They shout Houses, don’t they

All the attention following Kwasi Kwarteng’s “mini-Budget” centred upon the financial market reaction: cause enough bond market panic, bring about an emergency BOE intervention and yes, you will have our attention.  This, and a series of U-turns, ensures that this government’s reputation for economic competence is not likely to recover. Ever. Everyone was paying attention.  Particularly the people with mortgages.

Cue much lamentation from those free-market ultras willing to defend the package. How very unfair that a “febrile” market should overreact and in just a few hours taint for perpetuity a set of policies that is about so much more that just “cut all the taxes, who cares about the deficit”. We’ll never know, but I bet it is exactly what might have met a Corbyn government – “before you even let us nationalise all the utilities, the stupid markets showed us the red card! Didn’t they realise how well we would run the water industry?”

The key complaint is that the markets/media bubble/taxi-surfing think-tankers just hadn’t stopped to weigh the fantastic supply side reform buried within the market-terrifying package. Once you factor in the extra growth, there is much less to panic about, hardly anything in fact! I felt this was worth thinking about.

First point: it takes only a little back-of-envelope maths to realise that to eliminate a £45bn gap you need the markets/OBR to assume an insanely generous leap in growth from your policies. The OBR has never been so generous – not in response to policy announcements. This is not to say that the OBR hasn’t changed future growth forecasts by much more in the past (usually downwards – see the porcupine chart from this FT story)

But never because the Government has unveiled a new tax bung, Institute of Whatever, Growth Accelerator or so forth. The economic ship is too massive – it is only global currents and demand shocks that swing it around that quickly.  

Second, but what about the measures themselves, aren’t they good? Well, some of them might be. Maybe the investment zones will be brilliantly chosen to identify just where the growth will be positive-sum, not displacement, and electrify local growth incentives. Perhaps a little table-banging and corner-cutting will get infrastructure moving more quickly. A fresh, positive attitude towards economic migrants is certainly welcome. Of course, this is true of every budget, ever.

But the one that most interests me is the prospect of a massive increase in housebuilding, for the simple reason that it animates the widest range of properly respectable thinkers, on the left, right and middle (I have decided not to @ the lot of them). And because they surely have a point. Despite my labouring, a little trollishly, to amplify Ian’s refutation of the idea that a supply boom could solve housing affordability issues, I tend to think easier supply is a good thing, in most places and most markets. Certainly it is an odd economic model that hopes to build prosperity out of shortages and smaller markets*. I find it hard to see how the list of restrictions itemised in this impressive Economist piece, “Why Britain cannot build enough of anything” can actually help growth.

What I question is how much it might actually increase GDP. Consider these mechanisms:

Sheer increase in housebuilding activity. Let’s wrap some numbers around this.  Here, first, are the typical housebuilding numbers: about 200k, it was once over 300k per year

What does this amount to in terms of actual GDP? Here is the key chart from the ONS:

The whole industry was worth some £119bn in pre-pandemic times. Squinting at the above, building private houses is about £44bn or 2% of GDP. That appears to mean £200k per house, which sounds about right! Naively, if we raised housebuilding to 300,000 a year, on a pro-rata basis that figure might rise to £66bn, or 1% more GDP … for as long as it continued. If it turned out that we only needed a burst of extra building, then it would fall back again. Note: GDP, not GDP growth.

Is that a fair number? A couple of caveats. First, never forget that doing one thing means not doing another. In a full-capacity economy, you build more houses instead of doing other things. Perhaps you shift out of infrastructure or commercial building? Labour is constrained, and construction skills are hard to generate overnight. What about capital? Building a house requires some risk-seeking capital – would it subtract from capital used elsewhere? The example of the 1930s housing boom has been suggested to me – but that started with unemployment at 14%…

A smarter allocation of economic activity Great cities bursting with growth-y prospects are the first to hit their limits, and those limits stop them growing more. No lesser a personage than the former Chief Secretary has cited a well-known paper calculating how expensive housing regulations have been in the USA, through the “spatial misallocation of labor”.  Such constraints have apparently lowered US growth by a simply enormous amount. Truss suggested US GDP might be 3.7% higher – others have put it at much much more. H&M’s basic idea is “output can in principle be increased by expanding employment in high productivity cities at the expense of low productivity cities”. People are stuck in places where they are less productive than they might be, because they are stuck in the wrong place, because there aren’t houses.

This is a really intriguing possibility. In my interpretation, this means that we should be taking steps to allow Oxford, Cambridge and London to be much larger.  Apply some figures again. UK GDP per head is £36k; Oxford et al score £50k.  So shifting 3m people, say, out of the average and into a £50k bracket would in theory raise GDP by 3m x £14k or £42bn – a handy (again, one-off) rise in GDP by about 2% again.

Two obvious caveats, though. The first is the obvious political one: the growth idea expressed above is, in effect, to grow the Greater South East and shrink the rest. Insert your own mega-snarky point about levelling up right here.

The second, more geekily, is that there is academic doubt that simply moving to a high wage area makes you high-wage, raising national productivity.  This paper says

“Consistent with recent research from France, Spain and Germany, we find that two thirds of the variation in observed wage premiums for working in different CZs is attributable to skill‐based sorting. Using separately estimated models for high and low education workers, we find that the locational premiums for the two groups are very similar”

In English, “skill-based sorting” means the high-skilled (and therefore productive) sort themselves into the high-productivity locations you can see around you. It is not the Oxfordness that makes Brian or Melissa productive in Oxford, but the high skills Brian and Melissa already have, and which they take to Oxford.

I do not think this finding – if correct for the UK – is fatal for build-houses-for-prosperity, but it should warn us against the sort of naïve maths I performed above.  It does seem crazy that our most brilliant places should be strangled, and I doubt any available study can capture all the dynamic effects that are maimed before they can take flight. Planning frictions must wear away at all kinds of investment schemes – I heard too many examples from overseas investors to discount it. It would be daft for me to write a piece on Business Investment that makes Uncertainty the biggest culprit holding it back, and then brush off what must be a permanent source of it in this country.

But on houses specifically: what finally gives me pause is when I look around at other countries nearby and ask whether a housing boom produced the sort of permanent rise in productivity that we hope for.  Check out Spain (courtesy of tradingeconomics)

Or look at Greece or Portugal or Ireland. It doesn’t feel like a house building boom is necessarily the precursor to the sort of sustainable, higher growth we do indeed need. Better planning rules are definitely a good idea. Better local authority incentives so they want more houses would be lovely! More affordable housing, built with help from the state, would probably improve welfare – lower rents for landlords, more accommodation for the needy. There really is much to achieve here. But not, I think, £100bn more GDP in five or ten years’ time.

*someone tell the hard Brexiteers