Types of Market Failure in the Housing Market
- In particular we have a situation where many young people are struggling to be able to afford to buy housing creating inequality. The ratio of house prices to income, is very high, meaning many young people are unable to buy.
- Housing could also be seen as a merit good. If housing is of a poor standard (e.g. overcrowding, insanitary conditions) it can contribute to social problems such as rioting, crime and vandalism.
- Positive externalities in the housing market. Good quality housing can have positive externalities, such as: improved public health, reduced crime, reduced heating bills and air pollution.
- Price Instability. Because supply of housing is inelastic any change in demand causes a big change in price. Many are now predicting house prices could fall, although at the moment, prices seem to just be stagnating.
- The housing market has a significant impact on the wider macro economy. Falling house prices could contribute towards a recession.
- Geographical immobility. Due to divergence between house prices in the north and south, it can be difficult for workers to find suitable accommodation in London. Therefore, this leads to a shortage of key skilled workers in areas of very expensive house prices.
- Environmental factors. Another issue in the housing market is that building new houses on green belt land can lead to a loss of precious green spaces. There are negative externalities to building houses. However, this market failure is a contrast to the lack of new houses built leading to higher prices.
- A positive externality occurs when a third party benefits from the production or consumption of a good. In many cases, building the right kind of housing can have benefits to the rest of society. Therefore, the social benefit of good quality housing can be greater than the private benefit that property developers gain.
- The property industry (building new homes) can have several positive externalities:
- Good quality housing helps to reduce social problems, such as drug use, crime and vandalism. Poor quality, high density housing (e.g. 1960s tower blocks) were associated with various social problems, such as increased crime rates. This type of housing may be cheap to build, but investing in better quality housing with more features, such as gardens can create a better environment which helps to improve social welfare and strengthen local communities.
- Better public health. In extreme cases ‘slum’ housing with poor sanitation and damp surroundings can contribute to ill health. Building better housing without damp and with better sanitation can lead to improved public health which is a external benefit to society.
- Environmental standards. If houses are built with high levels of insulation, then they will help reduce the environmental costs of heating. This is an external benefit because society benefits from an improved environment related to the building of insulated housing.
- Building new houses helps to prevent a shortage of supply and resulting excess prices resulting from the squeezing of demand.
- Building new houses can also increase geographical mobility and provide benefits to local business and employers struggling to employ sufficient people.
Free market and market failure
If there are positive externalities in the housing market, then there may be social inefficiency. For example, in a free market, the property industry may not build better quality housing to replace slums. This is because those living in slums may be unable to afford to buy the more expensive new houses. Therefore, society experiences a socially inefficient level of housing stock. In many cases (though not exclusively), it was government intervention which knocked down slum housing in Britain (throughout the early Twentieth Century) and encouraged the building of new houses.A more modern type of positive externality is related to the environmental benefits of having minimum standards of insulation to protect against noise pollution and air pollution. In a free market, there may be little incentive to increase the building cost of a new house to improve environmental standards. Therefore, new houses would tend to get built cheaply without taking into account the external benefits of better insulation. To overcome this market failure, the government have regulations
Currently....
AS HOUSE prices rise globally, in Britain they are soaring. In the past 20 years they have increased by more than in any other country in the G7 ; by some measures British property is now the most expensive in the world, save in Monaco. It is particularly dear in the south-east, where about one-quarter of the population lives. According to Rightmove, a property website, at today’s rate of appreciation the average London property will cost £1m ($1.5m) by 2020
The booming market weighs heavily on the rest of the economy. People priced out of the capital take jobs in less productive places or waste time on marathon commutes. Young Britons have piled on mortgage debt—those born in 1981 have one-half more of it than those born in 1961 did at the same age—making them vulnerable to rises in interest rates, which are coming. Some will retire before they pay it off
Who is to blame?
One oft-cited culprit is rich foreign buyers, who are said to see London property as a tax-efficient investment, or even a way to launder ill-gotten gains. Having bought plum properties, they often leave them empty. Transparency International (TI), a pressure group, identified 36,342 London properties held by offshore companies. Polls by YouGov show that the most popular explanation for high prices is “rich people from overseas buying top-end London property”.
The argument does not stand up. For one, the number of vacant houses in England has fallen, from 711,000 in 2004 to 610,000 in 2014. And foreign ownership of houses is rare beyond a tiny corner of the capital. TI says that in Westminster one-tenth of all property is owned by firms in tax havens. But outside the centre things look different; the rate is just 1.3% in posh Islington, for instance, and beyond London it is even lower.
Demand from within Britain exerts a much bigger effect. In the past 20 years the population has grown by 11%, twice the average in the European Union. As in other countries, people are marrying later and divorcing more readily than they did in previous decades, meaning that one in ten Britons now lives alone, boosting the demand for homes.
Despite stagnant incomes, buyers have more bite in the housing market. The Bank of England’s base rate of interest has been 0.5% since 2009; in real terms, rates have been below their historical peacetime average since 2004 and in nominal terms they are at their lowest ever. Demand has been stoked by “Help to Buy”, a mortgage-subsidy scheme launched in 2013.
Britons have thus taken on masses of cheap debt. In the 1970s it took the average mortgage-holder eight years to pay off his loan, estimates Neal Hudson of Savills, an estate agent. These days it will take 20 years. Small wonder: the average loan-to-income ratio has jumped from 1.8 in 1981 to 3.2 in 2014. And many are not just buying houses for their own use. Outstanding “buy-to-let” mortgages for landlords are now worth £190 billion, more than 20 times their value at the turn of the century. The National Housing and Planning Advice Unit, a former public body, found that 7% of a total increase in house prices of 150% between 1996 and 2007 was accounted for by increased lending to landlords.
All this demand has run up against sluggish supply. Over the past 40 years growth in Britain’s housing stock has slowed sharply (see chart 2). In the 1970s local authorities built about 130,000 dwellings per year; they now build 2,000. After Margaret Thatcher’s government allowed local-authority tenants to buy their homes, councils struggled to replace them because they had to set aside most of the proceeds. New restrictions on the amount councils could borrow put another brake on building. According to an estimate from 2008, the public sector owns one-quarter of the land in Britain suitable for residential development, in old garages, ex-military bases and poorly designed council estates.
Private housebuilders have been idle, too. Strict planning laws are partly to blame. A quarter of English planning applications for houses are rejected, and even successful ones are often delayed. Protected “green belts”, which are supposed to contain urban sprawl and offer pleasant spaces to city-dwellers, now cover 13% of England. Much green-belt land is far from green: one-third of London’s and three-quarters of that in Cambridge is intensive arable land, estimates Paul Cheshire of the London School of Economics, who says there is enough green-belt land in Greater London to build 1.6m houses. The green belt remains sacred, but George Osborne, the chancellor of the exchequer, has vague plans to make it easier to force through some planning applications in the face of recalcitrant local authorities.
Yet even when planning permission is forthcoming, housebuilders have held back. As of October 2013, of the 507,000 units of land with planning permission, half had yet to see any building. For reasons that economists do not fully understand, for 40 years the construction of new houses has been a remarkably stable one-tenth the number of houses bought and sold. Mr Hudson says this relationship probably holds because housebuilders try to sell new-builds at a price in the upper decile of those prevailing in the local market. The number of transactions has steadily fallen since the 1980s, putting a ceiling on the probable number of new-builds.
One brake on buying and selling homes is stamp duty, a tax levied on housebuyers. Buying a house costing £430,000 (the average in London) would trigger a tax bill of £11,500, payable immediately. Last year the government changed stamp duty from a flat tax into a graduated one, turning it from a “very bad” tax into a merely “bad” one, in the words of the Institute for Fiscal Studies, a think-tank. Removing it entirely could boost housing transactions by 8-20%, according to different estimates.
Also ripe for reform is council tax, a property levy collected by local authorities. Last updated in 1993, it hits residents in cheap areas relatively harder than those in pricey places. (The highest council-tax band in flash Kensington and Chelsea applies to dwellings worth more than £320,000; the average price there is £2m.) With these revenues held down, councils have less incentive to build more homes. And relatively low taxes on the priciest homes encourage people to remain in houses that are bigger than they need, thus reducing the supply of large houses to families. Despite Britain’s acute housing shortage, one-third of households have two or more spare bedrooms.
Since coming to power in 2010 the Conservative government has done more to boost demand for housing than increase its supply. Labour, meanwhile, talks about rent controls, which could flatten supply further still. Persuading homeowning voters that more building is needed is hard. “When The Economist’s readers all write in to me having read your editorial and say: ‘Oh yes, and by the way, I’d like a house next to me,’ then we’ll know we’re winning,” says Mr Osborne. Letters should be addressed to the Treasury, London, SW1A 2HQ, before prices get any sillier.
