Thursday, 29 March 2018

Housing: the happy self-delusion of ‘no shortage’

Posted by Paul Cheshire

The assertion that there is no actual shortage of houses seems to be gaining, if not traction, then at least supporters. Ian Mulheirn, of the consultants Oxford Economics, originated it. Matthew Parris on 10 Feb in The Spectator took up the cause of no housing shortage. It is true house prices have more or less doubled in real terms in every decade since the 1950s and continued to rise well ahead of inflation until this year. We know the young are getting squeezed out of owning houses. Similarly we know that the ONS measure of affordability shows houses are twice as unaffordable as in 1998 and are now less affordable relative to incomes than at the height of the 2007 boom. The measure may be imperfect but it is transparent - just the ratio of the median house price to median income.

The currency the ‘no shortage’ assertion has gained seems to be less the result of the persuasiveness of the evidence for it than the fact that it is a comforting narrative, appealing both to politicians and the CPRE/NIMBY brigade alike. It allows people to claim nothing uncomfortable (or effective) needs to be done about the crisis of housing affordability. It appeals to the NIMBY/CPRE brigade because the ‘solution’ doesn’t require us to build any more houses.

But the problem is that this claim of no ‘shortage of houses’ is based on no understanding of how housing markets work or even how one might usefully define a ‘shortage’. A shortage can only be usefully defined in terms of the balance of supply and demand. Basic economics is enough to give at least a hint that if prices are persistently rising in the long term, as house prices have, supply is less than demand. One of the additional paradoxes of our shortage, however, is that the constraints on supply imposed particularly by our planning system, cause prices to be more volatile too. So when demand does fall, all the adjustment is via price.

The evidence cited in support of the ‘no shortage’ assertion is that there were more houses per household in 2016 than there were in 1971. True: but there were more doctors per person in 2015 than in 1971 too. Far more. According to the World Bank the number of doctors per thousand people increased from 1 in 1971 to 2.8 2015. By comparison houses to households hardly increased at all: from 1 to 1.02 (England).

No one is asserting there is a surplus of doctors. As people get richer they demand more health care; that also happens as they get older. The ability of doctors to treat illness has greatly improved. It takes more doctors to treat cancer patients now than in 1971, partly because treatment can do so much more. The rising ratio of doctors to people reflects rising prosperity, the aging population and technical progress complementary to the demand for doctors. Much the same is true of houses. One of the inconvenient facts about the demand for houses is not just that as people get richer they demand more housing space but they do as they get older. Even after adjusting for income, education and other relevant factors, older people demand more housing space. As car ownership has grown people demand more space around their houses.

Not only do people buy bigger houses as they get richer, a few buy second houses. A second home is no more ‘needed’ than is a private pension or a new outfit. But incomes are not equally distributed and that is how markets work. Also, of course, since the real price of houses has risen so rapidly over the past two generations (and since 2007, other assets have performed so badly) houses are, increasingly, pensions; not just shelter. They may be bought to let using equity accumulated by older owner occupiers or just be a nest egg, even if vacant.

Houses are not barrels of Brent Crude – all the same. They all vary and one attribute on which they vary is space: both internal living space and space in gardens. Also location is a critical attribute of houses. As we have pointed out before houses in Barnsley – though buildable on brownfields – are not substitutes for houses in Oxford – where the high productivity and high paying jobs are.

As I and LSE colleagues recently showed, more restrictive local planning in fact increases the number of vacant houses as well as increasing commuting distances for workers. Because houses all vary, ‘house hunting’ involves search - for the best set of attributes you can afford, where you want to live. More restrictive local planning increases local house prices, creating an incentive to keep them occupied.

But tighter local planning also makes it more difficult to adapt the characteristics of the housing stock to what people want and where they want to live. The result is house hunting becomes less efficient, so more houses are empty. These two forces work against each other but when you carefully analyse the data over the past 30 years, it is clear that impaired search dominates. Local vacancies are 23 percent higher if local planning restrictiveness increases by one standard deviation. 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 a 6.1 percent rise in commuting distances.

If, in the 25 years to 2016, we had built in England at the rate we built in the 25 years to 1991, we would have built 2.2m more houses; that is we would have built 63 percent more houses than we did. New houses have also been smaller. The result is an aging stock of increasingly cramped housing. In 1967 62.1 percent of English houses were less than 50 years old: in 2015 that had shrunk to 38.8 percent: not much more than the proportion that were less than 25 years old in 1945 – despite almost no building during the 5 years of WWII. English houses are akin to Cuban cars: they are still in use but they are clapped out and polluting.

There are two other important points. The no housing shortage assertion tells us to look at figures for ‘net additions to the housing stock’ not at those for completions – houses actually built. Politicians increasingly do the same. For example, housing forecasts and targets in the latest London Plan are all in terms of ‘net additions’. On the face of it this sounds plausible but there are good reasons why the number of new houses actually built gives a far more reliable and useful figure. We have comparable data for a very long time – at least since 1946. So one can track house building over the long term. You can count houses but ‘net additions’ include conversions and changes of use as well as taking account of demolitions.

In the old days we used to knock down unfit houses, so ‘net additions’ were less than completions. But as the price of houses has gone up and up, instead of knocking them down we spruce them up, often subdividing them into two smaller units. Thus one house becomes two. In other words the worse the shortage of housing, the higher will be net additions relative to actual building. So measuring changes in the shortage of houses by comparing the number of households and the stock of homes over time will definitionally tend to underestimate the ‘shortage’. There may be ‘homeunits’ but, reflecting the growing shortage, they are increasingly small and less fit for purpose.

A similar argument applies to the denominator in the chosen measure of ‘shortage’: households. The increasing unaffordability of housing has generated an increase in young people living with, or returning to, their parents. Young couples put off having a family and live in a parent’s front room. Household formation is itself a function of houses prices and as they go up in real terms, household formation rates fall. Again Ian Mulheirn’s measure definitionally underestimates the shortage.

There is certainly a housing shortage in the sense that we have not been building enough houses to satisfy demand for at least 25 years. That there are fractionally more homeunits per household is irrelevant: incomes have risen so therefore demand has too – substantially; population has aged so (paradoxically to some) demand for housing has increased; the stock of houses, reflecting the falling rate of building, is aging and decreasing in average size; and because of the shortage, the formation of new households has been choked off.

Sorry but the politicians cannot just sit back comfortably. There is a housing shortage and it is causing a crisis of housing affordability. The only way to resolve the problem is to do something radical and uncomfortable. Build more houses.