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54 Finance and economics The Economist January 2nd 2010 Global house prices Ratio rentals House prices are still far above their fair value in many countriesthough no longer in America WHEN The Economist last published its round-up of global house prices in September there were only two countries (Switzerland and China) in which prices were higher than a year earlier. Since then many housing markets have strengthened. The latest survey shows that house-price ination has turned positive in six countries, and in Hong Kong the rate of increase is now in double digits. Even where prices are still falling year on year, markets are healing. In America the S&P/Case-Shiller index of prices in ten big cities was unchanged in October, after ve monthly increases. That has left prices 6.4% below their levels 12 months earlier; go back a year and house-price deation was almost three times as high. That markets are now stabilising could suggest that prices have fallen far enough to correct the excesses of the global housing bubble. To test that hypothesis The Economist has created a fair-value measure for property based on the ratio of house prices to rents. The gauge is much like the price/earnings ratio used by stockmarket analysts. Just as the worth of a share is determined by the present value of future earnings, house prices should reect the expected value of benets that come from home ownership. These benets are captured by the rents earned by property investors, which are equivalent to the tenancy costs saved by owner-occupiers. Shares are deemed pricey when the p/e ratio is above its long-run average. Similarly, homebuyers are likely to be overpaying for property when the price-to-rents ratio is higher than normal. By that yardstick house prices seem low in only a handful of countries in our survey, as the nal column in the table shows. One is Japan, where steadily falling property prices mean the price-to-rents ratio is 34% below its average since 1975. Switzerland’s ratio is also less than its long-run average. Germany looks cheap as well, and since our valuation benchmark goes back only to 1996 and so misses out a period when German house prices were frothier, may be cheaper still. The global housing bubble Back to earth Ratio of house prices to rents Long-run average=100 Spain Britain United States (FHFA) United States (Case-Shiller national index) 1975 80 85 90 95 2000 05 09 Sources: FHFA; Nationwide; Standard & Poor’s; Thomson Reuters; government offices; The Economist 180 160 140 120 100 passed Japan and Germany by, so it is not surprising to learn that housing is cheap there. A more striking nding is that America’s housing bust has taken prices back to their long-run average value against rents. Based on the Case-Shiller national index, American house prices had fallen to 3% below their fair value by the third quarter of 2009, well down from their inated values at the start of 2006 (see chart). Another index from the Federal Housing Finance Agency, the regulator of Fannie Mae and Freddie Mac, tells a dierent story. On that The Economist house-price indicators % change 80 60 40 Latest Q3 2008 Under(-)/ on a year earlier 1997-2009* over(+) valued † Hong Kong 13.9 18.5 -20 +52.9 China 8.0 5.3 na +2.2 Australia 6.2 1.4 181 +50.0 South Africa 4.8 2.5 418 na Switzerland 4.1 3.7 28 -9.0 Britain 2.7 -10.4 175 +28.8 New Zealand 1.0 -6.7 101 na Sweden -0.4 1.8 152 +34.7 Canada -2.1 1.8 65 +20.6 Germany -3.9 -0.5 na -15.2 Japan -4.0 -1.8 -36 -33.7 United States (FHFA) -4.1 -3.9 75 +14.0 Italy -4.1 2.7 96 +15.0 United States -6.4 -17.9 98 +3.3 (Case-Shiller ten-city index) Netherlands -7.1 nil 87 +21.2 France -8.0 0.8 132 +39.8 Spain -8.0 0.4 167 +55.1 United States -8.9 -16.4 64 -3.1 (Case-Shiller national index) Singapore -11.0 8.3 -4 na Ireland -13.9 -10.0 159 +29.8 Denmark -16.4 -4.6 89 +18.4 *Or most recent available figure Sources: ABSA; ESRI; Hypoport; Japan Real Estate Institute; Nationwide; Nomisma; NVM; FHFA; Quotable Value; Stadim; Swiss National Bank; Standard & Poor’s; Thomson Reuters; government offices; The Economist † Against long-run average of price-to-rents ratio Interactive: Compare countries’ housing data over time at: Economist.com/houseprices basis America’s house price-to-rents ratio is still some 14% above its average. But that measure may not fully capture how far values have fallen, as it excludes homes that were paid for with subprime mortgages, for which re sales are more common. The correction in house prices has not gone as far in other countries. In Britain, where prices are increasing again, housing still looks expensive (if not quite as dear as in Australia). Prices in China are rising, too, but its market does not yet look bubbly. Hong Kong is a dierent matter. Its notoriously volatile market is booming again, even though the price-to-rents ratio is already more than 50% above its historical average. At least house prices are still falling in the euro area’s overvalued markets, such as France, Spain and Ireland. No valuation measure is perfect. One aw with the price-to-rents gauge is that it takes no account of shifts in real interest rates. Spain and Ireland have enjoyed far lower real rates than they did before they joined the euro in 1999. These might justify smaller rental yields and thus a higher fairvalue price-to-rents ratio than suggested by history. That would help explain why Spain’s price-to-rents ratio has trended upwards over time, in contrast with Britain’s, which has uctuated more obviously around its long-run average. Partly for this reason, fair-value gauges can also be sensitive to how far back the gures go for each country. Ireland may look less overvalued than Spain because the available data go back only to 1990 and omit a period of less bouncy markets. If the average price-to-rents ratio is calculated from 1990 onwards, Spain’s market is overvalued by 24%, rather than the 55% shown in the table (based on gures from 1975). That would make both markets similarly overpriced. In spite of these blemishes, the price-to-rents gauge is a useful check on how pued-up property markets are. A housing boom turns into a bubble when prices are driven up by expectations of future price gains. Scarcity of supply or population shifts are often used to rationalise high house prices, but such fundamentals should push up rents, too. That house prices in America are back in line with rents suggests the worst of its correction is over (although a further downward leg is possible since past housing busts have pushed prices below their fair value and there is a large stock of unsold houses to clear). Europe’s housing correction, however, seems far from over. 7
The Economist January 2nd 2010 Finance and economics 55 Economics focus How to combat the natural tendency to procrastinate EACH New Year’s Day lots of people make plans to do more exercise or give up smoking. But by January 2nd many of them have not moved from the sofa or are lighting another cigarette. Such triumphs of optimism over experience are common enough. But like other examples of repeated procrastination, they are hard to explain using standard economic models. These models recognise that people prefer to put o unpleasant things until the future rather than do them today. Asked on January 1st to pick a date for that rst session in the gym, say, you may well choose to start in two weeks’ time rather than tomorrow. But the standard models also assume that your choices about future actions are time-consistentthey do not depend on when you are asked to make the choice. By January 14th, in other words, you should still be committed to going to the gym the next day. In the real world, however, you may well choose to delay your start-date again. In a 1999 paper* on the economics of procrastination, Ted O’Donoghue and Matthew Rabin pointed out that people are often unrealistically optimistic about their own future likelihood of doing thingssuch as exercise or savingthat involve costs at the time they are done, but whose benets lie even further ahead. Mr O’Donoghue and Mr Rabin showed that this sort of behaviour can be explained if people are time-inconsistent. Presentbiased preferences mean that people will always tend to put o unpleasant things until tomorrow, even if the immediate cost involved is tiny. As long as they are unsure of the precise extent of this bias, they believe (incorrectly) that they will in fact do it tomorrow. But since they feel this way at each point in time, tomorrow never quite comes. Such a model can therefore explain endless procrastination. It can also suggest ways to change behaviour. A recent NBER paper by Esther Duo, Michael Kremer and Jonathan Robinson argues that a tendency to procrastinate may explain why so few African farmers use fertiliser, despite knowing that it raises yields and prots. In trials on the farms of maize farmers in western Kenya, the three economists found that using half a teaspoon of fertiliser per plant increased seasonal prots by an average of 36% per acre, even if farmers made no other changes to their farming techniques. Doing so after it was clear that the seeds had sprout- New-year irresolution ed eliminated most of the risk of paying for fertiliser in a year of poor weather. Only 9% of the farmers believed fertiliser would not increase their prots. Yet only 29% had used any in either of the two preceding seasons. When asked why, almost four-fths of farmers said that they did not have enough money to buy fertiliser for the land they farmed. Yet fertiliser was readily available in multiples of a kilogram, so even poor farmers earned enough to buy fertiliser for at least a fraction of their elds. Better intentions made little dierence: virtually all farmers said they planned to use fertiliser the following season, but only 37% actually did so. The reason for this gap between intent and action, the economists argue, is that many farmers are present-biased and procrastinate repeatedly. Right after the harvest, when farmers are cashrich, most can aord to buy fertiliser. But going to town to buy it imposes a small cost: a half-hour walk, say, or a bus ticket. So farmers postpone the purchase, believing they will make it later. But they overestimate their ability to put aside enough money to do that, ensuring that their plans to buy fertiliser meet much the same fate as a typical new-year resolution. A model of such preferences generates several interesting predictions. It suggests that a tiny discountenough to make up for the small costs associated with buying fertilisershould induce present-biased farmers to make the purchase. The model also suggests that a given discount would be more eective if oered immediately after the harvest rather than just before the next planting period, by which time it would be useful only for those farmers who had no problems with saving money. Solving St Augustine The economists devised a scheme in which farmers paid the full market price for fertiliser, but had it delivered to their homes by a non-governmental organisation at no additional cost. A subset received this discount at harvest time, while another group were also oered free delivery, but only when planting time was imminent. Still others were oered a 50% subsidy on the market price, an approach commonly taken by governments to encourage fertiliser use. As the model of time-inconsistent preferences predicted, the oer of free delivery early in the season pushed up usage of fertiliser by 11 percentage points over a control group who were not oered anything. The same discount late in the season, however, had a statistically insignicant eect. A 50% subsidy later in the season, a much costlier policy than free delivery, pushed up usage by about as much as the early discount. Interestingly, nearly half of a group of farmers who were offered a choice picked early rather than late free delivery. Early delivery means advance payment, with any interest that might have been earned in the interim being forgone. Many farmers, it seemed, were well aware of their own tendency to procrastinate and were looking for a way to force themselves to buy fertiliser. Such devices can help other procrastinators, too. In recent eld trials in the Philippines some smokers who wanted to quit were oered a commitment contract. Those who signed up put money into a zero-interest bank account. If they passed a test certifying that they were nicotine-free six months later, they got their money back. If not, it went to charity. The contract increased the likelihood of quitting by over 30% over a control group. Those new-year resolutions need not turn to ash. 7 ................................................................................................ * See papers referred to in this article at www.economist.com/procrastination
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IBM, the IBM logo, Lotus, Sametime,
Page 4 and 5: 4 Contents The Economist January 2n
Page 6 and 7: THANK YOU FOR MAKING US THE WORLD
Page 8 and 9: 8 Leaders The Economist January 2nd
Page 10 and 11: 10 Leaders The Economist January 2n
Page 12 and 13: Online The year ahead In anticipati
Page 14 and 15: 14 Executive Focus INTERNATIONAL TR
Page 16 and 17: 16 Executive Focus Board of Directo
Page 18 and 19: 18 Brieng Waziristan The Economist
Page 20 and 21: 20 Brieng Waziristan The Economist
Page 22 and 23: 22 United States The Economist Janu
Page 24 and 25: 24 United States The Economist Janu
Page 26 and 27: 26 Brieng Emerging markets and rece
Page 28 and 29: 28 Brieng Emerging markets and rece
Page 30 and 31: 30 The Americas The Economist Janua
Page 32 and 33: 32 Asia The Economist January 2nd 2
Page 34 and 35: Middle East and Africa 34 The Econo
Page 36 and 37: 36 Middle East and Africa The Econo
Page 38 and 39: 38 Europe The Economist January 2nd
Page 40 and 41: Britain 40 The Economist January 2n
Page 42 and 43: 42 Britain The Economist January 2n
Page 44 and 45: 44 International The Economist Janu
Page 46 and 47: 46 Business The Economist January 2
Page 48 and 49: 48 Business The Economist January 2
Page 50 and 51: 50 Brieng Women in the workforce Th
Page 52 and 53: Finance and economics 52 The Econom
Page 56 and 57: Brieng Mobile-phone culture 56 The
Page 58 and 59: 58 Brieng Mobile-phone culture The
Page 60 and 61: 60 Science and technology The Econo
Page 62 and 63: Books and arts 62 The Economist Jan
Page 64 and 65: 64 Books and arts The Economist Jan
Page 66 and 67: 66 Courses Announcements The Econom
Page 68 and 69: 68 Tenders THE MINISTRY OF TOURISM
Page 70 and 71: 70 Economic and nancial indicators
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