“How high property prices can damage the economy,” published in The Economist on July 28, 2022, mentions several papers showing how high land values lead to misallocation of capital from productive (or relatively more productive) investment to real estate speculation or to firms with more land to put up as collateral (but which are relatively less productive). Here’s a relevant excerpt from the article:
But the use of land as collateral has harmful effects, too, especially in places where banks play a big role in financing companies. Firms’ ability to borrow tends to be determined by their existing assets, rather than their productive potential. And those that own land find it much easier to borrow from banks than those, say, with lots of intangible assets. A paper published in 2018 by Sebastian Doerr of the Bank for International Settlements found that listed American firms with more property collateral were able to borrow and invest more than their competitors, even though they were less productive. These effects were also evident in Spain just before the global financial crisis. In research published last year, Sergi Basco of Universitat Barcelona and David Lopez-Rodriguez and Enrique Moral-Benito of the Bank of Spain noted that property-owning manufacturers in the country tended to receive more bank credit than other firms.
Rising property prices can also discourage productive lending, and lead to capital being misallocated. When housing markets boom, banks tend to engage in more mortgage lending. But because lenders face capital constraints, this is often accompanied by reduced lending to businesses. The effect is illustrated by research published in 2018 by Indraneel Chakraborty of the University of Miami, Itay Goldstein of the Wharton School of the University of Pennsylvania and Andrew MacKinlay of Virginia Tech. The paper, which looks at data from America between 1988 and 2006, found that a one-standard-deviation increase in house prices in areas where a bank has branches reduced lending growth to firms that borrow from the same bank by 42%. The total investment undertaken by the affected firms fell by 21%. Such crowding-out effects may have been sizeable in other places too, considering that banks around the rich world have sharply increased their mortgage lending. Across 17 advanced economies, mortgages’ share of total bank loans climbed from 32% in 1952 to 58% in 2016 (the latest year for which data are available).
Whatever the effects of high land prices in the West, the scale of the problem in China appears even bigger, given that the country’s investors have a huge appetite for real estate. A range of recent research suggests that China’s high land prices shift bank lending away from land-light manufacturers and reduce spending on research and development by listed firms; they also appear to lead to a reallocation of managerial talent towards the property sector. One especially striking result comes from a paper published in 2019 by Harald Hau of the University of Geneva and Difei Ouyang of the University of International Business and Economics in Beijing, brd on data from manufacturers in 172 Chinese cities. It concludes that a 50% increase in property prices would raise borrowing costs, reduce investment and productivity, and result in a 35.5% decline in the firms’ value-added output.
The papers mentioned are:
Doerr, Sebastian (2018). Collateral, Reallocation, and Aggregate Productivity: Evidence from the U.S. Housing Boom. Munich Personal RePEc Archive (MPRA Paper No. 106163). Retrieved from https://mpra.ub.uni-muenchen.de/id/eprint/106163
Basco, Sergi and Lopez Rodriguez, David and Moral-Benito, Enrique, House Prices and Misallocation: The Impact of the Collateral Channel on Productivity (September 21, 2021). Banco de Espana Working Paper No. 2135, Available at SSRN: https://ssrn.com/abstract=3927727 or http://dx.doi.org/10.2139/ssrn.3927727
Chakraborty, Indraneel and Goldstein, Itay and MacKinlay, Andrew, Housing Price Booms and Crowding-Out Effects in Bank Lending (March 5, 2018). Review of Financial Studies, Forthcoming, University of Miami Business School Research Paper No. 18-2, Available at SSRN: https://ssrn.com/abstract=2246214 or http://dx.doi.org/10.2139/ssrn.2246214
Hau, Harald and Ouyang, Difei, How Real Estate Booms Hurt Small Firms: Evidence on Investment Substitution. Available at SSRN: https://ssrn.com/abstract=4003834 or http://dx.doi.org/10.2139/ssrn.4003834
Later on, they also mention how a Land Value Tax can cure this!
A more ambitious idea would be to tax land values, which, by lowering the market value of land, might reduce its attractiveness as collateral. Such a tax was, funnily enough, the goal of many 18th- and 19th-century reformers as they sought a more equal society. A new obsession with land could well revive an old idea.
Elsewhere (before these excerpts), they also say:
Real estate is the largest asset class in the world. In 2020 it made up around 68% of the world’s non-financial assets (which includes plant and machinery as well as intangibles, such as intellectual property). Land, rather than the structures built on top of it, accounts for slightly over half of that 68%. As values have ballooned, the share of land in non-financial assets has increased sharply in some countries (though few report the data). In Britain, for instance, it went from 39% in 1995 to 56% in 2020.
This is from McKinsey’s “The rise and rise of the global balance sheet.” See this for their methodology.