Untangling the complex web of the UK housing market
25 October 2018
SUGGESTED
Government and Institutions
24 October 2018
Labour Market
Healthcare
4 July 2024
Our housing market is – undeniably – broken. The affordability ratio (house prices to earnings) has climbed across the country, particularly so in London and the South East. UK housing is now the third most expensive in the world, and among the most volatile. Not only does this harm productivity and GDP due to misallocation of space, it also damages public perception towards free markets and capitalism.
So what is driving these dysfunctionalities?
Our empirical analysis found a per-capita decline in housebuilding since the 1970s, reinforced by a “lack of supply responsiveness” identified in the Barker Review in 2004.
Between the years 1967 and 1991, the UK built approximately 5.7 million new-build dwellings during which the population increased by 4.5% (2.5 million people). Yet for the 1991-2016 period, the UK built just over 3.5 million dwellings with population growth of 14.3% (8.2 million people). Considering factors like densification, this implies a shortfall of at least three million housing units in addition to the ongoing deficit between housing starts and population growth.
Looking at factors of production, land has increased in price from 50% to 200% of GDP. This is clearly driving the lack of affordability.
But to identify the appropriate policy response, it is worth identifying the driver of land price inflation for residential development. It is clear, even from a cursory look, that our planning system is one culprit. The policy of urban containment established by the Town and Country Planning Act – and enforced through local plans, greenbelt designations, recursive height and density restrictions, protected views schemes and other policies – is a problem. But by far the greatest obstacle to housebuilding is the unpredictability of local planning authority decisions, as we can see from the positive correlation between rejection rates and the acuteness of housing need in a local area.
This is why, yes, we need “planning reform”, and our essay recommends a pilot scheme of Simplified Planning Zones (“SPZs”), which would eliminate the worst effects of the planning system in areas with the worst affordability ratios. In an SPZ, developers would submit shortened planning applications that, provided they met conditions around density and quality, would be given the presumption of development. This would reduce the risk premium (which currently favours large construction companies that build in bulk) and restore competition and certainty for house-builders, who would no longer have to amend plans due to NIMBY complaints, or deal with damaging obligations like Section 106 of the Town and Country Planning Act[1].
It would initially be piloted in areas with the highest affordability ratios, before a refined policy would be implemented nationwide. This policy is necessary – but on its own will be insufficient.
To achieve the volume of housebuilding required, we also need to adjust incentives at local level to boost housebuilding under the development control framework as well. To stimulate development outside of SPZs, our essay recommends aligning local government funding, per capita, to residential development. This would incentivise local planning authorities not only to approve more good planning applications but also encourage them and improve them. In nearly all cases in the UK, no such incentives exist for councillors to do that.
The only local tax, Council tax, is based on (outdated) property value, and it is for all intents and purposes irrelevant to UK tax revenue. In 2011, the Mirrlees Review rightly recommended that it ought to have more weight.
This could be implemented in a revenue-neutral way either by adjusting the formulae for awarding central government grants, by introducing a residential development precept on new-builds, or by introducing a value added tax on housing consumption. This would give councils full control over their council tax revenues and prevent central government from offsetting medium-term revenue from tax base growth against the funding given to councils by grant. This scheme could be run alongside the initiative proposed by Bosetti and Sims to train councillors to confidently guide developers towards high-quality development.
The UK requires a programme of housebuilding as ambitious as the New Town Corporations or the London Docklands Development Corporation. The current target of 300,000 new dwellings per year should be increased. In the longer-term, we must have a conversation about the Green Belt and the damage it does by preventing development on land that is easiest to integrate with current transport links. In the short term, more popular policies – such as the Right to Buy and Help to Buy – should be reviewed for effectiveness, cost and net welfare.
For now, however, the planning system remains the key cause of distortion and price inflation in the market. Recent estimates suggest that UK house prices would be 35% lower without the intersection of planning and local incentives. To us, that seems like the perfect place to start if you want to improve housing affordability and homeownership.
Charles Shaw and Daniel Pycock were shortlisted and ‘Highly Commended’ in the 2018 Richard Koch Breakthrough Prize, an essay competition seeking free-market solutions to the housing crisis. Read their submission in full here.
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[1] For the uninitiated, Section 106 requires housebuilders to negotiate with local planning authorities to mitigate perceived negative effects from development. In many cases, they are used to secure a percentage of “affordable” housing. The obligations decided upon however are only known very late in the process, and constitute a massive barrier to the acquisition of working capital and the accurate pricing of land.
So what is driving these dysfunctionalities?
Our empirical analysis found a per-capita decline in housebuilding since the 1970s, reinforced by a “lack of supply responsiveness” identified in the Barker Review in 2004.
Between the years 1967 and 1991, the UK built approximately 5.7 million new-build dwellings during which the population increased by 4.5% (2.5 million people). Yet for the 1991-2016 period, the UK built just over 3.5 million dwellings with population growth of 14.3% (8.2 million people). Considering factors like densification, this implies a shortfall of at least three million housing units in addition to the ongoing deficit between housing starts and population growth.
Looking at factors of production, land has increased in price from 50% to 200% of GDP. This is clearly driving the lack of affordability.
But to identify the appropriate policy response, it is worth identifying the driver of land price inflation for residential development. It is clear, even from a cursory look, that our planning system is one culprit. The policy of urban containment established by the Town and Country Planning Act – and enforced through local plans, greenbelt designations, recursive height and density restrictions, protected views schemes and other policies – is a problem. But by far the greatest obstacle to housebuilding is the unpredictability of local planning authority decisions, as we can see from the positive correlation between rejection rates and the acuteness of housing need in a local area.
This is why, yes, we need “planning reform”, and our essay recommends a pilot scheme of Simplified Planning Zones (“SPZs”), which would eliminate the worst effects of the planning system in areas with the worst affordability ratios. In an SPZ, developers would submit shortened planning applications that, provided they met conditions around density and quality, would be given the presumption of development. This would reduce the risk premium (which currently favours large construction companies that build in bulk) and restore competition and certainty for house-builders, who would no longer have to amend plans due to NIMBY complaints, or deal with damaging obligations like Section 106 of the Town and Country Planning Act[1].
It would initially be piloted in areas with the highest affordability ratios, before a refined policy would be implemented nationwide. This policy is necessary – but on its own will be insufficient.
To achieve the volume of housebuilding required, we also need to adjust incentives at local level to boost housebuilding under the development control framework as well. To stimulate development outside of SPZs, our essay recommends aligning local government funding, per capita, to residential development. This would incentivise local planning authorities not only to approve more good planning applications but also encourage them and improve them. In nearly all cases in the UK, no such incentives exist for councillors to do that.
The only local tax, Council tax, is based on (outdated) property value, and it is for all intents and purposes irrelevant to UK tax revenue. In 2011, the Mirrlees Review rightly recommended that it ought to have more weight.
This could be implemented in a revenue-neutral way either by adjusting the formulae for awarding central government grants, by introducing a residential development precept on new-builds, or by introducing a value added tax on housing consumption. This would give councils full control over their council tax revenues and prevent central government from offsetting medium-term revenue from tax base growth against the funding given to councils by grant. This scheme could be run alongside the initiative proposed by Bosetti and Sims to train councillors to confidently guide developers towards high-quality development.
The UK requires a programme of housebuilding as ambitious as the New Town Corporations or the London Docklands Development Corporation. The current target of 300,000 new dwellings per year should be increased. In the longer-term, we must have a conversation about the Green Belt and the damage it does by preventing development on land that is easiest to integrate with current transport links. In the short term, more popular policies – such as the Right to Buy and Help to Buy – should be reviewed for effectiveness, cost and net welfare.
For now, however, the planning system remains the key cause of distortion and price inflation in the market. Recent estimates suggest that UK house prices would be 35% lower without the intersection of planning and local incentives. To us, that seems like the perfect place to start if you want to improve housing affordability and homeownership.
Charles Shaw and Daniel Pycock were shortlisted and ‘Highly Commended’ in the 2018 Richard Koch Breakthrough Prize, an essay competition seeking free-market solutions to the housing crisis. Read their submission in full here.
–
[1] For the uninitiated, Section 106 requires housebuilders to negotiate with local planning authorities to mitigate perceived negative effects from development. In many cases, they are used to secure a percentage of “affordable” housing. The obligations decided upon however are only known very late in the process, and constitute a massive barrier to the acquisition of working capital and the accurate pricing of land.
6 thoughts on “Untangling the complex web of the UK housing market”
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Congratulations, at least you are on the right track and, unlike the winning essay, don’t see the issue as being one of design. However, I would ask whether “aligning local government funding, per capita, to residential development” would lead to developments in areas where people don’t want to live?
Any policy objective must be twofold, to make affordable land available for building and, provide an incentive for the development to take place now. Therefore, a key issue in developing affordable housing has to be getting rid of the development gain realised on the granting of planning permission. I stress “getting rid of” rather than appropriating it in some way.
At the moment the cost of policy and planning failure is borne by those that have been failed and not by those that have failed them and this needs to change.
our essay recommends aligning local government funding, per capita, to residential development. This would incentivise local planning authorities not only to approve more good planning applications but also encourage them and improve them.
The alignment of local government funding is highly apt to corrupt the disposition towards appropriate development because the developer in complicity with the local administration will tend to maximise political profit by arranging mediocre plans or, worse, by unfinishing the realisation of the plan. To explain, the allocation of funds will induce the recipients to devise plans so that the plan negligently and unmindfully, or better, with their minds to the political profit they can reap.
The idea of complicity already exists in most so called free-market-based national economies, and the generalised result is corruption between the local administration and the developers. The banking sector is of course beautifully consulted in the spree, and since the commercial banks are de facto dependencies of the governments, cronies and the officialdom, both local and central, will be benefitted.
No matter the intention of the essayist, this is the synthesis I obtain. The phrasing is such that additional fiscal orientation is proposed in order to attain a goal for the resolution of a fiscally generated problem.
A freedom-oriented think tank has commended such proposal. I am wondering what a socialistically driven institute would do.
I have to disagree with the reasons given for high cost of UK housing. Yes supply and demand can alter price, but allocation & supply of bank credit is the real reason UK housing has become so expensive.
Bank credit creation to fund the purchasing of existing assets will always create boom bust, because it inflates asset price without any adding value via productivity. The cost of housing today has no relation to the actual money that exists in the real economy. To create this relationship only existing money should be used to fund existing asset purchasing, eg sell mortgage bonds to savers, use bank credit only to create productivity and new assets.
This article explains the problem quite well.
http://www.cityam.com/266043/blame-bank-finance-caused-todays-housing-crisis/amp
Furst of all, thank you for reading our paper. Please accept my apologies for the delay (only saw them this weekend) in responding to your comments. I will take the last comment first.
PAUL FEAR writes that allocation & supply of bank credit is the real reason UK housing has become so expensive, hinting at the relevance of the endogenous theory of credit money. I would like to unpack this a little and offer some thoughts by way of response.
1) It is interesting that Paul should assert the importance of the credit channel of monetary policy (especially a bank-lending channel) in the housing market. You have to remember that the relevance of the credit channel depends on the structural features of the housing finance system, in particular efficiency and type of institutions active in mortgage provision. The UK the structural features of the housing finance system are well known: good access of depository institutions to wholesale general funding, strong role of depository institutions, building societies can issue mortgage backed securities (although capital requirements are relatively unfavourable to issuing mortgage-backed securities), weak role of non-depository mortgage lenders, integrated and competitive mortgage market, and so on. In that respect he is correct: allocation and supply of bank credit *is* important. But I don’t think there is a short or simple answer to this.
2) We did consider whether standard monetary policy, in the absence of macro-prudential goals, can contribute to making boom-bust cycles in credit and housing prices less pronounced. But one has to be careful here. For example, we know from empirical studies that strict inflation targeting generates high volatility of the real interest rate. This, in turn, delivers high volatility of both housing prices and the loan-to-GDP ratio and may be detrimental to welfare. Now, what do you think will happen – to volatility of housing prices, volatility of loans, housing investment, inflation — if policymakers try to direct (bank) credit only to create, as you say, “productivity” and “new assets”? Obviously, this is bound to have implications that will go beyond the housing market. Heterogeneity in the welfare implications for borrowers and savers make it difficult to assess such a policy framework without an empirical study. For what it is worth, I just do not think this would necessarily be welfare-improving. However, I am happy for you to change my mind or at least provide more substantive arguments in support of your thesis.
3) In general equilibrium, all assets matter, their presence, their absence, and market structure. But you have to remember that monetary policy a very blunt instrument. Of course, we do not dispute the presence of a bank-lending channel and more generally of a credit channel in UK housing market. But we believe that current housing market issues can be sensibly addressed without resorting to the tools of monetary policy.
4) Paul also asserts that “Bank credit creation to fund the purchasing of existing assets will always create boom bust”. Modern macroeconomics has achieved many things, but I think it is a little premature to say that we have understood the causes of business cycles.
5) All things considered, the intricacies of the nature of the relationship between asset supply, asset prices, and aggregate real activity still remain a hotly debated question in policy circles, and clearly quantifying effect of any policy on solving the housing crisis is likely to remain a contentious issue.
My co-author and I merely discussed the UK housing market in general terms that would be easily accessible to any layman with a casual interest in the subject, trying to back our arguments by evidence where we could and without over-relying on economic theory.
Again, thank you for your comment and I hope this answers your question, if only partially. But, if not, I am happy to remain at your disposal in case you would like to comment further or engage in further discussion.
Charles
LABBIANLIBEY, thank you for your comment. We tried to make the essay, and suggestions therein, politically neutral and palatable to many stakeholders (including taxpayers).
NEIL ABREY, thank you for your comment. What would be the incentives for developers to develop (or builders to build) where people don’t want to live?