztof Krogulski, Robert Sierhej, and Aaron Thegeya.

Although Poland has enjoyed strong growth and steady income convergence with the EU over the last two decades, important disparities persist at the regional level. Per-capita income is higher in the west—which is integrated into the German supply chain and enjoys higher levels of FDI—than in the east—where the economy depends more on less productive agriculture. Despite strong overall economic growth, the east has not been catching up to the west. This chapter identifies policies to increase productivity in the east, reduce regional income disparities, and promote overall income convergence. This would require improving educational attainment and reducing skill mismatches in the east, scaling up public infrastructure to attract investment to less productive regions, and facilitating labor mobility.

Despite strong economic performance over the last two decades, there are significant and enduring income disparities between western and eastern regions of Poland. These disparities are strongly correlated with labor productivity differences. While labor productivity growth in poorer eastern regions has been driven significantly by structural transformation, in wealthier western regions it has been driven by higher investment and integration with the German supply chain. Education and labor market conditions had a significant impact on labor productivity growth across regions. Similar growth rates in labor productivity across regions have prevented eastern regions from catching up to western regions.

The analysis of regional productivity determinants points to policies that could be conducive to regional productivity convergence.

• Support structural transformation and boost productivity in agriculture: Significant room remains to boost labor productivity growth within poorer regions by supporting the reallocation of labor from low-productivity agriculture to higher-productivity industry and service sectors. To unleash the potential for such structural transformation, a review of incentives pertaining to employment in agriculture would be appropriate to identify mechanisms that may encourage people to stay in low productivity farms. In particular, the highly subsidized pension scheme for farmers could be reformed to gradually align it with the regular system to discourage inefficient farming motivated by pension arbitrage. The more productive farms in western regions tend to be larger, so there may be merit in promoting consolidation of agricultural production also in the poorer eastern regions to exploit the economies of scale. In this regard, moving from the current agricultural taxation based on farm size and quality of land to an income-based tax would reduce disincentives to scale up farms and help define the base for social security contributions. To facilitate structural transformation, such reforms should be accompanied with measures to address skill mismatches and bottlenecks in labor mobility, as described below.

• Encourage labor mobility and reduce structural unemployment: Decomposition of productivity growth shows that the contribution from reallocating labor across regions has been relatively minor. This suggests bottlenecks in labor market mobility that could be addressed with proper policies, for example, by improving the functioning of the housing rental market. Currently, the rental housing market in Poland is shallow, discouraging labor relocation. Econometric analysis also suggests that high structural unemployment negatively affects regional productivity growth. While a declining working age population should generally reduce the unemployment rate, addressing high structural unemployment in less productive regions would require greater investment in active labor market policies to improve job searching efficiency across regions, upgrade skills, and reduce skill mismatches.

• Attract investments to less productive regions: Empirical findings show that higher FDI is associated with faster regional productivity growth. FDI is more prevalent in wealthier regions, and this pattern needs to change to support regional productivity catch-up. Some factors important for investors could be altered by government policies to support such a change. Specifically, strengthening transportation networks in poorer regions would help, and better targeting of EU funds could support this process. Furthermore, investor surveys suggest that access to skilled labor is important for location of projects. In this context, investing in education and tailoring it to local development needs is important; aligning vocational curricula closely to the needs of industry would facilitate the absorption of new production methods and technologies. While local governments’ role in boosting productivity appears less statistically significant, it does not imply that quality of local administration is irrelevant. For example, data suggest a positive correlation between regional productivity and the efficiency of local tax administration.

By IMF colleague: Giang Ho

“As offshore investment drops from its peak and oil prices retreat from their high in 2014, the Norwegian economy is going through a transition away from oil dependence,” according to an IMF report. “The transition from oil and gas is a gradual process, and more time would be required before a credible assessment can be made of its progress. The preliminary data show an ongoing marked decline in oil-related production and investment, whereas activity in the traditional goods sector is holding up but not sufficiently to pick up the slack. The divergent performance is perhaps most pronounced within manufacturing between oil-related industries (i.e. machinery and equipment, ships, boats and oil platforms) and nonoil industries. Overall, although the real value added share of the oil-related sector has shrunk from over 36 percent on average during 2000–13 to about 29 percent during 2014–15, much of this appears to have been picked up by the business services sector. The traditional goods producing sector remains a relatively small part of the economy, with value added share at a little over 7 percent and hours worked share declining to 11 percent.”

In a separate report, Jérôme Vandenbussche (IMF) points out that residential prices and rents have increased steeply since 2009, particularly in big cities. This is due to an unexpected surge in housing demand that is explained by stronger than expected net immigration in recent years. In 2009, net immigration was expected to rise from near zero to about 100,000 persons in 2014. However, the actual figure turned out to be 550,000. In his analysis, Vandenbussche takes a look at the housing supply response to changes in house prices and finds “(…) evidence that the supply response to changes in housing prices has declined over the past several years (…).”

In terms of policies to boost the supply response,  Vandenbussche discusses the 10-point action program to stimulate residential construction. He also says that “(…) several other factors, including stricter rent regulation and higher taxation of real estate transactions, are likely to have played a role in the recent decline of the price elasticity of residential investment [This includes] Two tightening rent control measures were taken in recent years (…) The real estate transfer tax rate has been continuously creeping up since 2006 (…) Other factors likely include inadequate staffing at planning and building authorities, and growing shortages of skilled worker in the finishing trade.”

“Rapid house price increases call for early policy action—including loosening housing supply restrictions, eliminating adverse tax incentives, and developing and timely implementing well-targeted macro prudential tools”, says IMF’s latest report on Denmark. The report points out that “Following speculative pressures on the exchange rate in early 2015, Denmark’s Nationalbank (DN) lowered its deposit policy rate—which first broke through the zero bound in 2012—deeper into negative territory (…). In the resulting environment of historically low mortgage rates, real house prices rose over 6 percent in 2015.”

In two separate reports, Giang Ho (IMF) provides a deeper analysis on house price and supply developments in Denmark.

On house prices, Ho says that price developments have been characterized by a “growing divergence” between different parts of the country. Big cities such as Copenhagen has experienced much more rapid price increases than other parts. A similar development is also seen in the market for owner-occupied flats (experincing larger price increases) compared to single-family homes. These regional house price differences are explained by a number of demand and supply factors: demographic trends, rising income and employment, favorable user cost of housing, and housing supply lagging behind demand. Ho’s analysis also points to “emerging overvaluation in Copenhagen and Frederiksberg’s housing markets—particularly in the market for owner-occupied flats.”

On housing supply, “Cities such as Copenhagen where the stock of housing is relatively inflexible and responds slowly to changes in housing demand could see higher price growth (…) the potential price impact of supply constraint can be economically significant”, says Ho. So how the supply constraints can be addressed? “While natural land constraints are difficult to overcome, distortions in the housing markets could be reduced to alleviate the supply shortage in high-stress urban areas such as Copenhagen. For example, there is scope for relaxing zoning regulations in certain areas. In addition, reducing rental controls to allow freely determined rents to apply to a larger fraction of the housing stock, and creating the incentives for municipalities and/or private developers to put land to good use would also be helpful. This is particularly relevant in the current juncture, given the low interest rate environment as well as the recent influx of asylum seekers putting additional pressure on the demand for housing”, according to Ho.

In another report on macroprudential policy, Jiaqian Chen (IMF), notes that given high household debt and other mortgage characteristics–like variable rates and interest only loans–financial stability concerns could  emerge if house price growth continues. She estimates the potential effects of tightening macro prudential policies. She finds that “First, the overall impact from macroprudential policies on the real economy appears limited, while the effect on debt levels can be significant. Second, out of the various modeled policies, amortization requirements seem to have the strongest impact on household debt, suggesting the importance of limiting the growth of deferred amortization mortgages.”

From Global Housing Watch Newsletter: June 2015

Global house prices remain “two-tiered”, says Global Property Guide. The “two-tiered” is reflected in house price increases in Europe and North America, while there is a sharp slowdown in Asia and the Middle East.

Looking in more detail, during the first quarter of this year, “house prices rose in 31 out of the 45 world’s housing markets (…). [Also,] only 21 housing markets showed stronger upward momentum, while 24 housing markets showed weaker momentum. Momentum is a measure of the “change in the change”; simply put, momentum has increased if a property market has risen faster this year than last (or fallen less)”, according to the analysis done by Global Property Guide.

The “two-tiered” view is also seen in the performance of house prices in advanced vs. emerging markets. Analysis by Scotiabank says that there is positive momentum in most housing markets internationally. However, momentum in general favours advanced nations over emerging markets.

Moreover, Knight Frank says that “Aside from Turkey, emerging markets have seen prices enter a period of flat or low growth since mid-2014 (…). The BRIC nations recorded annual price growth of 3% on average in the 12 months to March 2016, while four years ago this figure was closer to 11%. Capital flight, currency shifts (partly due to the US rate rise), volatile equity markets and slowing wages are hampering demand.”

Developments by region

Asia and the Pacific: House prices are weakening in Asia, except China. House prices rose in China, Japan, Korea, Philippines, Thailand, and Vietnam. Meanwhile house prices are falling in Hong Kong, Indonesia, Mongolia, Singapore, and Taiwan (Global Property Guide). “China’s housing recovery is broadening, with roughly two-thirds of major centres reporting annual price growth through April. However, authorities face a tough policy balancing act in their attempt to cool skyrocketing prices in top-tier cities while at the same time support the nascent recovery in oversupplied smaller centres”, according to Scotiabank.

Europe: In Europe, house price booms continue. Six of the ten strongest housing markets in the global survey are in Europe. Overall, house prices rose in 18 of the 22 European housing markets (Global Property Guide). However, conditions remain uneven, with strengthening labour markets supporting solid price gains in some member countries, notably Ireland, Spain and Germany, while other markets, including France and Italy, continue to languish alongside a more tepid economic recovery (Scotiabank). Separately, the National Association of Home Builders (NAHB) has looked into the impact of negative rates on housing markets in the Euro area. It finds that “(…) the balance of evidence to date suggests that a slightly negative policy rate has supported mortgage lending.”

On the UK EU referendum result, “For both residential and commercial property, there will be short-term market volatility. Potentially, and in selective instances, pricing could come under pressure (…) However, for both residential and commercial property, the long term market dynamics remain unchanged. Low supply will continue to be a day-to-day market reality”, says Knight Frank. Meanwhile, the Financial Times reports that on one end, buyers are pulling out of purchases amid house price and job security fears, while at the other end, overseas buyers race to secure London property bargains. Other experts have looked into what Brexit means for the U.S. housing market (Capital Economics, Housing Wire, NAHB, Trulia, and Washington Post).

Middle East and Central Asia: housing markets are weakening. All of the three Middle Eastern housing markets included in the survey performed worse in Q1 2016 than the previous year (Global Property Guide).

Western Hemisphere: North America’s housing markets remain healthy. The US housing market has now regained enough momentum to provide an engine of growth for the US economy, according to the latest The State of the Nation’s Housing report by Harvard Joint Center for Housing Studies. Meanwhile, Latin America’s housing markets are mixed. Brazil’s housing market remains depressed, while Mexico’s housing market grew stronger (Global Property Guide).

Developments in prime residential markets

Prime residential prices are moderating. Prime residential prices across the 35 cities increased on average by 3.6 percent in the 12 months to March 2016, according to analysis done by Knight Frank. Knight Frank’s narrative of overall moderate growth in prime residential prices is also in line with the view of Scotiabank. “Sales of high-end luxury properties have cooled in a number of large markets over the past year, including New York, Hong Kong and London”, says Scotiabank.

What explains the slowdown in prime residential prices? Scotiabank says that the “softening in demand mirrors the economic slowdowns in China and the Middle East, and deep recessions in Russia and Brazil, all key source markets of luxury foreign buyers.” Meanwhile, Knight Frank adds that “new regulation in the form of measures to improve transparency, new taxes or fees for foreign buyers are increasing in number. However, the impact on the market of such measures is largely dependent on market fundamentals and where each market is in relation to its property market cycle.”