Once again, the UK housing market is back in frontline news with the fear generated by housing price inflation again running rampant. Zoopla reported annual house price growth of 6.1% in the year to August 2021, up from 2.8% in August 2020, bringing the average value of a home across the UK to £235,000. This brings the average house close to ten times the average national income. For perspective, in 1992, the average house cost three times the national income.
After having removed a full-blown stamp duty holiday from England and Northern Ireland at the beginning of June, the UK government withdrew the remaining framework of tapered stamp duty reliefs at the end of last month. Despite the removals of reliefs, which allowed homebuyers to accumulate savings of up to £15,000 per property, Zoopla reported “little evidence of a change to buyer behaviour” in recent months and “no sign of a cliff-edge of demand”.
Despite inflation in house prices caused by Covid-19 and the response to the pandemic, the problem of house prices in relation to average income has been a contentious and embedded issue for many years.
UK house prices are extraordinarily high, and housing in London and the Southeast of England is some of the most expensive and cramped in the world. A standard measure of affordability is the ratio of median house prices to median annual full-time earnings. In fifteen years, the ratio in London has grown from 6.57 to 12.36, with median rent to income having climbed from 1:5 to 1:3 (ONS 2018). This problem has far-reaching consequences both for the UK as a whole and London as a global hub, as people often avoid moving to work in productive sectors because nearby housing is too expensive. Furthermore, the proportion of Britons who need financial support for housing is almost unique and is ubiquitously shared amongst young families when first stepping onto the housing ladder.
What has caused the problem?
According to the Bank of England Staff Working Paper No.837, “the rise in house prices relative to incomes between 1985 and 2018 can be more than accounted for by the substantial decline in the real risk-free interest rate observed over the period.” Furthermore, it concluded that: “An unexpected and persistent increase in the medium-term real interest rate of 1 percentage point from its level as at end 2018 could ultimately generate a fall in real house prices (over a period of many years) of just under 20%.” The bank doesn’t rule out other factors such as supply elasticities, mortgage availability, shifts in uncertainty along with the ups and downs of the business cycle; but concludes that all these factors have had more of a short term impact.
Interestingly, economists’ diagnoses of the root causes of house price inflation vary - from anaemic supply to the consequences of financial deregulation, to even a bubble. Crucially, Bank of England documentation finds that in the long run, the decline in the real risk-free interest rate can account for all of the rise in house prices relative to incomes. However, there is a multitude of facts that the framework provided by BoE documentation doesn’t seem to be able to explain:
UK house prices have risen more than in any comparable country. As figure 2 shows, the UK has seen house prices rise more than any G7 country. At the other end of the spectrum, Japan has barely seen house prices rise above their 1980 level. All of these economies have seen a similar fall in interest rates to the UK.
Many other UK asset prices have risen by the same amount as in other countries. Given the growth in UK house prices, you might expect other UK asset prices to have also risen a lot. Since 1980, equity prices in the UK have risen by almost exactly the same amount as in the average advanced economy.
Large regional variation in house prices across the UK. London has seen the highest growth in house prices of any region. On a regional basis, house prices in the Northeast have grown the slowest. Interest rates alone would not explain this regional variation.
So, what is missing from the framework?
Firstly, all economic models involve simplifications and abstractions. They are merely a tool used by economists to try to explain the overall outcome of many transactions within the complex web of an economy. However, given the importance of housing to well-being and economic growth, along with the financial stability that changes in house prices could jeopardize, a model that accurately explains the disparities in the UK is essential.
Moreover, the framework doesn’t include any explicit role for supply elasticity. Housing supply responds differently to prices in different countries and regions. Documentation such as the Barker Review asserts that the UK housing market is particularly strained by inelastic supply. Between 1967 and 1991, the UK built approximately 5.7 million new builds during which the population increased by 2.5 million people. For the period 1991 to 2016, the UK built just over 3.5 million dwellings for population growth of 8.2 million people (Cheshire,2018).
Importantly, spatial misallocation has limited the number of those able to work in London’s scientific, technological, engineering and research sectors; all of which are key if the UK economy is to grow and adapt. All of this hurts the capital’s productivity, which is estimated to have reduced aggregate UK GDP by between 13 and 30%. The crucial limiting factor to increasing housing supply is not available space (only 9% of English land is built upon, whereas green belt constitutes 14% of land in England), but rather nationalised, outdated, and cumbersome regulations.
Unfortunately, the failure to build enough housing is often called market failure, but this is misleading and not directly addressing the issue. The failure is of state planning. In 1947, the Town and Country Planning Act was passed. This, along with the system of green belt land that appeared in the 1950s as a result of our planning system, placed land use and ownership as the subject of more statutory control than ever in our history. Favouring large housebuilding corporations over small builders, this complex and bureaucratic planning system has led to Nimbyism and deep resentment of newbuilds in many localities.
Additionally, centralised taxation has led to few incentives for local authorities to allow housebuilding to gain additional revenue from new residents. Today, 95% of our tax goes to the central state. Local authorities have seen their powers reduced, becoming little more than distributors of grants or any money that the central government plans to give back to them. Consequently, when local authorities realise that they will receive relatively little tax benefit from approving housing but will face some of the costs necessary for new infrastructure and the initial administrative burden, there becomes a disincentive from approving new houses.
Our tax system at the national level is also to blame. High nationwide Stamp Duty actively penalises property transactions, harms labour mobility, discourages downsizing and leads to the misallocation of dwellings which causes a welfare loss. Add to this our tax inheritance system, which treats housing wealth preferentially to other wealth, further inflating demand relative to supply.
Solution
It is clear that our planning system needs reform. Urban containment, greenbelt designations and recursive height and density restrictions are the problems. Allowing still more local devolution of planning powers, such as to the street and village level, would give the advantage back to local firms which have the interest of local communities to heart. We need reforms that will bring down the cost of planning and increase the number of providers, increasing competition. Less restrictive markets will mean better buildings. Better buildings themselves will reduce restrictiveness by reducing resistance to housebuilding generally and rejuvenating property-owning democracy itself.
Devolving some taxation would also benefit local property markets. The centralisation of property taxes deprives local government of any incentives to allow building, while the structure of fiscal incentives at the national level distorts our housing market. Tax burdens such as Capital Gains Tax, which leaves homes exempt, simply increases house prices. This distortion can be reduced by lower Capital Gains on shares.
To conclude, the increasing unaffordability of homes within the UK is directly caused by poor planning policies imposed by central governments as well as poor fiscal policy. Supply constraints must be dealt with. Declassifying non-functioning green belt areas is necessary, as well as devolving taxation to benefit local property markets first and foremost. The 1950s central planning system has failed. We must deregulate the cumbersome and inefficient planning processes to suit local communities. Permitted development rights for individual streets will see residents gain from building, subject to a selected design code. Providing a free-market agenda that returns power to the locality is absolutely essential in replacing the failed central planning that has caused our national crisis to provide adequate, affordable homes.
Bibliography
https://www.forbes.com/uk/advisor/personal-finance/2021/09/30/house-prices-updates/
https://www.spectator.co.uk/article/the-insanity-of-britain-s-housing-market#
https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2019/uk-house-prices-and-three-decades-of-decline-in-the-risk-free-real-interest-rate.pdf?la=en&hash=7C12A901353CB615C3FC1A58557918D50775E470
http://iea.org.uk/wp-content/uploads/2019/07/CC70_Raising-the-roof_web.pdf
https://gallery.mailchimp.com/708e119fa74cd33e6a28f949a/files/da817b21-876e-429c-8f08-fd661048eea7/Charles_Shaw_and_Daniel_Pycock_entry.pdf
https://bankunderground.co.uk/2020/06/03/theres-more-to-house-prices-than-interest-rates/
https://bankunderground.co.uk/2020/01/13/whats-been-driving-long-run-house-price-growth-in-the-uk/
https://static1.squarespace.com/static/56eddde762cd9413e151ac92/t/5abd0887758d46f7ea637201/1522337942910/PCC+28+03+2018+v01.pdf
http://news.bbc.co.uk/nol/shared/bsp/hi/pdfs/17_03_04_barker_review.pdf
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