Princeton professor says increasing borrowing not a good strategy
Princeton professor and renowned economist Atif Mian has said that increasing borrowing for housing purposes is not a good strategy. In fact, it has never been successful.
If this is true, then this means that the State Bank of Pakistan’s Markup Subsidy for Housing Finance scheme will fail, eventually.
The Pakistani-American economist, while speaking at Oxford Economics Society’s online event titled Extreme Inequality, Indebted Demand and Threats to our Economic Well-Being on Tuesday, argued that the top 1% of the world’s population tends to save a much higher fraction of their income, but that doesn’t necessarily translate into investment. This surplus capital is then absorbed entirely by the bottom 99%, who end up borrowing more. The dependence on debt is increasing, the system is fragile, reaching a breaking point, he added. Excessive borrowing is evidence of an economic system that has become distorted by widening income inequality, whose magnitude has gone up significantly since 1980.
“I know many examples where such a policy has miserably failed,” Mian said and followed with the example of Brazil’s recent mortgage policy where they made it much easier for people [to get financing]. “It led to a boom in housing and borrowing so there is a short-term boom, but it failed miserably, eventually, and it came crashing down, partly because of that policy.”
But one can then argue: wouldn’t subsidised or lower interest rates help increase homeownership? Responding to this, Mian said this is a popular argument, especially within the political circles. “You are coming with a good heart, but you are going to miserably fail,” he said. Let’s take the example of subprime credit. “Mortgages have become more and more prevalent in the US. But have homeownership rates increased, particularly among poorer households in the US? Not at all. In fact, it’s the opposite.”
If interest rates continue to fall, the value of assets (for example land) continues to rise. So those who own assets will become richer without working hard, making these assets more out of reach for the lower segment.
“When you give people more purchasing power artificially—which is what borrowing does—you raise the price of the asset as well. Lower interest rates make prices higher. So, while you are giving them more credit, the price has also risen of the same house they were trying to buy before,” he said. On a net basis, you are actually not helping them. It’s a very basic but powerful insight.
Pakistan has already allocated Rs36 billion in subsidies to the central bank’s house finance scheme as PM Imran Khan’s government has been counting on this project to stimulate economic growth. When the real estate sector grows, dozens of allied industries also grow, which creates employment and boosts GDP growth, they say.
Mian has, however, expressed his doubts over this policy in the past on social media. He had tweeted about how real estate projects won’t solve our economic imbalances. In one of his tweets, he said houses can’t be exported. Pakistan must generate sufficient additional exports to pay back its debt, according to him.
Borrowing against house is not a growth strategy. “If you want to improve someone’s life, teach him how to fish, don’t try to give them fish,” Mian said in response to SAMAA Digital’s question about Pakistan’s house finance scheme, which offers subsidies on house loans. “Pakistan needs a growth strategy that fundamentally involves coming up with ways to teach people how to fish. ” Giving them a mortgage loan doesn’t make them learn how to fish.
There is a lot of fish out there; people just don’t know how to catch it. Train people how to fish, that’s how their incomes are going to rise, and that’s how they will have the real purchasing power that will allow them to buy the house they should have. There has to be an equality of opportunity, he said implying everyone should have access to health, education, and peace.
“We have to do it the right way and doing it through credit just doesn’t work,” he said.
Mian was featured in The Economist’s December 22, 2018-edition as one of the decade’s eight best young economists who want to change the world. You can watch his full talk here.