The harm of high housing costs

The Resolution Foundation points out that people are spending three times as much of their incomes on housing today than they were 50 years ago, and that 30-year-olds spend more of their income on housing than did their grandparents at the same age.

You can see this as an inter-generational injustice. But there’s another question here: are high house prices bad for the economy generally? I suspect they might be, for several reasons:

First, sharply rising house prices are associated with increasing household debt, which increases the chance of a financial crisis which has long-lasting adverse effects upon growth. As Mian, Sufi and Verner conclude (pdf):

An increase in the household debt to GDP ratio predicts a subsequent reversal in debt and lower subsequent GDP growth. The predictive power is large in magnitude and robust across time and space.

Secondly, housing is prone to the Baumol disease. Because the housing sector has lower productivity growth than other sectors, a shift in spending towards it tends to reduce overall productivity growth. To put this another way, if younger people weren’t spending so much on rent, they could spend more on other things, which would stimulate output, innovation and entrepreneurship in more dynamic sectors.

Thirdly, years of rising house prices have encouraged a culture of investment in bricks and mortar. This has diverted potential entrepreneurs into “property development” and away from perhaps more socially useful activity; has encouraged people to regard their house as their pension and so diverted capital away from business investment and formation; and might have encouraged early retirement and a loss of skilled labour*.

Fourthly, high house prices give people an incentive to protect their investments, and this breeds the sort of nimbyism which can delay infrastructure investment.  

Fifthly, high housing costs encourage people to commute long distances. Not only is this bad for their well-being, but it can also depress their productivity.

I’ll grant that there are some offsetting considerations. In the past, high house prices have been a source of collateral for entrepreneurs; thousands of people have taken out second mortgages to start businesses they’d otherwise be unable to. However, with so many energetic young people now locked out of home ownership, high house prices are perhaps less likely to stimulate entrepreneurship in the future.

Also, you might argue that it’s not wholly a bad thing that people are forced to rent. Andrew Oswald has shown that high home ownership impedes labour mobility and so raises frictional unemployment. I’m not sure how relevant this is, though. Big differences in rental costs across the country can also reduce mobility: many people can’t afford to move to London, even if they were stupid enough to want to.

My point here is that we shouldn’t simply be asking whether high housing costs are an unjust burden on young people. We should also consider the possibility that they damage the whole country’s economic prospects. Slower long-term growth means there’ll be less to spend on (among other things) the NHS, so even those of us who have benefited from high house prices up to now might suffer in future. Torsten Bell might well therefore be right to speak of a “housing disaster”.

* I’ll be retiring early thanks to the house price boom of 1994-2008 – not that it’ll be a loss.

Comments

[cjcjc]

Down with "property development"!
Except...someone has to build it!

House prices are also high in Canada and Australia.
Do the same observations apply?

Labour mobility should certainly be impeded by high prices (though that doesn't appear to have impacted London's population growth - perhaps the causality is the other way around).
And indeed nothing impedes mobility more than a too small rental sector and/or inflexible social housing where you are essentially forced to stay put.

Is Baumol's disease a big issue wrt housing?
Surely the cost which is escalating is the value of the land?
NB as we speak prices in central London at least are falling quite rapidly...

[Dipper]

Whoa hang on ... prices are set by the laws of supply and demand. One person's shortage of supply is another person's excess demand. If we had less immigration, then we would have lower demand for housing and hence lower prices. Problem solved.

[gastro george]

Nah, I reckon killing all first-borns would be more efficient.

[TickyW]

After all but wiping out manufacturing in the 1980s, how else could Thatcher and her successors produce a feel-good factor in the electorate other than by pumping up house prices?

[Lord]

I think housing is more the investment of last resort. What isn't invested ends up driving housing prices, so it is more an effect than a cause.

[Benoit Essiambre]

We need incentives to move jobs away from too dense areas.

[cjcjc]

FWIW UK manufacturing output was at a record high in 1990 the year of Thatcher's fall

[George Carty]

High housing costs also encourage asset stripping, by creating windfall profits for those who convert commercial or industrial land (quite heavily taxed via business rates) into residential land (much more lightly taxed).

This is the probable culprit behind the destruction of so many manufacturing SMEs in Britain.

[gastro george]

Or even public land ...

[Ralph Musgrave]

The Baumol disease argument is weak. How about this:

Productivity in connection with computers has increased at astronomic rates over the last 30 years compared to the equivalent increase for house construction. Ergo everyone should be induced or forced to buy ten times as many computers as they actually want.

[john]

Not listed is the huge harm to most buyers having to over-allocate lifetime income to housing. Since there is a fixed amount of this stuff, housing necessarily crowds out other categories of necessary spending. That is, high housing costs make lots of people poorer.

[Frederick_S_A]

@ cjcjc
Depends on whether you're talking about actual property development (building more homes) or "property development" (read: land banking).

[Avraam Jack Dectis]

.
If you wast something cheaper you have to increase supply and reduce demand.

One way to do that woukd be switching to Bond Funded Government - which, lacking income taxes, reduces demand for tax avoidance reasons and also, because it taxes assets, refuces demand even further.

Enlightened governmental incentives to build quality housing infrastructure could also boost demand. Shamefully, that seems unlikely -( the enlightened part ).

A crude more elaborate description of Bond Funded Government:

Avraam Jack Dectis said...
Speaking of running an economy hot:

.

The government funding model we currently use is like an engine designed to run cool/slow with levers to heat/speed it up when needed.

We are now finding that the economic environment/engine is stuck on low output and the heat/speed levers are not working.

Perhaps the old model is obsolete.

Why not have an economic system/government funding model designed to run hot/fast with plentiful unquestionably effective levers to cool it down when needed?

Perhaps a bond funded model should be adopted.

A bond funded government funds the majority of its needs through bonds, paid off when due via monetization. This is the engine designed to run hot.

Inflation, the only real concern, is held in check through interest rates, reserve requirements, loan to value constraints, asset taxes and transaction taxes - absolutely no income taxes. All these measures, and others, vary dynamically with the inflation rate. These are the cooling levers.

The central bank would have to be ceded the power to access these levers at will.

This solves many problems:

1) Zero lower bound, secular stagnation and fiscal dominance go away. Interest rates would have to be higher, no debt means no fiscal dominance and secular stagnation is unlikely in an environment where the government is free to invest, constrained only by inflation.

2) Low inflation and deflation go away, unless the government is too gridlocked to float the bonds and spend. Note that debt can no longer be used as an objection to spending.

3) Fiscal constraints and debt constraints would not exist - the only constraint is inflation.

4) Redistribution would no longer be possible, it would be distribution.

5) Greater public investment and the resulting economic effervescence would impel great private investment.

6) All income tax avoiding and evading activities would cease, along with all the associated conflicts.

7) A zero income tax regime would attract industry, thus boosting middle income wages, equality and employment.

8) Bond Funded Government would provide great economic certainty.

9) Demand would be greatly boosted as all entities were freed from income taxes.

10) Returns would be less structurally constrained because of the lack of income tax.

11) All of the above would countervail slow growth situations.

I think a bond funded government would be much more likely to keep an economy at maximum performance and it would have a plethora of tools to avoid exceeding the economic redlines.

If you took a poll, I suspect that literally everyone would risk higher interest rates and more difficulty getting a loan if income tax could be abolished.

( lifted from Mark Thoma's website: http://economistsview.typepad.com/economistsview/2015/12/the-new-supply-side-economics.html )
.

[Mannixesq]

Great article. It seems that expensive housing has been a big part of the last 35 year economic period. The troubling thing is that if you combine the housing markets of the old common wealth counties, real estate makes up an astonishing part of the economy. In Canada alone, real estate transaction fees are more than 2% of GDP, comparable to forestry and farming.

Productivity in the construction industry is also interesting. It seems with the cost of land increasing, all the gains have gone to land owners. The actual buildings are built on tiny profit margins, this had reduced training and innovation in the industry.

[Walex]

«everyone would risk higher interest rates and more difficulty getting a loan if income tax could be abolished.»

That seems rather unlikely to me as a lot of property and business owners already get much of their income tax-free. Consider for example typical owner-occupiers, and especially retired or divorced women.

[DavidM]

Dipper: "Whoa hang on ... prices are set by the laws of supply and demand."

Wrong. Prices are set by expectations, market power and financing availability. Three things that are wildly distorted beyond any imaginable concept of supply and demand.