WITH the new Help to Buy mortgage guarantee, which will provide government backing to high loan-to-value home loans, some have pointed out that the Treasury is set to become a player in the sub-prime lending industry. And the move will cost us: if private lenders are unwilling to take on a credit risk on an unsubsidised basis, we can safely assume that they have a good reason.
But wasteful though the policy will be, it is probably not big enough to cause major damage to the public finances. The mortgage guarantee’s main flaw is on a more basic level: it mistakes a supply-side problem for a demand-side problem.
Since the recession, homebuilding has declined sharply. In 2010, the number of newly-completed dwellings in the UK was about 23 per 10,000 inhabitants – basically nothing. But that is not, in itself, a problem. Construction has always been a volatile sector. Yet housing affordability does not depend on the levels of homebuilding in any one year, or even over a five-year period. It depends on average levels of homebuilding over the course of 10 or 20 years. And that is where the origin of the UK’s housing crisis lies.
The problem is that, compared to other European countries, levels of homebuilding in the UK have been extremely low for at least four decades. The current collapse is not unique to the UK, but the stifling of residential development in the preceding decades is. And unless we have a complete overhaul of the planning system in the meantime, the same constraints that have kept homebuilding down for 40 years will start to bite again once the economy recovers.
It does not take a degree in economics to see that stimulating demand in a largely static market will do no more than drive up prices. Unfortunately, the British housing market is such a market. Increases in demand only drive up prices, without generating additional building activity. Between the mid-1990s and the peak year of 2007, house prices more than doubled in real terms. Yet annual completions only went up from a risible 36 per 10,000 inhabitants – about half the levels recorded in France, Germany, the Netherlands and Austria at the time – to a still risible 38.
You can’t get closer to the textbook definition of perfectly inelastic supply, and we are paying the price. As recently as the 1980s, an average income earner could buy a house in the middle of the price range for three times their annual gross salary. Today, they would be lucky to find one for five times their annual salary. Rent levels, as always, have followed the same trajectory.
And there’s no prizes for guessing why supply is so unresponsive. There is now a substantial body of empirical research on the determinants of house prices, and the literature is as conclusive as econometric literature can get. House prices are affected by dozens of factors in the short run, but ultimately a lasting increase is almost always the result of regulatory constraints. Make it easy to build new homes and house prices will fall; make it hard and house prices will climb. It really is that simple. When I wrote a review of the empirical literature on this for my book Redefining the Poverty Debate, I was looking for some counter-evidence to avoid the accusation of cherry-picking, but failed to find it. The literature is one big cherry tree.
That is why the mortgage guarantee will do nothing to overcome Britain’s housing affordability crisis. The value of the implicit credit subsidy it contains will simply be capitalised into house prices. Housing in the UK is a supply-side issue, which is why any demand-side measure will be at best ineffective, and at worst counterproductive.
There is no shortage of sound economic research on how to address the supply-side constraints, and there is no shortage of developable land either. Even in south east England, 85 per cent of the land is undeveloped, so all we need to do is tap into this vast reserve, and convert the environmentally least attractive bits into residential land. The challenge is not an economic one, but a political one. But in order to achieve this, we must stop letting Nimby interest groups like the Campaign to Protect Rural England and the National Trust define the planning debate. We must expose their drawbridge mentality for what it is, rather than allow them to hide behind their rhetoric of “protecting the countryside”.
Politically, though, that is a bit more challenging than handing out freebies.
Kristian Niemietz is senior research fellow at the Institute of Economic Affairs and author of Redefining the Poverty Debate.