Tuesday, 12 April 2016

Effectiveness of place-based policies: UK evidence

Posted by Elias Einiö and Henry Overman

First published on VOX EU 


Areas experiencing poor economic performance are often targeted by governments with programmes aimed at improving employment. However, there are concerns that any increases in employment come at the cost of reduced employment elsewhere. This column examines the displacement effects of one such programme in the UK. While employment increased within the targeted areas, there were comparable decreases in employment just outside the areas’ boundaries. These findings suggest place-based policies should focus on traded activities that are less susceptible to local displacement effects. 

Governments around the world target large amounts of money at areas experiencing high unemployment and poor economic performance. In the EU, regional policy accounts for around 35% of total community spending. On top of this, many national governments run extensive programmes aiming to alleviate deprivation in the poorest areas. For example, in the US, Kline and Moretti (2014) have estimated that around $95 billion is spent annually on spatially targeted economic development programmes by federal and state governments. 

There’s little doubt among economists that well-designed support programmes can increase employment in supported parts of the economy. However, the worry is that these improvements may come at a cost of reduced employment in the unsupported parts of the economy. Unsupported businesses may well suffer from the assistance provided to their government-supported competitors. This has long been a particular concern with spatially targeted policies that provide support to firms in some areas, but not others. What if these policies simply shuffle employment from one area to another? If that shuffling occurs at large scales (say from the South to the North of England) then this may be consistent with government policy objectives. But what if, instead, any displacement happens at small spatial scales? If that’s the case, governments may be spending considerable sums of money to achieve little additional employment at either national or local level. Add to that the potentially large inefficiency losses due to higher tax burdens (often considered to be around 40%) and in the worst case scenario spatially targeted interventions may even cause significant net welfare losses. 

While these concerns over adverse displacement effects are long standing, there is little causal evidence on whether they occur in practice. A number of recent studies have begun to address this gap in our understanding of the effect of these policies. For example, in their 2013 study of a French active labour market programme implemented using a large-scale field experiment, Crépon and co-authors (2013) showed that supporting unemployed job seekers increases their likelihood of finding a job, but at the same time reduces the employment prospects of unsupported job seekers in the same local labour market. In another study, Hanson and Rohlin (2013) looked at areas just outside successful Enterprise Zones (a US policy targeted at encouraging enterprise in declining areas) and compared them to areas just outside unsuccessful zones, finding substantial evidence of displacement (areas just outside unsuccessful zones do relatively better because they don't experience the displacement). In contrast, Ham et al (2011) find no evidence of displacement effects for three US place-based programmes when comparing a set of nearest ineligible Census Tracts (contiguous to the treatment area) to a set of second nearest ineligible Census Tracts.

In a recent study, we add to the available evidence by looking at local displacement effects with the help of extremely fine spatial data on employment and businesses in the UK. We examined spillover effects in local markets at the boundaries of areas supported by the Local Enterprise Growth Initiative (LEGI) – a UK programme that targeted deprived areas in 2006-2011. We observed that the programme increased employment on the LEGI-side of the treatment area boundary, but this came at the cost of comparable employment losses in untreated localities just on the other side of the boundary. The data also suggested that these effects vanish quickly when moving away from the LEGI boundary, pointing towards displacement in local markets. Moreover, none of these effects persist after the programme was abolished in 2011. Figure 1 provides a graphical presentation of our results. It shows growth rates for employment within 1km-wide bands constructed based on the distance from the nearest LEGI area boundary. The estimates are based on employment data at a fine spatial scale and allow for differences in area characteristics as well as unobserved trends in employment in the neighbourhood of LEGI areas. The figure reveals a striking pattern of effects at the LEGI boundary, with the area just inside the boundary seeing employment gains, while the control area just outside the programme area suffered from employment losses. This pattern of results suggests significant displacement of employment in a small neighbourhood around the LEGI boundary. When looking at unemployment, we find no displacement effects, which is unsurprising given that workers are free to cross the LEGI boundary and the programme appears to deliver no net job creation.

Figure 1. Displacement of employment at the LEGI boundary 



Notes: Difference-in-difference estimates by 1km-wide control and treatment rings from column 2, table 4 Elias and Overman (2016). The outcome is the log change in employment from 2004 to 2009.

Because similar businesses that are located close to each other often compete in the same local product or service markets, displacement effects at the boundary of the programme area are not unexpected. On the contrary, they are predicted by theory – hence the concerns of many economists about the impact of such spatially targeted programmes.

The bottom line from our results is that LEGI did little to increase employment in the most deprived areas of England. The direct impacts of the intervention on the target area is simply attenuated by loses elsewhere in the local economy. Although we are unable to identify these spillover effects at a wider spatial scale (national or global, for example), our study makes an important contribution to the debate by showing that such effects seem to be at play at small spatial scales, within local markets. Moreover, our findings support the view that even relatively large place-based interventions may struggle to ‘transform’ the local economy (given that even the displacement effects do not persist post-funding).

Our findings are especially worrying for area-based programmes that aim to help economically disadvantaged areas because the neighbouring areas that suffer from negative displacement effects tend also to be among the most deprived (given that deprivation is persistent across space). Fortunately, there are things we can do that may reduce the amount of local displacement. For example, LEGI tended to target non-traded services for which the local market is fixed in size. This is precisely the kind of situation in which we would expect displacement to occur. To give a specific example – as one hairdresser expands, it’s pretty likely that business at neighbouring hairdressers is going to be negatively affected because most people simply do not travel long distances to get their haircut.

In contrast, supporting traded activities is less likely to lead to local displacement because the business stealing effect will hit firms located elsewhere in the economy (or even abroad). Consistent with this, research by Criscuolo et al suggests that the UK Regional Selective Assistance programme (which only provides support to firms that do not serve local markets) does appear to generate additional employment that is not simply the result of displacement from nearby areas (resulting in an overall increase in local employment).

So we can do better. But reforming these programmes requires policy makers to take concerns over displacement seriously. Better evidence is, hopefully, one way that we can convince them to do so.

References 


Crépon, B, E Duflo, M Gurgand, R Rathelot and P Zamora (2013) “Do labor market policies have displacement effects? Evidence from a clustered randomized experiment”, Quarterly Journal of Economics, 128(2): 531-580.

Einio, E and H G Overman (2016) “The (displacement) effects of spatially targeted enterprise initiatives: Evidence from UK LEGI”, CEPR Discussion paper, DP 11112. / Spatial Economics Research Centre Discussion Paper 191. 

Kline, P and E Moretti (2014) “Local economic development, agglomeration economies, and the big push: 100 years of evidence from the Tennessee Valley Authority”, Quarterly Journal of Economics, 129(1): 275-331.

Hanson, A and S Rohlin (2013) “Do spatially targeted redevelopment programs spillover?”, Regional Science and Urban Economics, 43(1): 86-100.

Ham, J C, C Swenson, A İmrohoroğlu and H Song (2011) “Government programs can improve local labor markets: Evidence from state Enterprise Zones, federal Empowerment Zones and federal Enterprise Community”, Journal of Public Economics, 95(7-8): 779-797.

Thursday, 3 March 2016

Could Abolishing the Stamp Duty Solve the UK Housing Affordability Crisis?

Posted by Christian Hilber (LSE Geography & Environment and SERC) and Teemu Lyytikäinen (VATT Institute for Economic Research)


First published in Disclaimer Magazine


In a recent article, the Economist argued that the current policy debate relating to the UK housing affordability crisis may focus too much on housebuilding. It may overlook a bigger potential source of supply: existing homes. The argument goes as follows: overcrowding has gotten worse over the last 20 years, but more than one-third of households have two or more spare bedrooms. The solution: abolish the Stamp Duty Land Tax (SDLT). This would boost housing transactions and lead to a more efficient allocation of housing. It would also encourage elderly couples to downsize after their children fly the nest. The Economist estimates that there are 16 million or so spare rooms. Allocating housing more efficiently would free up some of these.

Other Economists have branded the SDLT: it creates a mismatch in the housing market and can have adverse consequences on the labour market. The SDLT creates a disincentive for people to move house, in turn implying that the unemployed may be less flexible in their search for new employment. The consequence may be longer unemployment spells and higher unemployment rates.

There is convincing evidence for the UK, the US or Canada, that land transfer taxes - such as the SDLT - do reduce household mobility very substantially. But to date little is known about whether land transfer taxes mainly distort housing-related or job-related moves.

Some simple considerations suggest that the adverse effects of land transfer taxes may be confined more strongly to the housing market. To see why consider potential movers who compare the cost of a move with the corresponding benefit. The cost of the move - in the form of the transfer tax - will be independent of the nature of the move. However, the benefit associated with a move will likely vary widely depending on the type of move. Job-related moves and long-distance moves are typically more momentous and associated with larger benefits, typically happening regardless of the transfer tax. Housing-related moves and short distance moves, however, are often more incremental changes that are associated with smaller benefits that often do not outweigh the additional tax cost.

In a recent SERC Discussion Paper we test this prediction. Exploiting a discontinuity in the SDLT schedule (where the tax rate jumps from 1 to 3 percent), we isolate the impact of the tax from other determinants of mobility. What we find is intriguing. A higher SDLT has a strong negative impact on housing-related and short distance moves but does not adversely affect job-induced or long distance mobility. In other words: the distortions associated with the SDLT appear to be mainly confined to the housing market - not the labour market.

The estimated distortions in the housing market are not only significant in a statistical sense; they are also economically very meaningful. Back-of-the-envelope calculations imply that the welfare loss associated with the rate increase from 1 to 3 percent is between 36 and 47 percent of the additional revenue generated by the tax increase. The SDLT is a staggeringly inefficient tax because it creates very substantial mismatch in the housing market. There is a strong case for replacing it by another less harmful tax - ideally an annual local Land Value Tax or property tax. For the reasoning see here

Abolishing - or replacing - the SDLT would allow many more young families with children to live in more adequate housing space and elderly people to spend the monetary equivalent of a bed room or two on other things. And it could bring about a tremendous welfare improvement by means of a more efficient use of housing space.

But can abolishing the SDLT resolve the British housing affordability crisis? Probably not. Abolishing (or replacing) the SDLT will likely result in a more efficient allocation of space, with fewer underused or unused rooms. But it may not generate any (or much) new supply in the form of new housing units. Consider a stylized world with 50 small flats and 50 big houses and 50 empty nesters and 50 households with children. Initially the match is bad so that half of the units are misallocated. Now relocation costs are reduced significantly - not to zero because there are other moving costs apart from the SDLT - and the match becomes nearly perfect: the empty nesters move to the flats and the young families relocate to the larger houses. The existing housing space (rooms) will be used more intensively, but the reform would not create any new housing units, ‘just’ a better match.

In reality we have of course immigration and new households form each year, so more and more people need to be housed and, as a consequence, demand pressure increases over time. Moreover, housing is to some extent ‘malleable’. Even the existing British planning system allows some sub-division of housing units. In our stylized example, some of the large houses may be subdivided into flats and this would permit Adam Smith’s ‘invisible hand’ to house some newcomers (migrants or newly formed households) into the housing market. In such a setting, indeed abolishing the stamp duty could help - to some limited extent - alleviate the severity of the housing affordability crisis. But it could certainly not solve it.

Does the policy debate in the UK focus too much on housebuilding? The Economist argued that even if the government succeeds in spurring on house builders, prices may continue to gallop upwards because (1) “Britain is bad at putting houses where they are most needed” and (2) even if new developments are added in overheating parts of the country, “this may fail to tame prices” because according to a recent LSE London report new development may actually increase the value of housing in their immediate surrounding areas.

Britain is currently bad at putting houses where they are most needed. This is because the British planning (and tax) system is seriously flawed. It gives very few incentives to local authorities to permit any development at all, thus ultimately causing the housing affordability crisis. This is reinforced by NIMBYs trying to prevent any new development in their backyard, because it could adversely affect their views, lead to congestion or threaten their asset values. NIMBY pressures will be greatest in the most desirable - high demand - places. The only local authorities that have some real incentives to permit development are those with high unemployment rates. Commercial development may generate jobs and even residential development will temporarily create local construction jobs. So, construction takes place in economically disadvantaged - low demand - areas where new housing is least needed. The right conclusion however should not be not to focus on housebuilding. The right conclusion ought to be to fix the planning and tax systems, so they can provide the right incentives to local authorities to build housing where it is most needed.

The second argument put forward by the Economist - that new development locally may increase prices locally - is not necessarily incorrect but very misleading. If a new development brings in new infrastructure and boosts the local economy through extra spending on shops and services, this may indeed cause house prices to increase locally (this is what the LSE London report suggested). But the Economist muddles up two effects. The first effect, the supply effect, all else equal unambiguously lowers house prices. The second effect, more amenities and better infrastructure, all else equal will unambiguously increase local demand for housing and thereby increase house prices locally. It is well possible that the latter effect in some instances outweighs the former because additional amenities and better infrastructure draw in demand from elsewhere. But to conclude from that that more supply increases prices is wrong - or at least very misleading in the sense that it muddles the two effects. Moreover, and importantly, what this very “partial equilibrium” argument ignores is the fact that new supply locally - while increasing demand locally - will reduce the demand pressures elsewhere in the region. So a local development will marginally reduce prices, not necessarily in the location itself, but in the wider surrounding areas. Such an effect on wider surrounding areas triggered by one local development will likely be very small, possibly too small to measure empirically. However, thousands of local developments in overheating areas will likely reduce demand pressures in these overheating areas very substantially, helping to reduce house prices notably, and arguably even more importantly house thousands of households in desirable places. The Economist reached the wrong conclusion (that too much focus is on housebuilding) because it ignored this “general equilibrium” argument and neglects the fact that new houses in high demand places would bring huge benefits even if their impact on prices were limited.

The SDLT is a very inefficient way of collecting revenue. Abolishing or replacing the tax could improve the match of people and dwellings noticeably, but it would be unlikely to create many additional housing units - by means of subdivision - and it would be unlikely to affect prices much. The uncomfortable truth is that, to solve the housing affordability crisis, policy makers won’t get around fixing the broken British planning system. This is a big and complex political endeavour but one with huge returns for generations to come.

Monday, 29 February 2016

Bigger cities are more productive but higher cost: what policy could do but doesn’t

Posted by Paul Cheshire, LSE Geography & Environment and SERC 


Originally posted on the British Academy blog


Cities are founded on specialisation. They were ‘discovered’ about 14,000 years ago and are arguably humanity’s most important invention. Why did we invent the wheel? Probably because the productivity advantage those early cities generated led to the need and ability to pay for food from ever further afield. The productive city-dwellers created not only a need – to transport food further and in larger quantities – but the resources to pay for it.

This strength of cities – specialisation – persists and except for military defence – the advantages and specialisms of cities are still today as they emerged millennia ago: specialised services, artisans and skilled manufacturing, cultural activities and industries, specialised retail and government and administration.

Cities, however, are the constructs of people and they are about people: systems to produce welfare and increase productivity. So buildings, design and infrastructure are a means to an end, not the end itself. And enhancing the built environment cannot promote prosperity or happiness in itself – but can if it improves people’s lives or productivity and is critical in helping cities deliver welfare and productivity more effectively. Yet, while cities are economic & social constructs, policy dominated by ‘design’ & ‘engineering’ modes of thought. Architecture and urban design have been the intellectual traditions urban policy has drawn from rather than urban economics or sociology. But urban economics for certain has made great progress in the past 15 years or so and has valuable things to say relevant to urban policy.

As cities get bigger their capacity to increase productivity and deliver welfare increases. Economists call this phenomenon ‘agglomeration economies’. Over the past 15 years or so we have succeeded in generating quite credible estimates and it seems as if doubling a city’s size produces about a 5% increase in total factor productivity (TFP), holding everything else constant. This implies that going from a city the size of Bradford or Cardiff to one the size of Leeds would increase TFP all else equal by 5 or 6%: and going from a city the size of Leeds to that of London by 18%.

There are also direct consumption benefits of city-size: bigger cities, all else equal, improve the quality of people’s lives. There is a wider range of goods and services available and more neighbourhoods of different character. One of the major sources of satisfaction is ones relationships with neighbours and the larger a city is, the more varied are its neighbourhoods and the easier it is to find congenial neighbours. Another obvious advantage of larger cities is that many activities depend on audiences, so the larger a city is, the more specialised its venues can be. To take football as an example (but it could equally be opera, classical music, or art) in a city as large as London a football fan can easily choose to watch any one of four or five world class teams and expect to see the greatest stars in the world playing when they visit. This is only possible because of the size of the audience. For these consumption benefits of larger cities, however, there are not yet any really reliable quantitative estimates.

The problem is, however, that costs also rise as cities get larger. Partly because of agglomeration economies more firms and people bid to get access to the higher incomes, revenues and welfare bigger cities generate, so the price of space rises. So, too, do other costs such as congestion and pollution. Until very recently people assumed that these increasing costs just ended up cancelling out the agglomeration economies and cities stopped growing; even got too big.

Recent research by a French team is the first to provide a serious quantitative estimate of how these costs increase with size and what particular features of cities drive the rise in costs. It finds that while, with a fixed land supply, costs do rise at about the same rate as agglomeration benefits in productivity, if land supply is elastic, the rate of increase of costs with size is only about 0.4 times that of the benefits.

The clear message for urban policy is to relax constraints on land supply subject to possible environmental costs. Alternatively, that the increase in price of farmland at the fringe of British cities that would result from allowing it to convert to housing is a measure of foregone agglomeration economies. Getting permission to build houses on a hectare of farmland on the northern fringes of London would increase its price from perhaps £20,000 to £12m: a clear signal of the loss of value imposed by not letting more people live where they really want to. Letting more people live where they find life most attractive and productive we could reap the benefits of bigger cities but pay far less in terms of costs. Cities can be both bigger and better; and better by being bigger.

The two other types of cost that rise with city size are those of congestion and pollution. Again urban economics has a clear policy message. We should impose a charge on congestion that reflects the extra costs any journey causes to others as accurately as possible. The London Congestion Charge is better than nothing but does not do the job as effectively as it might since it is not closely related to the congestion costs any given journey creates and, as a cordon charge, in fact generates an incentive once you have paid the charge to use your vehicle.

Pollution is, like congestion, an externality; the price any individual pays does not reflect the costs imposed on others by their actions but pollution is less obviously amenable to pricing. Instead regulation can be very effective but often needs to be at well above the city level both because the wind carries pollutants across administrative boundaries and because imposing technical changes on, for example farming methods or vehicles, requires action at the national or international level. It may seem odd to include farming in this account of urban policy but the most recent findings are that emissions from intensive agriculture - mainly of ammonia – are the single most important cause of premature death for city dwellers in Western Europe from air-borne particulates.

Thursday, 25 February 2016

Three challenges facing the Northern Powerhouse

Posted by Neil Lee, Department of Geography & Environment and SERC 


The Northern Powerhouse is the government's latest attempt to spatially rebalance the economy. The idea is that by joining the cities of the north into a single functional agglomeration, they would have the scale and critical mass to counterbalance London. The optimistic goal is to ‘reverse the North-South divide'. The agenda has achieved public recognition far above other economic development policies, although this is a pretty low bar.

I’m speaking today at the Social Market Foundation on the economics of the Northern Powerhouse, as part of their 'ask the expert' series (I have a new SERC policy paper on the topic). There’s an element of fraud about my presentation: the Northern Powerhouse is far too fuzzy and wide-ranging for anyone to be an ‘expert’ on everything. It has become a broad agenda which drifts far from the theoretical underpinnings, with significant moves around devolution of powers, new and better coordinated transport, investments in science and innovation, and some tokenistic moves around culture. Many of these would have happened anyway, but my research suggests there has been some (limited) new investment.

There is much to agree with in the Northern Powerhouse agenda. It is loosely based on the economics of agglomeration and an optimistic view of cities as a driver of growth. Many of the institutional reforms, notably Transport for the North, seem overdue. And it is a great brand. But there are also some significant issues with the agenda.

First, it is geographically vague – and this has led to competition for resources. It isn't clear if this is an agenda about providing a single counterweight to London, or about creating an equal playing field across the North. As Ben notes here, spreading the jam too thinly risks achieving little. In addition, perhaps with an eye on the promised new finance, lots of places outside the North are also trying to become ‘Powerhouses’.

Second, it isn’t clear whether there is enough jam to have any meaningful impact. The government claims significant new investment as part of the agenda. But the evidence here is shaky. There is a long-standing debate about the extent to which government investment favours different places, and there is no definitive figure on Northern Powerhouse spending in official reports. A rough estimate suggests that while there has been some new resources, the new spending is around £10bn - nothing compared to that going into projects like Crossrail (I'm grateful for updates on any of the numbers here). Moreover, they must be set against significant general reductions in finance for Northern local authorities.

Third, it is unconvincing on the most important driver of disparities in the UK: skills. Wider improvements might (indirectly) attract skilled workers, universities do get more resources and some devolution deals will touch on skills. But these are minor parts of the agenda - and Jim O'Neill (Minister for the Northern Powerhouse) has recently begun to recognise the importance of education and skills to the success of the agenda. It is hard to see an easy solution, however. There are longstanding concerns about vocational education in the UK; so passing the buck to local areas would not be a great move. But spatially targeted improvements in schools seem to have had some impact in London. New ideas, particularly from the northern councils, are important here.

Tuesday, 23 February 2016

Turnover is not supply

Posted by Felipe Carozzi, Department of Geography & Environment and SERC

An article published in the Economist this month linked transaction volumes in the British housing markets with housing supply. Given that newbuilds usually amount to less than fifth of all housing sales, the sale of used stock is a key determinant of housing supply. According to the article, this is often overlooked by economists emphasizing the need for increased construction to boost supply and slow price growth in the United Kingdom.

This argument contains a slight confusion about what constitutes housing supply. Economists usually think of the stock of occupied houses as providing housing services which are enjoyed through renting or homeownership. According to this perspective housing supply is not necessarily determined by turnover (frequency of house sales), at least as long as the vacancy rate is relatively constant over time. Hence, transaction volumes do not in and of themselves increase supply. To illustrate this point, suppose there is an increase in the number of households moving home. It is true that these households will increase the number of houses on sale, but they will also increase demand for housing units in the market by (exactly) the same amount. Overall, total housing demand and supply of units remain unchanged. So the emphasis on turnover as a tool to curb increasing prices is misplaced.

Admittedly, it is true that some forms of turnover (e.g. trade downs by older households) may foster a better match between the size of households and their homes. But it is unlikely that this would solve the broader problem of insufficient supply in the South East.

Telling evidence on the relationship between sale volumes and prices can be found when looking at the series for different regions within England (available at the Land Registry website). Transaction volumes are low in all regions by historical standards. However it is only in the South East that prices have recovered to pre-crisis levels, and continue to increase. And low turnover is not the explanation for it.

Monday, 15 February 2016

Greenbelt Madness: or how to get it back to front


By Paul Cheshire, SERC and LSE Geography & Environment


A couple of year back I blogged about how the legalistic mechanics of land designation were threatening to destroy one of our most special wildlife sites. The most important nesting site for nightingales in the British Isles it might be but it was also a former Ministry of Defence site on the Hoo Peninsula. So it was a ‘Brownfield’ site and thus ‘judged’ suitable by Kent to accommodate 5000 houses. Goodbye nightingales….

Almost ever since I wrote the nightingale blog in 2013 planning lawyers have been locked in battle and earning a fortune arguing about whether the site on the Hoo Peninsula is, or is not, truly and legally ‘Brownfield’. No one is arguing about the real point: its importance to our rapidly diminishing remnant population of nightingales. Our planning system does not deal in reality; only legally constructed reality.

Now we have another case in Cambridge which illustrates the point in microcosm. The City is short of land for housing and housing is unaffordable there (we Brits have constructed a magic formula that means we build twice as many houses in Doncaster and Barnsley each year as in Cambridge and Oxford). Cambridge, in its desperation, has even proposed building some houses in its Green Belt. But now there is a proposal for 3 houses CLOSE to the Green Belt and this is causing an outcry.

The tragedy is that there are reasonable grounds for opposing building these three houses, on this particular site. Not because it is close to the Green Belt - less than 200 metres from the boundary. But because, unlike Cambridge’s Green Belt land, this site actually has significant environmental value and is probably used as an informal adventure playground by local kids. It is a part of the old Cherry Hinton Chalk Pits – from which the lime to build many of Cambridge’s ancient buildings came. Quarrying ceased in the 1980s and most of the site reverted to nature and is now a designated wild life area with rare chalkland flowers and butterflies. One of its plants – the Moon Carrot – is found in only 3 places in Britain; the Cherry Hinton Chalk pits, Beachy Head and Knocking Hoe in Bedfordshire. The 3 houses proposed are on a small section of the Chalk Pits filled with excavations for the new Addenbrooks hospital building. So probably no great rarities on this site: just a pleasant semi-wild little urban green space.

The real madness is that the outcry is not because it is a pleasant urban green space with a potential for nature and informal recreation: but because it is ‘near the Green Belt’. 74 percent of Cambridge’s Green Belt is intensive agriculture, providing no wild life habitat and no recreational value: just privately owned, subsidy-attracting, ‘tax-efficient’, chemically-drenched desert. Bounding the Chalk Pit Wildlife reserve is an endless expanse of arable crops. Google earth suggests heavily sprayed cereals in the nearest field – perhaps 30 hectares – and maybe rapeseed in the next 30 hectare field. Developing 60 hectares at 50 houses /Ha would mean 3000 much needed houses and still have a net gain in terms of environmental quality, biodiversity and equity.

According to Kate Barker in 2010 agricultural land at the edge of Cambridge – despite its subsidy and tax avoidance advantages – was worth only £18,500 per Ha: but with planning permission for houses the value shot up 150-fold to £2.9m. As Martin Wolf said in the Financial Times a year ago: “…building an economy upon a massive and growing distortion in the market for land is foolish. We do not need to concrete over England. We do need to stop constraining the growth of the places where people really want to live.” We do not need 3 houses on a pleasant little green urban patch: we need 3000 more, please, on the adjoining intensive agricultural land!

Monday, 18 January 2016

On the unintended consequences of housing policies: A cautionary tale of three developed countries

Posted by Christian Hilber and Olivier Schöni


This article was originally published on Asia Pathways, the blog of the Asian Development Bank Institute


Lack of affordable housing is a serious policy concern in many countries. In large prosperous cities such as London, New York, Beijing, or Tokyo, the affordability crisis is particularly acute. In these cities, households often live in excessively expensive and crammed spaces. Homeownership remains an unachievable dream for many. Not surprisingly, voters in these places pressure politicians into implementing policies that tackle the crisis. The solutions typically offered focus on the demand side. Policies such as the Help-to-Buy scheme in the United Kingdom (UK) or mortgage interest deduction (MID) in the United States (US) aim to lower borrowing constraints, and thus allegedly help low-income and young households to achieve their dream of homeownership. These policies tend to be popular because of the alleged benefits for the targeted households and the hidden costs for taxpayers. Yet, apart from the fact that these policies are extremely costly—the US MID, for example, costs about $100 billion per annum in foregone tax revenue—tragically, they all too often end up making the targeted households worse off.

The fallacy of demand-side policies

Take the example of the Help-to-Buy scheme implemented by the UK government in April 2013 in response to the severe affordability crisis observed in large parts of England and particularly in the Greater London area. The main aim of the policy has been to help first-time buyers get their feet on the owner-occupied property ladder. The government argued that the scheme would stimulate demand for owner-occupied housing and this should translate into new owner-occupied housing being supplied, leading to a higher homeownership rate. Yet, in the year following the announcement of the policy, house prices in London shot up by 25.8%, a residential building boom failed to emerge, and the homeownership rate continued to decline.

So why did the policy fail so miserably? The fallacy was that policy makers assumed that housing supply would respond to demand stimuli. But this did not happen. One problem was that the UK had—and still has—an extraordinarily rigid planning system. Height restrictions, view corridors to protect certain vistas, conservation areas, and listed buildings, among other restrictions, are widespread. Arguably even more important is the fact that the UK, unlike most other developed countries, does not have a rule-based zoning system. Instead it operates a development control system: The 1947 Town and Country Planning Act expropriated the development rights of landowners, so since then any change in the use class for any parcel of land requires development control permission. This is granted at the local level. The trouble, in this context, is that the UK is a highly centralized country with virtually no fiscal powers at the local level. Local authorities face most of the costs of local development but reap virtually none of the benefits in the form of greater local tax revenue. This diminishes incentives to permit local development. To make matters worse, by trying to protect their nice views, green spaces and—ultimately—their asset values, not-in-my-backyard (NIMBY) residents will oppose any new development. Because NIMBY residents are also local voters, locally elected politicians have not only no fiscal incentives but also no political incentives to permit residential development. In such a setting, demand-side stimuli will not increase supply; they will merely push up house prices further, making it even more difficult for young would-be buyers to accumulate the necessary deposit to purchase a house.

Sadly, as we discuss in our forthcoming ADBI Discussion Paper, the fallacy of demand-side policies is not confined to London or even the UK. It applies to any country and city that has fairly tight long-term supply constraints—be they of a regulatory, physical, geographical, or topographical nature. The US provides a particularly interesting laboratory in this context because it contains both, tightly regulated and geographically constrained metropolitan areas—such as Los Angeles, San Francisco, and New York City—and metropolitan areas that are pretty unregulated and geographically unconstrained—such as Houston, Dallas, and Columbus. Hilber and Turner (2014) exploit these spatial differences in restrictiveness to explore the differential causal effect of the US MID on homeownership attainment depending on the degree to which metropolitan areas are tightly regulated. They find that due to the capitalization of the MID-subsidy into higher house prices, the MID has a negative impact on homeownership attainment in strictly regulated metropolitan areas. The positive effects on homeownership are confined to higher income classes in less regulated metropolitan areas. All in all, the US government foregoes about $100 billion in annual tax revenue to achieve essentially a zero net effect on homeownership attainment. Similar to the UK’s Help-to-Buy scheme, policy makers in the US appear to have ignored the fact that in supply-constrained places, demand-side policies are bound to mainly push up house prices.

Lax planning systems and the problem of sprawl

In contrast to the UK and many American “superstar” cities, Switzerland appears to have a rather flexible approach to planning. In most of the country—with the exception of Geneva and perhaps parts of Zürich—housing supply can be considered to be fairly responsive to demand and housing affordability is, not surprisingly, not one of the hotter policy issues. Another housing issue is very high on the political agenda, however: the problem of urban (and rural) sprawl. Switzerland’s sprawl problem can be explained by its institutional setting, which is characterized by fiscal federalism. To begin with, income taxes at the local level—in conjunction with tax competition—provide strong fiscal incentives to local municipalities to zone desirable land for residential development. Such residential zones are often at the outskirts of existing suburban areas, presumably because wealthy mobile tax payers—the key target of municipalities—prefer large houses with plenty of garden space. Second, Switzerland has an exceptionally low homeownership rate, currently around 37%. Unlike homeowners, renters do not benefit from rising house prices and rents, so they have much fewer incentives to behave as NIMBYs. Lastly, Switzerland has a fairly flexible rule-based zoning system—that is, if land is zoned for residential purposes, landowners have in principle the right to develop it, subject to staying within the rules of the law. This, in contrast to the UK’s development control system, facilitates residential developments, especially on the outskirts of suburban areas, where land is often made available and NIMBY pressures are smaller.

Lessons to be learned 

So what are the lessons that emerging Asian countries and their governments might possibly learn from the cautionary tale told here? One view is that policy makers are doomed regardless of the system they implement: They either employ a planning system that focuses on urban containment—only to be haunted by a housing affordability crisis—or they implement a fairly flexible planning system, in which case sprawl will create another form of political backlash (as evidenced in Switzerland where voters recently approved an intrusive initiative to halt sprawl in touristic regions and another initiative that aims to drastically limit immigration). This is too coarse a view, however: Although a trade-off between housing affordability and sprawl exists to some extent, clearly there are worse and better planning systems and housing policies.

Let’s start with the worst kind of housing policy: demand-side oriented policies. Clearly, stimulating housing demand makes the situation worse, not better, independent of whether a country has a strict or lax planning system. In countries and cities with fairly tight supply constraints—be it because of geographical or regulatory constraints—demand-side policies mainly push up house prices and thus worsen the housing affordability crisis. Stimulating demand is also counterproductive in settings where supply is fairly flexible. This is because the demand push aggravates the sprawl problem.

What about supply-side policies? Blindly relaxing the planning system and providing huge fiscal incentives to local jurisdictions to zone land for residential development will, in all likelihood, create a sprawl problem, such as the one observed in Switzerland. Moreover, planning serves an important purpose: to correct for market failures by, for example, providing public parks, separating incompatible land uses, and protecting historic sites and buildings. So, abolishing planning would be a bad idea.

How should a planning system then look like and what would be good policies and instruments to tackle the key housing issues? First, a good planning system should be designed to focus on correcting market failures. Second, by (i) allowing vertical expansion (i.e., largely abolishing height restrictions) and thereby permitting densification in central parts of cities, (ii) imposing a land value tax, possibly with varying rates (to prevent excessive construction in areas where this is not desirable—tax rates could be extremely high, for example, in areas of natural beauty), and (iii) only allowing the construction of new housing near existing developments (thereby limiting the excesses of sprawl), policy makers could keep housing affordable and largely prevent sprawl. While implementing such radical reforms may be difficult and will undoubtedly attract resistance from vested interests, the political rewards in terms of sustained political support could be substantial. Now there is an idea for policy makers around the globe. 

References

Hilber, C.A.L. and O. Schöni (in Press) “Housing Policies in the United Kingdom, Switzerland and the United States: Lessons Learned,” forthcoming as Asian Development Bank Institute Working Paper.

Hilber, C.A.L. and T.M. Turner (2014) “The Mortgage Interest Deduction and its Impact on Homeownership Decisions,” Review of Economics and Statistics Vol. 96, No. 4, 618-637.