16 November 2017
The simple economics of the housing crisis
Address supply constraints to increase affordability.
by Frank O’Nomics
House prices are continuing their relentless march upwards. There are some signs of moderation in London, where the annual rise is 2.5%, but nationally the rate of growth increased from 4.8% to 5.4% last month. Such rises significantly outstrip wage inflation so housing is becoming ever more unaffordable. Numerous government measures to address the situation – Help to Buy, Lifetime ISAS etc. – only seem to be exacerbating it by stimulating yet more demand. Rising interest rates may ultimately do something to undermine that demand but this will take a long time on current forecasts. The only way that the housing crisis can be addressed is to look at the supply side of the equation – put simply, we need to build more houses.
For over forty years the UK has built fewer homes than were needed to satisfy the growth in demand. For the last one hundred years our population has grown by an average of around 1/2% per annum. Over the same period the average size of households has been falling, from around 4 to 2.5, as a result of young people leaving home earlier (at least until very recently) and empty nesters living longer. Taken together, these factors point to a need for the housing stock (which Is roughly 28 million homes) to grow by around 1% per annum which, when one adds in the need to replace unfit properties and account for the shift of populations towards modern urban centres, gives a need for some 300,000 new homes per year. We have not built anything close to this number of houses and flats since the 1970’s, and for the last decade have barely managed to produce around half of the required figure.
Simple economics tells us that restricting supply in the face of relentless increases in demand can only produce a rise in prices. Hence, since 2008, house prices have doubled in real terms.
There are two broad approaches to solve this crisis. The first, addressing the demand side of the equation is of little help. Controlling immigration to inhibit demand may make some difference, but may have more significant negative economic consequences by restricting the inflow of young skilled people – particularly when many of them work in the building industry. In terms of reversing the fall in the size of households, economic necessity is forcing young people to stay at home for longer, but again this is not a long-term solution. The only long-term solution to the problem is to address the supply side.
But just who is going to do this? The Thatcher government’s approach of selling off council houses led to a significant reduction in local authority involvement in housing, with an expectation that the private sector would fill the gap. The rise in house prices and the influence of rent controls and security of tenure meant that there was little appetite for building affordable housing, and by the time the buy-to-let market developed the price genie was too far out of its bottle. The answer some have come up with is to move back towards a much greater building of local authority housing.
The problem here is how to fund it? We may not want to argue with existing right-to-buy schemes, but only one in three homes sold in this way is being replaced. Local authorities can only keep one third of the receipts from the sales and are prevented from borrowing to make up the shortfall – which amounts to some 43,000 homes in just the last three years. The Local Government Association has called for changes in the Budget to allow councils to retain all of the cash from sales and to be granted the freedom to borrow to invest. The economist John Kay has gone further, in suggesting that an extra £20bn per annum of central government borrowing should be raised to fund the building of council houses. This would make sense given that the central government can raise money more cheaply and easily.
Many may be uncomfortable with a return to building more council houses, given a lack of confidence in local authorities getting it right, and that taking steps to encourage the private sector to fill the void would make more sense and be more efficient. However, this has not been happening. The Federation of Small Businesses has come up with its own solution by requesting greater financial support for small house builders. They argue for an extension to the £3bn home building fund and for a planning system that ensures a supply of serviced sites with planning consent that small builders can develop immediately. Currently builders have to pay a Community Infrastructure Levy to offset an exemption from affordable housing contributions, but councils don’t consider the size of a project when imposing the levy, making many small projects unaffordable.
The answer to whether the public or private sectors should be empowered to build more housing is straightforward – encouragement should be given to both if we are to make any headway in redressing the shortfall in building which has gone on for so long. Handing back control to local authorities may go against those who slavishly adhere to the legacy of Mrs. Thatcher, but this ignores the fact that they are best placed to access potential greenfield and brownfield sites – as well as to respond to potential NIMBY outcry. We have discussed the benefits of hypothecated government borrowing here before, and tapping into the savings glut to fund a solution to the housing crisis would seem another strong justification.
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