The (New) Northern Powerhouse Strategy

Posted by Neil Lee, Geography & Environment and SERC

The headlines from yesterday’s Autumn Statement were mainly about the grim economic forecasts, post-Brexit. But there were also some significant developments around the Northern Powerhouse (see my paper on the topic). There had been concerns that this agenda was going to end when George Osborne, who led it, left the Treasury.

Yesterday’s announcements suggest there is life in the agenda yet. While there was little new money, the government did publish a Northern Powerhouse strategy – a cheap way to confirm ongoing interest.

The strategy suggests some shift in focus. Under Osborne the Northern Powerhouse had four "ingredients" - transport, science and innovation, devolution, and culture (the poor relation). The new "strategy" seems based on: connectivity, skills, enterprise and innovation, and trade and investment. Culture is now justified mainly as an attempt to attract and retain skilled workers.

The focus on skills and education is important. SERC research has highlighted the importance of skills in regional disparities, but skills were - as I argued earlier this year - missing from earlier iterations. IPPR North released a sobering analysis of the problem faced and a review has been conducted. The success of these policies will have long-term implications. [Updated: As Alex notes here, there was no mention of skills in Hammond's actual statement.]

Second, the initial focus on innovation has broadened out to include enterprise. While few people are against enterprise, many firms are not the wealth creator politicians imagine (see Alex and Paul’s work here) and there are cautionary tales about the creation of lots of poor quality start-ups in lagging regions. The focus needs to be on quality, not quantity.

Finally, one critique of the Northern Powerhouse has been that it is a political brand rather than a genuine economic strategy. But the branding element is now an explicit goal of the policy (see this whizzy video), with the aim of using the Northern Powerhouse branding to attract trade and investment.  Given the state of the post-Brexit economic forecasts, let’s all hope this works.

Fear of Fracking: house price reactions to fracking in Britain

Posted by Steve Gibbons (LSE, SERC); Stephan Heblich (University of Bristol, SERC); Esther Lho (Duke University); Christopher Timmins (Duke University, National Bureau of Economic Research) 

Earlier this month, the government gave approval for exploratory drilling and hydraulic fracturing – ‘fracking’ – for shale gas at two sites in Lancashire. This follows a similar decision for North Yorkshire earlier in the year.

Some will see these as landmark planning decisions marking the way to a low-cost energy future for the UK, with shale gas becoming a major new source of energy in countries across the globe. For others, particularly those who live locally, they will be seen as leading to potential environmental catastrophe. These fears are fuelled by many reports from the United States about the risks associated with shale gas extraction by fracking – water contamination, earthquakes – plus concerns about the local impact of traffic and extraction infrastructure.

Our recent research investigates whether these fears affect what people are prepared to pay to live in areas affected by fracking, by tracing out the impacts of shale gas licensing and exploration on house prices in England and Wales.

Although commercial shale gas development has not yet taken place in the U.K., exploration licenses have been offered since 2008 and many exploration wells have been drilled. Our findings suggest that this licensing and exploration in itself had little or no impact on house prices throughout most of England and Wales. See the map below for licensed areas.

Note: The map shows blocks that were licensed for gas exploration in the 13th round in 2008 (red) and previous rounds (blue). Grey shaded areas have shale gas potential according to the British Geological Survey (BGS).

The one exception is the one site in the UK where exploratory fracking for shale gas has taken place (shown as a red dotted area in the North West on the map). Here we find that prices fell by up to 5% after fracking commenced. A specific trigger for this was the occurrence of two highly publicised earthquakes in 2011 which were linked to the fracking.

What happened is illustrated succinctly in the Figure below, which plots the trend in adjusted house prices at quarterly intervals up to and after the earthquake event in 2011. The solid line represents the earthquake zone, while the dashed lines show trends in other licensed areas and where licenses specifically mention shale gas. In this picture, prices are scaled relative to the beginning of 2011. Clearly there was quite a marked fall in transaction prices in the months after the fracking and earthquake event.

These earthquakes were minor and would not have caused personal injury or damage to property. So the most likely explanation for any impact on house prices is that the earthquakes reminded people of the potential risks, and so reduced demand for homes in the vicinity.

The implication is that there are ‘psychological costs’ associated with fracking, which should be compensated. An existing industry Community Engagement Charter already recommends payments to local communities by drilling and exploration companies, of around £100,000 for exploration, plus 1% of revenues during extraction. The government has recently consulted on a new Shale Gas Wealth fund that proposes using 10% of revenues from shale gas to fund payments with a maximum of £10 million per site, to communities and individuals affected by extraction. But aggregate costs per site implied by the house price reductions are far in excess of these – over £100 million!

Compensation to communities could prove to be very costly, if local objections to fracking are to be overcome by those who see fracking as the answer – at least in the short term – to securing Britain’s energy.

Do we value the London Congestion Charge?

Posted by Cheng Keat Tang, LSE Geography and Environment 

It may have gone unnoticed to many, but the London Assembly recently sought ideas on how to tackle congestion in the capital. One of the submissions from the London Chamber of Commerce and Industry (LCCI) calls for a radical rethink on the congestion charge and questions whether it is serving the purpose for which it was intended.

Although, contrary to some media reports, the LCCI submission does not advocate ‘ripping up’ the congestion charge, any hint of of removing the one congestion pricing system that has been successfully implemented in the UK will cause dismay amongst most economists. Congestion charging is, at least theoretically, an economically optimal way to reduce congestion, even if implementation can be practically and politically challenging. Greater use of road pricing was one of the policies advocated by the recent LSE Growth Commission report on transport infrastructure.

Of course there are many debates about how effective the London congestion charge has been in reducing congestion and at increasing the wellbeing of the capital’s residents. Surprisingly though, there is little rigorous empirical evidence on the question.

My recent research on the congestion charge addresses this gap by estimating the impact of the introduction of the charge and subsequent price hikes on traffic flows, and the consequent effects this had on house prices in the area – house prices being a useful metric of how much residents value the changes.

The headline finding is that the original congestion charge and the short-lived Western Extension reduced traffic. Homeowners valued these better traffic conditions in the western extension of the zone, where prices rose by around 4% when the congestion charge was implemented.

Background 

On the 17th of February 2003, London introduced the Congestion Charge Zone (CCZ) in Central London. A flat fee of £5.00 was levied on commuters driving into the zone between 7:00am to 6:30pm from Monday to Friday, excluding public holidays. The demarcated charge zone covered a total of 21 square kilometres and encompassed the financial centre (Bank), parliament and government offices (Palace of Westminster), major shopping belts (Oxford Circus) and tourist attractions (Trafalgar Square, Westminster Abbey, Big Ben, St Paul Cathedral) (See Map below). These are areas with the heaviest traffic flow. The rationale for the charge is not only to mitigate traffic bottlenecks and improve traffic flow and commuting time, but also to generate revenues to improve the public transport system.

Figure 1: Map of the Original Congestion Charge Zone (CCZ) & the Western Extension Zone (WEZ) (Source: TfL) 

Effects of the London Congestion Charge 

Is the charge effective? My research show that indeed it is. Relying on traffic data at a road level, I find that vehicular flow fell by 6% to 9% after the CC is first introduced in 2003, and 4% to 6% when the WEZ is implemented in 2007. Subsequent hikes, other than the initial increase in charge in 2005 (from £5.00 to £8.00), has a less discernible impact on traffic. This is understandable as marginal increases in the charge are less likely to dissuade drivers from commuting into the zone than its introduction. Commuters are now required to pay £11.50 to drive into the cordoned area when the CC is up. With less driving in the CCZ, air quality has also improved, according to others’ research. The implementation of the CC was associated with a 12 per cent reduction in air pollutants as such PM10 (Particulate Matter) and NO (Nitrogen Oxide) in the zone (Beevers et al. 2005). Roads are also much safer with a decline in accident and casualty counts (Green et al, 2016). The success of the original congestion charge led to the subsequent extension of the congestion charge zone to central west London (WEZ) in 2007 that covers Kensington and Chelsea borough - one of the most expensive and sought after estates in London.

How much do residents value these benefits?

So do homeowners pay for these benefits? To examine this, I restrict the analysis to properties very close to the congestion charge boundary (within 1 kilometre) to exploit the sharp discontinuity in traffic flow induced by the charge between roads just inside the zone and roads just outside (as drivers are deterred from driving into Central London). This ensures that properties in and out of the charged zone are almost similar other than being affected by the charge (or receiving the benefits from improved traffic conditions).

Comparing house price changes before and after the CC is implemented, my findings show that homeowners do pay for these benefits. When the WEZ was implemented, house prices rose by 4 per cent (about £30,000) relative to comparable transactions outside the zone. However, similar price increases did not occur in the original CCZ when it was introduced in 2003. There are several reasons for this. The initial introduction of the CC was not well-received by the residents. Many were unsure whether the charge was able to achieve its intended aims. Furthermore, based on census data, residents in the WEZ are more likely to own a car and drive more to work, stay further away from their workplace and earn much higher wages. All these factors could explain a larger willingness to pay to avoid traffic congestion.

Conclusion 

My findings show the effectiveness of the congestion charge and that homeowners appreciate these benefits by paying more for homes in the zone. Despite the success associated with the charge, it still faces vehement opposition from the public, who perceive it is as an extra tax. As a result, few cities are able to implement the charge, despite high levels of congestion. Some exceptions include Singapore, Stockholm, Gothenburg, Milan and Dubai. Having said that, for the charge to achieve its intended aims, drivers must be provided with a reliable public transport system to induce them to switch from driving.

References 

Beevers, Sean D, & Carslaw, David C. 2005. The impact of congestion charging on vehicle emissions in London. Atmospheric Environment, 39(1), 1–5.

Green, Colin P, Heywood, John S, & Navarro, Maria. 2016. Traffic accidents and the London congestion charge. Journal of Public Economics, 133, 11–22.

A housing failure: it’s not more rental stock we need; it’s more of the right kind of houses

Posted by Paul Cheshire, LSE & SERC 

The RICS recently called for a big boost to building houses specifically for rent because, they claimed, there will be an additional 1.8 million households looking for rental property by 2020. This misses the point and will not address the causes of our housing crisis. Our problem is not a shortage of rental housing; it is a shortage of housing - full stop. All houses are owned and occupied, vacant or rented and renting is a substitute for owning. As a result in the long run rents and prices tend to move more or less in step for a given type of house. But we have not only a shortage of houses but an unbalanced offer of houses. They are on average too small, not well enough designed or built, and in the wrong locations. That is cramped houses in places people do not really want to live. But because there is such a shortage both prices and rents have been rising consistently in real terms for two generations.

My LSE SERC colleagues and I have been generating the evidence of this shortage and identifying its causes for years now (see here, here, here or here). The uncomfortable reality is that the total unfitness for purpose of Britain’s planning system and how that interacts with our system of local taxes, seriously restricts the supply of new housing. This reality is somehow too disconcerting to confront. Politicians offer magic wands to build 1 million homes by 2020 or 55,000 a year in London but deliver no mechanisms to achieve it. They know that politically they cannot say they do not want to build more houses but they feel incapable of tackling the vested interests benefiting from both the causes of our desperate housing shortage and its results.

In 2014 my reasonably informed estimate was that the accumulated house building shortfall in the 19 years to 2012 was between 1.6 and 2.3 million homes. The problem is long term, not short term. We should not be London-centric but to illustrate with London: we were building around 75 to 80,000 houses a year in the GLA area in the 1930s; nearly 30,000 a year even in the 1870s. But since 1980 house building in London has only occasionally reached 20,000 a year. The only effect of raising ‘targets’ since 2000 – up progressively from 14,330 to now 55,000 – has been to increase the shortfall between promise and achievement. And given his policies Sadiq Khan will be no more successful at delivering on his targets than Boris Johnson was on his.

House prices have roughly doubled in real terms in every decade since the 1950 and since 2005 have risen by 47.4% But over this more recent period rents ‘only’ rose by 18.4%. This is not a ‘long period’ – the one in which we are all dead – but still the close link between prices and rents seems to have weakened.

Houses are a peculiar form of ‘good’ because they perform two functions at once. They provide a flow of housing services; they are places to live. But they are also investment assets. In a world of stable prices a sensible person would choose whether to own or rent on the basis of their circumstances and preferences. They might be young and mobile so want not to have the fixed costs of ownership. Their hobby might be do-it-yourself so they would want their own house to perfect. They might be scholars or inveterate travellers who did not want the ties of home ownership. From the investors’ point of view they might want something like a ‘bond’: a safe and secure asset, albeit not very liquid, providing a more or less guaranteed flow of income in the form of rents.

This world of stable real house prices is not an economist’s fiction. It is more or less the situation in Germany or Switzerland. Those countries have pretty sensible planning and local tax systems and they build enough houses to satisfy demand. Britain is, of course, different. We have a dysfunctional planning system and an almost equally dysfunctional system of taxes when it comes to land and housing. So both housing but even more land to build houses on, are in short supply and have been in increasingly short supply since we started to ration space by imposing Green Belts in 1955. 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 £12 to 15m: a clear signal of the loss of value imposed by not letting more people live where they really want to and could be most productive. So if you live in a world planned on British (as opposed to German or Swiss) foundations, a world in which the real price of houses nearly doubles in every decade, then of course you have a big incentive to be a home owner. Miss out at 25 and you risk permanent exclusion from the housing wealth ladder provided by our ever rising house prices. Home ownership as a tenure steadily rose from 32% in 1953 to around 70% in the early 2000s, but has now dropped back to less than 64%. For people born in the 1950s the homeownership rate nudged above 70% before they got to 34; in the past 12 years, however, homeownership rates for the under 34s have fallen from 59% to 34%. Younger people have been priced out of ownership, even become YIMBYs. This pricing out of ownership partly results from the ever rising price of houses relative to incomes but low interest rates have significantly offset that hurdle since 2007 because the annual mortgage payments fell with falling rates.

The growing hurdle for the young would-be home owner has just been getting a deposit together; especially in the face of competition – prices have after all risen relative to rents – from the fortunate cohorts born in the 1950s or 1960s withdrawing equity to get a buy-to-let as a pension. The median landlord only owns one rental property but given what has happened to returns on other assets, if you want a bit of income, letting out has become seriously attractive. So would-be owner occupiers have been squeezed out by wannabe landlords whose incentive is the extraordinary low returns on those assets normally financing pensions and the capital gains they have made and expect to make from owning homes in a market like Britain’s. This pushes up house prices but increases the supply of rental stock.

The problem is that unless we really step up house building all we do is redistribute an almost fixed stock between alternative buyers: buy-to-let landlords or owner occupiers or just a few second home owners – British or foreign – who do not occupy their houses very much. We do not need to build more rental stock; we need to build more homes.

The UK planning system – Proposals for reform (Part 2)

Posted by Christian Hilber, LSE & SERC

 

Part two of a two part series, originally published in Planning and Building Control Today

In the first part of this article (published in July), I presented an argument saying that the UK planning system has serious flaws and delivers benefits only at excessively high costs, mainly hurting the young. In this second and final part, I outline what I believe make viable proposals for reform.

Three proposals for reform 

When I gave evidence to the Treasury Committee back in April of 2016, I was asked by the Chairman what I would realistically do to tackle the affordability crisis if I were in charge of government policy. My response was the sketch of a three-pronged policy.

My first recommendation was to transition from the current development control system towards a rule-based zoning system. This transition could be piloted in a ‘Special Planning Zone’ and later introduced country-wide. The aim would be to rationalise and simplify the allocation of land use and dramatically reduce planning uncertainty, thereby also removing the valuable ‘real option’ to hoard land and delay development. The basic idea would be that instead of requiring development control permission for any change of ‘use’ of any parcel of land, certain areas would be zoned for residential purposes and within those zones, there would be an automatic presumption of development as long as the owner of land can convey that building regulations are obeyed. Neighbours could object only if they can substantiate that rules are clearly violated. This could replace the current process that involves a lengthy public consultation and often complicated Section 106 negotiations. Simplifying the planning process would have the additional benefit that it would make it easier for smaller scale developers to enter the market, thus competition among developers, reducing possible cohesive ‘oligopolistic’ behaviour among large-scale developers and ultimately leading to more production of housing and smaller ‘abnormal’ profits.

Of course just changing to a rule-based zoning system does not in itself alter the incentives of local authorities to allocate land for residential purposes. My second recommendation was thus that any reform of the planning system should be accompanied by additional fiscal incentives at local level to allocate land for residential purposes (either via granting planning permission under the current system or, preferably, via designating land areas for future residential development under the proposed rule-based zoning system). As a general principle, local property taxes should be given significantly more weight in the tax system. This could be achieved in a revenue-neutral way via replacing the national Stamp Duty Land Tax (SDLT) – a terribly inefficient tax that significantly hampers housing-related and short distance moves1. Moreover, development induced increases in the tax revenue base should not be equalised away through the central government grant system.

The current council tax, which bears little relation to underlying property values, ought to be transformed into a proper annual local property tax – or better, even a local land value tax – with automatic annual revaluation based on location-specific price changes. The key advantages of a sizeable annual local property tax are threefold: • It would generate a permanent revenue stream that would incentivise local authorities to make more land available for residential development; • It would reduce the occurrence of underused or vacant housing and would generally ensure the optimal use of the scarce resource land; and lastly • Such a tax would impose a far smaller economic ‘deadweight loss’ compared to the SDLT.

On a related note, local authorities should also be allowed to introduce impact fees. Such fees are imposed on proposed development projects to pay for all or a share of the costs of providing additional local public infrastructure and services.

My final recommendation was that the central government ought to require the various enacting bodies – typically local authorities – to critically review major existing planning constraints such as green belts, height restriction areas, protected view corridors or conservation areas. They would need to justify for each such constraint that a market failure exists and that the benefits associated with correcting this market failure can reasonably be argued to exceed the opportunity costs. For the case of green belt land, for example, a guiding principle could be that the enacting body needs to justify preservation for the various sub-sections of the belt one-by-one on grounds of significant environmental or amenity value. If no such values can be established for particular sub-sections, especially if such land is nearby already developed high-demand areas with pre-existing transport infrastructure, a presumption for development ought to be enacted.

Vested interests and a glimmer of hope 

After I outlined my proposals to the Chairman of the Treasury Committee back in April, his comment was: “I wish you well at the polls with your three-pronged policy”. Clearly, his concern was that it would be difficult to gather majority support for my proposals. He certainly has a point, although in some sense that is surprising: If policymakers were to implement a variant of the above outlined proposals, they would be bound to make the society as a whole better-off. So, why is it so difficult to gather support for such reforms?

One reason is that the benefits of certain policies or settings are concentrated among a small group of individuals with strong vested interests (e.g. homeowners benefiting from a protected vista or living adjacent to a green belt), whereas the costs are diffused throughout the whole society (all residents facing higher housing costs). While the former group has strong incentives to influence policy makers to protect the status quo, the latter group is not capable of organising their interests in a cohesive way.

A second reason is incomplete or distorted information about the benefits and costs associated with certain policies or settings. For example, consider expanding families in London that managed to get on the owner-occupied housing ladder some time ago. The staggering capital gains on their leveraged homes may well make them feel significantly better off. Yet, they are in fact likely losers of the broken planning system for three reasons:

• Compared to a ‘counterfactual scenario’ with more relaxed planning they live in artificially cramped housing; 
• They are increasingly priced out from moving to larger more adequate housing; and 
• They cannot realise their capital gains unless they move to a less desirable city with fewer planning constraints and lower house prices (or they leave the country altogether). 

 
The only real winners of the planning system are wealthy land and property owners who possess more property than they consume, elderly homeowners who are prepared to sell their houses, pocket the proceeds and move to a country with cheaper housing, and the children of wealthy parents once they eventually inherit property. The planning system cements wealth inequality, and the beneficiaries of this rising inequality have incentives to keep the system as it is.

Yet, there are glimmers of hope. There are signs that attitudes of the British public towards building more homes are changing, and are changing rather rapidly. The British Social Attitudes survey has shown a remarkable decline in NIMBYism in recent years. Opposition in England to new homes being built in the local area has declined by more than half between 2010 and 2014 from 46 to 21 percent. Similarly, support for local house building has doubled from 28 to 56 percent. Policy makers ought to take notice.

In fact, it appears policymakers already do take notice: the pre-Brexit Conservative government made some encouraging announcements (among less encouraging ones). The 2016 Budget explicitly mentions “moving to a more zonal planning system” as an objective and reducing planning related uncertainty appears to be a priority. The government also announced the full retention of the business rate by local authorities from 2020 thus providing fiscal incentives at the local level to permit commercial development. Sadly, this bold move may have the unintended consequence of discouraging local authorities from making scarce land available for private and social housing, thus potentially further worsening the housing crisis. However, it raises hope that the post-Brexit Conservative government will eventually follow with an even bolder move; to provide much stronger fiscal incentives to local authorities to permit residential development. That really could change the dynamics for the better – particularly for the young.

There are signs that the new Prime Minister Theresa May is serious about trying to tackle the housing crisis. In her last speech prior to taking on her new job, she stated the following: “Unless we deal with the housing [supply] deficit, we will see house prices keep on rising. Young people will find it even harder to afford their own home. The divide between those who inherit wealth and those who don’t will become more pronounced. And more and more of the country’s money will go into expensive housing instead of more productive investments that generate more economic growth.”

Theresa May appears to understand that lack of house building lays at the very heart of both, the country’s serious and worsening social divide and its economic crisis. She seems to understand that the stakes are high and bold action is required. This is encouraging from the point of view of those interested in affordable housing, especially the younger generation and the less wealthy. What is crucial, however, is that she and her ministers realise that demand-side policies such as Help to Buy won’t solve the housing crisis and the corresponding growing social and economic problems. In fact, more Help to Buy – notwithstanding its deceptive name – is likely to aggravate the country’s social divide and economic crisis. What is needed instead are bold reforms on the supply side – outlined in this article – that tackle the causes of the problem. This would require bold leadership that puts social welfare and social justice above vested and narrow party interests.

There is no denial that – despite changing social attitudes – implementing supply-side reforms entails a political risk. Any potential reforms are further complicated by the fact that Brexit (apart from attracting much of the political attention) is likely to significantly adversely affect the real economy in the short-run and thus house prices. This may (further) reduce incentives of developers to build new homes. It may also, in the short-run, weaken political pressure to impose effective supply-side reforms, implying an economy eventually recovers. If however Theresa May turns out to be a bold leader willing to take a political risk and enact meaningful supply-side reforms, then there is real hope. Real hope particularly for the young generation and those less wealthy. Real hope to move towards a ‘One Nation’ society that is less defined by social divide. If she also manages to limit the adverse long-run economic consequences of Brexit, then there is real hope for a more prosperous future for all.

This article builds on, and is in small parts, identical with my oral and written evidence to the Treasury Committee. 

References

Hilber, C. and T. Lyytikäinen (2015) Transfer Taxes and Household Mobility: Distortion on the Housing or Labor Market? SERC Discussion Paper, No. 187, October.

The UK planning system: fit for purpose?

Posted by Christian Hilber, LSE & SERC

Part one of a two part series, originally published in Planning & Building Control Today

There is no denial: the UK faces a serious housing affordability crisis. This crisis is not a short-term phenomenon, not the result of a financial bubble. The crisis has been brewing over several decades. Over the last 45 years, house price growth in the UK has been faster in real terms than in any other OECD country and has far outstripped earnings growth. Normally when demand is rising, construction booms as well and that eases price growth. This has not happened in the UK; construction of new housing has been decreasing more or less steadily since the late 1960s from 353k units in 1968 to 118k units in 2014, leading to a very substantial and ever growing housing shortfall. Not only that; newly built homes are also about 40 percent smaller than in similarly densely populated European countries.

In the Greater London Area (GLA) the problem is particularly acute. To illustrate this, the average house price in the GLA has gone up by £65.2k year-on-year since March 2015. The latest average household income estimate for the capital for 2013 is £51.8k. Put differently, last year, the average London homeowner earned more from capital gains than a renter from working all year long. It is therefore no surprise that young adults without wealthy parents are increasingly priced out from getting onto the owner-occupied housing ladder. Renting in the private sector is similarly unaffordable, so the young – even the highly skilled – increasingly have no other option but to stay at their parents’ home longer or leave the city. Consistent with this, the share of those employed in inner London working in professional scientific, research, engineering and technology jobs has fallen since 2011, hurting the capital’s productivity. The housing affordability crisis is an economic as well as a social problem.

Tight local planning constraints push up house prices 

Longstanding UK evidence, summarised in the Barker Review (2003) , demonstrates that housing supply is extremely unresponsive to changes in demand. That is, if real earnings and population grow over time, construction hardly responds, causing house prices to rise markedly in order for the housing market to clear. Long-run supply constraints are the only plausible explanation, but what kind of constraints? Barker suggested that the rigid planning regime may be a likely candidate. Others hypothesised that geographical and physical constraints are to blame.

In a recent study – published in the March 2016 issue of the Economic Journal – my co-author, Wouter Vermeulen, and I rigorously tested these conflicting hypotheses. Employing methods that allow us to establish causal effects rather than just correlations, we explored the impact on house prices of three different types of local supply constraints: (i) planning induced constraints, (ii) scarcity of developable land and (iii) topographical constraints.

Our evidence is strongly supportive that the planning regime in England is the main cause of the excessively high house prices, particularly in the GLA and the south east of the country. Our estimates imply that house prices in England would have increased by about 100% less in real terms between 1974 and 2008 if, hypothetically, all regulatory constraints were completely relaxed. More pragmatically, if the south east (the most tightly regulated English region) had the regulatory restrictiveness of the north east (less regulated but still restrictive by world standards) house prices in the south east would have been roughly 25% lower in 2008 and perhaps 30% lower in 2015. Topographical constraints also matter in a statistical but not in a quantitative sense. Finally, the effects on house prices of constraints due to scarcity of developable land are mainly confined to highly urbanised areas such as the GLA, but in these locations they are economically important. In a nutshell, house prices in London would still be fairly high by world standards even if regulatory constraints were relaxed, but housing would be substantially less unaffordable than today.

Tight planning constraints do not only push up house prices. In conjunction with business cycles they also amplify price volatility, thereby creating systemic risks. Moreover, regulatory constraints tend to be tighter and more binding in more desirable places such as the GLA, Oxford or Cambridge, implying that housing is built in the ‘wrong’ places; far too little housing is produced in the most successful, most productive cities where demand is strongest. Evidence for the United States suggests that lowering regulatory constraints in high productivity cities like New York, San Francisco and San Jose to the level of the median US city would increase production by about 9.5%. The ballpark figure may be similar for the UK.

Weighing the benefits and costs 

Planning induces both benefits and costs. There are considerable potential benefits in the form of correcting market failures such as monopoly power, externalities and lack of provision of public goods. For example, planning has the potential to solve the holdout problem in land assembly for transport infrastructure. It may prevent excesses of urban sprawl and may protect important views on landmarks and historic buildings. Planning may also ensure the provision of public parks as well as the preservation of natural habitats and cultural heritage.

The trouble with the UK planning system is that it often prevents, contains, preserves and protects even if no market failure is apparent, and with complete disregard to any costs that may outweigh the benefits of the intervention. One example to illustrate the point about market failure is London’s green belt. The green belt contains areas of outstanding natural beauty that ought to be protected. However, it also contains heaps of intensive agricultural land with little environmental or amenity value near existing developments with transport infrastructure. There is a strong case to permit housing on such land.

An example to illustrate the point that the planning systems disregards costs is the view corridor to St. Paul’s Cathedral from King Henry the VIII’s Mound in Richmond Park. This corridor was established in 1710 – when the St. Paul’s Cathedral was by some margin the tallest building in the country and the economic costs of view corridors were negligible. The protected vista frames the cathedral through a special gap in a holly hedging from a distance of over 16 kilometres. While this view is certainly enjoyable for those living nearby or for hikers, it arguably imposes an astronomic and ever growing economic ‘opportunity cost’: the protected vista prevents the construction of any tall building throughout the corridor that would obstruct the view. Worse, it also prevents tall construction in the backdrop of the cathedral, limiting development around Liverpool Street Station, one of the most productive hot-spots on earth. The protected vista, through limiting supply, raises housing costs of all Londoners and adversely affects the capital’s productivity.

Key flaws in the current system 

More broadly, three key flaws can be identified in the UK’s planning and tax systems. The first is the fact that the UK operates a so called ‘development control’ system, which is inherently geared towards containing development. In contrast to a rule-based zoning system – in use throughout most of the rest of the developed world – the UK system stipulates that any change of ‘use’ of any parcel of land requires development control permission granted at local level. Permissions are granted by local planning authorities, which invoke a consultation process that gives significant weight to NIMBY pressures.

The trouble with the development control system is, apart from giving weight to NIMBYs, that it is complex, substantially increases the cost of the development process and creates a great degree of uncertainty during the planning stage. The lengthy and uncertain process delays and significantly reduces the viability of projects. The viability is further threatened by Section 106 agreements that require complicated negotiations between local authorities and developers and imply a further degree of uncertainty for the latter.

The second key flaw – the lack of fiscal incentives at local level to permit residential development – relates to the first one. Local authorities that grant development control permission retain little tax revenue. This is made worse because of the central government grant equalisation system, which in the medium-term more or less eliminates any revenue gain for local authorities that permit more development relative to those that are more restrictive. Any increase in the local tax base is effectively equalised away by the central government. In other words, local authorities derive few benefits from permitting development, yet they face the costs of additional infrastructure that development makes necessary – local roads, schools and the like. These costs are rarely met fully by the central government. Worse, local residents bear the main burden associated with increased local congestion or pressures on public services such as local schools. This increases local opposition often beyond those neighbours who are immediately adversely affected.

The third key flaw of the UK planning system is the fact that since the Town and Country Planning Act of 1947, residential development has increasingly been prevented ‘in all directions’: The larger British cities are surrounded by enormous green belts that are effectively sacrosanct from residential development, thus preventing growth in a horizontal direction. (Moreover, green belts prevent the delivery of the type of housing – single family owner-occupied homes – that is most desired by large fractions of the population, but is arguably in shortest supply.) Height restrictions and view corridors prevent physical development in a vertical direction. In fact even digging below ground is often not a viable option to gain living space. Height restrictions constrain tall buildings in nearly all high-demand UK cities, particularly of course large parts of London. In addition, protected view corridors prevent construction of tall buildings in some of the most productive inner city areas. Lastly, preservation policies (e.g. Conservation Areas and Listed Building designations) limit redevelopment of existing structures at higher density or better adapted to current preferences. It is this combination of rigid policies ‘in all directions’ that explains why supply is so incredibly unresponsive in many British cities. If desirable cities such as London cannot grow physically over a longer time period, and as long as demand – mainly real earnings – grows and expectations are positive, house prices must rise markedly. (Brexit may change this. However, if prices fall as a consequence of a fall in real earnings, housing may not become more affordable.)

Why Help to Buy does not actually help to buy 

The fact that housing supply in the UK is so extremely unresponsive also has important consequences for the effectiveness of housing policies, including the Government’s flagship policy Help to Buy (HtB). The various HtB schemes are intended to stimulate housing demand and their aim is to generate new housing supply and higher homeownership attainment. However, in a setting where housing supply does not respond to demand side stimuli, the only direct effect of the policy is to increase house prices.

The effect of HtB on house prices has not yet been rigorously quantified in academic research. However, house price and construction statistics seem strongly suggestive that HtB did not have the intended effects. According to Nationwide, following the announcement of the first HtB schemes, house prices in London shot up by 25.8% between 2013q2 and 2014q2. A residential building boom failed to emerge and homeownership attainment continued to decline. The Government may have been well intended in helping young households to get on the owner occupied housing ladder, yet it has likely achieved the opposite. How is this possible? If the HtB subsidies indeed had the main effect of raising prices and through that the required mortgage deposits, this arguably made it even more difficult for young liquidity constrained households to afford a decent home, despite HtB. This proposition is consistent with evidence from the US, which reveals that the capitalisation of mortgage related subsidies into house prices decreased homeownership attainment in tightly regulated cities. To make things even worse, the HtB schemes may also have created a systemic risk in that the Government (and indirectly the taxpayer) assumes most of the risks associated with the guarantee schemes, with the remaining risk being assumed by the marginal homebuyers—those who stretched themselves to obtain a loan and could not have obtained one in the absence of the scheme.

In the second part, Christian Hilber, will offer three proposals for reform and provide a glimmer of hope for those interested in more affordable housing.

Brexit and the Location of Migrants

Posted by Felipe Carozzi, SERC & LSE

The results of the recent vote to leave the EU have come with a plethora of cross-sectional and spatial analyses, provided by the different British media outlets and their data journalists since Friday morning. We have learned about the generational profile of voters, the poor results of the stay campaign on traditional labour strongholds, the wide difference between results in large cities and small towns. While it is often hard to give a clear interpretation to these correlations, it is natural that we build our narratives and explanations of what happened on Friday with these elements.

I found one pattern particularly striking, the apparent negative correlation between the fraction of not born in the UK and the leave vote share. This correlation is depicted (once again) in Figure 1 for districts in England and Wales only. You can surely find it elsewhere (for example, here).

What is remarkable about this correlation in particular is that it seems to contradict the notion that the Leave vote was largely motivated by concerns about migration, symbolized in the claim that leaving would allow the UK to “regain control of its borders”. If fears of excessive migration fuelled the leave vote, wouldn’t we expect a positive correlation in Figure 1?

Of course, several candidate explanations for the observed negative relationship are available. Migrants may have sorted into more migrant-friendly areas. Or anti-immigration voters may harbour that position precisely because they are not acquainted with migrants. Or maybe a large fraction of the foreign born population had already acquired British citizenship and disproportionately voted to stay. Still, the robust negative correlation seems surprising in light of the centrality the debate about migration occupied during the campaign.

The apparent paradox is at least partly dispelled if we look at changes rather than the levels in the fraction of migrants. When we turn to the proportional change in the fraction of residents not born in the UK in the 2001-2011 inter-censal period, things start to align with anecdotes indicating that migration was indeed a key element leading to the Leave victory. Figure 2 shows this correlation for districts in England and Wales. We see that the correlation is now positive, indicating that places that experienced a larger relative increase in migration between 2001 and 2011 disproportionately supported the leaving the EU.

I will not make causal claims on this correlation, I know better. But if you wanted to argue that the leave vote was driven by concerns about migration, and felt perplexed about the widely circulated negative correlation in Figure 1, then the second figure may help understand things a little bit better. 

Technical note: Both correlations are robust to excluding London. I have also estimated a regression of the Leave vote share at the district level on the fraction of migrants in 2011 while controlling for the fraction of migrants in 2001. The coefficient on the first variable is positive while the coefficient on the second is negative, with both being statistically significant. Results are robust to including region fixed effects and flexibly controlling for population. For a rigorous analysis of the effect of immigration on voting behaviour by residents, see for example the work in Barone et al. (2016) for Italy, which carefully explores the causal links at play. Remarkably, they do not find an electoral response to migration in large cities.

References
Barone, G., D'Ignazio, A., de Blasio, G., & Naticchioni, P. (2016). Mr. Rossi, Mr. Hu and politics. The role of immigration in shaping natives' voting behavior. Journal of Public Economics, 136, 1-13.

You cannot regulate empty houses away

Posted by Christian Hilber (SERC & LSE), Paul Cheshire (SERC & LSE) and Hans Koster (VU Amsterdam) 

“Almost 57,000 homes in London stand empty…” writes David Smith in the Guardian on May 4th. This he claims is a significant cause of London’s housing problem and the “Key to this is tackling buy-to-leave investing.” The answer to this ‘problem’ is for the mayor to refuse planning permission and for Boroughs ”…to introduce planning restrictions …to prohibit the deliberate practice of letting properties lie empty.“ This is not a view unique to David Smith. For example, the well-known architect Lord Rogers in arguing against the desirability of permitting offices to be converted to housing to help with London’s housing shortage noted: “Why should we rush to convert office blocks when we already have three-quarters of a million homes in England lying empty.”

Leaving aside the fact that any housing market always needs empty houses if it is to run smoothly – people move house, they die or they need major building works – is this the solution, even if it is a problem? Is making planning permission more difficult to get or imposing additional conditions a feasible way of reducing the proportion of empty homes?

The trouble with interventions in the housing market is that however well-intentioned, they generate all sorts of unintended consequences. And sometimes achieve exactly the opposite of what was intended. The uncomfortable truth is that we need to understand how things actually work: not pass laws or regulate hoping to make them work the way we would like them to. One of our most recent research findings is that more restrictive local planning actually increases the proportion of vacant homes.

Of course by making housing even scarcer (which more restrictive planning achieves) it makes it more expensive. This generates an incentive to occupy it, so reduces vacancies. Unfortunately more restrictive planning also makes it more difficult to adapt homes to the constantly changing patterns of demand. Jobs grow in a locality, so demand for houses there increases; the local school gets better so the demand for family sized homes increases; people buy a car so want parking; they have fewer children or separate so they want smaller homes – the list is potentially endless. The result of this is that in more restrictive locations people wanting a home find it more difficult to match their preferences to what is available. So they have to search longer or further afield. The result of that is there are more empty houses.

These two effects work at the same time and in the opposite direction, of course. Which dominates and so whether more restrictive policies increase or reduce the proportion of homes that are empty net, is a purely empirical question. Our results for England, using data from 1981 and being careful to offset for reverse causation and other econometric problems, show that the net effect of more local restrictiveness is not just to increase the proportion of empty homes but to increase it substantially. A one standard deviation increase in local restrictiveness causes the local vacancy rate to increase by nearly a quarter. That is not all. Because it makes finding a suitable house locally more difficult it also increases the average distance people have to travel to work. The same increase in local restrictiveness causes an 8.5 percent rise in commuting distances.

So the Islington policy quoted approvingly by David Smith will in fact be likely to increase the proportion of empty homes in the Borough – not reduce it – and at the same time mean that people who work in Islington will end up commuting further. Roll it out over London as a whole and we would expect the same outcome. The absolute opposite of what the advocates of the policy wanted to achieve.

NHS walk-in centres are popular, but divert few patients from A&Es

Posted by Ted Pinchbeck, SERC 

Originally posted on the LSE Business Review, here.

In 2010 NHS Walk-in Centres were a valued feature of around 200 communities in England, but many of these facilities have since closed or are facing closure. My research may go some way to explaining why: less than a fifth of patients attending a centre would otherwise have attended an A&E, meaning the centres do little to relieve pressure at busy casualty departments.

The rise and fall of the NHS walk-in centre 

Walk in health services of one form or another feature in many healthcare systems, including Canada and the United States. In England, the first NHS walk-in centre opened in the late 1990s but only became prominent in the late 2000’s following a policy initiative that led to the opening of around 150 new facilities.

Offering extended hours and with no requirement for patients to pre-book or register, many new centres had proved highly popular with local residents with minor illnesses and injuries such as colds, eye infections, sprains and cuts. But despite this popularity, during the last parliament around a fifth of the facilities shut their doors, with a number of others, for example in Redruth, Hereford, and on Teeside, also currently at risk.

Taking sides 

Why the services should have closed in such numbers is not immediately clear: the scale of local opposition to some closures – for example in Jarrow, Worcester and Southampton – was intense. Their supporters argue they reach new groups of patients, provide easy and convenient access to care, and take pressure off other stretched NHS services.

At the same time, commissioners closing centres argue they represent a poor use of funds as many attendees have minor conditions that have little need for medical attention, and those that do could readily be treated elsewhere. Some have cited the need to fund seven-day-a-week access to GP services as a more pressing priority.

While not the whole story, one important question in these debates is whether walk-in centres divert patients from attending busy hospital A&E departments. This may be desirable since crowding at A&E is associated with high mortality and can have knock-on effects by reducing the capacity for hospitals to carry out planned medical treatments. In addition, many attendees at A&E have low severity needs which could be safely treated outside a hospital setting. Treating these patients as emergency cases in hospitals is considerably more expensive than treating them in walk-in clinics.

Building the evidence: do walk-in centres divert patients from A&E? 

Until recently there was no conclusive hard evidence – from either side of the Atlantic – either way. When surveyed, around a quarter of patients attending walk-in centres say they would otherwise have attended a hospital A&E. However, academic research using statistical methods has been unable to detect any such effect.

My research provides new evidence that goes some way to filling this gap. Combining detailed information contained in hospital records with difference-in-difference statistical techniques, I provide credible estimates of how patients’ use of A&E departments changes in response to the opening or closure of a new walk-in centre close-by.

Two main findings emerge. The first is that walk-in centres do significantly divert patients away from attending A&E. The second, however, is that relative to the number of patients attending walk in clinics the effect is small, with calculations suggesting only around five to 20 per cent of patients attending a walk-in clinic would otherwise have gone to casualty. The implication is that they only make a small dent on the overall A&E figures.

Conclusions 

The research points to something of a dilemma for decision-makers. Easy access services such as Walk-in Centres are popular, which suggests they are valued by patients. The evidence suggests they do make a small contribution to relieving pressure at over-stretched emergency services, but with low diversion rates from A&E they may be an expensive way to do so. The cold reality of a chilly funding climate points to hard choices in allocating scarce NHS resources to best meet local demand. With this in mind, fights over the remaining centres look set to continue.

Next London Mayor should work with Wider South East to rethink the green belt

Posted by Ian Gordon, SERC and LSE Department of Geography & Environment 

This article was originally published in the Centre for Cities’ Mayoral Elections 2016 blog series, in which experts from the worlds of business, housing, local government and academia discuss the big issues ahead of the elections on 5 May. 

Whoever becomes the next mayor must recognise the need to work with London’s neighbours to tackle the region’s housing shortages. 

Ahead of today's election, the various London mayoral candidates have been keen to emphasise their commitment to protecting the welfare of Londoners, present and future. However, one major issue missing from the mayoral debates so far is a recognition that this cannot be achieved by treating London as an island within the M25 – as both Ken Livingstone and Boris Johnson have done in their time in office. This isolationism is no longer sustainable given the threat posed by chronic housing shortages, as well as the size of the opportunities that an integrated regional approach to public investment would offer to both Londoners and their neighbours.

The incoming Mayor, taking over a strongly established GLA, has the chance to make their mark by recognising the crucial linkages between their turf and the Wider South East. Practically, this means taking serious account of how ‘cross-border’ economic, housing and labour market links will affect policy decisions. But it also means working more actively with representatives from the wider region to resolve shared problems and make the best of the joint potential of this southern heartland.

These themes emerge strongly in the final set of reports from the current Mayor’s Outer London Commission (OLC), but they have barely figured in the electoral manifestos of the leading mayoral candidates. Caroline Pidgeon has promised a specific dialogue with the rest of the South East about accommodating London’s household growth when brownfield sites in London ran out. But neither Zac Goldsmith nor Sadiq Khan have shown any more inclination than their predecessors to look beyond the borders of their electorate. In part, this is because these are not electorally appealing issues, especially given the sensitivities around the green belt. But with the housing crisis set to dominate the political agenda in the capital for years to come, the question of how London engages with its neighbours has become important to address.

This will not succeed if the Mayor is simply perceived as asking neighbouring regions to house those who they’ve failed to accommodate within the capital. Leaders from across the wider South East, who’ve held two preliminary summits with the current Mayor, are expecting London to do its bit in releasing extra land for development, but they have a wider agenda and are responding to the fact that the housing crisis is region-wide. Its common cause is the overall tightness of land supply across the South East, exacerbated by greenfield development quotas which have bitten most directly outside London.

The issue is shared because neither mayors nor planners elsewhere can ‘control their domestic borders’. Housing completions need to double to meet the estimates of housing need, but despite all the efforts currently proposed by the OLC and others, this is still unlikely. In that case, some of London’s projected population growth will simply get diverted into neighbouring sub-regions. But since capacity there is also limited, the likely knock-on effect will be for more local residents to look further afield for affordable housing – spreading London’s housing footprint even deeper into semi-rural East Anglia, Wales and the South West (if not to cities further north).

This would be a perverse and environmentally unsustainable outcome of ‘compact city’ planning policies. Instead, a much better idea would be to take a city-region approach – channelling growth into well-connected strategic locations closer to London, which would enhance both economic and environmental sustainability.

The OLC reports offer a series of recommendations for how the new Mayor can boost housing output from brownfield sites within London. However, this alone won’t close the supply gap, requiring new initiatives to bring other land into residential development. To address this in a sustainable way, the OLC recommends that the new Mayor should take a lead in ensuring strategic reviews of green belt are undertaken on a co-ordinated basis, both inside London and beyond. Another more specific proposal recommends a focus on the development of five Growth Corridors along major transport axes in and out of London, with an integrated combination of housing, employment and enhanced transport links.

As the Centre for London’s recent Manifesto for London also recognises, opening-up more land for development must be pursued in a controlled fashion that can command broad support. This may be best achieved through identifying specific well-bounded areas, with potential for dense development, to be excluded from the green belt – removing the fear of continual incursion into other areas. This should also be buttressed by ‘deals’ to enhance environmental quality across other nearby green belt areas, and to upgrade communications links.

Of course, these ideas are speculative – the point is that willing partners and public confidence will be required in order to find solutions to the housing crisis across the South East. As the most powerful political actor in the extended region, the Mayor of London could play a crucial leadership role in this process, by helping to negotiate deals with the government and to build habits of co-operation among regional partners.

But most importantly, the new Mayor must recognise that London simply isn’t a free-standing city-state, and that it can’t ‘consume its own smoke’ in accommodating its projected population growth. Securing a decent quality of life, both for Londoners and their South East neighbours, will require region-wide efforts to re-model a much-valued – but outdated – green belt for the 21st century.

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.

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.

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.