11 August 2017

The housing crisis: an act of devastating economic self-harm


In 2015, two talented professors, Enrico Moretti at Berkeley and Chang-Tai Hsieh at Chicago Booth, decided to estimate the effect of shortage of housing on US productivity. They concluded that lack of housing had impaired US GDP by between 9.5 per cent and 13.5 per cent.

In a follow-up paper, based on surveying 220 metropolitan areas, they revised the figure upwards – claiming that housing constraints lowered aggregate US growth by more than 50 per cent between 1964 and 2009. In other words, they estimate that the US economy would have been 74 per cent larger in 2009, if enough housing had been built in the right places.

How does that damage happen? It’s simple. The parts of the country with the highest productivity, like New York and San Francisco, also had stringent restrictions on building more homes. That limited the number of homes and workers who could move to the best job opportunities; it limited their output and the growth of the companies who would have employed them. Plus, the same restrictions meant that it was more expensive to run an office or open a factory, because the land and buildings cost more.

The housing market is also, as Matthew Rognlie of MIT has pointed out, the biggest single driver of wealth inequality.

So what’s the situation here in Britain? The honest answer is that nobody knows. We sent a Freedom of Information request to the Treasury, asking for their estimate of the impact of the housing crisis on GDP, but they didn’t have one. Yet the OECD and the McKinsey Global Institute have been pointing to the productivity impact of our limited housing supply for years.

It is, however, possible to make a rough estimate by comparison with the US. The value of the land under US houses is about $10 trillion, or 12.5 per cent of total net wealth.

Most of that is not actually the cost of the land, of course. It is the value of the official legal permissions for housing to exist on it. You can estimate that premium by comparing the cost with farmland, which has no such permissions and is therefore much cheaper. Land in city centres will always cost more, of course.

So what about the UK? The Office for National Statistics figures imply that the total value of UK land under dwellings is about £3.7 trillion, or 40 per cent of the country’s net wealth. If we use the total market value of UK housing provided by Savills rather than the ONS, the number is more like £5 trillion. (The ONS counts the value of planning permissions for land without dwellings separately – and doesn’t yet attribute any value at all for the “hope” value of potentially gaining more planning permissions on farmland.)

This figure for net wealth is partly because Britain is more densely packed than America, so has more houses and less landscape. But it also arises because of our more restrictive rules against building homes, which do an even better job of preventing people from living in the most productive places (Cambridge rather than Canterbury, for example) and getting the most productive jobs.

Yet if the present value of those monopoly “rents” (in the technical economic sense) is £4-5 trillion, then the deadweight loss to GDP must be substantial – quite possibly far in excess of the annual value of that “rent”, not least because risk aversion, information problems, uncertainty, liquidity constraints and externalities of agglomeration mean that rents will not rise to reflect the true marginal benefit to the nation of bringing each extra person into a productive city.

If we were simply to be conservative and take half of the damage that the second Moretti and Hsieh paper estimates for the US economy (even though comparisons of the two balance sheets – 40-50 per cent versus 12.5 per cent – implies that the UK problem may be, not half as bad, but three or four times worse), we would conclude that the UK impairment is on the order of 32 per cent.

More conservatively, using the relative distortions of the balance sheets as a proxy but taking only the original Moretti/Hsieh estimate of a 9.5-13.5 per cent impairment, a rough estimate for the UK would be that the damage to the economy caused by these restrictions is over three times the level in the US – perhaps not as high as 39.5 per cent of GDP, but it could certainly be in the region of 25-30 per cent.

To put that in context, 30 per cent of GDP is about £600 billion, or roughly what central government spends in a year. Or to put it another way, if this rough calculation is even remotely accurate, our current housing crisis represents one of the most incredible pieces of self-inflicted economic harm in UK history.

To put things in perspective, the graph below shows England’s GDP since 1910. We have assumed that England caught up to its trend growth about 20 years after each world war. On the other hand, growth before the 2008 financial crisis may have been elevated because of unsustainable credit expansion.

You can easily see that the red area, showing the estimated damage caused by the housing crisis, is far larger than the areas showing the GDP impairment from either world war.

For a longer perspective, the Bank of England has kindly supplied GDP numbers going back to 1270:

There is, in other words, a prima facie case that the housing crisis has caused more damage to GDP than any single event since the Black Death – when two-fifths of the population died.

This may be an exaggeration. It may also be an understatement, if we take the second Hsieh/Moretti study at face value. But it is certainly the case that you can trace back all manner of Britain’s problems – low productivity, inequality, sluggish GDP growth, our lack of competiveness internationally – to our failure to provide enough houses, and the economic ill-effects that has caused.

So how do we fix it? There are many ways, but so far no government has looked in the right places. Vital research from political science, psychology, law and economics has been overlooked or ignored. The government has not used methods that the World Bank, OECD and the UK’s own Department for International Development apply to find politically feasible reforms in developing countries.

The key is finding effective reform ideas that can unite a winning coalition of voters behind solving the problem. It is not impossible: in less than a year, our new campaign has found at least two ideas that would unlock dramatic improvements over time. We describe the best suggestions we have seen for the current government in our paper published by the Adam Smith Institute: Yes-In-My-Back-Yard: How to end the housing crisis, boost the economy and win votes.

To give just one example, the Georgians managed to build far more homes per acre, often producing better-looking streets – think of the prettier parts of Bloomsbury or Pimlico. The Victorian mansion blocks of Chelsea have even more homes. If homes in London as a whole were built more like that, land would be much cheaper. Instead, half of the homes in London are in buildings of only one or two floors, often surrounded by expanses of concrete.

Upgrading a single plot from 1930s-style to Georgian land use can easily increase the square footage by a factor of five, creating several new homes and, with the right design code, making for better, more liveable and more walkable places. Yet this country has, with the best of intentions, nearly frozen the path of gentle improvement within cities that worked to supply many new homes for hundreds of years.

What gets measured, gets improved. If we recognise how much damage the lack of homes is causing to the UK as a whole, and to our competitiveness against other nations, perhaps we can finally all get together to build many more beautiful buildings again. This is not a zero-sum game of landlord against tenant or homeowner against the priced-out, or urban vs rural. We can fix the shortage of housing, make our cities much more attractive and liveable, and protect precious countryside – while making nearly everyone happier and better off.

John Myers is co-founder of London YIMBY, a grassroots campaign to end the housing crisis with the support of local people