Liberating housing: a free market approach

Kristian Niemietz writes for Housing Market Intelligence

If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidise it.”

This famous quote by Ronald Reagan was meant to be a summary of governments’ approach to economic activity in general, but it is difficult to think of a more fitting contemporary example than the British housing market. Choked by an absurdly restrictive planning system, it has stopped moving long ago. We have now reached the point where policymakers are thinking about how to ‘boost’ homebuilding, through incentive measures like the New Homes Bonus.

It is, of course, commendable that policymakers are at least recognising the problem. But by asking what the Government can do to ‘encourage’ homebuilding, they are starting from the wrong premises. The Government should not do anything to encourage homebuilding.

In a market economy, it is not the role of government to encourage production, be it of homes, apples, trainers, or shaving foam. The best thing the Government could do for the housing market is to get out of the way. Don’t try to ‘boost’ or ‘promote’ it – just stop strangling it.

Government interference and house price inflation

The housing market has long been characterised by excessive government interference on the supply side, and the results have been dismal. Over the past 40 years, house prices after inflation have increased three-and-a-half-fold (ONS, 2012; ONS, 2012a). Income growth has not remotely kept pace with house prices.

In the 1970s, the average homebuyer needed less than three gross annual salaries for a house, excluding interest payments. Today, it costs them more than five gross annual salaries, again excluding interest payments (ONS, 2012). By international standards, the UK is an extreme outlier on both counts (Demographia, 2012).

 

-based on figures from ONS (2012) and ONS (2012a)

In other markets rising prices entice new suppliers to enter the market and existing suppliers to expand their supply. In the housing market this simple mechanism has long been suppressed. As house prices exploded, fewer and fewer homes were being completed.

 

        

-based on figures from DCLG (2012) and IFS (2012)

These figures are, again, extreme outliers in an international comparison. For at least three decades the UK has trailed far behind its neighbours in terms of housing construction (Eurostat, 2010).

Finding out why is not rocket science. The determinants of house prices are now well-researched and the literature is fairly conclusive (Niemietz, 2012, pp. 17-18). House prices are always driven by a variety of factors – but the impact of most of them is either modest or transitory. Substantial and lasting house-price increases are almost always the result of restrictive planning regulations.

Red herrings

The evidence is as clear as it gets, but housing is one of those areas where the political debate is remarkably impervious to facts. It circulates, instead, around red herrings.

One of them is population density(e.g. BBC News, 2008). True, parts of the UK are fairly densely populated. The South East of England and the West Midlands count just over 400 inhabitants per km2. But so what?

The German state of North Rhine-Westphalia houses more than 500 people per km2, and so do the Swiss cantons of Zug and Basel-Landschaft, as well as several Dutch regions. North and South Holland, meanwhile, accommodate well over 1,000 people per km2. None of these regions have experienced housing cost explosions.

On a more basic level, if population was really an issue, we would expect a shortage of developable land, but we observe the precise opposite.

Only about one tenth of the English surface area is currently developed. In Wales, Scotland and Northern Ireland, the proportion is less than one twentieth. By far the largest part of the English surface area consists of agricultural land. There is abundance of land which could be readily used for residential development without sacrificing (or even getting near) any attractive natural landscapes.

Table: Surface area of England by land use

Land use

% of area

Farmland

55.3

Grassland

14.4

Urban

10.6

Woodland

9.5

Heaths, Mountains, Moorland

5.3

Coastal margins, waters & wetlands

2.5

Unclassified

2.4

Total

100

-UK National Ecosystem Assessment (2011, pp. 60-66)

Another red herring is the singling out of particular tenures. It is often asserted that there was a specific lack of public and social housing, rather than an overall lack of low-cost housing (CPAG, 2012). With waiting lists of more than 1.8 million households, it is easy to see why.

But what proponents of this position fail to notice is that the British social housing stock is already one of the largest in the developed world (Eurostat, 2010). It accounts for one fifth of the total dwelling stock, which is, ironically, a higher share than in the Scandinavian countries which social housing enthusiasts often praise as role models. Tenure is irrelevant. There is a general lack of low-cost housing across all tenures, and the long waiting lists for social housing are just another symptom of it. They are just another good reason to liberate the housing market from planning constraints.

Asking the wrong question for the wrong reasons

The Government does not just ask the wrong question, it is also does so for the wrong reason. The political rhetoric of the day suggests that the Government sees the housing market primarily as a tool to ‘create jobs’ and ‘stimulate growth’. These might indeed be accidental by-products of a liberated housing market, but this should not be the motive for liberating it. If we could make houses appear out of thin air without producing a single job and with no impact on GDP figures, we should do it.

The purpose of a functioning housing market is to deliver the homes that people want, not to generate economic activity. This may sound like nitpicking, but it does have practical implications. A pro-development agenda that finds its justification primarily in low growth and high unemployment figures is likely to run out of steam as soon as the economic situation looks a bit better.

But since the current housing affordability crisis is the result of at least three of decades of systematic under-building, there can be no quick fix for it. Resolving it will require a sustained period of elevated building activity. Thus, a policy strategy for the housing market ought to be viable under a broad range of scenarios. It should make just as much sense in a boom period with full employment than it does now.

Having said that, it remains true that a functioning housing market produces a variety of beneficial side-effects. It raises labour mobility and makes housing bubbles less likely (OECD, 2011). It raises productivity in sectors which require space, especially retail (Cheshire, P.; C. Hilber and I. Kaplanis, 2011). It would enable massive fiscal savings, while also improving work incentives.

With Housing Benefit rates pegged to rent levels, the sharp increase in rents has led to a massive expansion of the Housing Benefit rolls. 44% of all those in rental accommodation now qualify for this payment. On the one hand, this has led to a cost explosion, with the Housing Benefit bill now standing at over £20 billion per year. But it has also undermined work incentives. Housing Benefit is tapered away at a rate of 65p per £1 of net earnings, thus effectively acting like a second income tax, which penalises work. If rent levels fell, Housing Benefit rates would follow suit, taking some recipients off the rolls entirely. This would not just save taxpayers’ money, but also improve incentives to work.

The way forward

The way forward for housing policy is to free the supply side by liberalising the planning regime. One way to do this would be to institute a general presumption in favour of development – not ‘sustainable’ development, but development, without useless buzzwords – which can only be overridden in well-defined exceptional cases. But such a solution would be unstable, because it would go against the grain of the system’s incentive structure. A planning system does not exist in a vacuum; it is intertwined with other policy areas, and with the fiscal structure in particular. If the Coalition wants to diffuse the system’s anti-development bias, they should first of all get serious about their ‘localism’ agenda, especially in the fiscal realm.

Imagine a fiscal system in which local authorities had to fund their entire expenditure through locally raised taxes, say, a local income tax and a local land value tax. Granting planning permission would then become a way for local authorities to enhance their tax base. It would attract new residents, aka local income tax payers, and raise the taxable value of land.

The more permissive a local authority’s approach to planning, the broader its tax base would be. And the broader its tax base, the lower its local tax rates, and/or the better its local public services. Of course they could pander to ‘nimby’ voters. But this would shrink their tax base, so that ‘nimby’ councils would either have to charge higher local tax rates, or cut the provision of local public services. ‘Nimbyism’ would still be possible in a fully localised system, but it would not come for free.

It does not have to stop there. Imagine even the Housing Benefit system was devolved to the local level. Local authorities would then face a straightforward choice: More restrictive planning decisions would lead to higher housing costs, which would lead to more people depending on housing benefit, which would lead to higher local expenses, which would lead to higher taxes and/or to cuts elsewhere, which would lead to angry voters and lost votes. Or they could choose the opposite path of a virtuous circle of permissive planning, affordable housing, less dependency, lower expenses and lower taxes.

The key merit of a fully localised system of planning and taxation is that it would restore full transparency about the costs and benefits of different approaches to planning. Let’s see how popular nimby policies would be once people got to see the bill.

References

BBC News (2008) ‘England ‘most crowded in Europe’’, 16 September 2008

Cheshire, P., C. Hilber and I. Kaplanis (2011) ‘Evaluating the effects of planning policies on the retail sector: or do Town Centre First policies deliver the goods?’, SERC Discussion Paper No. 66, Spatial Economics Research Centre, London School of Economics

DCLG (2012) ‘Table 241: House building: permanent dwellings completed by tenure, United Kingdom historical calendar year series’, Live tables on house building.

Demographia (2012) ‘8th annual Demographia international housing affordability survey: 2012. Ratings for metropolitan markets’, Performance Urban Planning.

Eurostat (2010) ‘Housing Statistics in the European Union 2010’, at http://abonneren.rijksoverheid.nl/media/dirs/436/data/housing_statistics...

IFS (2012) Dataset accompanying ‘Living Standards, Poverty and Inequality in the UK: 2012’ IFS Commentary No. 124, London: Institute for Fiscal Studies

Niemietz, K. (2012) ‘Abundance of land, shortage of housing’, IEA Discussion Paper No. 38, London: Institute of Economic Affairs pp. 17-19

OECD (2011) ‘Housing and the economy: Policies for renovation’, chapter in Economic Policy Reforms 2011. Going for growth, Paris: OECD Publishing

ONS & DCLG (2012) English housing survey. Households 2010-11, London: Department for Communities and Local Government

ONS (2012) Dataset ‘House Price Index’, House Reference tables, Table 22:‘Housing market: house prices from 1930, annual house price inflation, United Kingdom, from 1970 (DCLG table 502)’

ONS (2012a) Dataset ‘Consumer Price Indices - July 2012’, Table 21: ‘RPI all items: 1948 to 2012’

UK National Ecosystem Assessment (2011)The UK National Ecosystem Assessment: Synthesis of the Key Findings, Cambridge: UNEP-WCMC, pp. 60-66.

This article originally appeared in a Housing Market Intelligence Report (£).

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