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Source link: http://archive.mises.org/11115/is-housing-a-higher-order-good/

Is Housing a Higher-Order Good?

November 30, 2009 by

When the boom continued longer than many thought possible the question became, Why is there no bust? Maybe houses are the equivalent of big refrigerators. Maybe home prices can go up forever. FULL ARTICLE by Doug French

{ 20 comments }

Jonathan Finegold Catalán November 30, 2009 at 9:31 am

An excellent article, Mr. French! Has the Ludwig von Mises Institute ever thought of publishing all their daily articles relevant to the current financial crisis in a book? It would be similar to the other books sold on this website which are also collections of articles.

Lucas M. Engelhardt November 30, 2009 at 10:51 am

What’s not clear to me:

How a “durable consumer good” is different from a “higher-order good” in terms of Austrian business cycle theory. A durable consumer good gives “payoffs” (in the form of consumption services) in the far future. When interest rates fall, these payoffs aren’t discounted properly, so people become more willing to buy them – this increase in prices drives resources to be misallocated into durable consumer good industries (just like capital good industries), and so on.

So, even if we buy that housing is a durable consumer good, it seems that the ABCT still applies…

Todd November 30, 2009 at 12:18 pm

In reality there is no a clear distinction between capital and consumer goods. Every good is to some extent a capital good until the precise moment it is consumed. It simplifies the exposition of economic principles to refer to “capital” and “consumer” goods. But it would be more accurate to say higher- and lower-order goods.

As housing is “consumed” over a period of many years, it is clearly a relatively high-order good, and thus ABCT would apply.

There is another point made by Mr. French that he didn’t quite make explicit: The bubble was not just in house prices themselves, but in numerous related activities such as construction, financing, land development, production & sales of furnishings and appliances, etc. Even if someone wants to argue that housing itself is a consumer good, it’s pretty obvious that all these other activities represent investments in capital.

Jonathan Finegold Catalán November 30, 2009 at 12:32 pm

In any case, Jesús Huerta de Soto dispels the idea that if credit expansion is poured into lower-order goods (i.e. consumer credit) then the Austrian theory no longer applies. He does so in his book Money, Bank Credit and Economic Cycles: http://www.economicthought.net/2009/08/consumer-credit-and-the-theory-of-the-cycle/

neo_austrian November 30, 2009 at 12:42 pm

I just want to amplify Mr. Catalan’s comment regarding de Soto’s book. Better than anything I’ve ever read, de Soto shows how credit cycles begin, and what the effects are. Reading his book helps clarify many things about the current crisis.

Del Lindley November 30, 2009 at 2:47 pm

Lucas M. Engelhardt wrote:

“What’s not clear to me:
How a “durable consumer good” is different from a “higher-order good” in terms of Austrian business cycle theory?”

I believe that the distinction between a capital (high-order) good and a durable (low-order) consumer good with respect to ABCT is how each is converted into a serviceable unit of consumption. In the case of the durable consumer good its service is provided continuously through the mere passage of time. Similarly a capital good is converted into serviceable consumption units over time, but its metaphorical transformation also requires the input of scarce land and labor factors. It is the misapplication of these factors within longer term projects (caused by an underestimation of consumer time preferences) that forms the basis of ABCT.

One could argue, as you might, that artificially low interest rates would induce manufacturers to produce higher-quality (i.e. more durable) versions of current consumer goods to profit from a (perceived) higher discounted value. My guess would be that the diversion of resources caused by this effect is negligible compared to that caused by entirely new long term ventures, whether or not they ultimately lead to durable consumer goods.

Craig November 30, 2009 at 5:53 pm

Not an altogether convincing article. Housing is a consumer good. That it is produced by a roundabout production method dependent on the vagaries of the Federal Reserve doesn’t change that.

In that light, yes, it is still worth discussing in Austrian theory.

Duncan November 30, 2009 at 11:20 pm

I think Doug’s article is on the money. It has to be remembered that housing is an industry with its own structure of production – it’s not just an aggregate called “housing”. Look at Roger Garrison’s work to see how the boom-bust cycle works its way through production, from early stage to the final consumer, changing the capital structure as it goes. I have seen first-hand evidence of this living in New Zealand, where the property sector has undergone a significant retraction, taking with it many land developers at the speculative end and the property financiers with them. This is still being played out in our business media, where some companies are looking to require the distressed assets (loan books) of the (almost) failed financiers, many of whom have either moritoria or drip-feed repayment plans to their mum and dad debenture holders. This loss of savings (capital) is very significant in a small country not known for its high savings rates.

EE December 1, 2009 at 6:19 am

To me the distinction between capital and consumer goods is that capital goods are used to make money (produce other goods) whereas consumer goods are used for consumption (i.e. do not produce other goods). I think that this is George Reisman’s point in “Capitalism:…”.
In this sense French is wrong. Housing is a consumer good.
In my humble opinion however it is the Austrian standard theory that must be expanded. When written in the past the banks lent money only to businesses and it is no wonder that the bubbles were created in higher order goods. Nowadays banks lend money to business and consumers alike and bubbles can be formed everywhere. Anyway, it is worth thinking about this point. So basically, my claim is that bubbles are formed in the place where fiat money is injected.

EE December 1, 2009 at 6:23 am

To me the distinction between capital and consumer goods is that capital goods are used to make money (produce other goods) whereas consumer goods are used for consumption (i.e. do not produce other goods). I think that this is George Reisman’s point in “Capitalism:…”.
In this sense French is wrong. Housing is a consumer good.
In my humble opinion however it is the Austrian standard theory that must be expanded. When written in the past the banks lent money only to businesses and it is no wonder that the bubbles were created in higher order goods. Nowadays banks lend money to business and consumers alike and bubbles can be formed everywhere. Anyway, it is worth thinking about this point. So basically, my claim is that bubbles are formed in the place where fiat money is injected.

criolle johnny December 1, 2009 at 7:53 am

“clearing malinvestments and reallocating misdirected resources”
… could also be the reason that your book has been reduced in price from $14.00 to $12.00.

(8?» December 1, 2009 at 2:04 pm

While reviewing a book about the financial crisis, a policy analyst of the free-market persuasion pooh-poohed the notion that housing constitutes a long-term project or “higher-order good,” insisting that homes are instead a “durable consumer good,” and thus he believes that examining the housing meltdown through the lens of Austrian business-cycle theory is illegitimate.

Ok, I’m confused by this distinction, especially as it is logically posed as being mutually-exclusive.

I see no reason that a house cannot be both. A higher-order good refers to a good created though a longer, more complex structure of production than a lower-order good, while a durable consumer good is a reference of a good’s consumption over a long span of time as compared to non-durable goods. These two abstractions in no way have anything to do with each other. The former is a classification of production, while the latter is one of consumption.

In general, I can see nothing about a long period of production for a good having anything to with it’s length of consumption. While durability may increase value enough to promote investment in longer periods of production, it is by no means a requirement.

So, unless someone can enlighten me as to what this is all about, to me the debate appears to be absolutely moot, being a false dichotomy.

JL Bryan December 1, 2009 at 2:55 pm

My understanding of ABCT is that the bubbles will occur in any interest-rate-sensitive area of the economy. Once upon a time, this was mainly just capital goods. Now it includes consumer goods like houses and automobiles, or anything that is typically bought on credit. Easy credit will naturally cause bubbles in any area of the economy that depends heavily on credit.

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Nelson December 3, 2009 at 6:37 pm

The distinction between types of goods only confuses things as all goods are created to serve some purpose.

The housing crises was simply a bubble created by a feedback loop. Rising prices made them look like a good investment, so people bought them which made prices rise further. Whether houses are classified by experts as “consumable durable” or “higher order” is a tangential distraction.

RandomWalker December 5, 2009 at 9:49 pm

EE Wrote: “To me the distinction between capital and consumer goods is that capital goods are used to make money (produce other goods) whereas consumer goods are used for consumption (i.e. do not produce other goods). I think that this is George Reisman’s point in “Capitalism:…”. In this sense French is wrong. Housing is a consumer good.”

I, too, think Reisman has it right. But it is not accurate to say that “Housing is a consumer good.” It is not wrong, either. It all depends on the purpose of the owner of the house. If someone buys or builds a house to live in it, then it is a consumption good. If someone buys or builds a house only to sell at a hoped-for profit, then the house is a production good. When it is sold to a person who intends to live in it, it becomes a consumption good.

As the interest rates were lowered, it became profitable to buy and build houses to sell into an expected rising market. More and more people were led into speculating this way, buying multiple houses that they had no intention of living in. These were not, therefore, consumer goods, they were capital goods otherwise known as “business inventory”, until sold. The cycle eventually encouraged poor credit risk people to buy their first houses (consumer good) with no hope of paying it off after teaser rates expired. When rates increased, credit collapsed in both the business loan side (loans to builders, mortgages to speculators) and the consumer side (mortgages to poor credit risks).

nate-m August 3, 2011 at 8:01 pm

“Housing is a consumer good.”

All goods can be capital goods or consumer goods. It just depends on the context and perspective.

I make a sandwich to eat and I eat it… therefore a sandwich is a consumer good.

I made a sandwich to lure my dog back into the house because the stupid thing won’t come in unless I feed it. Therefore that sandwich is a capital good since I used it to turn a outside dog into a inside dog. Also by using the sandwich to produce a ‘inside dog’ I made myself wealthier because I value the dog being inside more then the sandwich and a outside dog.

:)

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