TCS Daily


A 'Winner's Curse'

By Christopher Lingle - December 7, 2004 12:00 AM

Bali, Indonesia -- Successful property speculators in Korea face a "winner's curse" by provoking contempt by an Administration guided by a populist ideology that feeds a penchant for class warfare. As it is, the attempt to incite jealousy over the material gains of others is an old trick for justifying poorly-conceived public policy. And so the Roh administration has announced plans to maintain tough anti-speculation real estate policies reflecting short-sighted thinking blinkered by ideology.

Unfortunately, President Roh's advisors are unaware or uncaring about the unintended consequences of their policies that reflect a confusion of symptoms with causes. For example, they seem willing to ignore the effects of their proposals on the struggling construction business.

There is no doubt that the prices of real estate properties are sky high. It is said that the total valuation for land in Korea is six times greater than all the land in Canada with the average land price being eight times more expensive than in France.

But a careful consideration of the causes behind this massive over-valuation of property reveals that policy decisions are to blame. As such, speculators are being made scapegoats to cover the tracks of politicians and bureaucrats that allowed the problems to occur.

In an effort to "normalize" the real estate market, the government proposed imposing a 60 percent capital gains tax on real estate transactions on households owning more than three homes from next year. On top of the levy of additional 20 percent for new comprehensive real estate taxes, wealthy real estate holders would pay an additional property holding tax next year.

One element of the reform to impose taxes on valuation is in order. With property taxes imposed on the space of houses instead of their prices, owners of cheap houses can pay higher taxes than the owners of expensive houses.

It may be the case that the South Korean real estate market is highly speculative with multi-home owners boosting their wealth by buying and selling. But contrary to the ill-informed projections of politicians, actions taken by speculators tend to stabilize prices over the long run. As such, they play a more useful role in the promoting the proper functioning of markets than do politicians or central bankers.

In their simplest form, the activities of speculation involve attempts to buy low and sell high just like the innocent act of any shopper. However, property and currency speculators are often improperly portrayed as evil manipulators that exploit other market participants.

Speculators are merely trying to anticipate price movements that they believe might take place and neither initiate nor cause these changes to occur. By anticipating what they think other people will do, they try to be first.

If they expect a buying spree, they will make quick purchases. And if a selling spree is expected, they will sell before others act. Then they sell what they bought before the end of the buying spree or buy back what was sold before the selling spree ends.

By making correct predictions and moving with accurate timing, speculators can make money. But they lose money by being wrong or moving too slowly.

Making wrong guesses or action can also exacerbate price swings and destabilize market conditions. But actors that lose often will exhaust their funds so they are no longer a factor.

As such, successful speculative actions have a smoothing effect on price swings that would have taken place even without their actions. Therefore, markets with active and successful speculators tend to be less volatile.

With historically-low interest rates, it is no surprise that a real estate bubble has emerged. Instead of demonizing speculators for increasing property prices, blame should be directed towards irresponsible central bankers that flooded the economy with cheap credit. Without the excessive liquidity and easy credit, rising prices in one sector of the economy would have to be offset by price declines in other sectors.

At the same time, politicians try to deflect blame from themselves for creating budget deficits that add fuel to a property bubble. Exploiting economic ignorance of the population and promoting an ideology of taking from the rich provides a political rationale for expropriating more income and wealth. As it is, politicians and bureaucrats like nothing better than being able to grab more tax revenues.

In sum, persistent problems in asset price speculation are the consequence of policy interventions of politicians seeking electoral support or irresponsible central bankers or both. Therefore, speculation in property markets can be traced to the fiscal profligacy of policy makers in Seoul and the credit promiscuity of the Bank of Korea.

Christopher Lingle is Global Strategist for eConoLytics.


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