Parrots, housing and redistribution

The FT has offered a cornucopia of housing crisis commentary over the weekend. John Kay argues that it’s so simple a parrot could tell you: an undersupply of housing is behind the explosion of house prices over the past 20 years. Chris Giles, in his Friday column, gave a nuanced response to my earlier blogs looking at the national housing picture.

Both pieces make one very important direct challenge to my case, where I disagree. Chris’s then makes a number of relevant distributional observations with which I agree, but for which increasing general housing supply is not the solution. In the interests of progressing a fruitful debate, it’s worth addressing these points.

The key objection

The main objection to my argument in Chris’s piece is that high house prices have constrained household formation, which explains why the rising surplus housing stock can still be consistent with a story of undersupply.

“The reason why we have more “boomerang families” and grown-up kids applying to “the bank of Mum and Dad” is because forming a new household is so expensive for young people. Much pricier than it was for those of us who bought houses in the 1990s.”

John Kay takes the same line:

“The mechanism through which higher prices have equated demand and supply is a lower rate of household formation.”

It’s clearly true that buying a house is far less affordable than it was 20 years ago. But do high house prices constrain household formation? This is the key question in the debate.

Overwhelmingly, new households form into the rented sector — some 80 percent over the past decade, but two-thirds even back in 1999–2000. And those who choose to buy their first home are a relatively well-off group who also had the option of renting. So rent levels — not house prices — are the channel by which household formation might be constrained.

This goes to the heart of the confusion. There are always two housing markets in operation: the supply and demand for housing services, equilibrated by rent (or rental equivalence for owner occupiers); and the supply and demand for housing assets, equilibrated by house prices.

John Kay’s argument is about the former, but then he adduces changes in the price of the latter as evidence. But since 1996 the number of households in the UK has grown by 166,000 per year on average, while the stock of houses has averaged about 199,000 per year. If he looked at the appropriate price — the one for housing services — he would find that it is behaving exactly as one would expect in those circumstances.

Since rent levels have fallen relative to incomes and prices, it’s very hard to make a case that a housing shortage is preventing household formation. Even in London — while things are less clear cut — household incomes appear to have at least matched rents.

People parroting ‘supply and demand’ to explain the ills of the housing market is precisely the problem in the housing debate: which demand? Which price? It’s vital we use the right price measures to avoid drawing the wrong policy conclusions.

Distributional problems and housing

Chris’s piece goes on to raise a number of other important observations. In particular, he points out that the average floor area per person in the rented sector has shrunk and argues that ‘younger generations find the rent they can afford buys less space’. The English Housing Survey suggests that these problems are real, so we’re right to worry about them.

How can we square this with the data showing falling real rent and residential space outstripping population growth? The answer is that these are distributional problems. Three in particular have been building for a while.

First, young people’s incomes have fallen compared to others’ in recent years. Past Oxford Economics work, as well as a forensic exploration by the Resolution Foundation, clearly shows that younger people have been hit hard in the labour market since the financial crisis. This is a key factor in the dynamics Chris highlights.

Second, the social housing stock had shrunk. In the mid-90s some 22 percent of the stock in England was social housing, sheltering people from market rates of rent. Last year that proportion was barely 17 percent. That’s over a million more low-income households now facing market rents than would have been the case had the proportion remained constant.

Third, housing benefit cuts and caps have reduced the financial help that used to be available to people on lower incomes in the private rented sector.

These three things — and probably others — have conspired to make market rents less affordable for millions. They may also be constraining household formation. But none of them are caused by a lack of supply.

What’s the story?

Chris ends his piece saying: “This is an issue in which national averages mislead and the whole story is in the distribution.” The story certainly should be about the distribution. But alas, what we hear in the public debate isn’t. Rather it revolves around sky-high house prices and the claim they’re caused by a general lack of supply. That’s why John Kay’s piece is about national averages. So is this FT leader. Page one of the housing white paper grounds the case for action on the straight-forward assertion that undersupply has driven national prices. This House of Commons briefing note plays the same tune. And countless articles every day parrot the same faulty logic.

The purpose of my blogs has been to explore whether a lack of supply has been behind the explosion in house prices of the past 20 years. They show that it has not been the cause and, given plausible elasticities, will not substantively lower prices any time soon. Rather it is falling global interest rates and deregulation of mortgage lending that have inflated house prices relative to incomes. While these conditions remain as they are, we can expect little relief from high prices (though Brexit may take its toll).

But we can take some comfort from the fact that cost of putting a roof over your head is — on average — no more than it has been over the past two decades. Maybe if we can agree on that, we can avoid the housing supply red herring, and focus instead on the worsening distributional problems, the solutions to which lie elsewhere.