Business Rate Retention

Nick Clegg's speech on business rate retention suggested that the reforms will not hurt poor councils. This will be true in the short run - because the initial allocations can be made to replicate current funding - but it cannot possibly be true in the long run if retention is to provide incentives to local councils.

Local financing in Britain is incredibly complicated but my understanding of why incentives and level playing fields are incompatible runs roughly as follows. Business rate revenue is currently centralised and then redistributed. HMT will have built assumptions about this stream of revenue in to spending plans. As any growth in business rate revenue now goes to local councils, HMT will either need to cut elements of the central grant or make some items of central expenditure the responsibility of local councils (or both). As this happens, councils who have experienced slow growth in business rates (relative to the average) will be worse off. Countering this would require periodic readjustments to equalise expenditure across local authorities. But these re-adjustments remove the incentive effect. Only if the reform generates a large amount of additional growth in the country as a whole could top-slicing provide additional money to poorer councils while leaving strong(ish) incentives in place. Even those of us who are optimistic that there would be some impact on growth from providing good incentives would be careful about pushing the argument that far.

A final point - the current plans are about business retention rather than allowing flexibility in business rates. My research on the impact of business rates when they were set locally suggests the government may be right to be cautious in this area. By comparing employment over time in firms close to local authority borders with that in neighbouring local authorities we showed that business rates have a negative effect on employment growth by existing firms. We also document wide variations in business rates across neighbouring authorities. Perhaps today's local authority leaders would be more worried about the extent to which they could tax business, but the historical record suggests there are reasons to be careful when it comes to re-localising rates.

City Life Bad for the Brain?

Research looking at brain activity suggests that brains of city dwellers react differently to those of rural inhabitants when people are subject to stress. The findings were quite widely reported, but reading the paper suggests considerable caution in interpreting the results (as the authors, but not all the reporting, points out).

The problem is one that is familiar to social scientists who are interested in the importance of place effects. Let's imagine that you are trying to study an outcome such as the propensity to drop out of school. There is plenty of evidence that individual ability and family background play a major role in drop-out. What about neighbourhood? The problem, of course, is that people are not randomly assigned to neighbourhoods. So when you observe high drop out rates in a neighbourhood this may be because of something specific to the neighbourhood, or it may be because of the type of families (and hence children) that live there. In the social science literature, researchers have tried to deal with this problem in a number of ways. Some studies look at very large cross sections with lots of information on individual and family background so that they can try to control for other factors. Studies which follow people over time are usually seen as an improvement on these cross-section studies (because they allow researchers to at least control for factors that are fixed over time). Even better are situations which might be viewed as quasi experiments where something - e.g. bombing in the second world war - has affected neighbourhood composition for reasons that are nothing to do with choices by today's residents. Finally, there is the "gold standard" of randomly assigning people to neighbourhoods - an approach taken by the Moving To Opportunity programme in the US.

The difference between these approaches can matter a lot in practice. In SERC research on wage differences, controlling for observable characteristics of individuals substantially reduces estimates of the effect on wages of living in big cities. Controlling for unobserved individual characteristics reduces the effects yet further. Taken together, control for individual characteristics explains at least half, if not more, of the difference in wages between UK towns. To take another example, in earlier research looking at obesity and urban sprawl we found that any positive relationship disappeared when we followed a large sample of individuals across time.

Which brings us back to the brains of city dwellers. Because MRI scans are costly to administer, sample sizes in this research are necessarily small - 32 people in the case of this most recent study. This makes it very hard to attribute any observed differences to a causal effect of urbanicity per se, rather than to the sorting of individuals with different characteristics across rural and urban places. It does seem slightly ironic that just as the social sciences have moved towards studying individuals subject to random placement (such as in MTO), neuroscience studies are forced to move in the opposite direction (controlling for observable characteristics in small samples of non-randomly selected individuals).

Investing in London's Affordable Housing

An interesting report from LSE London argues that the government should invest more heavily in affordable housing in London. [Disclosure: I am affiliated with LSE London]. It justifies this conclusion on the basis of need (crowding and rent-to-income ratios are higher than in other parts of the country), value for money (costs are higher, but land used more intensively and private sector leverage higher) and housing numbers (the government will not reach its affordable housing number target otherwise).

There are a couple of striking differences here with the message I took from Steve Nickell's LSE lecture on housing and immigration. First, Nickell argued that reducing supply constraints at the top of the housing market would be the cheapest way for government to drive down prices across the market (including for smaller houses and flats). Second, Nickell thinks that strong incentives for local government are the key to achieving these increases in supply.

In part, I think these differences come from different underlying assumptions about equality and access to housing. Welcoming the report, Stephen Howlett, chief executive of London housing association Peabody noted: "that while G15 associations are trying to make the most of the new system, it doesn't enable them to provide affordable housing for larger families particularly in central London". I can't speak for Steve Nickell, but personally I am pretty sure that this should not be a priority for affordable housing investment. Most professionals cannot afford large family homes in central London so I see little to be gained by trying to address that problem via affordable housing investment.

What about the issue of direct grants versus local incentives? Here, I think there are two interpretations. Taken narrowly, LSE London are calling for a focus of existing funding allocation in London. That is, given that we are going to spend the money on affordable housing, we may as well spend it in the place where it is most needed and provides most value. More pessimistically, however, it may be that the authors feel that the incentives simply will not be large enough and that direct subsidies will remain necessary.

Given that I have highlighted the disagreements, let me end by focusing on an important point of consensus. Whether using subsidies or incentives (and subject to the usual caveat on externalities) both Nickell's lecture and the LSE London report agree that policy should encourage house building in places with high house prices.

Moving the Poor out of London

In an article in the Evening Standard, Ben Rogers (who directs the new Centre for London) argues that moving the poor our of London will not do much to help address poverty.

I am sure he is right but, as the article also acknowledges, allowing them to stay put doesn't do much to help address their problems either. If you want to read more on the evidence, take a look at our SERC policy paper on the effects of mixed communities. That paper also talks about some of the benefits of segregation that Ben Rogers refers to in his piece. You can read about a more trivial example here.

On the related issue of housing benefit reform, seven months ago I published my list of open questions about the impacts. While I think we are slightly further along in terms of knowing how many people might be directly affected, I think many of the other questions remain unanswered.

Localism and Housing Supply

I wrote recently about unresolved conflicts in the government's approach to planning, economic growth and the natural environment.

One of those conflicts involved the tradeoff between localism and growth in terms of the supply of housing (to recap: localism may encourage NIMBYs, while incentives to local authorities try to encourage growth). According to the Guardian, research by BNP Paribas suggests that the NIMBYs are winning and that localism may make housing shortages worse. Looking at target figures, the research finds that half of local authorities have announced they are sticking to original targets, 12% cutting and only 2% increasing. The average change is a cut in target of 20.6%.

It is, of course, possible that the authorities that are considering increases will announce later. But if that doesn't happen extrapolating this cut across all LAs means 31,000 fewer homes built next year (leaving total targets around 85,000). This is some way short of the 270,000 houses per year that Steve Nickell suggested were needed in his lecture earlier this week.

It's also possible that these figures may improve once the system beds down and the economy improves. But I wouldn't like to bet on that.

London still getting away with it (cont)

A report from the CBI covered in today's Telegraph suggests London firms hiring "as normal".

Last month's London's Economic Outlook from GLA Economics suggests London performed marginally better than the rest of the UK during recession and is now recovering fairly strongly.

Latest figures from the Land Registry on house prices also support this picture. In the year to April 2011 house prices in London rose 5.0% and in the South East by 0.5%. Every other region saw house prices fall in the same period: down a little over 2.5% in the East and West Midlands, down over 4% in Yorkshire and the North West, down over 8% in the North East. The average for England and Wales was a 1.3% fall.

In my January lecture "How did London get away with it?" I explained my thinking on this relatively good performance (both compared to expectations and the rest of the country). There is off course, still time for all of this to change, but the pattern so far remains striking and is unusual relative to the last major recessions in the UK.

Immigration and the Housing Problem

Steve Nickell gave the final lecture in the CEP 21st birthday lecture series last night looking at the link between immigration and the housing problem.

He started by highlighting the shift in the overall pattern of immigration in the UK from net negative (more people going out than in) to net positive (more in than out). This change is being driven partly by students and partly by flows from the A8 accession countries. These immigrants are spread pretty equally across skill groups (for those of you that follow the cricket - Steve Nickell suggests that in the last decade a majority of English test games have been played with an immigrant as captain).

Economic analysis suggests that these higher immigrant numbers have had little effect on average incomes, although they may have had a small negative effect (about 2-3%) on wages about the bottom of the income distribution. Most of the focus has been on these income effects but, as Steve pointed out last night, the most obvious measurable effect is the associated increase in population.

This brings us to housing because, as frequently discussed in this blog and elsewhere the UK builds very few houses. Steve Nickell suggests that we need to build around 150,000 houses per year to cope with the increase in demand that comes from real income growth and another 120,000 per year to cope with changing patterns of household formation. These kind of rates would be needed for price houses to real income ratios to stabilise.

The lecture was delibrately vague on how we might achieve this increase - some combination of "financial incentives" and "local authority ownership and sale of more land". Nickell was pessimistic about localism for reasons I have discussed before. He also chose to be fairly non-commital on what his analysis suggested for overall immigration numbers, instead sticking to his main point that it would be unfair to blame immigration when the system is incapable of delivering sufficient housing to cover domestic demand.

Personally, I think the link from immigration to the housing problem does raise issues for those of us who believe the country should be reasonably liberal in terms of immigration policy. Overall, in terms of measurable (economic) costs and benefits the evidence suggests no effect on average wages, negative effects for the worst paid and increased house prices (with all the associated affordability problems). This leaves one pushing non-economic points (and here there are clearly costs as well as benefits) or looking to areas of the economy where we haven't been able to carefully measure the positive impacts. The most obvious area for further analysis is in terms of the dynamic effects coming from the impact of immigration on innovation. However, recent SERC evidence on immigration and innovation in cities doesn't suggest these effects are that strong (see SERC DPs 0068 and 0069).

Overall, I came away a little depressed. I suspect immigration will continue to be blamed for problems in the housing markets. I am also in agreement with Steve Nickell's assessment that we are still some way from the tipping point where politicians are able and willing to do something about the underlying problems.

[Video, podcast etc of the lecture should be available shortly]