12 08 2009

On economic journalism and economic nonsense

If the financial crisis has brought us something good, it is that it has exposed the ignorance with which the economy has been treated by the media. The downside of it is that few seem to have noticed, and that the economic journalists don't seem to have learned anything from it. This is particularly clear when looking at the way news about the stock market and the housing market are treated.

The most obvious of these two it the housing market. When real estate prices go up, the media are cheering: “The year X has been the best ever for the housing market”, “Optimism as new data show that housing prices have increased with X percent”, “Increasing house prices show that the economy is buoyant”, etc. This is absolutely illogical. Why should it be good that the price of an essential good as a place to live increases? High prices means that more of the income has to be used to pay for housing, be that buying or renting. This is bad for real wages and it is bad for the competitivity. It is a real problem for young families, particularly families with children, which have a hard time finding an affordable place to live at all. Take the example of Denmark. At the height of the housing price bubble there, it was difficult to hire civil servants in the Greater Copenhagen area simply because low paid civil servants as school teachers, nurses and police officers were unable to pay for a place to live as first time buyers.

When housing prices spiral out of control, several mechanisms can be at play. Of course there is the bubble factor – everybody at that moment expected prices to continue increasing so houses were bought at a high price, with the expectation that prices would be even higher in a couple of years. But that is only part of the story. Housing is a producible good, so when prices can increase so much it reflects that the supply is not working as it should, and this normally comes down to public policy. One of the crucial elements is urban planning, where the public authorities (in most countries the municipalities) often failed to make sure that enough new areas with good access to public transport were laid out for urbanization. There are many reasons for this, but it is difficult to avoid the suspicion that an insider-outsider mechanism has been at work: local authorities are mostly home-owners and both they and an important part of their constituency benefit from the increasing housing prices, so they have little incentive to go into the trouble to change the local planning to benefit newcomers to the market. Why bother?

Does this mean then, that it is a good thing when housing prices go down? Not necessarily. What is a bad thing is price volatility, which means that people looking for at place to live have to play the roulette of a volatile housing market, with no real possibility to influence the result. Very often, a decision to buy cannot be postponed, because of a change of job or because of the forming of a family. It should therefore be an obvious job for the policy makers to try to stabilize the market. What they have done in many developed countries the last couple of years has been the opposite: to fuel the price increases in stead of trying to dampen them. When prices were already increasing, little or no action was taken to increase supply, and instead demand was further stimulated by a deregulation of the credit markets (the maturity of loans were increased, then loans with no amortization at all were invented, and finally even loans with negative amortization), a tax system favouring ownership over renting and abandonment of social housing programmes. This violent up and down movement of housing prices has created a considerable redistribution of wealth between winners and losers – between those who quit the housing market at the right time, and those who entered the housing market at the wrong moment, often with no choice. Forcing people to play the real estate roulette is hardly responsible public policy.

Of course the politicians can say: how could we know? It is the market forces at play, and we can't outsmart the market. That shouldn't be that difficult, however. Take the example of the UK. House prices there were in mid 2007 almost six times the earnings, where they ten years earlier had been around 3 times the earnings. Despite the recent fall in prices they are now more than four times the earnings, so they still have some way to go. And the same pattern is repeated in most of the developed world. How blind can you be?

The media are now looking for signs of increasing house prices. And when they find signs of that they cheer again. “Good news for the housing market: prices are increasing again”. So they seem to have learned nothing.

For the stock market, the story is similar, but somewhat different. When stocks go up, the economic journalists are cheering: “Record year for stock market XX”, “Good mood at the stock exchange reflects optimism about the economy”, “Sad day at the stock market as prices fall...”. So there have been a lot of sad days lately.

A share is, as the word says, a certificate that the shareholder owns a fraction of a given company. The value of the share therefore depends on the value of the company, which basically derives from the stream of incomes the company is expected to produce over the coming years. So the value of the share should go up and down according to the expectations regarding the company's future earnings. As share prices are very volatile, it is of course difficult to believe that the expectations as to the future earning of a company can vary so much over a couple of days or weeks. Again, apart from the expectations regarding the future of the company, what influences the price is also the prospect of the price going up or down, independently of the performance of the company – when shares are bought principally because the buyers expect to be able to sell it for a higher price in the future, a bubble is building up.

So should we be happy then when share-prices are increasing? Well, the shareholders should of course be happy, particularly if they are smart enough to sell before they start falling again. But what about all the others who own no shares? Generally, they shouldn't care, whether prices are high or low. It does not matter whether the Dow Jones index in the US is at 6,000 or 12,000 points. It has very little impact on the real economy, except that companies wanting to raise capital issuing new shares will have a harder time doing so.

Then, what about the employees at the company? They are often expected to be happy, when prices of the shares go up, even if they own none of them, as it means that the future for the company looks bright and hence there should be job security and hopes for wage increases. But alas, there is no automatic relation between company profits, share prices and working conditions for the workers.

Firstly, a company may very well decide after a year with bumper profits to for example outsource production. They are not compelled to do that in the same way as if profits were squeezed due to the competition, thus making outsourcing a question of life or death for the company. But it is worth remembering that particularly after the down-coming of the wall two decades ago, the developed countries are increasingly shareholder economies, not stakeholder economies. So past profits don't count, only future profits. Employees should therefore not expect gratitude from the shareholders.

Secondly, as share prices go up, shareholders are expecting profits to increase. For them, they already paid for the existing profit level, they are expecting an ever increasing level of profits to produce further increases in the share price. So it is a never-ending screw of claims for more profit. If share prices are high, it will actually put a pressure on the company to increase profitability, which may easily end up costing jobs and squeeze salaries. So again, in a shareholder economy, don't expect gratitude.

The moral of the story is that when you soon see the media touting good news for the economy as share and housing prices start increasing again, don't believe them. They don't know what they are talking about.

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Thorbjorn Waagstein

Thorbjørn Waagstein, Economist, PhD, since 1999 working as international Development Consultant in Latin America, Africa and Asia.

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