Government’s influences on residential development

The changes, whether cyclic or not, in the general business economy are affected by the government’s attempt to control economic ups and downs (Kyle and Baird, 1995: 28). Generally, a stable, moderately increasing economy is considered healthier than a rapidly growing economy (and healthier, of course, than a rapidly shrinking economy). In its attempts to control major economic fluctuations, South African government has set up a number of programs and regulatory agencies (Kyle and Baird, 1995: 28).

Just by reading the newspapers and watching the television news, one should be aware that all economies suffer from periods of recession, when growth is low and unemployment is high. This is followed by periods of recovery and relative economic prosperity, which can lead to escalating inflation and rising imports if the economy begins to ‘overheat’ (Warren, 1993: 162). This process mentioned above was described and demonstrated in Figure 3.2. With further examination, Warren (1993:

49) explains that government policy is also an important variable to consider. For example, demand may be encouraged by general mortgage tax relief or even local

as direct, are general government fiscal policy and monetary policy (Warren, 1993:

49). Kopcke, Tootell and Triest (2006: 3) share the same opinion as Warren (1993:

49) and state that the effect of government expenditure, taxation and debt on the aggregate economy is of immense importance and therefore great controversy in economics.

Property development is carried out within a macro-economic framework and is thus affected by government fiscal and monetary policies (Zhu, 1999: 55). Fiscal policy is where governments attempt to manipulate the economy by changing the level of government expenditure and/or taxation. Monetary policy is where governments attempt to manipulate the economy by changing the cost and/or the availability of credit (Warren, 1993: 49). Thus, in order to attempt to achieve a stable and steady rate of growth, the government has a variety of economic management tools at its disposal in an attempt to reduce both the frequency and amplitude of such cycles.

By managing the economy, the government would hope to promote a strong, confident economic environment (Warren, 1993: 162). Such intervention in the macro economy by the government can be via the use of ‘demand management’

policies, and/or ‘supply side’ policies (Warren, 1993: 162).

A good point to note, mentioned by McKenzie et al. (2011: 60), while studying economic indicators for future trends in the residential property development sector, is the mere fact that it takes time to collect, analyse and publish economic indicators. For this reason McKenzie et al. (2011: 60) state that they always reflect change that has already happened and worse is that some economic indicators even tend to lag behind an economic change, such as business cycles discussed

earlier in this chapter. The delayed indicators are best known as lagging indicators. There are however other indicators that do not lag behind economic change, but rather tend to change earlier and these are known as leading indicators, and are closely watched for clues to future economic change (McKenzie et al., 2011: 61).

3.4.1.1. Fiscal policy

According to Gravelle and Hungerford (2013: 2) current fiscal policy theories began with a work published during the Great Depression by British economist John Maynard Keynes (McKenzie et al., 2011: 64). As a result, this type of policy is often referred to as Keynesian, although there have been numerous refinements and developments in the theory (Gravelle and Hungerford, 2013: 2). Kopcke (2006: 4), Keating (2011: 47) and Nyandat (2014) all share the same opinion as that of McKenzie et al. (2011: 62) who mention that the fiscal policy is a process used by the government through its taxing and spending to minimize the effects of recession, unemployment, inflation and to influence the level of aggregate demand, thus achieving price stability. In other words, government spending policies influence macro-economic conditions within the economy (Nyandat, 2014). When the economy is in a recession, an increase in government spending for goods and services increases the demand for land, labour, capital and business skills (McKenzie et al., 2011: 62). This generates more income for individuals in the form of rents, wages, interest and business profits. Some of this added personal income will be saved, but much will be spent in the marketplace. This increase in individual spending should stimulate economic activity (McKenzie et al., 2011: 62). Zhu (1999:

the national income, it plays an important role in harnessing the national economy and influencing urban development. An increase in government spending is expected to generate multiplier effects to urban construction (Zhu, 1999: 55).

Warren (1993: 163) shares the same opinion as McKenzie et al. (2011) and explains that fiscal policy is a demand management technique whereby governments directly intervene in the running of the economy by using instruments of changing government expenditure and/or levels of taxation. Because of this direct approach, fiscal policy is seen as being a more interventionist policy than a monetary policy (Warren, 1993: 163). McKenzie et al. (2011: 62) add to the above statement and explain that the economy can be stimulated if the government cuts taxes. A general tax cut will give consumers more disposable income and provide businesses with more after tax profits (Keating, 2011: 47; McKenzie et al., 2011:

62). Some of this additional income and profit will be spent, thereby stimulating economy activity. Increased government spending to fight recession should not be financed by in an increase in taxes, because a tax increase would reduce private income at the very time an increase in spending is needed (McKenzie et al., 2011:

62). Instead, the government frequently finances additional spending by going into debt. When government spending exceeds government income, it is called deficit spending. This tends to stimulate the economy (McKenzie et al., 2011: 62).

However, if governments, businesses and consumers spend too much, it will drive up demand and cause inflation. One could possibly say that inflation, which is part of the fiscal policy, can harm the economy’s aggregate demand and have an impact on the residential development sector. McKenzie et al. (2011: 62) explain that

inflation drives up prices without increasing output. The uncertainty about prices causes businesses and consumers to act hastily and to become dismayed, discouraged and confused (McKenzie et al., 2011: 62).

3.4.1.1.1. Recession

Warren (1993: 164) explains that should the economy experience a recession, or worse a depression, aggregate demand will be low. This situation of low aggregate demand is usually referred to as a deflationary gap. That is, there is a gap between where aggregate demand should be for a healthy economy and where it actually is.

Therefore, in terms of the built environment and most likely the residential property development sector, it is unlikely to see many new buildings under construction.

Further to what Warren (1993: 164) explained above, is that governments could attempt to improve the situation by initiating an expansionary fiscal policy aimed at increasing the level of economic activity and overall prosperity. These polices are hoped to have an inflationary effect on the level of aggregate demand. Such an expansionary demand management policy could be achieved by increasing government expenditure and/or decreasing taxation (Warren, 1993: 164).

Investopedia (2015c) elucidates that expansionary policy is a useful tool for managing low-growth periods in the business cycle, but it also comes with risks.

First and foremost, economists must know when to expand the money supply to avoid causing side effects like high inflation.

There is also a time lag between when a policy move is made (whether expansionary or contractionary) and when it works its way through the economy

impact of a policy may occur sometime after the policy and its associated measures have been introduced. Such time lags can be divided into two categories, namely decision lags and execution lags (Warren, 1993: 168). With respect to decision lags, policy may be delayed simply because it takes time to recognize that the economy is in an undesirable situation. Execution lags, on the other hand, occur because it can take some time for the full effects of fiscal policy, once initiated, to be worked through (Warren, 1993). This makes up-to-the-minute analysis nearly impossible, even for the most seasoned economists. Finally, prudent central bankers and legislators must know when to halt money supply growth or even reverse course and switch to a contractionary policy (Investopedia, 2015c).

3.4.1.1.1.1. Increasing government expenditure

According to Warren (1993: 165), if a government increases its expenditure this will usually lead to more public sector projects being undertaken. If the public sector has to employ more people or contract the work out to private businesses in order to achieve such projects, both people and businesses will experience rising income and profits. Therefore, one would expect the positive multiplier process to be initiated. To analyse the implications of increased government expenditure in more depth, it is important to distinguish between two categories of public sector spending. Firstly, there is capital expenditure (Warren, 1993: 165). Capital expenditure is money spent on new construction work such as road, schools and hospitals. Moreover, one also finds under this classification capital grants for buildings in the private sector (residential development sector possibly included).

Warren (1993: 165) says that it should be noted that not all capital expenditure is money spent on the built environment. The second type of government expenditure

is money spent on the running of government, the civil service and any nationalized industries (Warren, 1993: 165). The purpose of this study was to investigate capital expenditure and the influence it has on development in the private and residential sector.

3.4.1.1.1.2. Decreasing taxation

As with increasing government expenditure, the lowering of taxation is an attempt to stimulate higher levels of aggregate demand. Taxation is levied upon both consumers and firms. With respect to consumers, if taxes are reduced people will have more money (disposable income) left over to spend on goods and services (Warren, 1993: 166; Kopcke et al., 2006: 5). Thus, depending upon their marginal propensity to consume, a proportion of this additional disposable income will be spent on additional consumption again giving rise to the positive multiplier effect (Warren, 1993: 166; Kopcke et al., 2006: 6).

One could argue that if taxes are lowered, it would have a positive effect on the residential development sector because buyers would be more willing to take a risk and use the increased disposable income to invest in a new residential development project for own occupation. The other effect of lower taxes would be that developer’s profits would rise and this would reassure them to undertake new residential projects that were previously deemed marginal (Warren, 1993: 166). As mentioned by Warren (1993: 166) the high costs of developing a particular site may have prevented a company wanting to build on it, however lower taxes could partially offset such high costs, enabling an acceptable profit to be made by going ahead

achieved by increased government spending or decreasing taxes, should enable the government to stimulate the economy out of recession and lead to a shift in higher aggregate demand (Warren, 1993: 166).

3.4.1.1.2. Overheating

If the economy begins to overheat it is usually due to growth in aggregate demand outstripping the economy’s ability to supply the increase in the level of economic activity (Warren, 1993: 167). The economy is liable to overheat when it reaches the peak of a cycle, where aggregate demand has reached very high levels. Any more increases in demand are likely to lead to inflation (Warren, 1993: 167). As mentioned by McKenzie et al. (2011: 62) inflation is harmful, because it drives up prices without increasing output. The situation of excess demand is often referred to as an inflationary gap. Government could attempt to decrease high levels of demand by introducing a contractionary fiscal policy. The same instruments of fiscal policy would be used, but in reverse (Warren, 1993: 167). The instruments used in reverse would decrease government expenditure and increase tax.

3.4.1.1.2.1. Decreasing government expenditure

Decreasing government expenditure is obviously the reverse of an increase in government expenditure. However, one must note that by decreasing government expenditure there is usually a decline in government capital expenditure rather than a reduction in current expenditure. The reason for this preference of cutting capital expenditure rather than current expenditure is that the latter will tend to lead to more job losses than the former and is therefore more politically sensitive (Warren, 1993:

167). Moreover, many may be unaware of future government spending plans and are therefore oblivious to the fact that they have been shelved or scaled down (Warren, 1993: 167).

3.4.1.1.2.2. Increasing tax

In order to promote a similar deflationary effect to that of decreasing government expenditure, the government could attempt to reduce aggregate demand by increasing tax levels (Warren, 1993: 167). This policy of raising taxes would leave consumers and firms with lower disposable incomes, and as such they would demand less. Thus, a downward multiplier would again be initiated, as well as a contraction in the magnitude if any positive multiplier effects the economy (Warren, 1993: 168).

Warren (1993: 168) introduces a noteworthy statement and states that effective contractionary policy, whether achieved by lowering government expenditure or raising taxation, should be able to pull the economy down from inflationary peaks, back to a more steady level of growth. Warren (1993: 168) raises a further important point and mentions that it must be appreciated that both contractionary and expansionary fiscal policy can fail, producing other problems.

3.4.1.2. Monetary policy

Either in addition to or instead of using fiscal policy, the government can use monetary policy to counteract recession, unemployment or inflation. The

money in an effort to stabilize the economy (McKenzie et al., 2011: 63). Just as fiscal policy, monetary policy is part of demand management. However, monetary policy is perceived as being less interventionist than fiscal policy as it is conducted through the intermediary of the financial institutions (Warren, 1993: 173). Monetary policy, as a control of a nation’s money supply directly by manipulating its provision or indirectly by measures affecting cost and availability of credit, will raise the level of aggregate demand through increasing money supply and lowering interest rates, thus inducing investment and spending in the short run (Zhu, 1999: 56; McKenzie et al., 2011). However, in the long term continued expansion of money supply will eventually cause inflation. Remember that expansion of the money supply acts to increase demand. As demand continues to increase, it runs into limits on supply, causing prices to increase (McKenzie et al., 2011: 63). The same principle applies to real estate and property development, where demand is high so prices for properties are high, as demand declines so do property prices. This price inflation, or fear of it, also cause lenders to increase interest rates to offset the loss in value of their capital due to inflation (McKenzie et al., 2011: 63).

Monetary policy is a technique that enables government attempt to manage the level of aggregate demand by using the instruments of changing the rate of interest and/or changing the availability of credit (Warren, 1993: 173). However, it must be noted that monetary policy need not be used in complete isolation to fiscal policy as they can be used in conjunction with one another in order to achieve desired policy goals (Warren, 1993: 173). In terms of the interest rate, it must be understood that this term either refers to the official government guide rate or is an average of interest rates in the economy. This point must be clear, as there can be a very wide

range of interest rates at any one time for both borrowers and depositors (Warren, 1993: 173).

According to Prinsloo and Prinsloo (2004: 54), property development is extremely sensitive to increases in interest rates. The entire property market is driven mainly by interest rates (Prinsloo and Prinsloo, 2004: 145). The main monetary policy objective of the South African Reserve Bank, like the Federal Reserve Bank of USA is price stability (Prinsloo and Prinsloo, 2004: 146; McKenzie et al., 2011: 88). To this effect interest rates are one of the main instruments by which inflation can be managed (Prinsloo and Prinsloo, 2004; McKenzie et al., 2011). Interest rates determine the amount that people can finance/borrow to buy a house or in terms of property development invest for the construction of a new house. A reduction in interest rates will automatically lead to lower monthly re-payments of a mortgage loan (Prinsloo and Prinsloo, 2004: 146). However to the contrary, as is seen during periods of inflation, real estate mortgage lenders are hurt. The reason for this is that the money they receive from loan repayments is worth less than the money they originally loan (McKenzie et al., 2011: 85). Thus, to protect themselves during periods of rapid inflation, mortgage lenders increase interest rates. However, an increase in interest rates causes monthly payments to increase, thereby preventing some potential buyers from qualifying for loans (McKenzie et al., 2011: 86). This reduces the demand for real estate and possibly causes a slowdown in residential development projects (McKenzie et al., 2011: 86). Mortgage loans are discussed in further detail later in this chapter as a legislation matter, which forms part of the PESTEL Analysis. Prinsloo and Prinsloo (2004) further state that in effect, the lower the interest rates, the lower the monthly instalments on the same amount borrowed

before the reduction in interest rates. Below in Figure 3.4 is an example explaining how inflation affects the economy.

Figure 3.4: Demand-pull and cost-push inflation

Source: (McKenzie et al., 2011: 85)

3.4.1.2.1. Recession

If the economy should experience a recession, expansionary monetary policy could be introduced as an attempt to increase the level of aggregate demand and thus the level of income and output (Warren, 1993: 174). Such a policy would aim to achieve this via a rise in borrowing and spending by both consumers and firms. This could be tried by lowering the interest rate and/or increasing the availability of credit (Warren, 1993: 174). For a more in-depth explanatory discussion about recession and the conditions created, please refer to the fiscal policy above (Warren, 1993:

174).

3.4.1.2.1.1. Reducing interest rates

As many consumers obtain credit in order to finance a portion of their expenditure, it is likely that a decrease in the cost of such a loan would encourage more people to apply for them (Warren, 1993: 174). As more people obtain loan finance, their spending power is increased and via the multiplier process, this is likely to have a positive impact on the construction industry. That is, more consumption expenditure could lead to a retail boom whereby new retail outlets and shopping areas are required (Warren, 1993: 174). Such consumer booms could lead to the re-development of inner city retail areas and/or the setting up of new retail parks on the periphery of urban areas. In this process, once again the derived nature of construction is evident. There is also likely to be a direct demand for construction in the residential sector, as the majority of people seek finance to purchase housing through borrowing funds in the form of mortgages (Warren, 1993: 174). Thus, if

could afford to buy their own homes. This would have the effect of pushing up the demand for housing and encourage further developments (Warren, 1993: 174).

Lower interest rates should also encourage businesses to carry out more work and investment. The reason behind this statement is that many projects that were previously unprofitable, or too marginal to risk, could now be worthwhile due to the availability of cheaper project finance (Warren, 1993: 174).

3.4.1.2.1.2. Increasing the availability of credit

McKeznie et al. (2011: 63) agree with Warren’s (1993: 175) statement above and explain that during periods of recession, the government may increase the supply of money, which in the short term should lower interest rates and increase availability of credit which in return should stimulate aggregate demand (Zhu, 1999: 56).

However, the continued expansion of money, mentioned by McKenzie et al. (2011:

63), will eventually cause inflation. It is important to note that expansion of the money supply eventually acts to increase demand and the economy could emerge from the recession and experience the benefits as described earlier on regarding

63), will eventually cause inflation. It is important to note that expansion of the money supply eventually acts to increase demand and the economy could emerge from the recession and experience the benefits as described earlier on regarding