International Articles: HOUSE PRICES AND ECONOMIC GROWTH IN SOUTH AFRICA: EVIDENCE FROM PROVINCIAL-LEVEL DATA

Abstract This paper empirically examines the effect of house price changes on economic growth across provinces in South Africa. The economic impact of house prices is estimated using a panel data set that covers all nine provinces in South Africa from 1996 to 2010. The findings show that when heterogeneity, endogeneity, and spatial dependence are controlled for, house price changes exhibit a significant effect on regional economic growth in South Africa. The paper introduces a seemingly unrelated regression (SUR) specification and shows that spatial effects are highly important in South African housing markets. Moreover, the estimation results suggest that the wealth effect is important at the aggregated level, which contrasts the relevance of the collateral effect found at the regional level. (ProQuest: . denotes formulae omitted.) Disparities in growth rates have been widening among South Africa's provinces, which account for significant inequality in the spatial distribution of economic activity (Naude and Krugell, 2006). The four fastest growing provinces averaged an annual per capita growth rate of 2.62% over the past five years. In contrast, the two slowest growing provinces registered a 1.62% growth rate on average over the same period. The high growth regions differ in terms of population densities, building construction, personal income, as well as job market conditions. Gauteng and Western Cape are examples of densely populated regions with high house prices that have grown faster over the past five years. Free State is less densely populated and has grown tremendously over the same period, but the house prices are lower and there is a moderate unemployment rate. Conversely, Northern Cape, the slowest growing province, has the highest house price inflation over the past few years (Exhibit 1). Holly, Pesaran, and Yamaga (2010) state that changes in housing prices have major implications for output and credit market. Also, house prices fluctuate due to job market conditions and relocation costs (Holmes, 2007). It follows that the housing market may stimulate the economy or may trigger economic recession as vindicated by the recent global financial turmoil, which had its roots in the subprime crisis in the United States. However, from the differences in average house price inflation across the regions, it is not clear whether regions experiencing high increases in house prices grow faster than those experiencing slow increases in house prices. In effect, house prices may simply keep pace with inflation such that house prices in the relatively poorer regions may not be below the cross-regional average as expected. Understanding how economic growth is related to house prices is therefore of considerable value. In South Africa, housing accounts for 29.40% of household assets and 21.68% of total wealth (Das, Gupta, and Kanda, 2011). The permanent income hypothesis asserts that house price inflation increases the expected lifetime wealth of homeowners and hence impacts their desired consumption. This is known as the wealth effect. The collateral effect, on the other hand, postulates that fluctuations in house prices relax homeowners' financial constraints, which may in turn affect their actual consumption. While the wealth effect is immediate, the collateral effect assumes households are financially constrained. Consequently, distinguishing between the wealth effect and the collateral effect of house prices may contribute to understanding which policy measures will be effective in raising growth. For instance, easing borrowing constraints to stimulate the economy may not be efficient if the recession is due to the wealth effect; meaning that ''. households voluntarily reduce consumption because they feel poorer'' (Miller, Peng, and Sklarz, 2011). Against this backdrop, this study investigates the effect of house prices on provincial gross domestic product (GDP) in South Africa over the period of 1996 to 2010. …