Housing Market Failure and UK Government Housing Policy

Unit 1 AS Micro Economics

Housing in the UK

• 26.4m: The number of households in the UK in 2012 – predicted to rise to 28m by 2016

• In 2005-06 home ownership peaked at 71% of dwellings (figures for England only). It declined to 65% in 2011-2012 and is expected to fall further.

• The number of privately rented homes between 2005-06 and 2011-12 went up from 2.4m to 3.8m

• 449,000: The number of households with six or more occupants

• The most common household in England - 7.9m properties – is two people living in a home.

Source: www.theguardian.com/money/2013/aug/17/statistics-behind-uk-housing-market

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What is market failure?

• Market failures mean that the market-driven outcome diverges from a socially optimal outcome

What is market failure?

• Market failures mean that the market-driven outcome diverges from a socially optimal outcome

The importance of housing

“Housing is crucial for our social mobility, health and wellbeing – with quality and choice having an impact on social mobility and wellbeing from an early age, and our homes accounting for about half of all household wealth.”

Source: UK Government Report, November 2011

Optimal markets … require

• Competition between suppliers

• Perfect information among agents (buyers and sellers)

• Markets that fully value externalities into the pricing of goods and services

• No missing markets e.g. non-provision of public goods and under provision of merit goods

• An equitable final distribution of scarce resources

What are some of the root causes of housing market failure?

Chronic imbalance between housing demand and supply

• UK Housing Market Review (2013) (link)

• “The gap between housing supply and projected new household formation is still a wide one. New output in England has stayed a little above or below the 100,000 mark for five years, whereas even the slightly lower official projections up to 2021 now expect there to be 220,000 new households each year. The massive mismatch between household growth and housing output suggests that housing shortages will increasingly prevent people from forming households and lead to greater sharing and overcrowding.”

Empty housing – a waste of scarce resources

• Why are there empty homes when there is huge excess demand?

• Just over 635,000 homes in England are empty, and around 216,000 of those have been empty for over 6 months (Feb 2014)

• Is empty housing a cause of allocative inefficiency?

• What can be done?

Empty housing – negative externalities

• A neglected empty home can quickly start to cause problems for neighbours, depressing the value of adjacent properties and attracting nuisance, squatting and criminal activity.

• This creates additional burdens on local authorities and the emergency services.

Chronic housing shortages

• Shortages of affordable homes have been a major problem for years

• Too many poor quality homes also

• Main house builders possess enough land with at least outline planning permission to build hundreds of thousands of homes

• Shortages affect the mobility of workers in the labour market

Housing shortages

• UK house prices could quadruple to an average of over £900,000 in twenty years' time and make home ownership impossible for millions if the Government does not take action to tackle the housing shortage, a leading charity has warned.

• Shelter called on the Government to make reforms aimed at increasing the amount of new homes being built to 250,000 a year by 2021 in order keep up with demand, as it said currently there was a shortage of 100,000 houses a year in the UK.

Source: www.shelter.org.uk

Housing shortage (Shelter report)

250,000 homes minimum projected to be needed in the coming years – in part due to population growth

Homelessness – outsiders in the housing sector

• Homelessness is estimated to cost between £700 million and £1 billion each year in extra housing costs and wider public costs on e.g. benefits, health, crime and education

• More than 80,000 young people experience homelessness each year in the UK

Imperfect information in housing

• Asymmetric information is a key feature of the housing market

• Normally sellers know more than buyers

• There are costs involved in securing accurate information

• Risk of mis-selling by estate agents and distortion of the market

Building new homes – the external costs issue

• There is a chronic housing shortage in the UK

• Economic and social trends suggest that we will need over 3 million new homes in the next twenty years

• House building involves private costs and benefits

• There are also externalities associated with new housing developments– External costs (negative externalities)

– External benefits (positive externalities)

• Poor decisions on where to build new homes can create market failures

Population growth and rising demand for housing in the UK

Are we building enough homes?

"Britain, a wealthy & resourceful country with 90% of its land still undeveloped, cannot...properly house its people.“

Guardian, May 2014

Rented housing costs in the UK

Private and external costs & benefits of house building

Externalities

• Externalities are third party (spill-over) effects arising from production and consumption of goods and services for which no appropriate compensation is paid

• Externalities cause market failure if the price mechanism does not take account of the social costs and benefits of production and consumption

• Externalities can be positive and/or negative

Private and external costs of building new homes

Private costs External costs

Land purchase

Construction costs

i.e. Wages

Raw materials

Meeting costs of building regulations

Private and external costs of building new homes

Private costs External costs

Land purchase Noise

Construction costs Air pollution

i.e. Wages Lost natural habitat

Raw materials Increased congestion

Meeting costs of building regulations

Private and external costs of building new homes

Private costs External costs

Land purchase Noise

Construction costs Air pollution

i.e. Wages Lost natural habitat

Raw materials Increased congestion

Meeting costs of building regulations

Reminder: Measuring housing externalities is a complicated task – not everything can be accurately measured and valued

Negative externalities from house building – social cost > private cost

Costs and Benefits

Output of new housing

Marginal private and social benefits

Marginal private cost (MPC)

S

T

Marginal social cost (MSC)

U

V

W

Y

Z

Loss of Social Welfare due to market failure

Private and external benefits of new housing projects

Private benefits External benefits

Building firms

• Revenues /profits

Home buyers

• Utility from purchasing / living

Employment

• Jobs on construction projects

Private and external benefits of new housing projects

Private benefits External benefits

Building firms Better public health

• Revenues /profits Improved mobility

Home buyers Less crime

• Utility from purchasing / living

Lower environmental costs from new builds

Employment Benefits for local businesses

• Jobs on construction projects

Impact on value of nearby housing

New housing can also create positive externalities!

Costs and

Benefits

Output

Marginal private benefit

Marginal private cost and social cost

A

B

Marginal social benefit

C

D

Loss of Social Welfare due to market failure

If there is market failure – there is a case for some government intervention

• Taxation – for consumer and suppliers– Changes in council tax and stamp duty– Taxation of building materials / – Inheritance tax– Corporation tax for construction companies– Tax on undeveloped land (land banks)

• Direct intervention e.g. maximum rents• Regulation

– Health and safety legislation & housing planning controls.

• Subsidies e.g. for new affordable housing

Increasing the supply of new homes in the UK economy

• Making available surplus public sector land e.g. Former air bases, council buildings

• Loan guarantees for housing developers to encourage the building of more social and privately rented housing

• Measures to encourage self-build homes

• Reducing planning regulations on house builders to lower costs of projects

• Creation of new garden cities e.g. Close to Ebbsfleet

Is self build an effective option in the UK in the long run?

Judging government intervention

• Why is the intervention being proposed?

• Will it work? Will it be effective in meeting specific objectives or goals of policy

• On what assumptions is policy being based?

• What are the alternatives to a particular policy?

• Are there any negative consequences arising from a particular policy being introduced?

• Beware of the law of unintended consequences!

• There is always the risk of government failure

Current aims of UK housing policy

• Sustainable housing– Everyone should have the opportunity of a decent

home at a price they can afford, in a place in which they want to live and work

• Raising home ownership by boosting housing supply and making it more affordable

• Improve the supply and quality of social housing• Improve the supply-side performance of the UK

construction industry to increase productivity• Making the most of brown-field land as a source of

land for new housing developments• Meeting the long term housing needs of a growing

and ageing population – more smaller homes?• Strategy to reduce homelessness in towns and cities

Follow Geoff Riley on Twitter @tutor2u_econ

For the AS micro exam, follow the hash tag #econ1

www.tutor2u.net for extra revision resources