Uncharted Territory

January 23, 2009

It’s the Construction Industry, Stupid!

Filed under: Credit crisis, Economics, Housing market, Markets — Tim Joslin @ 7:53 pm

To help revive the UK economy, the Government should change the rules to encourage more house-building for the private market.

Back in the early 1980s, I occasionally asked members of hard left groups, such as the Militant Tendency, how they proposed to lift Britain out of recession. I recollect that, after the mantra: “Nationalise-the-top-two-hundred-companies!”, their prescription was massive investment in the construction industry. They had a point.

Some of the objectives of the raft of economic measures the Government has announced are absolutely correct. Broadly, their aim is to short-circuit the process of reduction in bank-lending (“deleveraging”) which would otherwise occur. Renewed bank lending will hopefully slow the disastrous cascade of bankruptcies leading to further bankruptcies, for example, amongst failed companies’ suppliers and customers.

The Government hopes that renewed lending will also stimulate new investment and consumption, thereby promoting economic recovery. But where will economic activity increase in the UK? Financial services is on its knees, the car industry is practically mothballed and, from retail to aerospace, most other industries are seeing reductions in demand, albeit less dramatic.

But there is huge unmet demand for housing. Waiting lists for social housing are at record levels. At the same time unemployment is heading towards 3 million. A naïve observer might suggest trying to tackle both problems at once. They’d be right.

So far the Government has attempted to address only the demand side of the housing market. Margaret Beckett is even, disgracefully, trying to scare first-time buyers into taking the plunge. But demand will only return when prices drop to a level justified by the new reality. Currently, sellers are marking house prices down by an average 2% a month. This rate may slow later in the year, but is so high it suggests prices are likely to fall for quite some time, until first-timers can buy for 3x salary, and enough of them have saved a hefty deposit.

Perhaps Beckett does not clearly understand that we have entered a period of consequences. The fact that house prices are falling rapidly now is a result of past mismanagement of the market. The Government is clear that we can’t return to the lax lending practices of the past. Quite right. It follows that the housing market will not return to its previous state.

Many commentators (and it seems Government ministers) appear to confuse the bubble phase of the housing market, when supply constraints inflated prices, with the current crash, when all that really now matters is affordability and hence demand. Observe how the oil price is behaving in a similar way to the UK housing market – the fact that we couldn’t get the stuff out of the ground quickly enough a year ago is suddenly entirely irrelevant.

The UK housing market differs from a number of others in that there was no oversupply during the bubble years. On the contrary, many first-time buyers were priced out of the market. It matters not a jot now whether there are 1000 properties on local estate agents’ books, or 10, if no‑one can afford to buy any of them. First-time buyers still can’t enter the market because, quite rightly, mortgages are harder to obtain and require a significant deposit. Unless the Government plans to encourage lenders to reinstate 100% mortgage deals, house prices will tend towards a new equilibrium level, at least in relation to average wages. The Housing Minister should be considering now how to change the rules of the game in order to incentivise developers to build houses for private sale in the lending conditions likely to prevail for the next 10 or 20 years.

Reading Margaret Beckett’s words: “If demand starts to turn up before supply turns up, you’re immediately back in inflationary pressures… when the upturn comes, there will probably be a mad rush”, it starts to dawn on me (to my horror) that the Government might be happy to see a lack of house-building for private sale. This is a mistake. Instead, the Government must do everything it can to promote house-building. In terms of the effect on the housing market, the pay for the jobs created would more than compensate for the increased supply of housing, since the full cost of construction has to be paid out when property is built (i.e. put into the economy now), but this money is borrowed (i.e. is only taken out of the economy in the future), first by the developer and later by the purchaser of the house.

So, encouraging a bit more house-building now would be a very good idea. The problem is that, not only is the housing market in freefall, the Brown Government has already splashed money about remarkably liberally. Rather than devise ways to help the banks raise fresh private capital by, for example, underwriting deeply discounted rights issues, the Chancellor has simply reached into the taxpayer’s pocket. The pound is now under pressure and concern about the fiscal deficit will make it more and more difficult for the Government to borrow. Consequently, the Government is not in a position to finance a massive social house-building programme, much as it would like to. But they could change the rules to reduce costs to developers, encouraging them to build more houses.

The reasons why there is so little house-building now are the same as during the bubble years. Then, the lack of supply inflated prices more than would have otherwise been the case, contributing to the mess the economy is now in. Now, more house-building would help the economy out of recession.

First, the local planning process is seriously dysfunctional. The Government should redouble its efforts to speed applications along. Unfortunately, there is stiff resistance to the necessary measures, and I also suspect the Government is in something of a bind, as one of their aims is to empower communities. The trouble is, when it comes to planning, “local democracy” is a contradiction in terms. Decisions are overly influenced by the concerns of anxious neighbours – often bordering on the ludicrous, for example, in terms of sensitivity to increased traffic – to the detriment of the general interest in adequate housing provision. At a minimum, the Government needs to constrain the planning process to restrict the grounds for objection. For example, objections on grounds of supposed traffic increases should only be admissible if a new through-road is being created.

Second, the level of house-building is much reduced by Section 106 agreements with Councils, whereby developers fund, not just supposedly necessary infrastructure improvements, but also the provision of new social and “affordable” housing. Section 106 taxes inevitably reduce the supply of housing because (as would be learnt in an Economics 101 class) restricting developers’ profits will, as sure as economic gloom follows euphoria, result in less investment in house-building. To try to increase social housing provision through such a measure as Section 106 is a colossal blunder, since, by reducing the overall supply of housing, more people end up on local authority lists because of the lack of supply to the private purchase and rental markets (and consequent high prices), than if Section 106 schemes to provide “affordable” homes didn’t exist! The Government should stimulate house-building by drastically restricting the ability of local authorities to, in effect, tax first-time buyers through Section 106 agreements, and permanently abandon the use of this method of funding “affordable” housing provision.

If the Government were to take these steps, house-builders would judge many more potential projects to be commercially viable than would otherwise be the case. For many developments, they would be able to reduce their costs sufficiently to be able to sell the property profitably when the housing market stabilises in a year or two. Developers would have an incentive to make use of the bank-lending the Government is encouraging and restart the house-building industry, providing a much-needed stimulus to the economy in general. The increased economic activity from a revival of the house-building industry would itself contribute to arresting the decline in house prices.

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4 Comments »

  1. […] the right for the town they live in to remain the same forever.  Because other people have the right to a house as well, or to create a business, amenity or […]

    Pingback by Globalisation rights « Uncharted Territory — February 4, 2009 @ 8:09 pm

  2. […] digression: note that the UK is in the fortunate position of being able to build houses.  As I’ve already spelt out, the Government should consider what needs to be done to stimulate lending for […]

    Pingback by Good Banks, Bad Banks and Nouriel Roubini « Uncharted Territory — February 13, 2009 @ 12:27 pm

  3. […] The Government could and should make life easier for the builders, as I’ve discussed in a previous post, but a full revival will only take place when house prices stop […]

    Pingback by Turning the UK housing market « Uncharted Territory — February 24, 2009 @ 5:03 pm

  4. […] pointed out the same problem with housing a while ago. It is entirely illogical for local residents to be given […]

    Pingback by The Age of Stupid Planning Processes « Uncharted Territory — March 17, 2009 @ 7:59 pm


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