Graeme Leach: We need help to supply - not help to buy

Graeme Leach is Chief Economist at the Institute of Directors

The IoD has reacted strongly to the extension to the Help to Buy scheme, under which the Government will guarantee part of a home buyer’s mortgage on properties worth up to £600,000. In its press response, the IoD said that instead of trying to pump up prices, the Government should focus on radical reform of planning laws and reducing local authority charges on developers, to make it easier to build more homes.

So why did the IoD react so strongly? It’s basic economics that if you stimulate demand in a market that exhibits a very steep supply curve, the stimulus will impact more on prices than output. Yes, the Help to Buy scheme might increase the supply of properties a little, but those homebuyers will be paying more for their properties. The Government says that that there is plenty of evidence that supply will be very elastic to an increase in mortgage availability, so we can avoid a large price response. We beg to differ. Any increase in the flow (new builds) of housing is peanuts compared with the overall housing stock.

UK house prices do not look cheap, quite the contrary. They remain expensive on a long-run comparison of the ratio of house prices to earnings. Yes, debt servicing measures suggest they’re more affordable, but we can’t take a judgement based on record low interest rates now, which ignores any future normalisation of interest rate policy in the future. So we have a housing market grossly distorted by the planning system, where land with building rights can sell on a multiple of 100-200 times agricultural land, and on top of this we propose to superimpose another layer of distortion.  Of course we recognise that housing transaction levels are below average but further increasing prices is hardly going to help this situation in the long term.

There are deeper concerns as well. It will be very easy for politicians and the electorate to get hooked on this subsidy drug. The Government may intend the policy to be temporary, but so was Income Tax. Look how long we took to wean the housing market off MIRAS. One can easily envisage a situation where future politicians are scared of ending the scheme, because of the potential negative impact on house prices. Once the scheme becomes capitalised in house prices it will also become politically embedded as well.

The UK has the smallest, most expensive and densely populated housing stock in Europe, with 90% of the population living on 9% of the land. This is a market screaming out for radical supply-side reform. Help to Buy may provide a temporary feel good factor over the 2014-15 period as house values pick-up, but there will be a price to pay. There always is.

In a City AM editorial earlier this week, Allister Heath made two very strong points related to the debate around Help to Buy. The first point relates to schemes such as the Community Infrastructure Levy (CIL). The second relates to developer’s land banks. Looking at schemes such as the CIL he said:

“It’s not just planning that is reducing the supply of homes and increasing their cost but also hidden taxes in cash and kind that are imposed on new building projects. These drastically reduce gains that developers can make … there have long been levies for local government to grab chunks of the planning gain and schemes to get developers to pay for social housing, schools and new roads as part of the green light for private housing developments … But there is no free lunch – if you slap a tax on home construction, somebody will have to pay for it. Fewer new homes will be built, and those that are will be sold at higher prices”.

With regard to land banks Heath stated:

“It is also true that sometimes developers do sit on land banks. Yet such behaviour only happens because of the madness of our planning system and would disappear were land more easily available … under our current idiotic system land prices keep going up because of artificial scarcity – so some developers have an incentive to hold on to ever appreciating assets.”

Heath’s point is very simple. If we had radical liberalisation of the planning system which made more land available, the incentives for land-banking would be reduced sharply. The share of land in house prices can obviously vary, but a reasonable estimate is that it is around 40 per cent. If we really want to help first time buyers get on the housing ladder, this is where we should focus policy. The housing market is not a functioning market. A real help to buy policy would make it one.