Housing and productivity: how rising property prices impoverish the economy

BarcelonaThe housing crisis not only impacts individuals struggling to find a place to live, but can also impact businesses and the economy as a whole. The creation of price bubbles and rising property prices in stressed areas distort businesses' access to credit, which affects their investment capacity and, therefore, future productivity and development.

This has direct effects on everyone. In other words, rising housing prices not only make citizens poorer because they have to spend more money on rent or a mortgage, but in the long run, they are condemned to live in an economy with less productive businesses than they could be.

This is the conclusion of the study. House prices and misallocation: the impact of the collateral channel on productivity [Housing Prices and Misallocation: The Impact of the Guarantee Channel on Productivity], published in 2024 in the academic journal Economic Journal and written by Sergi Basco, professor of economics at the University of Barcelona, ​​​​and David López-Rodríguez and Enrique Moral-Benito, economists at the Bank of Spain. The article compares the evolution of credit and productivity in Spain with the housing market between 2003 and 2007, the period of maximum growth of the last real estate bubble.

Productivity is the efficiency of production. That is, a company (or also a worker or machine) is more productive if it can produce more with less. Despite being a rather ethereal concept, it is essential to understanding the economic development of countries, since the most productive economies are also the most advanced, those with industries that make more expensive and innovative products and where workers are better trained and better paid.

Distortion of loans

But what economic mechanism causes this distortion in productivity due to rising real estate prices? Banks. And, more specifically, the collateral they use to lend money to companies.

The situation works like this: two exactly identical companies in the same sector that want to make the same productive investment (new machinery, a research project, new vehicles, a new software program, etc.) should have the same access to credit. That is, if both went to the bank to ask for money to invest, they should receive a loan with the same conditions. "In an ideal world, financing decisions don't depend on their assets, and both companies should have their investment, but that's not the case," explains Sergi Basco, co-author of the article, in a conversation with ARA. In reality, the bank will look at what assets each of the two companies has that could serve as collateral (in financial jargon, collateral) in case of loan default.

"The bank asks for the collateral," says Basco. If it were renting, the first company could access the credit and move forward with the investment, while "the bank would tell the other company it wouldn't lend them that money," the economist indicates. Credit would involve dividing the money equally between the two companies, because operationally there are no differences. Efficient distribution of money and efficiency in the distribution of credit," says Basco, since "the asset determines access to credit, and access to credit determines the investment" that a company can make.

Location also matters

But that effect isn't the whole story. This article analyzes data by municipality across Spain, and even by district in the case of large cities such as Barcelona and Madrid. The analysis shows that, when real estate prices escalate rapidly, as occurred during much of the 2000s, the distortion in access to credit suffered by companies without real estate is exacerbated by geographic location. Thus, in regions, towns, or even neighborhoods where land prices rise the most, companies receive more credit than in areas less affected by the ups and downs of the real estate sector. Simply put: a company with offices in Barcelona—where real estate prices rose significantly—was much more likely to access good credit than one in a small town in the Pyrenees, even if the latter was better managed.

The explanation is simple: the bubble "distorts the value of houses and housing." Thus, a company that owns buildings or plots of land in a stressed area with high demand will have greater access to credit, because the value per square meter will rise. In areas where there is less demand, prices grow less (or remain flat), and therefore, its collateral when it needs to apply for a loan will be lower, as will the amount the bank will lend it.

Therefore, the inefficiency in credit distribution caused by rising real estate prices is not only between companies due to the simple fact of whether or not they own buildings as collateral, but is also geographical, as more credit is rewarded to companies located in parts of the country where the bubble is immobile. "An increase in the dispersion of investment between companies within the same industry is a sign that the economy is worsening," adds Basco.

The article, despite working with data from two decades ago, remains relevant, as the Spanish real estate market is once again entering a speculative bubble. In fact, several studies suggest that in recent years, Barcelona and Madrid have been experiencing a bubble for over a year. Despite being caused by different factors, the behavior of financial institutions regarding business credit remains similar to that of twenty years ago.

More financing outside the banks

Access to credit is vital to improving the productivity of companies and, by extension, of the entire economy, particularly in Europe. While in the United States (and to a lesser extent in the United Kingdom) many companies finance their growth by issuing bonds on the debt markets, in Europe this practice is reserved solely for large multinationals, and even these use it less than companies on the other side of the Atlantic. Therefore, access to bank credit is essential for most companies if they want to obtain money to finance their growth or productivity-improving projects. Furthermore, to prevent banks from granting loans that are too risky (i.e., to clients who cannot pay them back), regulations require that loans be backed by collateral, which is usually real estate.

This distortion of bank credit to companies results in arbitrary distribution of money, leaving companies that could make successful investments that would bring wealth to the country on the sidelines. The end result is that periods of sharply rising housing prices ultimately lead to a decline in productivity: "In Spain, it fell at an annual rate of 0.4% from 2003 to 2007," says Basco. And the real estate bubble was largely to blame: "The additional increase in [housing] prices from 2003 to 2007 explains 40% of this 0.4% annual drop that occurred during this period," the economist notes, citing the results of the study. "That happened because of the real estate bubble, because it distorts the efficient allocation of resources, both capital and investment," he insists.

"We should try to make it possible for companies to obtain financing beyond banks," says Basco, as a possible solution to the problem. But he goes further when it comes to finding remedies to prevent real estate bubbles from forming.

The authors differentiate between two distinct areas of the state, or, as Basco says, "two Spains": one that didn't suffer from the real estate bubble, where building was easy, and the other that did and had limitations on potentially buildable land. "In the Spain where it's very difficult to build, any increase in housing demand translates into higher prices," while in regions with more space, an increase in housing demand usually translates into more construction (an increase in supply), which keeps housing prices more stable.

"What we can recommend is increasing the housing supply. Everything we're saying wouldn't happen if there were more supply," says Basco. This involves incentivizing private companies to build more and increasing investment by public administrations to create publicly owned social housing. "What the research indicates is that governments should implement policies that increase supply, not policies that incentivize demand," such as checks. public loans and guarantees or tax reductions for the purchase of apartments, as this only further increases demand when the root of the problem is often a lack of supply.