Wednesday 30 November 2011
For what it's worth, I came away from yesterday depressed by both the economics and the politics. The economics is self explanatory (for anyone that was listening). In terms of politics, and at the danger of stating the obvious, it seems this crisis is capable of bringing out the worst in everyone. The Labour Party continue to imply that this is all Osborne's fault for pursuing austerity. But as Evan Davis argued so coherently on the Today Programme, is Ed Balls really claiming that a 1% extra stimulus last year would have had such a large effect on medium term growth rates? The OBR certainly doesn't appear to agree with this assessment (blaming revisions to forecasts on price inflation and the eurozone). On the other side, Osborne's absolute insistence that we are currently at the limit of bond market tolerance (with no wriggle room) certainly deserves closer scrutiny in the light of changed circumstances.
Turning to my more usual remit, what about the urban and regional elements of the statement? Here, my fundamental question remains one about priorities. In a world where it would be good to have growth coming from anywhere how much emphasis should the government place on 'regional rebalancing'? The (as yet untested) regional growth fund receives another 1bn to help the areas most affected by public sector job cuts. Why not focus on the people most affected by job cuts which helps focus on the fact that other areas might best be placed to generate new jobs for those people? On broadband we will see ten ‘super-connected cities’ across the UK. I think it's reasonable to ask whether (for example) Belfast should be a priority for this kind of investment? More generally, the national infrastructure plan will 'invest in all parts of the UK'. Again, does this make sense in terms of priorities? To take just one example (although one of my favourites) is now the moment to halve tolls on the Humber Bridge through a debt write down of £150m? At the same time, local transport projects only receive an extra £170m. And then there's the tricky issue of billions on HS2.
Even in better times, SERC argued that it might make sense to focus investments so that government was working with market forces at least within regions. A discussion around these issues appears more important than ever, if we want policy to be as effective as possible in helping those worst hit by the downturn. Of course, the politics of this are awful, so I am realistic about the likelihood of any serious discussion. That's a pity, because politics aside, it's possible (although unlikely) that the economics of this could be awful as well and you would hope that some free and frank debate might help figure out if this was the case.
Monday 28 November 2011
Unfortunately, when Eddington looked at this issue, it was clear that the system in the UK was better at generating options for some types of schemes than for others. Indeed, if I remember correctly, for some types of intra-urban schemes, there were so few schemes on the books that it was hard to assess the spread of possible returns (these are the numbers that I have used in the past to make comparisons to HS2).
One concern here is the political difficulties about the location and nature of projects. Following Nick Clegg's LSE speech earlier this year, I discussed the new focus on infrastructure: "This will start with the regional growth fund, where round 2 will, we are told, prioritise infrastructure projects. I don't think this is necessarily a great place to start because much of the economic literature is generally sceptical about the role of infrastructure in boosting local economic activity in struggling areas. After all, as population in these places is historically declining, they likely have plenty of infrastructure relative to people. How is adding more going to help? [...] Delivering transport infrastructure investment on time and on budget (another commitment) is generally a good thing, although unrelated, as far as I can tell, to fiscal stimulus. After all, overspends and overruns still involve government expenditure. I would welcome a genuine move to prioritise transport projects in terms of bang-for-buck (how about dropping HS2 in favour of the kind of smaller high benefit schemes that Clegg highlighted in his speech today)? I might even welcome more infrastructure spending. But with net capital expenditure set to fall dramatically (even if plans are in line with Labour's projections) this prioritisation will take place within a significantly smaller pot.
These worries remain. At least, post-Eddington, DfT put a considerable amount of effort in to improving option generation. Let's just hope that work had some impact in generating the current portfolio so that we don't end up funding lots of schemes like the one discussed in detail here.
Thursday 24 November 2011
Coming so close to one another, these figures made me thing of Steve Nickell's lecture on immigration and housing from earlier in the year. In that lecture he suggested that we need to build around 150,000 houses per year to cope with the increase in demand that comes from real income growth and another 120,000 per year to cope with changing patterns of household formation. These kind of rates would be needed for price houses to real income ratios to stabilise even if net immigration was zero.
Somewhat ironic then that the (unlikely to be met) short term aim of government is to stimulate demand for new build in the hope that this creates employment in the construction industry, while in the long run the problem remains that the growth in demand will continue to exceed the expansion in supply.
Tuesday 22 November 2011
Yesterday's launch of the Government's Housing Strategy - and some of the reaction to it - have turned the spotlight back on to the planning system. As Henry Overman points out here, planning factors are one of the three factors influencing levels of housebuilding.
Here [pdf] and here [pdf] are two new papers on the economics of planning, written by Henry and I. Versions were also submitted to the National Planning Policy Framework (NPPF) consultation last month. (For those outside the UK, the NPPF, subject of furious public debate during the summer, is part of Ministers' attempt to speed up the English planning system.)
The papers pull together SERC research on planning (paper 1) and assess the Government's proposals for planning reform (paper 2). Henry and I don't agree on all of this - I'm certainly more pro-brownfield than he is - but we both felt that important pieces have been missing from the recent public conversation.
The key messages are:
1) The job of planning is to balance environmental, social and economic welfare. This means tradeoffs, so all planning systems have costs and benefits.
2) Planning's economic effects, especially the costs of the status quo, have been underplayed in recent debates. We summarise evidence strongly showing current rules increase house prices and volatility, increase office rents, probably lower retail productivity and lower employment in small independent shops.
3) Paradoxically, land restrictions in the most popular areas have led to some truly unsustainable development - such as selling off school playing fields for housing. Similarly, brownfield-first policies have delivered some positive benefits for cities like Manchester, but aren't a panacea.
4) The draft NPPF needs to be much clearer about sustainable development, potential tradeoffs and how practical decisions might be made (for example, using the National Ecosystem Assessment).
5) We agree with the National Trust and others that there's a basic tension between Government's desire for localism and some important national objectives. Ministers need to be clearer about what trumps what, or (more in keeping with localism) provide stronger incentives to align interests.
6) The presumption in favour of sustainable development that is consistent with the plan should be retained. But local authorities need time to adjust to the new rules, and the Government should introduce the change gradually.
7) Current incentives to ramp up housebuilding, such as the New Homes Bonus, are probably too weak and need to be strengthened. And one-size land restriction policies (such as town centre and brownfield first) don't work well in practice. Rather, we suggest Whitehall sets the appropriate framework to try to encourage particular patterns of development but then allows local authorities to develop their own land use restriction policies.
This piece was originally posted on the squareglasses blog on 6 November 2011.
Monday 21 November 2011
The government has two problems. One is short term. (At least) three things are combining to make current building figures look very bad. First, the recession makes things very uncertain for housebuilders. Second, the debate around the National Planning Framework is reinforcing that uncertainty. Third, the lack of mortgage finance is compounding the problems stemming from this increased uncertainty. There's not much that can now be done about the first two of these (although I did suggest some time ago that the government might regret the haste with which it abolished regional plans in the absence of something to replace it). The new build indemnity scheme will do something to tackle the third problem of mortgage finance - at least for new build. This will have some positive effects on supply, but it is possible they might be quite limited. Not least, because developers with schemes that are not started may be better off exercising the option value of holding on to undeveloped land until the market outlook improves.
On schemes that are stalled, the government has announced a Get Britain Building investment fund. Apart from the more boring description, and the smaller amount of money available, its not clear that this is massively different from the labour government's 'kickstart' programme. As a results, and as with the new build indemnity, the effects are likely to be positive but limited.
Longer term, I think the fundamental problems remain and my take on this is little changed from earlier in the year. The government has a real problem and one that is mostly not of its own making. The under-supply of housing has been a long term problem which the previous government were unable to tackle effectively. Labour were slow to recognise that something needed to be done about the planning system. Once they realised there was a problem they introduced top-down regional plans that tried to force local authorities to build more housing. These were incredibly unpopular with local authorities in parts of the country that needed more housing and were quickly abolished by the coalition. The national planning framework intends to replace this top down system with more localism and a set of incentives to encourage development. For a number of reasons I think these reforms should be welcomed but worry about the short term as discussed above.
In addition to these short term issues, there is the longer term issue of what the government will do if its package of financial incentives are insufficient to encourage more development. With the new system yet to bed in it could be a number of years before the government is able to assess whether the system is working (the recession compounds the problems here). That brings us close to an election where a change in government could see a change in policy. Cue more uncertainty for developers. This suggests that the government might have been better going for stronger initial incentives (e.g. on NHB and local business rate retention) which could then have been scaled back.
Another area which Labour struggled with, was the insistence on high brownfield targets. I have discussed the problems with these targets before but they remain incredibly popular (see, for example, the recent National Trust proposals on the NPPF). There is a real danger here that the coalition will not be able to resist calls to strengthen constraints on building on greenfield land in the national planning framework. They have already committed to maintaining green belts, but there are many other categories of 'protected land' where policy remains uncertain.
So much for some of the problems on the supply side where, as I have said, many of the problems are long term and not of the government's making. As already discussed, I think the short run effect on the demand side will be limited. In the long run, I just don't think policies on the demand side will help and may well create more problems than they solve. Setting aside the big demand side issue (the fiscal stimulus) the government continues to spend money on policies that try to 'help people on to the housing ladder'. Such policies to boost demand exacerbate the price problems caused by supply constraints and only help those lucky enough to get assistance from a scheme. This will always be at the expense of someone similar who doesn't benefit from the scheme and does nothing much to address the fundamental problem. The politics of this are tricky because it allows the government to say they are 'doing something to help' but the money would be much better spent on increasing incentives on the supply side. The government should certainly resist calls for further measures on the demand side.
In short, today's announcements might do something (although likely not much) to help in the short run but the longer run problems remain. Worse for the government, those long run problems (particularly around uncertainty and the resulting option values for developers) may well dampen any response to the short run policies.
Thursday 17 November 2011
Let's start with what caused the decline in British manufacturing. The economists explanation of this is pretty simple - Britain's comparative advantage lies in services rather than manufacturing so as the world globalised, we shifted towards services away from manufacturing. Of course, comparative advantages are generally created, rather than god-given, so it's reasonable to ask whether there are things policy could do to change this. For example, two popular prescriptions are that we could introduce more apprenticeships or different ways of funding businesses. In short, we could be more like the Germans. Unfortunately, these kinds of explanations muddle cause and effect. Who says that these parts of the system haven't developed in response to the fact that manufacturing in Germany got big because of some other comparative advantage - e.g. the fact that Germany is more centrally located in the EU than the UK (which makes it a better place to manufacture heavy machine parts that need shipping around). In short, we have no idea if replicating bits of the German system would make any difference.
Similar problems apply for calls to spend 'more on innovation'. We already have an R&D tax credit and various other BIS run schemes that try to do exactly that. Perhaps we should 'invest more in manufacturing'? Trouble is, the Regional Selective Assistance scheme has been making big investments directly in manufacturing firms since the 1970s. In short, even if the government had the money, spending more of it wouldn't necessarily shift our comparative advantage that much. At the end of the day, the UK is relatively good at services for many reasons.
Of course, there is always the argument that the structure of our economy is 'distorted' because of what happens in the financial sector. I have some sympathy with these arguments and have considered them in more detail in a previous post. But even if we removed some of these distortions - e.g. by changing the pay structure in financial services - why think that the rebalancing is towards manufacturing over other service activities that the UK is good at?
The issues are further complicated by the fact that the debate often assumes that these changes would benefit lower skilled workers or declining places. Both of these assumptions are highly questionable. Even if we did manage to improve our manufacturing share, lower skilled workers would still be hit by the double whammy of competition from China and technological change. For a long while, research suggest that the latter had actually been far more important than the former in explaining the widening pay gap. More recent evidence suggests that intense competition from China may now also play a role, especially for the lowest paid. Unless people are seriously willing to consider much more trade protection (or some sort of ban on technologies) then 'more manufacturing' is likely to be able to do relatively little for the lower skilled. If restrictions on trade are out, we either need to increase skill levels, or get the lower skilled to provide non-traded goods. But when economists say 'non-traded' goods they often mean services (cleaners, builders etc) so that doesn't necessarily equate to more manufacturing either. Of course, in non-traded goods lower skilled workers often face intense competition from immigrants, but suggestions of restrictions there run in to both political and practical difficulties (lots of this competition is from EU workers). Again, evidence on the magnitudes of these effects on wages and employment are mixed, although moving towards finding larger effects in periods when immigration has been larger.
Similar arguments apply to whether a move towards manufacturing would help declining places. Who knows where these new manufacturing jobs would be created. In addition, here, I share Aditya Chakrabortty's intense scepticism about calls to change the skill composition of places (get more high tech jobs) as a means of indirectly helping the lower skilled.
It should be clear that I do not think this is an area where there are any easy answers. My gut feeling is that there is no reason to think that the UK is going to generate lots of additional manufacturing jobs anytime soon. In fact, I worry that this continued focus on the structural composition of the UK economy is a considerable distraction from the tasks at hand. In the short term this is all about finding sources of demand. The longer run issue may be even trickier. How do we improve the labour market outcomes for lower skilled workers? 'More manufacturing' is simply not an answer to this question.
Tuesday 15 November 2011
Matt Freedman (Cornell) looked at the effect of the New Market Tax Credit in the US. This scheme mostly provided support for commercial development and involved billions of dollars of expenditure, mostly spent on commercial development. Matt's paper gets at the effect by comparing eligible to non-eligible areas (what's known as a discontinuity design). My take on Matt's results is that the scheme (at least around the threshold) had no effect on home values, median income, unemployment rate or employment. There does seem to be some effect in reducing the poverty rate, but household turnover is up so this may well just be a composition effect. It's also not clear where this effect is coming from given the absence of effects on employment or house prices (which might conceivably drive this effect)
Matt's paper didn't explicitly consider the issue of displacement, but this is considered by Andrew Hanson and Shawn Rohlin. Their paper looks at areas just outside successful enterprise zones and compares them to areas just outside unsuccessful zones and find substantial evidence of displacement (areas just outside unsuccessful zones do relatively better because they don't experience the displacement). In preliminary work, Elias Einio and I show that the only effect of the UK Local Enterprise Growth Initiative was to move employment from an area approximately 1km outside the boundary of the scheme to 1km inside the boundary. Aside from this displacement we can (so far) detect no other net effects.
Florian Mayneris and co-authors look at the French EZ scheme which spends a big amount of money (something over 300 euro's per person if I remember correctly). They find that this scheme can have a significant effect on firms tendencies to locate inside scheme boundary, but no effect at the level of the municipality as a whole. That is, the scheme shuffles firms from the non-eligible to the eligible part of the municipality.
Of course, policy makers may want to claim that all this displacement of jobs is what they are trying to achieve -but it is certainly not consistent with the rhetoric that is usually used (which usually talks about 'creation' rather than displacement).
One final thought, the French paper is part of a series of four projects due to report early 2012 to help inform the French government's decision whether or not to renew the scheme. The problem? The scheme was already extended for five years in 2011. Another depressing example of evidence based policy making in action?
Thursday 10 November 2011
Given the location (we're about a mile from Miami Beach) it seemed appropriate that the session started with Jan Brueckner's great paper on beaches, sunshine and public sector pay. Jan's research looks at whether or not public sector workers are able to get higher pay (relative to private sector workers) in high amenity cities. Jan's research shows that this is indeed the case, with the effect being particularly strong for unionized public sector workers. Jan's NBER paper gives more details.
In the same session, Giulia Faggio presented some of our work on the impact of public sector employment on private sector employment. Those results are still a little preliminary for a proper public airing. But one thing that did strike me is the fact that in the US the major controversy appears to be around pay, while in the UK the current concern is much more about employment. More to come on our substantive findings for the UK in a few weeks time.
[PS: For those of you based in London, Jan Brueckner will be presenting his work on Sub-Prime Mortgages and the Housing Bubble at the LSE on Monday 5th December.]
Tuesday 8 November 2011
The capacity constraint arguments revolve around the BCR, which the report gives as follows:
|BCR without WEI
|BCR with WEI
On the basis of these numbers, the select committee conclude that HS2 represents "high" value for money because HMT classifies BCRs above 1.5 as good, above 2.0 as high.
But this is a little misleading, because the BCR for transport projects tends to be higher than for other investments (part of the reason why some people argue that we tend to underinvest in transport in the UK). Here's the picture for a bunch of DfT projects taken from Eddington's 2006 report (figure 3.1):
These figures include some wider benefits (Eddington doesn't have a figure for the traditional CBA) so you need to compare to the second row of the transport select committee table. To read these 'box and whisker' plots notice that the box captures the 25%-75% range of project BCRs with the big horizontal line capturing the average. On my reading, a wider BCR for HS2 of 2.0-2.6 puts it, at best, in the bottom 10-15% of projects that DfT had on its books at the time of the Eddington report. I am not sure that these numbers are 100% comparable, but I think that they are roughly right. If so, that suggests that the case for HS2 remains weak when compared to many other transport projects.
Monday 7 November 2011
Joe Gyourko, (from the Wharton School) gave a great SERC seminar on Friday. The NBER paper - An Anatomy of the Beginning of the Housing Boom: US Neighbourhoods and Metropolitan Areas - attempts to figure out when the boom began in different US cities and neighbourhoods and whether any fundamentals were moving in the ‘right direction’ to help explain timing and magnitudes.
The research provides pretty convincing evidence -- using some amazing data -- that housing markets are 'local' (i.e., metro area) phenomena and are to a large extent driven by income as the main fundamental on the demand side and by regulatory and physical/geographical constraints on the supply side. Supply constrained cities boomed earlier and the research explains pretty convincingly that strong income growth occurred at the same time and offers a plausible explanation of house price booms in those cities. This is essentially ‘Economics 101’. Even more interesting, however, are the places that experienced substantial house price booms that were not explained by high income growth and tight supply; those in places such as Las Vegas or Phoenix. In these places Joe finds no evidence of the boom coinciding with a positive income shock nor is supply very tight. One further thing we know from Joe’s paper: The housing booms (or bubbles) in Las Vegas and Phoenix emerged much later and both the boom phase and the bust phase were very steep. So how can these phenomena be explained?
As Joe was careful to emphasize; the paper he presented does not provide an answer and at this point we can only speculate (although he is promising much more research to come). One plausible explanation to me is the following: Irrational exuberance needs some sort of ‘convincing story’ to emerge. Strong house price growth in places such as SF, NYC, Boston, LA etc. – that were supply constrained and at had good fundamentals – coupled with the extremely low interest rates created the “story” that the house price boom was being driven by historically low interest rates (or other changes in the economy). People started believing in this story. I would imagine that there may have been some spatial contagion effect. This is at least what the ‘spatial history’ of the US boom suggests – and is consistent with some maps on timing that Joe showed during his seminar. Essentially the belief in ever growing house prices may have spread from places such as SF and LA to places such as LV or Phoenix, even though the fundamentals in those places - apart from the interest rates - were extremely different. Now, in the places where it is easy to build (e.g., in Las Vegas or Phoenix) developers started to build like crazy. In places such as SF or NYC perhaps irrational exuberance started to contribute to the price increases originally driven by fundamentals. But how can prices increase at all in LV or Phoenix if supply is elastic? Perhaps the explanation is that supply is only very elastic in the long-run but not in the very short run; this is due to various planning, development and construction lags. So in the very short run if price growth expectations are (too) high this may encourage developers to add a lot of new housing stock. This pushes up house prices in the short-run but once supply adjusts in the medium and long-term prices come back to the pre-boom levels or may even fall below those. Because overbuilding can easily happen in LV or Phoenix but not in Los Angeles or SF, this can explain why the house price levels in SF and LA are still significantly higher than before the boom started, whereas this is not the case in LV and Phoenix. The downward adjustment was much steeper in LV and Phoenix.
Again, Joe’s research doesn’t yet prove any of this – so this is only informed speculation on my behalf. But SERC research shows that elements of this story – e.g. that planning constraints and physical/geographical constraints in conjunction with strong income growth explain the strong increase in prices – are certainly consistent with UK data. There are likely other explanations and the above may be too simplistic to explain everything. After all, on our Real Estate masters we spend several lectures on the fundamentals of housing markets and house price dynamics and there are numerous factors that contribute. Still the above may be a rough explanation of the fascinating picture Joe painted about the timing of the boom across different US metro areas.
Thursday 3 November 2011
In periods of economic distress it is natural to think in terms of cycles. Reaching the bottom of the cycle is a painful experience but at least gives some hope: from that point onward, things can only get better. UK house prices, however, look still far from their bottom.
In a recent research project for the IMF, I have studied the house price expansions and contractions of 19 OECD countries since the first quarter of 1970, and identified 55 expansions (of which 6 are ongoing) and 62 contractions (of which 13 are ongoing). On average, expansions last 6 years and produce a 60% house price increase in real terms; contractions last 4 and a half years and produce a 30% real price decline.
These numbers give the impression that real house prices are increasing in the long run, because expansions are longer than contractions and entail bigger absolute price changes. If one removes the most recent house price boom from the sample, however, this impression largely disappears. Other studies, which have a more restricted geographical focus but a broader temporal window, show that over the centuries real house prices are fundamentally flat. (Piet Eicholtz, for instance, has studied three centuries of house price data for the Herengracht canal in Amsterdam and has found their average real annual growth has been fairly low, at about 0.5%).
If there is such a thing as a pattern for house prices in the long term, it is not that they are increasing; it is that they are cyclical. All the countries I examine in my research have gone through multiple expansions and contractions of national house prices. These fluctuations are not just due to randomness – in the paper I show that the probability of ending a house price expansion increases with its duration. In other words, longer expansions are more likely to terminate: what goes up has to come down.
What does this mean for the UK? The figure below shows the real house price index and the corresponding peaks and troughs for three countries of my sample: Germany, the UK, and the US.
A couple of things stand out from the chart. First, the last house price boom did not involve all countries. There are a few cases of advanced nations, like Germany (or Japan), which did not experience any substantial price increase. For Germany in particular, over the last 40 years real house prices have stayed constant or declined slightly. Once again this is proof that real house price growth should not be taken for granted, even in productive and well-functioning economies.
Second, if history is any guide, countries like the UK and the US will continue experiencing real house price declines for some time. This adjustment process is already under way. According to the Land Registry, nominal house prices in England and Wales are down 2.6% on a year-on-year basis. Taking into account an inflation rate of 5%, real house prices have fallen by almost 8% in the last 12 months. However, there is surely potential for more substantial drops, especially considering that US house prices (which have grown less than in the UK during the boom) have already fallen by more than 30% from their peak.
Third, and most importantly, while some degree of up-and-down in house prices is unavoidable, the range of these oscillations should be carefully monitored. Ups and downs are an intrinsic feature of all economic series but booms and busts are not, and this is where the UK compares unfavourably with other countries. Even by US standards, UK house prices look like a rollercoaster: they more than doubled in real terms since the mid nineties; before that, they fell by almost 40% from 1989 to 1995.
For prices to vary so much, quantities must be very sticky. Indeed, a recent OECD working paper shows that the number of new housing units built in the UK is low compared to other nations. A report by the Department of Communities and Local Government suggests that strict planning regulations hold back housing supply and make prices more volatile. Let’s hope therefore that the current debate on planning reform will provide solutions that go in the right direction.
It might seem strange to advocate more house building in a period where house prices are falling. However, the current decline in house prices represents a cyclical adjustment that is not due to abundance of housing units. If this were the case, we wouldn’t see the current rent increases.This post first appeared on the LSE's British Politics and Policy blog on 1 November. Follow them on twitter @LSEpoliticsblog