firmly in place has been confirmed through an abundance of historical evidence.
Soaring house rent fees and cabbages prices
Although Jonse prices have been soaring, they fall far short of selling prices. What does the gap mean? Do rising Jonse prices have anything to do with wealth tax or transfer tax? Is it desirable to increase public low-rent housings as some claims? Should we criticize banks` lending more money for house rents?
Let`s think about some questions over recent jump in Jonse prices from the perspective of economics.
Big gap between selling prices and rent prices
Newspapers call the recent hikes in rent prices as "Jonse Crisis." But whether the term is appropriate is a question.
First, the current rent prices are so well below the selling prices that it is questionable whether we should call it a crisis from an economist`s point of view. Unless there is a deflation and home selling prices rise faster than those of other goods, there is no reason that home sale prices should come below rent prices. Those who live in their own houses pay opportunity costs. For example, a man decides to rent his own house worth 300 million won at 200 million won. He could have sold the house for 300 million won and rent it at 200 million won while investing the rest 100 million won in bonds or time deposit with some interest income. He does not sell the house because he believes the home selling price will increase at least by inflation rate and the value of 200 million won that he would be paid back after the contract period will decline.
Therefore, the term of the "Jonse crisis" can be misleading as inflation is general phenomenon in Korea and rent prices usually approach the selling prices. The phrase also makes a special government measure appear necessary.
In the Korean real estate market, Jonse prices tend to fluctuate far greater than home selling prices during a period of an economic boom and downturn. It is because many people betting on falling home prices (more specifically, expecting home prices to rise less than inflation rate) opt to rent a house. Under the circumstances, rent prices will continue to rise up to the level of selling prices. When rent prices hit or even surpass selling prices, then people will begin to consider buying a house more seriously. As such, a surge in Jonse prices can be one of natural aspects during a business cycle.
Boomerang effect of punishing the rich
One of the major considerations in purchasing a house is expectations of higher prices. The decision making can be also affected by various tax and policy measures. For example, a heavy tax on real estate or on those owning more than two houses will reduce the incentives to buy a house and instead encourage renting.
Tenants who cannot afford to buy a house may welcome the idea of heavy taxes on property or multi-home owners. But this can lead to a decline in supply of houses for rent and put an upward pressure on Jonse prices. Therefore, such a punitive policy may not be necessarily good news for all. When the government temporarily abolished transfer tax in the suburb areas surrounding Seoul to revive the property market, the demand for new homes have increased without creating the "Jonse crisis."
The recent surge in Jonse prices can be explained as a complicated consequence of business cycles and the prospect that home selling prices may not rise faster than inflation as no new taxation policy has been introduced. And it shows that the situation for tenants can be worse when leaseholders are in trouble.
Similar misunderstanding can be found over imposing tax. Levying heavy tax on the rich may appear to serve the interests of the poor but this is not necessarily true. Since stiff taxes prevent wealth accumulation, there will be little capital competing to hire the poor people, leaving fewer jobs or less chance for wage increase. When the poor support a policy aimed at depriving the rich of their wealth, it will only backfire and the poor will lose. Similar dynamism works in the real estate market. A policy that dampens the desire to buy a house will only lead to fewer homes for rents.
Case for more public homes for rents and more cheap cabbage supplies
It is a relief to see that the Jonse crisis has not prompted a call for price control. When cabbage prices surged due to bad weather, many people strongly blamed the government and called on it to supply "cheap" cabbages. Similar argument has emerged in the wake of the Jonse crisis. They now demand the government increase the supply of public homes for rents.
Market prices have powerful function well beyond our imagination. The fact becomes very clear when you look at the cabbage war ending up with a mere fuss. A surge in cabbage prices led to weaker demand for cabbage, more consumption of substitutes, and more supply. Some may think the prices have stabilized due to the government`s move to provide cabbage imported from China at prices below the market level. The government also had to buy cabbages at market prices but sell them at cheaper prices. The losses were covered with taxpayers` money. We have to remember that consumers have paid not only cabbage prices and taxes but also an opportunity cost for hours in queue to buy them at cheaper prices. This means the state-subsidized cabbage was more costly than in the market.
The case for more public rent homes is not different from the demand on the government to increase the supply of cheap cabbages. Public homes for rents will satisfy the tenants only the rent prices are below the market prices. If they are rent at cheaper fees, taxpayers should fill the gap, leaving no economic benefit and instead adding new costs for long queues. It is easy to predict that many people will want to cut in line by paying bribes if the costs of queuing or expected gains are too big.
The government or politicians may have to allay public complaints about soaring Jonse prices with some policy measures. This is not the area that economics can explain. (From an economist point of view, the best way is to persuade the people that a government intervention would only produce adverse effects). The government should not pretend that it can resolve many market failures. The government and politicians should avoid overreacting. It is just as well that the government has not taken extreme or unnecessary actions so far.
Bank`s increased lending for rents is also controversial. The issue is whether the "artificially low interest rates" may stir up lending that would not have been possible in a normal situation. If those who have heavily borrowed to rent a house cannot repay the debt once the interest rates rise, it can be a big trouble. But the government does not have to intervene as long as the banks want to lend more to tenants and they believe that all of the loans would not go sour simultaneously, with the Jonse prices still far below home sale prices. Bank loans can provide better economic opportunity for the tenants by allowing them to stay where they live even if Jonse prices rise.
State intervention distorts the market process
Home sale prices usually do not have big gap with the Jonse prices. A huge discrepancy reflects expectations for capital gains and property market boom due to persistent inflation or monetary easing. When it comes to a downturn period where the expectations can decline, the gap can be sharply reduced or even reversed as seen in the recent case of soaring Jonse prices. As such, we have to refrain from describing it as a crisis as it can easily justify state intervention that may distort the market process. As much as stiff taxes on the rich do not help improve the poor`s life, calling tenants a victim of the Jonse price hikes would not help the weaker. Fortunately, the government has not taken any hasty action to counter the problem such as policy measures to supply more public home for rents and left the market resolve the issue.
Kim Ie-seok, visiting scholar at Korea Economic Research Institute
