from Follow the Money

Is France the US of the Eurozone — at least when it comes to housing?

October 12, 2006

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I have --on occasion -- pushed against the standard economic narrative on the US and Europe, one that contrasts the "flexible" US with "rigid" Europe.   It has a grain of truth, but only a grain.  

The emphasis on US flexibility and European rigidity misses, for example, the fact that employment growth has been more impressive in Europe than the US over the past few years, something recently highlighted by Floyd Norris.

A narrative that emphasizes differences also misses at least two key similarities the US and Europe: Europe (at least the Eurozone) now runs a current account deficit financed by the emerging world and most of Europe is enjoying a housing boom.  While Europe’s current account deficit isn’t really comparable with the US deficit, its housing boom is.  See this paper by Gilles Moec of the Banque de France.

Germany and Netherlands don't fit the housing boom story.  But then again, neither does Detroit or Central Kansas.  Spain, by contrast, looks a bit like Nevada and Florida (before the housing slump).  And France looks a lot like the US.   

Charles Gottlieb of the Center for European Policy Studies -- who looked at the overall European housing data in his last guest post -- focuses on the French housing market this time around.   He highlights the similar evolution of US and French housing prices.   The tendency of the French market to follow the US market up (with a lag) -- and down (with a lag) -- seems ominous.  Maybe not for 2007.   But certainly for 2008 .

However, Gottlieb also notes the ways France does seem to differ from the US.   Residential investment hasn't been as strong in France as in the US (or Spain).   And  France hasn't been as efficient at converting rising home values into stronger domestic demand growth as the US.    Enjoy his guest post.

The French housing market: housing crisis or housing-based prosperity?

Of all the European markets experiencing strong home price appreciation, the French housing market seems the hardest to grasp. On one hand, the housing sector is booming, with vibrant construction, on the other politicians’ talk of a housing crisis, with a shortage of affordable housing. This emphasizes the current conundrum in the French housing market. 

In Spain and Ireland, strong economic growth, financial deepening and the fall in yields associated with joining the Eurozone suggest that the surge in housing stems from the dynamics of convergence. 

France hasn’t benefited in the same way from European integration.  The explanation for its surge in home prices must lie elsewhere.  Indeed, the OECD data (see Chart 1) shows a remarkable similarity between the recent surge in French and US housing prices, and even a similar cycle in housing prices.  

Chart 1: French and US housing price trends compared



French housing prices have actually increased more than US prices.  In France, though, this increase in housing prices has not prompted a surge in residential investment comparable to the surge in the US. This is well illustrated by the below Chart 2

Chart 2: Residential investment and house prices: the supply side

The strong supply response in the US suggests increased concern, given that an overhang of inventory potentially could trigger a bigger price correction in a downturn.  (The same could be said of Spain and Ireland, as securitisation data is on a steep slope in those countries).  Indeed, as Chart 2 of my first contribution showed, the increase in US domestic demand and residential investment associated with home price appreciation was far stronger than in other countries experiencing strong price pressures.  The obvious risk is that both may also respond strongly to a price downturn.

The relatively weak expansion of housing supply in France parallels the relatively weak expansion of supply in the UK.  The most credible explanation seems to be the restrictive zoning that limits new residential investment (supply adjustment) in those places with the most demand for housing. 

However, this may be changing.  In June, the INSEE (the French national statistics institute) published data on new home construction  that showed that 2005 was a vibrant year for French housing.  410.000 new dwellings mushroomed … a figure which was only topped back in 1980. In fact, the 13% increase in home construction puts France at the top of any Euro Area league table – at least in terms of housing growth.   With annual house price growth that still flirts with a 8-9% rise (YoY), new home construction is likely to remain robust in 2006 as well.

A recent announcement by the governor of the Banque de France mentioned signs of slowing house price growth on a monthly basis (-0,54 % for apartments and -0,73 % for houses - MoM). But such assertion seems a “langue de bois” – central banker talk – there is no observable evidence that suggests the durability of this trend, but more a governor willing to reassure investors and house-owners. 

A deeper look into the regulatory aspects of the French housing market seems to well explain the sluggishness of adjustment in supply to the surge in demand. The Robien-Borloo scheme has increased the incentives for house purchases (as it provides tax advantages for home buyers who rent). Moreover, the current tax structure for landowners does not penalize land retention. Both measures pushed prices upwards, and hindered supply side adjustments.

Stiff “urbanism” rules, strong environmental and agricultural protection have kept many areas off limits for housing development, and slowed issuance of construction permits. Moreover an academic paper emphasizes that the rent and construction subsidies offered by the French state during the 1990s fuelled housing price growth.  

One other factor may be important.  The above mentioned housing policies have mainly created incentives to address supply at the top end of the housing market. A more effective policy would have focused on removing potential bottlenecks to the supply of social housing.  60% of the French active population have annual incomes inferior to 18.000€, making about ¾ of French households eligible to social housing.

Politicians are currently addressing the home affordability issue by granting zero percent loans, by offering a standardized house for the price of 100.000€ (which turn out to cost 125.000€) and by setting out plans to build 500.000 social housing units by 2009. The issue should have been addressed the other way around - that more social housing should have been built earlier. In fact, already back in 1996, statistics highlighted the fact that the bottom decile of the population was already paying a higher square meter rents than the top decile.  

As is often the case, a key question is whether further regulation and state led intervention on this market will prove to be counterproductive… why not deregulate instead of regulating against previous regulations?

Consequently, despite similar price dynamics, the French housing market remains very different from the American housing market, particularly if we look on the finance and regulatory sides of the story.  

Nonetheless, Chart 1 shows that French housing prices tend to follow US housing prices with a time-lag of two years (Chart 1).   The past is not necessarily a good guide to the future, but if this pattern holds, the French housing market should begin to slow in 2007 or 2008.

Fortunately, as emphasized in my previous contribution, French domestic demand seems to be less sensitive to home price movements than US domestic demand (in part because French credit market as not as well developed). Thus French households are not as strongly exposed to potential drop in house prices as US households are, even if a mix of low interest rates, tight supply (at least in some areas) and speculation has propelled housing market in both countries to the sky.

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