Inspired by the publication this week of NYU scholar Alain Bertaud‘s critical new book Order without Design: How Markets Shape Cities (MIT press), Sandy Ikeda‘s pre-book development series Culture of Congestion over at Market Urbanism, and London YIMBY, here is a note on housing reform.
Classical liberals see the economic solution to housing as relatively simple: increase supply to better meet demand. By contrast, the political economy of housing is almost intractably complex. The reason for this is that there are endless externalities associated with new housing: access to light, picturesque landscape, open space and uncongested roads just for starters. These gripes and grievances are the bread and butter of local politics. Unlike consumer product markets, housing cannot be disentangled from these social, political and legal controversies. A successful market-based housing policy must establish institutions that not only encourage housing supply growth but navigate around these problems while doing so.
Policy reform proposals that deliberately favour increasing owner-occupied single-family homes, as tends to be the focus among market liberals in the UK (and to some extent in the US), are currently self-defeating. As justified as they were in the past to achieve a more market-friendly political settlement, they are now a barrier to achieving plentiful, affordable housing. This is because every new homeowner becomes an entrenched interest, a potential opponent to subsequent housing development in their area. They impose more political externalities than renters. I propose we cut the link between support for home ownership and housing supply policies. This would free up policymaking to focus on expanding provision by all available market-compatible means.
This should include greater encouragement of institutional landlords, especially commercial enterprises. Commercial landlords have more incentive and capability to expand supply on estates that they own, while long-term renters (unlike homeowners) have an interest in keeping rental costs low. The lack of private firms dedicated to supplying housing in England compared to much of the rest of the world is startling and yet often overlooked even by friends of free enterprise.
Nobody has good neighbours
Why are people generally sceptical of markets in housing? The classic answer is that housing development is one of those activities where private benefits cannot be easily reconciled with social costs. This was the academic (if not always the public) justification for what amounted to the nationalisation of land development rights under the Town and Country Planning Act 1947. The idea was that public officials would better be able to plan the housing needs of the community than an uncoordinated, even chaotic, market.
Hard experience, as well as research in public choice and new institutional economics, has challenged this naïvely interventionist case. Public choice shows that political incentives and lack of knowledge stymie local officials from effectively planning for housing needs, creating the chaotic outcomes wrongly imputed to markets. The noise of existing residents in town and village halls can effectively drown out the voiceless interests of people who would benefit from more housing but aren’t yet fixed to one area. Meanwhile, Ronald Coase posited that if property rights are well-specified, protected and easily exchanged, externalities can be overcome through bargaining between neighbours and new entrants. It is only when property rights are poorly specified that new developments are curbed. Rights can be bought out, making everyone square, while inchoate interests lead to never ending conflict and fewer new builds.
Indeed, before national planning, English common law had embedded within it many principles that facilitated development. The concept of damnum absque injuria (loss without injury) established baseline limits on hearable legal complaints about new or existing developments, including loss of natural light. The rejection of claims against neighbours based on new entrants ‘coming to the nuisance’ gave the activities of existing property owners priority over newcomers which, in turn, made new developments less of a threat to existing residents, commerce and industry. This prevented subjective grievances from being used to justify coercion, but neighbours remained free to contract for alternative arrangements.
The problem is that as soon as the market becomes regulated, the usual restrictions on what can justify legal coercion go out the window. Suddenly, whatever commands a local majority or official political support determines what gets built or not. In this context, existing property-owners tend to err on the side of preventing new developments and suppressing even well-established sources of noise and nuisance. It is possible to imagine that at least this system gives homeowners free and peaceful enjoyment of their property if they can afford it. However, the freedom of the typical homeowner is sadly a bit of an illusion in Britain. Property owners possess hardly any capacity to alter their estate without permission from the local community. Far from building an extra storey or annex, in some areas you can’t even put a satellite dish on your own home without facing complaints.
Housing regulations turn a minor commons problem, people taking stuff out of common stock for their own use, into a much worse anti-commons problem: spheres of life and activity that should be determined by individual property owners become subject to veto through endless legal and political processes. From this perspective, regulation designed to protect your property from incursion from neighbours becomes a mechanism through which neighbours ultimately exert control over you. An Englishman’s home is his castle only up to the point that he wants to pick the colour of stone to build it.
A return to common law solutions would represent a revolution for competitive housing provision. Unfortunately, it is not in keeping with the tenor of today’s politics. People are much more sensitive to environmental hazards today even than in the 20th century when planning was introduced. Moreover, addressing emotional distress is at the heart of many people’s political motivations. Allowing small existing property-owners to unilaterally develop their own estates seems to be off the table not least because the very same people who would benefit from being able to develop their land would fear giving that power to their neighbours. It is telling that this solution has never been politically stable in any common law jurisdictions. Planning or zoning regulation that take decisions about housing development out of the spontaneous order of the market and into local politics seems to some extent inevitable.
The new lord of the manor
We have an externality problem between homeowners that makes the classic free-market solution of voluntary exchange against a background of strong individual property rights difficult to sustain. What’s the solution? In business, when contracting is too costly between firms, you change the contours and/or scale of the enterprise. You take the function, that was previously contracted out, in-house and use internal policies to manage its production. This is what accounts for a great deal of efficiency-enhancing vertical industry mergers or corporate buy-outs.
In housing, the equivalent solution is having larger units of territory controlled by a single owner that offers a bundle of services to renters. This can include provision and maintenance of common areas, private roads, parking and utilities. The main advantage of this approach is that it takes internal development and maintenance of the estate, as well as the challenge of resolving internal disputes out of the political sphere. If the private estate is large enough then owners can build more densely within without imposing any plausible costs on people outside. For example, a corporation can work out how many car owners it can fit onto the estate without causing congestion on its private roads. It can price or license parking spaces appropriately. As a result, these private estates can be safely exempted from some planning use designations and be allowed to open schools, churches, community halls, shops and offices on-site. Meanwhile renters, without having enormous amounts of capital tied up in their own units, will be less troubled by changes that the estate owner makes around them. If they do not like the changes, they still have viable opportunities to exit. The estate owner has strong incentives to keep the rental units attractive to bring in new tenants and keep existing tenants. There are strong endogenous incentives for them to create an asset that will maintain or increase in value. What this effectively does is carve out spaces from which the state no longer has to take a micro-managing interest. Individual corporations can fail but the conditions are there for business to succeed.
This basic approach is compatible with a variety of ownership structures for corporate landlords. Indeed, publicly owned housing estates can make a benign contribution under some regimes. The outstanding pace of development in common law jurisdictions like Hong Kong and Singapore shows that publicly owned housing corporations can bring great benefits so long as political incentives are aligned to make these corporations pursue genuinely valuable investments based on market signals rather than reward political insiders. In addition, some of Britain’s best examples of housing estate development for working families emerged in the 19th and early 20th centuries through philanthropic organisations like the Peabody Trust.
What these historical and international examples share is an emphasis on creating liveable environments despite relative density as well as aiming at affordable rents for everyone in full-time work. Nevertheless, there is a special place for commercial enterprise. For-profit companies are unique as they possess strong incentives to scale up to meet demand because this will produce a better return on investment, whether for private owners or shareholders. This makes a much larger amount of private capital available for further development. For-profit investors are encouraged by the prospect of bringing in more tenants (and thus income streams). By contrast, cooperative and non-profit enterprises remain perfectly viable if they can use their existing tenants to pay for their given costs. The classic British success story of commercial development of this kind happened to be a predominantly business estate, Canary Wharf. In this case, a single development corporation (with other large corporations as investors) was able to create what amounted to a second City of London. The Government’s main contribution was establishing planning permission and, critically, linking it to new public transport infrastructure.
Running through fields of wheat
On its own this proposal is an important piece of the puzzle. Whatever land is available for development, it is important that it is efficiently utilized. Corporations in control of relatively large estates are probably the most able, and commercial enterprises the most incentivized, to do this in practice. The problem is that without a great many of these schemes, however socially valuable they may be individually, they will barely make a dent in terms of national access to housing. The next piece of the puzzle is getting local authorities to set aside more land for this sort of approach. While central government can champion some specific developments, the nature of housing means that any widespread policy is going to have to utilize local knowledge and satisfy community interests. Local governments need a push to find new opportunities for development, not central commands about where precisely they should be.
If we were starting from scratch, we could institute fiscal federalism and require local councils to raise their own funds by attracting a tax base to their area. This is politically infeasible for the moment because existing council services in poor areas rely on enormous transfers from central government. A second-best solution is for central government to give local councils a 50-year accounting exemption on council tax collected from new housing built either on former green belt land and/or from newly recovered land set aside for corporate development in the manner I have set out. In other words, local councils would keep the additional revenue raised from new taxpayers. This could be spent at their discretion, whether on local services or to cut local taxes for existing inhabitants. This would introduce a particularly strong incentive for local councils in wealthy areas to expand supply quickly as their per household property value (and resulting tax take) would be higher. Currently, successfully expanding the tax base means a local authority sees progressively more funding support withdrawn by the Treasury. Under this scheme, local authorities that grow faster would have a proportionate increase in their own effective budgets.
In the past, developers have been keen to sell properties rather than manage them as rentals because of the political risk of a future government introducing rent controls after development has taken place. So I suggest, in addition, a 50-year exemption for corporate developments from future rent controls. This is not because rent control is ever a sound policy (it never is) but because a 50-year exemption is a somewhat more credible commitment than an indefinite undertaking from one Parliament that can easily by reversed by future Parliaments that will (correctly) not feel bound by the will of a previous administration.
Reconceptualizing property-owning democracy
Does this approach abandon or vitiate the British notion of a property-owning democracy? In fact, all this does is disentangle two aims of a property-owning of democracy: widespread participation in saving and access to housing. It is a great thing for families to have comfortable, attractive accommodation and significant security of tenure. It is also a good thing for families across the income spectrum to have assets that they can use to support their children and better control their lives especially in old age. The mistake that free-marketeers sometimes risk making is aligning the two too closely and trying to make a house a home and a savings vehicle simultaneously. For many people, the two goals are best managed separately.
For people at the margin of owning a home, those that need to take on a large mortgage, a house or flat imposes a series of peculiar and correlated risks. A single house can suffer floods or subsidence, substantially reducing its value. If homeowners buy at the top of an economic cycle, they may face a loss of employment income and a drop in equity at the same time during a recession, leaving them struggling to service a debt. Homeownership increases the costs of relocating to a new area with better employment prospects. In other words, becoming homeowners easily exposes people to correlated risks. From a financial planning perspective, such individuals are better off renting, paying off existing debts and saving in a diversified portfolio rather than taking on a precarious mortgage.
On the other side of the ledger, large commercial landlords can issue debt and offer equity through financial markets. Through these mechanisms, renters can, in fact, become property owners without having to make the difficult jump to personal homeownership. Their savings can draw on income streams for multitude of homes rather rely on a single housing asset maintaining its value. Fortunately, millennials and post-millennials are more used to purchasing what used to be goods as a stream of services, and there are an increasing number of investment apps and scheme that make saving easier and attractive. The overall result will be fewer sudden personal financial shocks and more financial independence. Precisely what a property-owning democracy is supposed to deliver.
Although geographic and financial mobility is an advantage that we shouldn’t discourage, widespread renting need not be a substitute for homeownership altogether but rather a useful complement. Right now, home-owners invest in second homes because they want to extend safe assets, and to avoid themselves or their children having to pay excessive rents when they are staying in another part of the country. This leads to a lot of under-utilized accommodation and contributes to higher prices for first-time home buyers. Under my proposed scheme, the rental sector would be more competitive because of the supply of denser housing estates. This would free up more traditional homes for younger buyers.
Clement Attlee nationalized real estate development, making Britons dependent on the state for permission to build for generations, and forcing many to be tenants of the state indefinitely. Margaret Thatcher challenged this system of dependency by giving existing social housing tenants the right-to-buy and liberalizing financial markets. This democratised access to mortgages and allowed some people to become substantial landlords. Valuable as this strategy was at the time, it has met its match as the political heft of existing homeowners prevents new housing from being built. A reform that carves out more spaces for corporations to supply rental properties competitively is inspired by successful policies of other common law countries and Britain’s liberal past. Yet it also aligns with the financial savviness and mobility of the current home-hunting generation. By giving Millennials not yet ready to settle down more and better living options in dense accommodation with competitive amenities, those that are ready to buy will have more choice to buy at a lower cost.