Housing

The problem in housing

It helps to be clear about the problem in housing.  This is simply that prices are too high.  What do I mean by too high?

• The average age of a first time buyer is now approaching 40!
• In the period 2001 - 2010, nominal average earnings rose by 34%, but nominal house prices rose by 94%!
• National Averages disguise how the situation is worse in major cities, particularly London.

This last point is more important than it sounds.  Among the modern couples trying to get on the housing ladder, both partners will (hopefully) work.  This limits the geographical choice they will have.  It is only in the major cities that they can guarantee that they will both be able to find work in their chosen careers.

Many might be forgiven for feeling that the music has to stop some time and they should wait until a crash before they buy.  Unfortunately this is wishful thinking.  While easier credit has certainly been a factor in the house price boom of the late 20th and early 21st centuries, the way prices (especially in the cities) have held up during the credit crunch, indicates that they are being driven by scarcity.  

To correct the housing market, we must understand the housing market

The problem in the housing market is the severely constrained growth in the supply of new housing.  Population growth has outstripped housing growth by a rate of two to one.  Furthermore, while the population is growing, the number of households is growing even faster than the population.  This is a result of young people waiting longer before they marry and put down roots.  Although it is an open question which trend begets which.  It is entirely possible that young people wait longer because of the high cost of housing.  They are reluctant to start families when they can only afford small quantities of housing.

In economic terms, the supply of housing is not adjusting with the price.  We can represent this with a vertical supply line.  The demand for housing however responds to the price of housing.  We can represent this with downwards sloping line.  That line will shift upwards as the population increases; as people get richer; and as credit becomes easier to access.  In the last thirty years or so, the population has increased; people got richer (for most of it); and credit became easier to access.

In that time the housing stock has remained virtually static.  So the entire change in the housing market comes through in a price increase.

With this simple model in mind, we can see how some measures designed to help those who have not yet brought houses, might actually exacerbate the problem.  Policies to help home buyers have included reduced stamp duty for first time buyers and government guaranteed mortgages for some buyers.  However such policies will only shift the demand curve further up.  They will not alter the number of houses, neither will they alter who gets the houses.  Indeed a policy such as this is merely a transfer of wealth from tax payers to home owners disguised as a measure to help those who don't  yet own homes.

The real question then is why has the supply remained fixed?  There are only a few possible answers.  Basically one of the things required to build houses must be in fixed supply.  In order to build houses, one needs: labour; land; and materials.  Over the period in which house prices rose so dramatically, labour has not been in short supply.  The period encompasses the accession year when the former Eastern Bloc countries joined the EU and their citizens gained the right to come and work in the UK.  Neither has there been a particular shortage of materials.  Land has been in short supply.  This may come as a surprise to anyone who has ever flown over the UK in daylight hours.  There seems to be a lot of land available.  The problem is that one is not able to build on it.  Planning law essentially makes it very difficult or expensive to build more houses.  Indeed the more desirable a place is to live, the more difficult it is to build there.  Our major cities are protected by a so-called "Green-Belt" that was put in place around 50-60 years ago.

While the government is (at the time of writing) trying to reform planning law, cutting more than 1,000 pages from the rule book, it is doubtful whether:

1. the reforms will actually go ahead; and
2. they will actually go far enough.

What kind of change is needed?

Let's go back to basics.  Why might someone think that planning law is needed?  Essentially there is what economists call an externality here.  If I own the plot of land next to your house, then what I do with land will affect you.  Your enjoyment of your house will be affected if I build a tower block of flats on the patch next door.  The price of your house will also be affected. The result is that if I want to make any change to my land, I must seek the permission of the local government and this process gives you the right to object.

With this in mind, from a political economy perspective (this is the branch of economics that considers the incentives of policy makers), it is not difficult to see why house building has been so sluggish.  Bear in mind that there is no one single housing market in the UK.  There are a collection of more or less linked but separate markets.  Building new houses in any town will increase the supply of housing in that town and so lower the price of houses in that town.  The people who's permission must be sought in order to increase the local hosing stock are answerable to the people who already own houses in the area.  The economic losers out of development effectively have a veto.  No one speaks for the economic winners from proposed development (who are typically poorer than the losers).

However there is another way to take the externality into account.  Let ownership mean ownership, but create a vehicle for  owners to commit not to develop.  Such vehicles already exist in property law in the form of restrictive covenants.  This is best illustrated through an example.  Suppose I am a loss making farmer with a field near a village.  I could sell the field.  The only person who would be interested in buying is a developer.  The village is a short commute from London where there are lots of well paid jobs but housing is expensive.  Because of this proximity to London, housing is expensive in the village too, just not as expensive as London.  If the developer buys the field they will build more houses and the price of housing in the village will fall.  The current system effectively gives the villagers a veto on the development of the field.  Instead we should give the farmer the ability to sell the right to develop the field to the highest bidder, whether that be the developer or the villagers.

The development will go ahead if the villagers value a lack of development less than the developer will get from developing the land.  The developers profits from developing the land represent the benefits to those currently without housing from getting housing.  The development will not go ahead if the benefits to the villagers from keeping the land vacant exceed the benefits to those without housing from being able to move to the village.  These are precisely the situations in which we want development to go ahead or not go ahead.  Such a system could be achieved by allowing owners to enter five year restrictive covenants with their neighbours.  The covenants would be tied to the land rather than the person.

There is one difficulty with this system which I must admit. There will be a common action problem among the villagers in terms of buying a restrictive covenant from the farmer.  Indeed in order to reduce opportunities for corruption, I believe the local council must be prevented from buying restrictive covenants from owners.  Otherwise there will be too many opportunities for local politicians to enrich their chums by preventing "ghost" developments that the voters actually would not mind.  This actually makes the common action problem worse as people will not have access to the organising technology afforded by local government.  However preventing the system from being used corruptly must surely take precedence.  Furthermore, after such a long period of too little development, it would take a long while before any reforms led to too much development.