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Evaluate the extent to which any government should intervene in the housing market for example by using subsidies or leave the provision of housing to the free market.
A Background to the Failure of the Housing Market
In some instances, the housing market can appear to have failed. One of the issues surrounding the market for housing is the hardship of first-time buyers to enter the market, due to the barriers to entry created by banks supplying mortgages. Such barriers include a housing deposit, which, in the UK, is currently “around 15%” (Anthony, 2019) of the property’s value. The other barrier is the potential buyer’s credit and financial history. Requirements include a history of stable (and recorded) long-term employment and an absence of liabilities such as credit cards and other loans. Earning a high enough income is also an entry barrier. According to the Institute for Fiscal Studies (2018), “Even with a 10% deposit, many young adults are severely restricted in their ability to purchase a home. Most mortgage lenders will not lend more than 4.5 times salary.” The Office for National Statistics (2017) states that the UK average median income in 2017 was £28,677. Recorded in the Land Registry database (2019), the average house price in the UK is currently £234,370. Proceeding with this data, a bank would be able to lend an individual with a good history approximately £129,046.50 (taking into account a loan of 4.5x median income), which clearly is not enough.
One could also compare the purchase of a house to a merit good; a good that is underconsumed in the free market. The US Department of Housing and Urban Development (1976) defines a merit good where “people consume less of it than they ought to, for their own benefit”. Merit goods can also generate positive externalities that can be felt throughout society. Rosen (1983) says, “When an individual improves his property, it increases the value of this investment. Simultaneously, the improvement may increase neighbors' property values.” This means that to increase economic efficiency (and welfare), more people should own their own homes.
However, The US Department of Housing and Urban Development (1976) argues that housing and some other goods are “essential needs” but the state providing this goes against our basic beliefs of individual liberty. We must take into account that individuals choose to spend their incomes in different ways. In terms of the poor, they may “prefer to spend it on, say, liquor and gambling rather than a new apartment” whereas the rest of society “the taxpayers, may prefer to have the poor occupy their apartment, rather than spending money for other purposes” (The US Department of Housing and Urban Development, 1976). This may be an over-simplistic viewpoint, but in this situation, a housing program may not be efficient as long as each individual is happy with their choices.
Despite this, there still exists a problem of increasing property prices and lack of affordability. Savills estimates that in the UK, “house prices will rise 15.3% on average in the next five years” (Butterworth, 2019).
Therefore, the underconsumption of houses probably stems from the inability to buy one, rather than bad spending choices. This is therefore more closely related to the problem of income and wealth inequality. Incomes must therefore rise. As stated by Chen (2016), the National Bureau of Statistics of China claims that the major cities’ ratios of house prices to earnings are higher than those of other countries. For example, Beijing’s ratio of house prices to earnings is 19.1, far higher than London’s 9.2.”
Likewise, in the UK, “Since 1997, the average property price in England has risen by 173% after adjusting for inflation, and by 253% in London. This compares with increases in real incomes of 25- to 34-year-olds of only 19% and in (real) rents of 38%...Rising house prices have benefited older generations at the expense of younger ones and increased intragenerational inequalities (Institute for Fiscal Studies, 2018).”
On the supply side, there are also some issues in the UK. One of these is inelastic supply, caused by added complexity and legality of new-build housing. One obstacle is planning permission, which inhibits developers to increase supply in response to demand. According to the Institute for Fiscal Studies (2018), “Increasing the supply of homes and the responsiveness (or elasticity) of supply to prices is crucial”.
Policies to Help Reduce Market Failure in a Housing Market
We have identified only some of the core issues within the housing market. Let’s now examine some historical government responses that have been used to address these issues.
One policy is public housing projects. This is where the government funds the building of new housing, especially designed to take in lower-income and disadvantaged families. It’s most efficient when it benefits the truly needy, and it reduces the financial burden of one’s basic needs.
However, the costs are substantial, despite the politics and ethics being difficult to agree on. For example, in 1979 Weicher (cited in Rosen 1983) referred to the “social cost of slums”. The notion is that poor housing does more than merely lower neighborhood property values. “It breeds crime delinquency, fires, disease, mental illness, etc” (Rosen, 1983).
Furthermore, public housing is typically inefficiently produced. According to Rosen (1983), “public housing is inefficiently produced, distorts consumption patterns on the part of the beneficiaries, and redistributes income capriciously...We have not touched upon the administrative complexity of the program and the associated costs.”
Public sector projects are typically less efficient than private ones. This argument is strengthened in a study of public housing by Muth (1982), where the ratio of market value to resource cost is 0.82. Rosen (1983) states that in the US, “Because capital costs are paid by the federal government, local authorities in effect face a price of capital below its social marginal cost. This gives them an incentive to produce housing which uses too much capital and too little maintenance.”
An alternative policy to public housing is government subsidisation. This is where the government supplements either house building companies on the supply-side, or consumers on the demand-side.
One such policy is a demand-oriented subsidy program called “housing allowances”. This is where a “qualifying individual receives a payment equal to the difference between the cost of standard housing established by the program and some fraction of his income” (Rosen, 1983). The allowance is spent on any housing in the market, providing it meets a specified level of quality.
The main problem with this program is the considerable added complexity and administration cost due to the standard of build required, which reduces the program’s efficiency. However, these standards have to be there in order to “protect the poor from unscrupulous landlords who would take their money and provide no services in return” (Rosen, 1983). This argument does have credibility considering a landlord’s incentive is to maximise his own welfare, thus the incentive without any intervention would be to reduce costs.
However, according to Sinai and Waldfogel (2005), tenant-based programs do a good job of increasing the consumption of housing among families who otherwise would have not consumed their own. This program reportedly produces 0.7 units of net new housing when compared to the less than 0.3 units of project based programs. Another positive note is that tenant-based programs discourage welfare fraud. The policy is means-tested and it forces the consumer into a particular consumption bundle that they may not have valued as optimal, had it been a cash transfer.
On the other hand, tenant-based programs could just make renting more affordable, and in 2002, Susin (cited in Sinai and Waldfogel 2005) pointed out that “if vouchers lead to higher market rents, on net the programs might transfer income from tenants to landlords, thus, worsening inequality” and the root cause of this problem. Ideally, a solution to this problem will also allow the disadvantaged to buy their own homes instead of rent, as “housing is not only a consumption item, but an investment as well” (Rosen, 1983).
Another intervention is the UK’s Help to Buy scheme. One of its incentives target buyers of new-build homes, where only a 5% deposit is required, and the remaining deposit is paid by the government scheme. This can make a substantial difference and offer a meaningful incentive for those wanting to buy a home in the near future.
Downsides of this policy include a further increase in house prices, making homes even less affordable. This is amplified by inelasticities in supply, which is severe in the UK due to strict planning laws. Hilber (2013) argues “as a consequence of all this, Help to Buy will likely have the effect of pushing up house prices (and rents) further with very little positive effect on new construction.” Another downside is that there is not a restriction on first-time buyers alone. The policy is available to those who are already on the property ladder. The only stipulation is that the buyer must be purchasing a new-build home, and not currently own another.
Conclusion
To conclude, the housing market is probably best not left to the free market, as pre-existent inequality of wealth and income will continue a culture of owners and renters. If the last century’s trend in house prices and real incomes is to be assumed, government intervention will become even more necessary.
On the other hand, existing government policy must adapt to cater for the present problems in the market. Government policy must evolve to address the root causes of these issues, those being inequality and restrictions in the construction of new housing. In all of the literature referred to, these two factors repeatedly appear as not being fully addressed. If supply continues to chase demand, prices will continue to rise, the wealthy will only get wealthier and the poor will take even longer to save for housing deposits. A scheme like Help to Buy could be a step in the right direction, but there is still too much focus on the demand-side problem and not enough focus on the supply-side.
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References
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Butterworth, M. (2019). How much will house prices rise near you? Values are forecast to go up by £35,000 in five years in some parts of the country. Daily Mail, [online]. Available at: https://www.dailymail.co.uk/property/article-7677467/House-prices-rise-35-000-average-five-years-says-Savills.html [Accessed 14 Nov. 2019].
Chen, W. (2016). Economic Modelling. Policy failure or success? Detecting market failure in China’s housing market, [online] 56, pp. 109-121. Available at: http://thuir.thu.edu.tw/bitstream/310901/27433/2/%E6%AA%94%E6%A1%88%E4%B8%8B%E8%BC%89+(1).pdf [Accessed 14 Nov. 2019].
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