‘An artificial and temporary recovery based on property inflation’

Happy New Year and all the best for 2014.

It’s quite a long time, around 40 years, since I picked up an economics textbook. But the basic laws of supply and demand get lodged in your brain and help in the daily struggle to interpret what is happening in the world.

However foggy and distant these memories are, I seem to be better informed about the interaction of supply and demand than our Prime Minister. As the New Year breaks, David Cameron has been keen to make a big noise about his ‘Help to Buy’ scheme, which has now supported 750 households to buy a property. Yesterday he dismissed fears, expressed by almost every economic commentator, that it would create a new property market bubble. His argument was that property prices outside London and the South East are ‘still way below the peak they reached in 2007′. There is, he said, ‘no evidence of a problem’. He dismissed criticism of Help to Buy as ‘London-centric’ (no hint of irony!), pointing out that prices in other regions have been relatively stable, failing to mention that one-quarter of the purchases so far have been in the London and South East.

Better versed in economics than Cameron, Business Secretary Vince Cable takes a diametrically opposing view from his boss. Cable has attacked the Help to Buy policy consistently, repeating his complaints at least twice over the holiday period, warning about ‘a raging housing boom’ in London and the South East on the Marr Show and a recovery based on property inflation’ yesterday in the Evening Standard.

Cable argues that help should be targeted at areas where the property market is flat. ‘Help to Buy is a good idea if prices are collapsing and development is stalled’, he said, ‘I’m sure it has a very useful role to play in Northern Ireland and parts of the North of England’. He attacked the central economic policy of the Government: ‘What I want to see is a real economic recovery based on British industry and exports of goods and services, not an artificial and temporary recovery based on property inflation.’

So what does economic theory tell us about subsidies and how they might impact on the housing market? As a subsidy, Help to Buy works on the demand side, enabling people to borrow more to buy their property. Theory says that subsidy on the demand side puts prices up, which in turn leads to a responsive increase in supply. However, housing is an unusual product because the supply of it is inelastic. Price rises might encourage more existing owners to put their homes on the market but the speed at which the market can respond by building additional houses at the new higher price is extremely slow. The policy will potentially have a big effect on prices before it has any impact on supply. This is simply not what is needed.

The alternative policy of introducing subsidy on the supply side would have very different effects. It would reduce the market price at any level of demand, but also increase supply. Supply would still be inelastic, but the effect of the subsidy would be more direct and predictable for builders. (For anyone interested in reading more, a useful summary explanation of supply and demand for housing can be found here.)

Currently we have no mechanism for introducing Help to Buy in some regions and not in others, so the impact on the housing market in London and South East, which is already drastically overheating, is inevitable and cannot be dismissed in the superficial way that Cameron has done. A further increase in house prices in London will have a wide range of economic effects and will push homes further out of reach of people on even good incomes.

Help to Buy is the wrong policy at the wrong time and acts on the wrong side of the supply/demand equation. In the words of the Institute of Directors, ‘The world must have gone mad – the housing market needs help to supply, not help to buy’.

This policy is not about housing affordability, housing supply, or pursuing the home ownership dream as Cameron would put it. It is a desperate attempt to boost the Tories’ chances at the 2015 Election by creating the appearance of economic good times whilst the truth is less rosy. Nothing is more damning, or more accurate, than Vince Cable’s description of it as ‘an artificial and temporary recovery based on property inflation’.

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7 Responses to ‘An artificial and temporary recovery based on property inflation’

  1. Orchard says:

    I do agree that a further increase in house prices in the London area will have a wide range of economic effects that will be out of reach for those on a median or good income. The general south east area of the UK will outpace the generic London area in terms of commuter land. Thus, in a recent article from the Guardian, it is predicted by 2018 a million more people will move into rented properties. Is this a big contradiction to the Help To Buy scheme?

  2. Edward Harkins says:

    Is there a problem at the Red Brick Blog with posting? I’ve tried twice over a couple of days to post a comment on ‘An artificial and temporary recovery…’

    On each try it seemed to have been submitted OK – but nothing has appeared. Can you advise please?


    Edward Harkins

    • Hi Edward
      For some reason your previous comment went into the spam filter although this one did not. Technical reason for that is beyond me! However it is now retrieved and posted and thanks very much for submitting it (and for your new year wishes!).
      I don’t check comments every day, hence the delay, but I do check the spam filter in case something that is not spam ends up in there, which it occasionally does. The spam filter is important because there are dozens of spam messages to deal with and I don’t want them getting through and cluttering up the site. In the site’s history I’ve only ever not approved 2 comments, both offensive and from trolls.

      • Steve, first I’m impressed with such a speedy response Sunday night after Hogmanay! I didn’t realise that my enquiry would appear here on the blog (red face). I’ll need to check with Gmail as this is second oddity with spam I’ve had in past two days. Onwards and upwards in the New Year..

  3. And a good old Scottish Happy New Year to your Steve and all involved in Red Brick.

    You’re right to carry over into the New Year the theme of the tawdry pork barrel politics that comprises of the Conservative Coalition UK Government’s housing ‘policies’. The extension of the Help to Buy into the Help to Buy 2, was met by a mixture of dismay and bemusement -even among many commentators on the ‘right’ of housing policy making. It is already impacting on the emergent housing bubble. In response to one feature in an economist journal wittering on about rising house price inflation being a sign of UK ‘consumer confidence’. I responded with:
    “To describe more and more Britons electing to stay in mortgage indebtedness as a sign of ‘improving consumer confidence’ is bizarrely contrarian in to say the least. It’s a reasonable to assert that it’s a sign that under the UK Coalition Government induced Austerity they ain’t got the earnings with which to sensible pay off their debts.”

    But unabashed, the Conservative Coalition Government is intent on larding Right to Buy with even more taxpayer funded subsidy. We in Scotland can but be thankful that the Scottish Government is instead moving in the opposite policy direction with the intended abolition of RTB.

    The Conservative Coalition UK Government’s insistence on the strengthening of RTB alongside the other irresponsibility’s is a continued triumph of uninformed ideological conviction over rational, evidence-based policy making.

  4. danfilson says:

    Given Vince Cable’s comments, the logic is to introduce the power to disapply “Help to Buy” in those parts of the country where property prices are over-heating whilst retaining it in those parts where the building trade is depressed and property is not shifting. But this still begs the question whether given limited resources this is a sensible application of limited funds. 750 homes? In the totality of things, that is chicken-feed and that demonstrates how desparate the PM is becoming. If we want to see improving home ownership – and I have reservations as to what % of the population can ever be home owners, nor whether long-term a property-owning democracy is quite as desirable as so often made out.

    The first priority is to get full employment or as near as dammit to it. It cannot make sense for a nation to have parts of its resources not engaged quite apart from the personal tragedies involved in every case.

    The second priority is to raise earnings to stimulate internal demand and, incidentally, reduce the benefits bill by so doing. I’d begin with a hike in the National Minimum Wage to above the level of the so-called Living wage, but also slowly unfreeze the other wage sectors, but keeping caps – if necessary by law – on the ratio of top salaries to those obtaining in the local economy, never mond the company itself.

    The third priority, and I only put it third of these three, is to get a massive home construction programme going to ensure all this nation’s people are housed in homes that are dry, capble of being kept warm and which have sufficient space for the occupants and their exisitng and devloping needs. Such a programme would also generate jobs, so helping meet the first priority and would stimulate wages, so aiding the second; and would also increase tax receipts on wages and NIC receipts such that then et cost migth be less than the gross, and even less still when the mutiplier effect of public spending is considered.

    Stimulating the demand side is wholly unecessary and actually unwise. Housing, as my rudimentary economics taught me (mine is even more rudimentary than Steve’s) has an elastic demand but inelastic supply. Rising demand does not, per se, create rising supply. If anything we should bring in the kind of credit controls that existed until the abolition of purchase tax in 1971 (in the 1960s the levers of regulatory twitches were perhaps given too much credence, but the concept was not altogether unsound). Minimum deposits for goods bought on credit and likewise for property bought with mortgages. No more than x% paid by way of debt, whether it’s HP or a mortgage. We need to move from being a nation constructed on debt towards one constructed on savings nad investment. If we do so, some of that investment might go elsewhere than into property ownership; I have long observed that businesses need risk capital and working capital, to say nothing of more active shareholders. So we need to level the property playing field, by elminating the incentives that make property a more desirable asset to own than say shares in your nephew’s new company. It cannot make sense for property to be something in which people invest in the not inaccurate assuption (on present terms) that values will contrinue to rise inexorably in the long term and so provide a geared investment with a tax-free yield. You cannot borrow 90% of the money needed to buy shares in a company, so why should it be possible to do so when buying a house? Let alone get a taxpayer grant to do so.

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