For Victoria, it's a case of life in the slow lane

THE problem with the Australian economy is that there isn't one. Rather, there are two of them, or arguably several. The data groups them as one, which makes it a misleading guide.

You know the story, but even so, the data is astonishing. Half of Australia's growth is coming from investment in one sector, mining, which generates just 7.5 per cent of our output. In the past year, on the latest figures, mining investment grew by 80 per cent. This is the biggest mining boom we've seen.

The other half of Australia's growth comes from the rest of the economy. Growth in the mainstream of our economy is just 1 to 2 per cent, in line with population growth. To put it another way: take out mining and its offshoots and growth per head in the rest of the economy is about zero.

Take out mining from the capital expenditure figures, and they show business investment in the rest of the economy has slumped to its lowest level in almost 40 years: less than 5 per cent of GDP. At last report, non-mining business was forecasting a further fall in 2012-13.

If they were some minor part of the economy, you might say, so what? But this is not minor: it's the mainstream of the economy, it's High Street, it's Victoria, New South Wales, south-eastern Australia, south-eastern Queensland. It's us.

Victoria is at the centre of it. After 20 years of surprisingly solid, even enviable, growth, this state is now at the crossroads. The forces that drove its growth in recent years have gone into reverse. The headwinds it has struggled against have grown stronger and more dominant. It is not clear where the state's next drivers of growth will come from.

The story is certainly not all bleak. Victoria's housing industry is no longer running at record levels, but it's still the shining light in a weak national outlook. A couple of big hospital projects saw the state also lead Australia in 2011-12 in new non-residential building approvals. The Baillieu government has budgeted for record infrastructure spending in 2012-13 and is looking for ways to accelerate that in future. And the state continues to outperform the rest in attracting new visitors.

All through Victoria, creative minds are finding ways to overcome the problems heaping up on them: the overvalued dollar, the new wave of consumer restraint and cost-cutting by other businesses and governments. Despite the dollar, many are building or maintaining export-oriented firms. Victoria's exports of goods in 2011-12 grew 10 per cent, faster than Western Australia or the nation.

To explore the options for Victoria's enterprises, The Age has joined with Victoria University and the Committee for Melbourne to present a conference later this week, Victoria at the Crossroads, with speakers including Prime Minister Julia Gillard and Victorian Treasurer Kim Wells, and experts from a wide range of areas.

The springboard was concern that global and Australian economic conditions are now working against Victoria. The state will have to find new sources of growth or remain stuck in the slow lane of a two-speed economy.

For example:

. In the year to March, demand (total spending) grew 10 per cent in the mining states (WA, Queensland and the Northern Territory) but just 2 per cent in the rest of Australia, including Victoria.

. The state's unemployment rate has risen in a year from 4.9 per cent to 5.5 per cent, with the official figures showing 27,000 full-time jobs lost and 41,000 part-time ones added.

Ominously, the June survey of the Victorian Employers' Chamber of Commerce and Industry found only 9 per cent of its member companies surveyed expect the Victorian economy to strengthen over the year ahead, while 61 per cent expect it to weaken.

The problem is that Victoria has lost its main drivers of growth. Spending by foreign students in the state fell by $1 billion in 2010-11 as the high dollar, tougher migration policies and anti-Indian violence sent students elsewhere. The heavy debts we took on in giddier times now restrain consumer spending. In Spring Street and Canberra, expansionary budgets have given way to contractionary ones.

Housing starts in the six months to March were down 16 per cent from their record high a year earlier, and housing is a big buyer of goods and services. House prices have fallen for a year and a half, provoking caution.

Manufacturers from Ford to the backyard sheds are doing it tough and shedding jobs under the crushing weight of the high dollar. And investment surveys suggest there is worse to come.

This is not just Victoria's story; it's the story of south-eastern Australia. The Reserve Bank's recent interest rate cuts will help at the margin, but the core message from policymakers is: it's your problem.

That means it's got to be our solution. We must be tough, resourceful, patient and creative: to find better ways to work, make new products and find new customers. Good luck.

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Opening night at the economic forum

JULIA Gillard has renewed her push to cut company tax rates and taken aim at the states' stamp duties on home purchases, at the launch of the government's economic forum in Brisbane last night.

Opening the forum, the Prime Minister asked delegates to focus on how the nation could improve its competitiveness and increase labour mobility to ensure that Australian workers filled more of the jobs created by the resources boom.

She made it clear that despite scrapping her promise to lower company taxes, Labor would revive it if it had support from other parties. The tax cut was abandoned after the Liberals refused to support it and the Greens insisted it be restricted to small business.

"I've got no doubt the company tax rate should be lower and no doubt the revenue base has to be maintained as well," Ms Gillard said.

She linked the issue of labour shortages in the mining sector to stamp duties on real estate transactions, saying: "We've got to talk about labour mobility . . . We've got to crack this nut.

"We've worked on national licensing of professions and trades and on incentives for welfare to work, and now we're turning attention to more improvements to jobs services, and to issues like state transaction taxes on property as well."

Abolishing stamp duties on conveyancing would be popular with home buyers, who fork out $23,500 in tax to buy an average $500,000 Melbourne home. But in most of Australia, it is the third biggest source of state revenue. Victoria relies on it to fund $3.5 billion a year of spending.

The ACT government last week began a 20-year phasing out of stamp duties, which it will replace with higher property rates. The states' choices would be to increase the GST which the Gillard government has ruled out or raise land taxes, as the Henry tax review urged.

Critics point out, however, that the mining boom has had to be manned by fly-in, fly-out workers because Australians prefer to stay with their friends and families.

At the opening dinner, Treasurer Wayne Swan called on the 150 delegates from business, unions, governments and community groups to focus on improving productivity in service industries, so that they become the suppliers of choice for Asia's rapidly-growing middle class.

He urged Australians to put down partisan views and start "a mature debate about productivity" with the aim of lifting Australia into the world's top 10.

The opening session of the forum focused on the importance of Asia to Australia's economic future but also on the reforms needed if Australia is to maximise its gains from Asia's phenomenal growth.

Five sessions today, mostly behind closed doors, will debate the problems of the patchwork economy and the high dollar; innovation and collaboration in industry; investing in infrastructure; building skills and education; and deregulation and reform of competition policy.

Mr Swan announced that he would lead a business delegation to China and Hong Kong next month, to celebrate the 40th anniversary of diplomatic relations between China and Australia, and give Australia's business leaders "an opportunity to develop business links with major Chinese companies and authorities".

Mr Swan said he welcomed debate on productivity, but some claims being made "were not grounded in facts". He struck a John Howard stance, telling business leaders: "The challenges and opportunities of the Asian century are bigger than the day- to-day cut and thrust of our political debate. They're bigger than any partisan divide."

But his appeal for bipartisanship fell on deaf ears. Ted Baillieu is the only Liberal premier to attend the event, and Opposition Leader Tony Abbott dismissed it as "a carefully-scripted, choreographed event".

"She [Ms Gillard] is not interested in changing policies. She's just interested in stifling criticism," Mr Abbott said.

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Stevens: Why it doesn't feel as if we're doing okay

GLENN Stevens has three messages for us.

First, the economy is going better than we think: our glass is "at least half full".

Second, don't blame the mining boom for the rest of the economy growing slowly: rather, it's the hangover from our binge during the decade of debt.

And third, the days when "the effortless way to get rich was to gear into rising house prices" are gone for good. House prices and debt will not rise like that again. The Reserve Bank will not act "to pump up speculative demand for assets".

And we might draw a fourth message from the governor's speech in Adelaide: don't expect more interest rate cuts soon, unless things in Europe get really ugly.

The first message is hard to dispute after this week's bonanza of strong economic data even if Stevens hints gently that, like other economists, he takes the estimate of 4.3 per cent GDP growth with a grain of salt.

"The underlying pace of growth is probably not quite that fast, but it is quite respectable, something close to trend," he says. "If the recent data are taken at face value, the non-mining economy has grown at about 2 per cent over the past year."

Yes, but with the population growing at 1.5 per cent, economic growth of 2 per cent does not leave much new money to spread around.

And if the GDP number is revised down, as big growth numbers usually are, it leaves less again. Still, he's right: our glass is half-full.

The second message is his central one. Stevens is puzzled by why Australians don't see their economy as the island of growth it seems to outsiders.

He thinks much of our dissatisfaction really stems from the fact that household wealth is now going backwards, after a decade in which it averaged real growth of 6 per cent per head per year. But its growth was fuelled by sharply rising debt, and that had to end.

As we save more and spend less, Stevens says, real growth in consumer spending per head has roughly halved, but our financial position has strengthened: "A certain degree of thrift" is good for us.

His key point is that that thrift is a return to normal. It was the years from 1995 to 2007 that were unusual.

Retailing, banking, real estate and housing investors won't see those times again.

We need more confidence, he says, but "it has to be the right sort of confidence".

Our growth from here should be based on productivity, "doing things better, in 1000 different ways" not on speculation.

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Who says one state can't phase out stamp duty?

Stamp duty on conveyancing will be phased out, insurance taxes abolished and payroll tax cut, in pathbreaking tax reforms adopted yesterday in the Australian Capital Territory.

While the Federal government has shelved the Henry tax review’s reform plans, the ACT government has seized on them in a bold set of reforms that shifts its tax burden to property rates.

A minority Labor government supported by the Greens, the ACT government commissioned its own tax review, headed by former ACT Treasurer Ted Quinlan, which came out with proposals broadly similar to those of the Henry report.

Its tax reforms are the first of their kind in Australia, shifting the weight of taxes from transactions to land — in this case, using rates rather than land tax.

They also introduce new forms of Labor’s Robin Hood reforms — hiking taxes on the well-off and cutting them on the hard-up and middling.

Under the reforms set out yesterday by the territory’s Treasurer, Andrew Barr:

* Stamp duties on conveyancing (transfer of property) will be phased out over 20 years, starting today.

* All taxes on insurance will be phased out within five years, starting from July 1.

* The threshold for firms to pay payroll tax will be lifted to $1.75 million, almost three times Victoria’s level.

* Land tax on commercial properties will be abolished.

* Land tax rates will be lowered for 75 per cent of homes, but raised on properties in the top 10 to 15 per cent of the market.

* To pay for all this, rates will be hiked for households and businesses alike, and made more progressive, with rates rising steeply on properties with a high land value.

Mr Barr said the reforms are fairer, simpler and more efficient. ‘‘Tax bases around Australia – including in the ACT – are unsustainable’’, he said.

‘‘The cost of some essential services, notably health care, is rising faster than the rate of economic growth, and the GST base is eroding. Land sales are a finite resource. Further, our taxes are inequitable, volatile and inefficient.’’

The reforms will reduce stamp duty on the sale of a typical $500,000 home by $2450 overnight and by $7000 over the next four years. (Canberra’s median prices are similar to Melbourne’s, but you get more house for the same price).

The new rates system will combine a flat charge of $555 for all households with a new system of four tax brackets ranging from 0.22 per cent to .41 per cent. Rates on a property with a land value of $ 1 million will jump more than 50 per cent.

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Victoria. Great one day, on the slide the next

KEY economic indicators are showing an alarming slide in Victoria's economic activity and weakness throughout the nation's south-east, intensifying speculation of another interest rate cut next week.

Business investment in Victoria slumped 14 per cent in the March quarter from a year earlier, Bureau of Statistics figures reveal.

This wiped away more than 2 per cent of the state's output, as investment sank to 2008 levels.

The high dollar and high interest rates have flattened Victoria's economy, along with most of the south-east and even parts of Queensland and Western Australia remote from mining.

In the six months to March, investment boomed at an annualised rate of 40 per cent in mining, but slumped 10 per cent in service industries and 18 per cent in manufacturing.

A sense of crisis is growing in the global economy. China's index of manufacturing activity slumped 5.5 per cent in May. India reported that its gross domestic product grew by only 5.3 per cent in the year to March, its slowest growth for nine years.

China and India have generated most of the world's growth since 2008, including Australia's export boom. As their demand falls, Australia's trade has sunk into deficit. Commodity prices have slumped 10 per cent, falling 1.8 per cent in May alone.

Futures markets now see interest rates going into free-fall for the rest of the year. They have priced in the equivalent of six more interest rate cuts by December, the first coming when the Reserve Bank board meets on Tuesday.

Economists are divided. The ANZ Bank said the non-mining economy was underperforming and inflation presented no threat. But Merrill Lynch chief economist Saul Eslake said a rate cut now could be wasted, with the federal government handing out $2.4 billion to households through the Schoolkids Bonus and compensation for the carbon tax.

Europe, meanwhile, is sliding deeper into crisis, with no sign of agreement on how to reverse it. Spain's central bank revealed that nervous depositors took ?97 billion ($A124 billion) out of Spanish banks in the March quarter, even before the turbulence of May.

The bureau's figures show Victoria has been flattened by the high dollar and high interest rates.

This week's data shows that:

. Home building approvals slumped 23 per cent in the year to April. Housing, one of the state's great strengths during the global financial crisis, is now in reverse.

. Total construction activity slumped 5 per cent in the March quarter, with building activity shrinking faster than engineering work grew.

? Retail turnover is now flat as shops rely on discounts to attract sales. In the past year, retail sales have simply kept pace with inflation.

. Unemployment on the smoothed trend figures has risen from 4.8 per cent to 5.5 per cent of the workforce, the highest rate outside Tasmania.

Yesterday home prices were added to the list. The RPData-Rismark index reported that Melbourne prices tumbled 2.7 per cent in May alone, and by 8.4 per cent in the past year, to a median price of $490,000.

Westpac economists said the slide in prices was even steeper after seasonal adjustment. In the six months to May, they estimate, house prices fell at annualised rate of 16 per cent, and units and apartments at over 10 per cent.

Westpac senior economist Matthew Hassan said falling prices and rising auction clearance rates suggested part of the slide in May was due to sellers lowering their prices to ''meet the market''.

Manufacturing is also in trouble. The Australian Industry Group's manufacturing index slumped 1.5 points in May to 42.4, its second lowest since 2009. The only growth was in wages, input costs and unsold stockpiles.

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Irish nightmare: Prepare

MARIAN Wilkinson's absorbing Four Corners report this month on the collapse of the Irish economy was a powerful reminder of two fundamental truths. Booms tend to end in busts. And the busts do more harm than the boom does good.

It could be a valuable lesson for the Gillard government - which desperately needs to reconnect with the voters and economic reality - for its advisers, for the Reserve Bank, for the federal opposition, now in effect a government-in-waiting, and for all of us.

A day after Queensland's electoral massacre, Treasurer Wayne Swan began his weekly note with another enthused spiel on how good things are - ''an economy that is growing solidly, low unemployment, very low debt, sturdy public finances, and contained inflation'' - and above all, '' a resources sector that is going from strength to strength''.

''New (resources) investment has risen from $47 billion in 2010-11 to $95 billion this year, and will rise again to an expected $120 billion in 2012-13'', he said, momentarily confusing facts and forecasts. ''The boom in investment isn't surprising given the boom in exports ? (which) are likely to reach nearly $200 billion this financial year, and climb to around $258 billion in five years.''

And all this is good for us? Remember the property boom in Ireland, and how rich it made the Irish feel - until it bust?

Our boom, too, is likely to bust: most booms do. The bigger the boom, the bigger the bust.

Don't worry about it, officials say. This time is different. This boom will last for years, maybe decades. The growth of China and India will see to that.

Uh-huh. Take a look at the graph, produced by the Reserve Bank. The terms of trade is a measure of export prices, expressed as a ratio to import prices. As you see, this is not the first big boom in our export prices. There was one in the 1920s, which ended in the Great Depression. There was one in the Korean War, which ended with 20 per cent inflation and recession in 1952-53.

As the graph shows, those booms ended with a hard fall, and prices then resumed their long-term trend decline (the blue line slanting downwards). This is our third export price boom: how will it end?

Frank Gelber, director of Sydney economic consultants BIS Shrapnel, has been thinking about that. BIS Shrapnel has had an outstanding forecasting record, winning the Palme d'Or as the best tipster in The Age midyear survey seven times since 1993.

Gelber has looked on with alarm as mining investment has risen from 1 per cent of GDP to 4.4 per cent last year, and perhaps 7 per cent by 2012-13. He sees at least five years of strong mining investment ahead. He has seen the Reserve Bank jack up interest rates in response, to rein in the economy so that this boom doesn't lead to an inflationary breakout. And he's seen the dollar soar to its new peaks in response to the mining investment, the high interest rates and the uncertainty over the big Western economies.

But if mining investment is booming by 50 per cent a year, and the economy's growth is held to slightly above trend, that means other sectors of the economy have to shrink to make way for it. Long-established businesses are dying, factories closing, jobs going overseas - all to accommodate a boom that is only temporary and will give way to a bust.

''The boom will end when the supply of minerals catches up with the demand,'' Gelber says. ''I don't know when that is. We've now locked in projects that will underpin investment activity for the next five years, so the question is: what are the probabilities that it will proceed beyond that?

Gelber and BIS Shrapnel estimate a 25 per cent probability that the boom won't continue once these projects are built. They estimate an almost two-in-three probability that the boom will end within 10 years, and 90 per cent that it will be over within 15 years. Whenever it ends, he warns, Australia faces a major recession.

Why? Because the real boom is not in mining, a capital-intensive sector, but in mining investment, which reaches out far more into the economy. Treasury deputy secretary David Gruen estimates that while mining is only about 10 per cent of GDP, the ''mining-related'' economy is now about 20 per cent of GDP. That puts far more jobs at risk when the boom goes bust.

''Half of all the office space in Perth is now tied up with people servicing mining investment,'' Gelber says. ''The same is true for a quarter of the office space in Brisbane. Think of all the jobs in the construction sector, the back-line employment. The fall in investment will see a major decline in growth.''

But can't we then just bring back the industries now shrinking because of the high dollar? No, says Gelber. ''We're burning our bridges. We are losing the skills, the equipment and the markets. When the Australian dollar collapses, we won't have the industries any more. We will have to go through a total reversal of the process of structural change we are seeing now. We will see a big drop in our standard of living.''

What can we do to avert it? Gelber is pessimistic. The mining tax has been neutered. He sees value in governments investing in ''productivity-enhancing infrastructure'', such as the NBN, and in ''soft infrastructure'' such as research and development, and skills training.

But he warns: ''This is a long war of attrition.'' Firms in trade-exposed industries will be fighting for survival. Gelber wants policy makers to grasp that this boom, too, will end, and Australia will need a very different economy then. ''We've got to have an eye to what will happen after the mining boom. I'm aghast at how we are walking over the cliff, like lemmings.''

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High-rise growth hits new lows as approvals slump

MELBOURNE'S high-rise boom is off the boil.

Approvals for new high-rise units in the six months to December slumped to less than half the level of a year earlier, as building approvals continue their downward spiral.

But the Bureau of Statistics reports that in 2011 Victoria again dominated Australian home building. For the second year in a row, 35 per cent of all new homes approved in Australia were to be built in Victoria, which has just 25 per cent of the population.

In the rest of Australia, approvals for new homes are at their lowest level since the depths of the financial crisis. Bureau trend estimates show just 11,189 homes approved, down 19 per cent in a year.

The federal government's stimulus has ended with a thud. Just 139 public sector homes were approved in December, fewer than in any month since records began in 1983, and probably since World War II, when home building virtually halted.

The best news is that trend approvals for private sector houses are flattening, after a two-year fall since the Reserve Bank began raising interest rates. But at 7400 new homes a month, they are well below estimates of underlying demand.

Just 149,076 new homes were approved in 2011, down from 176,564 in 2010. Experts estimate Australia needs 220,000 new homes a year.

Victorian approvals fell from a record 62,198 to a still strong 52,056. But by the end of the year the brakes were on, especially in the most volatile sector, high-rise apartments.

Approvals for new high-rise apartments in Victoria (virtually all in Melbourne) jumped from 3766 in the second half of 2009 to a record 8623 a year later. By the second half of 2011 they were back to 4243, still a high level. Approvals for low-rise apartments and units remain close to the record highs recorded in 2010.

The industry seized on the weak national figures to call for another interest rate cut when the Reserve Bank board meets next Tuesday. Financial markets estimate an almost 80 per cent chance the board will cut rates.

The bank yesterday promoted senior insider Dr Christopher Kent to be assistant governor (economics), in effect the chief economic adviser to governor Glenn Stevens and the board.

Dr Kent, formerly the bank's research chief, will replace Dr Philip Lowe, who becomes deputy governor on Valentine's Day. Previous occupants of his job include Mr Stevens and his predecessor as governor, Ian Macfarlane.

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Property market levels out, but city still slipping

AUSTRALIA'S year-long decline in house prices may be levelling out. Capital city home values fell in every quarter last year but the rate of decline was slowing, the latest figures from property analysts RP Data-Rismark show.

In the last three months of 2011, prices fell by 0.5 per cent, a smaller decline than the previous June and September quarters when they dipped 0.8 per cent and substantially less than a 1.5 per cent decline in the March quarter.

Last week, data provider Australian Property Monitors released figures which showed national house prices stayed flat in the December quarter.

At a state level, the figures calculated by each provider using different methods were more contradictory.

According to RP Data, Melbourne's house prices fell 1.4 per cent in the December quarter. But figures from APM and the Real Estate Institute of Victoria show values rising by 1.1 and 1.9 per cent respectively in the same period.

New Reserve Bank figures showed debt-shy households are becoming even more wary of borrowing. Annual growth in housing credit in 2011 was just 5.4 per cent, the slowest yearly growth ever recorded since the data was first tracked in 1976. Year on year, the entire national growth in housing loans was accounted for by a surge in loans to first home buyers in New South Wales. The Australian Bureau of Statistics shows that in the last months of 2011, NSW first home buyers rushed in before the state government axed their $20,000 stamp duty exemptions from January 1.

In the three months from August to November 2011, loans to first home buyers in NSW jumped 77 per cent, while loans to Victorian first home buyers fell 2 per cent. That surge will recede in 2012, casting doubt on forecasts that a recovery is under way.

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Home prices segregate Melbourne

MELBOURNE is becoming increasingly segregated along class lines. Rises in house prices in the inner and middle suburbs have far outpaced those further out, leaving poorer families with fewer choices about where they live.

An analysis of shifts in house prices and households over the 20 years to 2006 has found that Melbourne's real housing shortage is a shortage of affordable housing in inner and middle suburbs.

The analysis, by Maryann Wulff and Margaret Reynolds for the Australian Housing and Urban Research Institute, finds that between 1986 and 2006, more poor households moved to the outer suburbs, while inner and middle suburbs became increasingly full of well-off people.

In 1986, housing prices were remarkably similar across most of Melbourne.

The Bureau of Statistics divides the city into 16 suburban regions, and in 1986, median house prices in 11 of them were clustered around or just below the city's median price, between $140,000 and $163,000, in 2006 prices.

The exceptions were at the top: in the arc of leafy middle suburbs from Balwyn to Beaumaris, in the inner suburbs, and in the Yarra Valley around Eltham.

But between 1986 and 2006, house prices in all these areas except the Yarra Valley outer fringe grew much faster than prices in the rest of Melbourne. And their social make-up changed.

The inner suburbs were traditionally the first home of migrants arriving in Melbourne. By 1986, gentrification had changed that, but the old and the new were evenly balanced: 38 per cent of residents were in the top two bands of household income, and 35 per cent in the bottom two.

But between 1986 and 2006, housing prices in the inner suburbs grew faster than anywhere else, the median price jumping 220 per cent even in real terms (after deducting inflation).

And by 2006, even with tens of thousands of students there, only 28 per cent of inner-suburban households were on low or lower-middle incomes, while 58 per cent were on upper or upper-middle incomes.

By contrast, in outer suburban Hume (Broadmeadows/Craigieburn/Sunbury), real house prices rose only 61 per cent between 1986 and 2006, so people on lower and lower-middle incomes flocked to suburbs where they could afford to buy or rent. Their share of Hume's households jumped from 17 to 29 per cent.

On the opposite side of town in Dandenong, suburbs that were middle-class in the '70s now have Melbourne's highest share of low-income residents, with 40 per cent of households on low or lower-middle incomes. The study notes that a third of the Somali refugees in Melbourne went to Dandenong.

Separate data issued by the Valuer-General shows that while 116 suburbs in September 2009 had median house prices under $400,000, 86 of them were 20, 30, 40 or more kilometres out of town. Most of those closer in were around Sunshine.

Professor Wulff and Ms Reynolds urge the federal and state governments to focus particularly on increasing the supply of affordable rental housing in inner and middle suburbs.

They suggest that more public housing be built there, and incentives offered for social housing in redevelopments by VicUrban and private developers.

The Age, July 12, 2011

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Mining boom failing to spark national economy

THE Australian economy has ended the financial year with the brakes biting hard. New data released yesterday reports lending and activity slowing, house prices falling, and job opportunities shrinking.

Separate snapshots released by the Australian Bureau of Statistics (ABS), the Reserve Bank and private research bodies throw doubt on official forecasts that the new financial year beginning today will see a boom in economic activity.

The Reserve has forecast growth of 4.5 per cent over the coming year, and recent speeches by governor Glenn Stevens and assistant governor Phillip Lowe flagged more interest rate rises ahead. Treasury is forecasting growth of 4 per cent, and more than 200,000 new jobs.

But yesterday's figures reported that:

. Net lending by the banks rose just 0.3 per cent in May, after recording no growth in April, as Reserve Bank figures show business and households remain averse to taking on new debt.

. Job vacancies in the private sector, as measured by the ABS, fell by 12,000 or 7 per cent in the six months to May, with Victoria and South Australia recording the biggest falls.

. House and unit prices nationally have fallen in every month this year, according to the RP Data-Rismark index, dropping by 0.3 per cent in May and by 2.7 per cent since December. In Melbourne, the median price fell by 1.8 per cent over the May quarter to $500,000.

. Hotels, motels and serviced apartments recorded a 0.8 per cent fall in takings in the March quarter, ABS figures show, as Australians profited from the strong dollar to holiday overseas while overseas tourist arrivals remained flat.

While the Reserve Bank would not be concerned to see little growth in debt, or house prices edging down, yesterday's figures come after broader-based measures show employment growth has slowed to a virtual standstill in recent months.

They come amid rising fears for the future of the global economy. The US government is now only a month away from running out of money, with Republicans and Democrats locked in a bitter stalemate on how to reduce the deficit.

Global ratings agency Standard & Poor's warned on Wednesday that US bonds would be downgraded to a D, or junk bond status, if it defaults on debt payments. US Treasury Secretary Timothy Geithner warns this is inevitable unless Congress raises the country's debt limit by August 2.

In Greece, Parliament on Wednesday approved an austerity package to cut its deficit but the fear is this will do little more than postpone an inevitable default, with the Greek government's debt now 150 per cent of GDP.

The domestic economy seems to have entered 2011-12 with mining construction booming but the rest of the economy sluggish. That might not stop the Reserve Bank raising interest rates again in coming months, since it believes the weakness is temporary, and next year it will need to rein in growth to stop the mining boom setting off inflation.

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Sky the limit for building

MORE than 20 per cent of all new homes approved in Victoria this financial year have been in high-rise apartments, as Melbourne's population boom is making it build up as well as out.

In a dramatic shift in favour of higher-density developments, almost 40 per cent of new homes approved in the state in the first two months of 2010-11 have been either high or medium-density.

This has climbed from just 15 per cent in the 1980s as little as 8 per cent in some years as developers and governments have responded to buyers' desire to live closer to the city.

In Melbourne alone, almost half of new dwellings approved this financial year have been apartments, units, terrace houses or other high or medium-density housing.

Councils in the greater metropolitan area have approved 4702 traditional detached houses, and 4026 apartments, units and terrace houses.

It's a dramatic shift from the 1980s and early '90s, when 85 per cent of homes built in Melbourne were detached houses on a block of their own. In the '90s recession, high-rise construction ground to a halt.

But in the past decade it has taken on a new life, especially in and around the CBD. Almost a third of new housing in the metropolitan area in the 2000s was on shared blocks. And in 2009-10, three in every eight homes were some form of medium or high density.

The Australian Bureau of Statistics does not publish figures for approvals for high-rise units defined as apartment blocks of four storeys or more in cities. But in the year to June, 7590 high-rise apartment units were approved in Victoria, almost the highest level on record. They made up 14 per cent of the state's new dwellings, compared with 5 per cent in the '90s. Yet in the first two months of 2010-11, this has risen to one in every five new dwellings in the state.

If you assume they're in Melbourne, then one in four new homes approved in the city so far this year is in a high-rise apartment block.

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Housing slump may help keep rates on hold

AUSTRALIA'S housing recovery has vanished. Dwelling approvals plunged again in August to their lowest level in a year, throwing serious doubt on the prospects of another rate rise soon.

With the federal government's stimulus programs coming to an end, the banks turning away builders, and six rate rises in the past year deterring buyers, seasonally adjusted housing approvals fell 4.7 per cent in August to 13,049.

In just five months, approvals have crashed by 24 per cent, after hitting a high of 16,835 in March. Half that crash is due to the Rudd government's social housing initiative winding down, and half to a slump in private sector activity.

The crash has come overwhelmingly in New South Wales, Queensland and Western Australia with Victoria, South Australia and Tasmania islands of strength in a drifting continent.

So far this financial year:

More than 40 per cent of Australia's private sector housing approvals have been in Victoria which has just 25 per cent of the population.

More homes were approved in Melbourne alone than in Sydney, Brisbane, Perth and Canberra combined.

The Bureau of Statistics reports that 8728 new homes were approved in Melbourne in July and August, but just 3420 in Sydney, 2652 in Perth, and 1863 in Brisbane.

Non-residential building also remains very weak. The federal government's school building program has wound down, while private sector activity is still bumping along the bottom.

The figures suggest that the Reserve Bank's six interest rate rises in a year have dampened the economy's prospects more than the Reserve has been willing to admit.

Financial markets, which had been pricing in a further rate rise when the Reserve board meets next week, yesterday slashed the odds of a hike to 50/50, amid mounting evidence of economic weakness.

The Reserve itself reported that business credit slumped by another 0.6 per cent in August, while credit to people buying their own homes in the past quarter grew at the lowest rate on record.

The HSBC bank's new chief economist Paul Bloxham until recently one of the Reserve's senior economic analysts predicted that the Reserve would hold off raising rates again until it had more data to justify a rise.

"One of the least good outcomes would be that the Reserve Bank is in a position where it has to reverse a decision quickly," Mr Bloxham said. "This would be disruptive for both the economy and the financial markets."

The IMF also sounded a warning note in a new report on Australia, released yesterday. It forecast only average growth in 2011, with a risk that a deteriorating world economy could slow the economy further.

The government had hoped rising housing activity could help reduce the shortfall of an estimated 200,000 homes.

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Home ownership out of reach

IN 1986, 68 per cent of middle-income Melbourne households headed by people aged 25 to 44 owned their own home. By 2006, only 57 per cent of the equivalent group were home owners. The slide was even sharper in Sydney: from 60 per cent to 45 per cent. The blame game over Sydney's problems have missed a basic point: young people have left Australia's biggest city to go somewhere they can afford to buy a home.

One day, they could have to leave Melbourne, too.

What is so remarkable about this slump in home ownership rates, say Flinders University housing experts Joe Flood and Emma Baker, is that it happened in an era of rising employment and prosperity. Gross household income rose 23 per cent in the decade to 2006. Workforce participation rates hit record highs. Normally, that creates more home ownership. This time we saw less.

"It appears that the benefit of higher household incomes in the benign decade 1998-2007 went into pushing up house prices and debt, rather than improving home ownership or increasing the stock of housing," they conclude in a new paper for the Australian Housing and Urban Research Institute.

"The country that promised limitless land, cheap housing and near-universal home ownership to all comers now has some of the most expensive housing in the world.

"High house prices act as a drag upon growth and competitiveness, have exaggerated inequities of wealth and intergenerational equity, and they will eventually increase the welfare burden on the community."

Anyone disagree with that? All of us who own a home feel good about seeing its value rise until we have to buy another home, when we find it's just inflation. The wealth it confers is illusory, unless you take your money out of housing, and invest it somewhere else.

And the cost of those prices is that a million or so young and lower-income Australians who want to buy a home of their own are now unable to afford a home that suits them. It has been a classic case of policy failure the more so, as the Reserve Bank has pointed out, because the tide of rental investment that has pushed up prices is essentially tax-driven.

It's one of the big problems that a bold, reformist government should take on. Yet the new Gillard government no longer has a minister for housing. Social housing has gone to Mark Arbib, and hopefully that means the senior portfolio minister, Jenny Macklin, amid all her other responsibilities, will now take charge of the issue herself to drive reform.

Housing prices are primarily an issue disadvantaging the young. But Flood and Baker highlight other lesser-known victims. In the 45-to-64 age group, between 1986 and 2006, the proportion of lower-middle income households in Melbourne without their own home rose from 19 per cent to 28 per cent, and in Sydney from 26 per cent to 40 per cent. And in the lowest income group of that age, 53 per cent are no longer home owners in Sydney and 40 per cent in Melbourne.

That implies, they warn, that in future many, many retirees will not own their homes, and will require costly rental assistance.

Flood and Baker see three ways to tackle the problem. As the libertarians argue, we could end zoning, and allow people to build anything, anywhere: but any government that did so would not be re-elected. And the huge price rises in Melbourne despite ample zoned land shows that's not the problem.

A second option is to limit finance, as China has. With reports that banks are now offering close to 100 per cent of loan valuations again, one serious option is to bring back the old 80/20 rule, requiring borrowers to put up 20 per cent of the property's value as a deposit. But, as Flood and Baker note, in the short term that would hurt the groups you want to help.

They argue instead for a range of targeted solutions. Some would require tax reform and a lot of political courage: taxing the capital gains on owner-occupied homes, and quarantining negative gearing by preventing owners using rental losses to reduce tax, except for new housing projects.

Other proposals include programs to build more affordable housing, and to tackle the rapid fall in home ownership among lower-income over-45s.

The weakness of their paper is that it looks for demographic reasons for the fall in home ownership, when it is clearly the result of competition from housing investors.

In the 1980s, 85 per cent of finance to buy existing homes went to owner-occupiers and 15 per cent to investors. In the '00s, investors' share averaged 41 per cent. In Victoria, in May and June 2010, investors buying existing homes got 51 per cent of bank finance, and owner-occupiers 49 per cent.

You cannot have investors increasing their share of the market without squeezing out the first home buyers. It's a zero-sum game, and politicians such as Wayne Swan who give $5 billion a year in tax breaks to investors are in effect blocking young and low-income buyers from owning a home.

Oh no, they say, you can't take away the negative gearing tax break without creating a shortage of rental housing. Yes, you can.

Aspiring first home buyers are mostly renters. When they buy a home, they cease to rent. There is one less home to rent, but one less household wanting rental housing. Supply falls by one, demand falls by one, and the net balance is unchanged. The market does not tighten. Rents do not rise. Families are not thrown out on the street.

This is an issue ripe for a reform government that is prepared to lose some skin to make Australia work better.

The paper is at www.ahuri.edu.au

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Rental houses pushing boom

INVESTORS are driving Victoria's real estate market, taking out almost half of new lending in May to buy existing homes.

The Bureau of Statistics reports that Victoria is the only state where bank lending for housing increased in the 12 months to May but the entire growth is in lending to investors buying rental properties.

In May, investors borrowed a record $2.2 billion from the banks and other lenders to buy existing real estate in Victoria almost matching the $2.4 billion lent to owner-occupiers.

The ABS keeps no statistics on how many properties investors are buying. But the figures imply that investors are buying almost every second house sold in Victoria.

In dollars, lending to owner-occupiers in Victoria was down 1 per cent from a year earlier, but lending to investors was up 47 per cent, from $1.4 billion in May 2009.

Melbourne has been the epicentre of the property boom, largely because it has become the hot city for rental investors.

The ABS figures show that lending to investors to buy in other states grew just 9 per cent year on year with more than half the national growth in investor activity in Victoria.

Total lending to people buying existing homes in Victoria jumped 17 per cent in May from a year earlier, setting a new record of $4.6 billion.

Real estate monitor Residex estimates that the median house price in Melbourne grew 20 per cent in the year to May to a new peak of $582,000, while the median price of units rose 18 per cent to $445,000.

There are signs that the market is cooling, with auction clearance rates last weekend just 68 per cent, down from 85 per cent a year ago. But the growth in prices is expected to slow or stabilise, rather than fall.

Financial markets still expect the Reserve Bank to leave interest rates on hold until 2012. But economists in the same financial houses are predicting another two rate rises this year.

Tax Office statistics show that two-thirds of rental investors claim to be losing money on their investments.

But this does not appear to be deterring more investors flocking in, to claim losses and reduce their taxable income.

The tax statistics show that one in 10 taxpayers is now a negatively geared investor.

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Could this be the end? Mood and data mixed, nellies nervous

JUST months after the world entered a recovery, some analysts are worrying that we might be about to exit it.

As we open a new financial year that we expected to bed down the recovery, nervous investors are now speculating that the world will sink back into a double-dip recession.

That's not unusual. Keep this firmly in mind: nervous investors tend to see a lot of recessions coming that never arrive. The consensus view, here and overseas, is that this is another of those times.

But the consensus too can be wrong. And if the mood and data grow darker, it will hurt the Gillard government in its bid for re-election as the government that kept Australia out of the global financial crisis.

In 2008, Kevin Rudd had the money to spend his way out of trouble. Julia Gillard doesn't have that option.

Yesterday the sharemarket sank for the seventh day in a row, in the wake of Wall Street falling to its lowest point for eight months. The benchmark S&P/ASX200 Index, which topped 5000 in mid-April, ended the financial year at 4301.5, falling almost 15 per cent in the past 11 weeks.

For those who prefer pessimism, there are clouds almost everywhere: some of Europe's governments have borrowed more than they can readily repay; the potential for China to be blown off course as its real estate bubble bursts; the data showing very weak growth in Europe and unsteady growth in the US.

In Australia, the data is mixed, with growing signs that the Reserve Bank might have moved too fast in raising interest rates.

Yesterday the Bureau of Statistics reported that job vacancies shrank 3 per cent in the past three months, even in seasonally adjusted terms. New home sales tumbled in May, while building approvals are doing zigzags rather than rising as predicted. Business and consumer confidence have plummeted since March. And the trend of retail sales has been virtually flat so far in 2010.

And yet there has been no letup in the pace of jobs growth, which is still charging along. Business investment plans as of April/May were still strong, especially among mining companies. China has kept growing at breakneck pace, pushing demand and prices for our minerals to records.

Our fortunes depend more on China, Japan, India and Korea than on Europe and the US. Some analysts warn that China's local governments are so heavily in debt that even Beijing will not be able to bail them out without serious damage.

In those idyllic times two months ago, when the market downturn was just beginning, the Reserve forecast growth of 3.5 per cent over the new financial year, and Treasury forecast 3.25 per cent. The way things look now, they might be too optimistic, but probably not by much.

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Loss of stimulus hits home

THE Reserve Bank has blamed the strange behaviour of Australia's housing market in recent months partly on the end of federal government stimulus for first home buyers.

Trying to explain the housing market in 2010 when housing prices have soared yet home lending has plunged an article in the Reserve's quarterly bulletin says at least part is due simply to the sharp fall in sales to first home buyers.

The article, by researchers Paul Bloxham, Daisy McGregor and Ewan Rankin, does not explore the role of foreign investors, who have been widely blamed for driving house prices upwards, especially in Melbourne, when finance to local buyers was shrinking.

But they point to a different explanation.

The big change in the market this year, they say, was the fall in purchases by first home buyers once the boost to the federal first home buyers grant ended on December 31.

In 2009, when federal grants for buying existing homes temporarily doubled to $14,000, first home buyers borrowed as much as 25 per cent of all money lent for home purchases. That shrank to just 12 per cent in March and April.

The researchers say 90 per cent of first home buyers take out a mortgage, whereas only 65 per cent of existing home owners moving home do so.

As first home buyers retreat from the market, that explains much of the fall in lending.

Moreover, they say, first home buyers tend to buy cheaper houses. That means that when their share of the market shrinks, the median price of homes rises even if the underlying trend is flat.

"As the composition of housing turnover normalises, the more typical relationship between housing price growth, loan approvals and auction clearance rates is likely to be re-established."

This explanation ignores the central role of housing investors, who on average borrow 40 per cent of all finance for home purchases.

Investors tend to be even more heavily geared than first home buyers.

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Victoria - cashed up and ready to spend

IN A budget of few surprises, the real surprise is that Victoria's finances have come through the recession in such good shape. In the downturn, it spent more than ever before. And in the upturn, it plans to spend even more and yet end up with a much bigger surplus.

It is worth looking at how this happened. It illustrates more than mere budget numbers, but says something about what is happening to life in Victoria, and its system of government.

We might have thought that the recession, even if it was much smaller than expected, would reduce state revenues. And indeed, in 2008-09, state taxes did fall marginally, partly because the budget had given away tax cuts in the expectation of a normal year, which then turned out to be anything but normal.

But even in 2008-09, total state revenue increased by 5 per cent, because the falls in state taxes were outweighed by a 10 per cent rise in grants from Canberra: partly through a steep rise in Victoria's share of GST revenues and partly through the Rudd government lifting tied grants for schools, hospitals and transport infrastructure.

What about 2009-10? It's turned out to be a boom year for Victorian government finances. Total revenues are now forecast to rise 11.4 per cent. Most of that is coming from Canberra, with total Commonwealth grants up more than $3 billion, or 17 per cent. But state tax revenue is also estimated to grow by $1 billion, or 8 per cent, despite payroll tax receipts turning out weaker than expected.

Why? Treasurer John Lenders is a beneficiary of the boom in housing prices, even as it has killed off young Victorians' hopes of owning their own home. This year, stamp duty revenue on property transactions is expected to rise by roughly $700 million, or 25 per cent, in line with Melbourne's soaring prices.

Should the government cut the tax rates to make housing more affordable? No. There is a case for cutting them in a price slump, but when prices are soaring, experience suggests measures that give people more money to spend whether cuts in stamp duty or rises in first home buyers' grants would flow straight into even higher prices. What Lenders has done instead is very sensible. From July 1, the state's $2000 top-up for first home buyers purchasing existing homes will end, and the government instead will target all its resources on boosting the supply of new housing, lifting the total grant for people building or buying new homes to an impressive $20,000 in Melbourne and $26,500 in regional areas.

In effect, all the state's housing boost is now going into boosting supply, not demand. It is a lesson for Lenders' federal counterpart, Wayne Swan, who wants to keep giving out $5 billion a year of tax breaks to negatively geared investors and more than $1 billion to first home buyers, which boosts demand while doing nothing for supply.

On payroll tax, the extraordinary weak revenues up just 1.1 per cent in a year when the Bureau of Statistics shows Victoria adding 104,000 jobs is kind of stunning.

Maybe a lot of the jobs growth has been in small business or the public sector, which don't pay the tax. Maybe there has been a big rise in tax evasion. Or maybe the bureau's figures, based on a sample of households, seriously overstate how well Victoria has been doing.

What of 2010-11? The budget forecasts more moderate revenue gains. Commonwealth grants are tipped to rise only 3.5 per cent as stimulus programs run down. State taxes are expected to climb 7 per cent, with housing prices flattening out but the boom's impact on land values lifting land tax 12 per cent, while payroll tax collections grow 6 per cent.

Put it all together, and since 2006-07, state revenues will have grown by $11 billion, or 31 per cent, in three years. Frankly, it's not too hard to be a state treasurer when you have that sort of money flowing in. You can boost services across the board, boost investment across the board, and still lock up a decent surplus on your bottom line. And that's what Lenders has done.

Hospitals last year overtook schools as the main recipients of state spending, and with all that extra money flowing from Canberra, this budget entrenches that. Of $3.1 billion of new funding over the next four years to provide government services, $855 million, or 27 per cent, is for health, overwhelmingly for hospitals. Of $10 billion in new funding for capital assets announced in the past year, $2.3 billion is to build or renovate hospitals: $1.1 billion for the Parkville cancer centre alone.

To fund this asset spending, the state expects to increase its total debts from $10.6 billion at mid-2009 to $26 billion by mid-2014. Net debt would rise from $5 billion to $16 billion in that time when on these figures it would flatten out at roughly 4 per cent of gross state product. The wider measure of public sector debt would grow from $10.7 billion now to $32 billion in 2014, when it too would level out at about 8 per cent of GSP. That's a level that does not worry the ratings agencies, as they made clear yesterday in reaffirming Victoria's AAA credit status. It should not worry anyone except debt obsessives.

What does worry me is that it would level out only because the forward estimates suggest net investment in fixed assets will slump from $6.4 billion next year to $3.9 billion in 2013-14. By then, all investment for tomorrow would be financed by taxes on current taxpayers.

That's a formula that bows to the Coalition's scare campaign against taking on debt to finance capital works. But business constantly takes on debt to finance its new investment. If the benefits of the investment outweigh the cost, what's wrong with borrowing to invest?

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Taiwanese solution to soaring house prices: don't have kids

IN TAIPEI the other day, a crane drove up to the front of the Parliament building. It lowered a man sitting in a plastic container shaped like a house, and suspended him in the air in a protest against the high price of real estate. Through a microphone, he urged onlookers to rise up against high housing prices, declaring: ''People without homes, slaves to property, stand up!''

It is not only in Australia that young people have seen their dreams of home ownership evaporate as house prices boil. Throughout east Asia, a crisis is building as cashed-up investors who fled the sharemarket in 2008 moved their money into real estate, sending prices soaring.

This matters because housing is not just an asset like shares or bonds. It is where we live. It's natural for investors to prefer the security of bricks and mortar. But as governments throughout the region are discovering, it is also natural for people to want to own a home - and to turn against governments that allow prices to soar out of their reach. In Taiwan, the costs have become particularly serious, as we shall see. Their would-be home buyers - ''snails without shells'' as they call themselves - have reacted by scrapping the other big expense facing young couples: children.

At home, the Rudd government last week reversed its 2008 liberalisation of foreign investment rules on real estate, and set up a unit to ensure the rules are obeyed. It also set up a joint working party with the states to ask why housing prices have soared out of reach. But that will work only if it tackles the single biggest cause: the tax-driven growth of rental investors, whose borrowing has grown 30-fold in 20 years, squeezing out home owners.

China, in the midst of a full-scale housing bubble, has now done so. After real estate sales revenue jumped 75 per cent in a year, its state council last week hit investors with tighter rules. Banks are now forbidden to lend investors more than 50 per cent of the sale price (in Australia, 100 per cent is common). Investors must now pay a premium of at least 10 per cent above the normal interest rate, while first home buyers receive a discount. New loans are banned to investors who already have one property. And there is talk of a tax on rental property ownership.

China's goal is to deflate the housing bubble before it bursts, derailing the world's economic locomotive. Wish them luck.

But Chinese buyers are looking abroad, and so are their neighbours. In a bookshop in Taipei a few days ago, amid all the books and journals in Chinese, I spotted an Australian magazine on the shelves: Australian Property Investor. Clearly, people in Taipei are buying Australian real estate.

But Taiwan itself is the best example of what can go wrong if governments let housing investors and market anarchy push prices out of ordinary people's reach, leaving young snails without shells.

Taiwan has become rich very fast, largely by inching its way into a central role in global IT and communications manufacturing. This year, the International Monetary Fund estimates, its GDP per head will overtake that of its one-time colonial master, Japan. Its economy is almost as big as Australia's, and growing twice as fast. Yet its new wealth shows only fleetingly amid the grimy, cramped apartments built in earlier, poorer times.

Taiwan is in the grip of a housing crisis worse than ours. It is a rich country, but wages and most prices are roughly half the levels here - because the government, like China's, holds down the exchange rate to keep its manufacturing globally competitive.

Yet while wages remain low, apartment prices in Taipei are close to those in Melbourne, particularly for anything modern.

Why can't they build more apartments? Because ownership of those grimy old apartment blocks is fragmented among dozens of occupants and investors. To demolish, even to upgrade, a developer must buy them all out, which is prohibitively expensive in time and money. There are classy new apartments on the urban fringe, on greenfields sites, but too few to meet the demand from occupiers and investors. So prices have soared.

So the snails save hard to buy a shell, and do without other things. That means, above all, they do without children, or with just one child. By 2008, Taiwan's fertility rate was the lowest in the world. Its women bear on average just 1.05 children over their lifetimes. The cost of housing is not the only reason, but analysts say it is the main one.

But not having children creates even bigger costs ahead. Right now, Taiwan has 6.8 people of working age for every retiree. But preschools are already closing for lack of children, and the population is set to shrink dramatically. By 2032, demographers project, Taiwan will have just 2.5 potential workers for every retiree - and by 2056, just 1.4. If nothing changes, Taiwan - like China, Japan and Korea - will slowly become economically unviable.

So far, that hasn't happened here. But if governments keep subsidising investors to outbid first home buyers and low income earners, it will. Snails want shells. Taiwan - and soon, possibly China - are showing us what else can go wrong when the price of shells soars out of the snails' reach.

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No room for NIMBY syndrome

MELBOURNE abounds in affordable housing. The Valuer-General reports that in the September quarter last year, there were 116 suburbs in which the median house price was less than $400,000. For the city as a whole, the median unit price was $385,000.

But there was a catch. Of those 116 suburbs, 86 were 20, 30, 40 or more kilometres out of town. Another 20 were 15 to 20 kilometres from town, all in northern and western suburbs. The suburbs with affordable housing closer in were all in the north and west, mostly around Sunshine. It was the same story with units and apartments: expensive close in, cheaper the further out you go. And on the fringe, the median block of land cost just $165,000 - even less in the suburbs where most blocks were sold: Tarneit, Craigieburn, Pakenham and Doreen.

The moral is clear. The housing that has become unaffordable for aspiring home buyers is mostly housing in the inner and middle suburbs: areas within easy reach of the city centre, serviced by trains or trams, the sort of housing most of us grew up in.

In recent days, The Age has explored how Melbourne might develop to house the 7 million inhabitants now forecast for 2050. This debate has a long way to run, but our Project Melbourne series has shed light on the issues the Brumby government must now confront if it wants to lead, rather than drifting with the tide.

But it has also shown that the causes are largely beyond the state government's responsibility. Housing prices have soared because of an imbalance between supply and demand. More people want to buy houses than there are houses to buy. And the comparison of prices shows that imbalance is not so much on the perimeter, but in the inner and middle suburbs.

Interest groups keep telling us the solution is to zone more fringe land for housing. But we already have zoned urban land in spades, owned by developers who are holding on to it so they don't flood the market. Releasing more land will solve nothing.

We have an imbalance because demand for houses has been swollen by three policy changes made by federal governments, while the supply of housing in inner and middle suburbs has barely grown. So we now have shortages of the houses people want - and so prices have risen.

The interest groups know that, but want to shield their interests from change. If that's our attitude, we'll solve nothing. If we try to shift the blame or tinker at the edges rather than fix the problem, house prices will keep rising. Australia will keep changing from a nation of home owners to one of landlords and tenants.

The first policy change was the Hawke government's restoration of negative gearing in the 1987 budget as an approved tax break. Since then, the number of rental investors has more than trebled, from 511,000 to 1.7 million. They now own at least 2.4 million homes and their share of bank finance to buy established homes has soared from 8 per cent to 40 per cent.

The huge growth of rental investment has pushed up prices, and pushed out more than a million aspiring home buyers, who have been forced to remain renters (keeping the rental market tight). Census figures show that just in the decade from 1996 to 2006, the proportion of middle-income Melburnians aged 25 to 44 who owned their own home shrank from 68 per cent to 57 per cent. If the tax break stays, many of them will never own a home.

The second policy change was the Howard government's huge increase in net immigration: nationally, from 79,000 a year in the '90s to roughly 300,000 now - and in Victoria, from 20,000 a year to more than 80,000. This required far more housing and better infrastructure in the cities that housed them. But that didn't come in the time and scale required. If you push more people into the same housing stock, prices rise.

Now it appears that Melbourne prices are being lifted by a third policy change: the Rudd government's decision in December 2008 to stop requiring temporary residents to get approval from the Foreign Investment Review Board to buy a home. At the time, Labor wanted to prop up housing prices against the risk of a US-style collapse. But now, Melbourne prices are being pushed higher still by money from outside.

In Victoria, in the four months to January, bank lending to people buying existing homes was just 1.6 per cent higher than two years ago, and heading down. Yet Melbourne housing prices were 16 per cent higher, and heading up. Assistant Treasurer Nick Sherry was faking it last week when he told us the government was monitoring purchases by temporary residents - it no longer collects any data on them.

The federal government's tax breaks increase demand for housing, not its supply. To lower house prices relative to income, we will need to sharply increase supply. Redirecting those tax breaks to lift supply instead of demand could be a big help. But two other changes are needed.

First, the Rudd government's valuable social housing initiative - building 19,400 more homes for public, co-operative or defence housing - should not be a one-off, but the start of a renewed government role as a provider of affordable rental housing. Housing Minister Tanya Plibersek notes that if public housing's role had simply been maintained at 1996 levels, today there would be 90,000 more units, and less pressure on low-income renters.

But the other change must come from us. We need to kill off the NIMBY syndrome. If we want more affordable housing in our suburbs, we have to make room for it. We need to give up knee-jerk reactions against new housing in our street, and become more proactive, looking at where those new homes can go. We can either build out, or we build up. It makes sense to build up around the main suburban centres, around train stations and on tram lines. I once lived in a city like that, and it works.

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Caught in the cogs of tax regime

SINCE 1987, under Labor and Liberals alike, the federal government's housing policy has worked to make housing more unaffordable. The task of policy now is to reverse that, and make housing affordable. That cannot be done by small schemes, such as those Kevin Rudd took to the 2007 election. It will require bold actions, and politically dangerous ones.

But if you want to solve the problem, and make housing affordable, these are actions you have to take. While housing is a tax shelter, more and more money will flow into it. That money will keep bidding up prices, pushing them further out of reach of aspiring home buyers.

The same is true for the foreign money that has flowed in over the past year, after the Rudd government changed the foreign investment rules. At the time, it feared a damaging property bust. Instead, it has fuelled another price boom how much, we don't know, because for all the anecdotes, the government collects no data on how many properties temporary residents are buying.

Ordinary Australians expect to be able to buy their own home. Young and lower-income Australians are fed up with policies that work against them being able to do so. The proportion of homes they can afford to buy is shrinking year by year right now, month by month.

For a bold government, there is an opportunity to cut through and make big reforms by appealing to people's sense of fairness and the need to get policy back on track.

In one swoop, it should remove the two big tax distortions of the market. End the exemption of the family home from capital gains tax. End the tax break for negative gearing or limit it to new homes built by the investor. And, at the very least, require temporary residents to report their property purchases, so we can know whether we have a problem or not.

Over time, those changes will bring down housing prices relative to income. Tax breaks for housing have inflated house prices. Phase them out, and prices will fall back into a range that ordinary people can afford.

Last week, the Tax Office reported that at least 1.2 million Australians one in every 10 taxpayers are now negatively geared landlords. On average, in 2007-08, they claimed losses of more than $200 a week on their properties. This gave them a tax break of about $5 billion that year 4 per cent of all income tax revenue. In effect, other taxpayers had to pay that $5 billion to subsidise their losses.

As public policy, this is ridiculous. But since negative gearing was restored in 1987, this tax break and the decision to halve the tax rate on capital gains have seen investors' share of finance to buy existing homes jump from 8 per cent to 40 per cent. Those squeezed out were first home buyers.

My article last week led to an interesting debate on The Age website, and later on the Business Spectator website. Not surprisingly, many landlords argue passionately that negative gearing is good for us but mainly because they misunderstand how the housing market works. Let's take those arguments, and see how they stack up to reality.

Claim 1: If tax breaks for negative gearing were limited to offsetting rental income, landlords would pull out of the market. This would create a shortage of rental housing, and drive up rents. The victims would be the renters.

Response: This is a basic misunderstanding of something that is quite simple. If a house is not sold to a landlord, it will be sold to someone buying their own home. There will be one less home for rent, and one less household looking for rental accommodation. Supply will fall by one, demand will fall by one. There will be no change in the balance of supply and demand, hence no shortage, and hence no rent rises on this score. It would be different if investors stopped building new housing. But 91 per cent of lending to investors is for purchase of existing homes. One option for reform is to restrict the tax break to construction of new homes.

Claim 2: We saw what happened when the negative gearing tax break was abolished in 1985. Investors stopped building new homes and and rents soared. That will happen again.

Response: Sorry, but that is an urban myth. Yes, construction fell, but by investors and owner-occupiers alike, and why? Because interest rates soared to 17.5 per cent for investors and 15.5 per cent for owner-occupiers. Even so, construction by investors was a higher share of GDP in those years than in 2009.

As for rents, Bureau of Statistics figures show capital city rents rose 22 per cent in the two years when the tax break was abolished, and 23 per cent in the following two years after it was restored. End of urban myth!

Claim 3: Investors in all kind of assets are allowed to write off losses against income from other sources. To restrict rental investors to writing off losses against rental income only would introduce a new distortion that would simply push investment elsewhere.

Response: This argument normally has force. But when 70 per cent of housing investors are claiming losses, we have a distortion here and now. It is sending investment into activities that clearly do no good to the economy, and harm those who want to be able to buy their own homes.

The problem is not landlords: they will always have an important social role. The problem is the tax laws, and the politicians on both sides who lack the courage to right the wrong done to younger and lower-income Australians.

We also need to build more homes, especially in inner and middle suburbs where people want to live. But that is another story, for another day.

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