Generation Rent: rational ignorance or rational irrationality


Tax and Fiscal Policy
‘Generation Rent’ seems to be the media catchphrase of the day, and this should come as no surprise. Over the past fifteen years, house prices have risen so sharply that despite the recent fall, they are still more than twice as high in real terms as in the mid-1990s. For a while, the availability of easy credit appeared to ease the pain, but that lubricant is now gone.

The economics behind this is not complicated at all. What matters is the price elasticity of supply, because it determines whether an increase in demand will trigger an increase in quantity supplied, or just an increase in price.  In Britain, the long-run price elasticity of housing supply is a meagre 0.4, compared to values around 1 or well above in the Scandinavian countries, Japan and the US. This means that if Scandinavians demand more homes, more homes are built; while if Britons demand more homes, homes just get more expensive. Supply responsiveness is mostly a matter of how easy it is to build new homes, which is a function of the planning system, and thus a political choice. So why don’t we just vote for policies that make our lives easier?

One could answer this from a standard Public Choice angle. The benefits of restricting development are concentrated, while the costs are dispersed. Those who already own a house know that its value is likely to drop once other houses are built in proximity, not to mention increased traffic, crowding, and the disappearance of a field or grassland. Homeowners have a lot to lose, and they know it. For would-be homebuyers, the situation is very different. What difference does it make if one particular plot of land is given planning permission or not?

However, Bryan Caplan has argued that the Public Choice explanation seldom tells the full story. He notes that when we are merely ignorant about an issue, we are normally randomly ignorant. When asked about the straight-line distance between London and Windhoek, most of us would surely come up with a figure that is wildly off the mark – but we are just as likely to overestimate it as we are to underestimate it. We would not systematically err in either direction. But in economic policy debates, as Caplan demonstrates, systematic biases are present. There are beliefs which we simply like to hold, because holding them feels good. Giving up a dearly held belief is painful – it comes at an emotional cost.

But while nobody likes to admit their own errors and revise their actions, in private economic decisions we frequently do just that. People change careers and familiar work patterns, businessmen overturn business strategies, and students change their disciplines. It makes a huge difference, according to Caplan, whether we personally bear the consequences of our decisions or not. In the political sphere, we don’t. Why incur the emotional cost of rejecting a cherished belief if there is nothing to be gained?

The Public Choice angle of rational ignorance may go a long way towards explaining why we, as voters, inflict unnecessarily high housing costs upon ourselves. But there may be more than an element of what Caplan calls ‘rational irrationality’ at work as well. Apparently, there is emotional comfort in blaming high housing costs on private greed, speculation, immigration or a lack of social housing, while sticking to a romanticised view of a pastoral idyll that must not be destroyed by residential development.

If so, there is an even stronger case for denationalising the allocation of development rights, and returning planning to the market.

Dr Kristian Niemietz is the IEA's Head of Political Economy. Kristian studied Economics at the Humboldt Universität zu Berlin and the Universidad de Salamanca, graduating in 2007 as Diplom-Volkswirt (≈MSc in Economics). During his studies, he interned at the Central Bank of Bolivia (2004), the National Statistics Office of Paraguay (2005), and at the IEA (2006). He also studied Political Economy at King's College London, graduating in 2013 with a PhD. Kristian previously worked as a Research Fellow at the Berlin-based Institute for Free Enterprise (IUF), and taught Economics at King's College London. He is the author of the books "Socialism: The Failed Idea That Never Dies" (2019), "Universal Healthcare Without The NHS" (2016), "Redefining The Poverty Debate" (2012) and "A New Understanding of Poverty" (2011).

1 thought on “Generation Rent: rational ignorance or rational irrationality”

  1. Posted 01/06/2011 at 21:24 | Permalink

    It is also worth taking into account the very small proportion of the voting population who actually select Conservative candidates MPs (who tend to represent areas where housing is most constrained). Interestingly, it would be very easy for young renters to take over many of these constituencies and most selections take place in open meetings where 100 votes can swing it. There is certainly a political market opportunity here to be exploited if young people can put up with all the other aspects of being a member of a political party.

Comments are closed.