Posted by Paul Cheshire, SERC and LSE
The British
housing market, especially the English housing market, is in crisis. This is
not a crisis just confined to housing: it threatens to extend to the whole economy.
We have analysed these issues on this blog several times before.
The supply elasticity of new housing is approaching zero. In each of the last
three years fewer private market houses have been built than in any peacetime year
since
early in the 20th Century.
The noose constraining new housing
development has been tightening for 30 years at least. The cause is mainly the
constraints on land supply imposed by our planning system. But these are made
worse by the way the planning system injects risk and uncertainty into
development, reinforcing the monopoly power of larger British developers (only
born and bred British developers can understand the system and only big ones really
have the resources to negotiate a way through it), and by a fiscal system which
still effectively fines local communities who permit development.
As I argued in 2009 this results in housing becoming ever less affordable relative
to incomes, and to ever increasing price volatility. In turn, this creates problems
for monetary policy. It also fuels an obsession with house prices, and sucks
savings into housing consumption and speculation. Not getting onto the housing
ladder is a long term disaster for someone who aspires to a decent standard of
living and at least a moderately comfortable old age. Given that housing demand
is highly income-elastic, and - as Nick Boles has perceptively observed - as
people get richer they aspire to a patch of garden too and the fact
that over the past 60 years, real house prices in England have risen more than
almost any other asset, it is entirely rational for people to pour money into
housing.
That does
not make it good for us collectively to behave like this. It is very bad news for
people who end up spending too high a fraction of their incomes on the mostcramped housing in the developed world. It is also bad for the
performance of the real economy. Over-borrowing to get into the housing market was
a major cause of the financial crisis; our housing obsession also almost
certainly diverts both funds and the willingness to take a risk from productive
entrepreneurial activity.
To illustrate
with a personal anecdote: my wife – also an academic - held a chair in
Switzerland and so bought a flat there in 1994. Having returned to a chair in
London she sold this flat in 2012 for exactly the same number of Swiss Francs
she paid in 1994. But while this was the same number of Swiss Francs, converted
into pounds Sterling it represented a capital gain of some 50%. The Franc’s
appreciation is not hard evidence - but certainly suggestive of a causal
relationship. Real house prices in Switzerland have been stable at least since
the 1960s (of course there is a cycle but there is no long term upward trend)
so the Swiss feel little pressure to be owner occupiers and do not divert all
their available funds and credit into buying houses. The Swiss economy has been
similarly stable and hasn’t it done well?
Since 2010 the
coalition has been trying to make the planning system more responsive to market
signals, and give local communities incentives to allow development. As
colleagues suggested at the time, it was a mistake to get rid of one
planning system without having another in place. The new planning policies and
incentives may help to deliver more
houses but even if they do it will certainly take time. Well under half of local
authorities even have local plans approved yet – a requirement of the new
National Planning Policy Framework which goes live today. NIMBY resistance to allowing housing to be
built where there is most demand is as strong as ever The last thing a
home-owner in the green Home Counties wants is new houses occupying any rolling
acres near them. Note the outrage caused by the Planning
Minister when he suggested it is reasonable for those lucky enough already to
have a patch of garden, not determinedly to frustrate the desires of those seeking
a patch of garden of their own
As colleagues and I have argued before the balance of our judgement is that the coalition’s changes will fall far
short of what is really needed to improve things on the supply side. But it will be at least another four years
before we can judge whether the politically costly reforms of the past two
years will actually deliver any improvement anyway.
Which brings
me to the budget: this is pumping up the demand side and encouraging more
borrowing. As Robert Peston and others have noted, the government
(that’s us) are shouldering a risk banks have sensibly been fighting shy of. There
has to be a significant risk that house prices have further to fall. The budget
measures will feed through into house prices higher than they otherwise would
be: indeed that is more or less all they will do. Supply is, after all, more or
less perfectly inelastic for the reasons given above. We have shaken up a
broken planning system but not yet achieved any improvement.
Higher house
prices will lead to housing becoming yet more unaffordable, and yet more
borrowing secured against highly volatile assets – which policy itself has made
yet more volatile. In the long term, house prices tend to rise in real terms.
But in the short term, this debt still has to be serviced – while incomes are stagnant,
and interest rates will be rising.
All in all a
recipe for double disaster: a terrible housing situation made worse and a
serious additional risk in the offing. Perhaps the only explanation is the very
cynical one. The election is even closer than the economic disaster to which
this budget may contribute. Let the next Chancellor get out of that one!
