Prosperity and Planning

The housing affordability crisis is due to supply restrictions. There are far too many restrictions on land use. Land use regulation in the UK takes the form of absolute growth constraints such as green belts as well as density and height restrictions. In addition, the planning system prescribes and fixes designated land use categories for all land parcels. Population growth and the tendency of urban concentration due to the new economy pushes up land prices, especially in the economic pole of growth London, because politically-imposed restrictions prevent an adequate supply response. Prices are further inflated because the non-transparent planning process—with its wide, unpredictable political discretion—discourages, delays and often altogether prohibits redevelopment on urban land that is in principle within permissible limits.

All this can be attributed to politically backed nimbyism, a form of protectionism that privileges current owners of residential land and property. It implies an overpricing and undersupply of residences in comparison to what the market would deliver.

By far the larger part of house price increases in recent decades is attributable to the increase in land prices. Fifty years ago, total UK land values amounted to around 50% of GDP, now they amount to 200% of GDP. More land supply and more construction would bring land prices and property prices down. This is basic economics.

Recent examples of 'successful' nimbyism in London include the rejection of the redevelopment of an ASDA and its car park into nearly 2,000 new homes on the Isle of Dogs; and the discouragement of the redevelopment of the Bishopsgate Goods Yard in Hackney. Local councils were opposed to the Bishopsgate plans, believing they would have a "severely detrimental effect on the character of Shoreditch and the nearby residents and businesses". The GLA planners' report also recommended refusal. The site is a closed off, derelict 11-acre area in the immediate neighbourhood of the high-value Liverpool Street business cluster. The primarily residential scheme also proposed offices and retail spaces. All this was proposed on an empty site with no immediate neighbours. The developer proposed 12 buildings across nine plots ranging from 177.6m (47 storeys) to 24m (7 storeys), mostly apartments, including studio flats that could sell for about £700,000, and one bedroom flats for about £1 million, an enormous value locked up and blocked. This value prospect was paradoxically one of the reasons why the councils rejected the proposal, considering these homes to be "well beyond the reach of the people that need them". If these politicians indeed know what "their people" need, a questionable assumption, then they exercise nimbyism here. The prosperity of London, the UK, and indeed the world, would benefit from attracting and integrating workers whose productivity would allow them to afford the prices asked for here. Enhanced production and higher incomes would also increase the council's ability to provide better services for current residents. Milieu protection and anti-gentrification are recipes for stagnation and impoverishment. In a globalised world standing still means falling behind.

Delays or outright rejection of development are the most obvious cost of political interference. However, land use zoning, restrictions on the land use types, are also very costly. High and rising relative prices of residential land in comparison to non-residential land prices demonstrate that land dedicated to residential construction is made artificially scarce by local planning agencies. Prevention of free land allocation and conversions of use to preferred land uses has led to the build-up of severe land value distortions that burden house prices. The land values of equivalent sites in the same location, that would be equal in value if the market were allowed to work, often diverge massively depending on the imposed land use category. Residential land values in London reach up to a four-fold value multiple in comparison to equivalent plots with office-only permits. This large effect is observed despite the fact that office space in London is, in comparison to other major European cities, also burdened by undersupply and so relatively overpriced due to overall planning restrictions. [3]

Since heavy industry has moved out of the city, there are no inherent incompatibilities between various city uses. Nothing can thus justify land use impositions and their eradication would benefit the overall value and utilisation of our cities.

The Coalition government's 2013 initiative instituting 'Permitted Development Rights' (PDR),the blanket permission that allowed conversion of existing office buildings into residential buildings, bypassing the local permit process, was a step in right direction. Unfortunately, most London boroughs made extensive use of an opt-out clause, so that this initiative has so far been stunted, and has frozen the current misallocation of land resources in place.

The freedom of mixing land-uses is crucial for the vitality of the city. Only a creative trial and error process guided by price signals can discover and optimize, at each individual site, the most value-enhancing use-mixes that best synergize with the particular urban adjacencies of that site. The planning bureaucracy lacks the requisite knowledge, as well as agility and the incentive to optimize. It is precisely these co-location and agglomeration benefits that motivate us to live in cities in the first place.

Height and density restrictions are the next impediment we should look at. Here externalities like rights of light and traffic pressures have to be considered, but I am convinced that a free market would discover much more viable trade-offs than current planning restrictions manage and without the high price increases they create.

To the extent that collective decision making is called for to regulate development rights in the light of externalities, I suggest that an organized association of property owners should set regulations. Voting rights could be distributed in accordance with the relative value of the respective holdings, analogous to shareholder rights in stock companies. Such a privately organized planning system (similar to how to many successful industry self-regulation initiatives operate) can be expected to maximize total social value, in contrast to our current political processes.

A related idea has recently been proposed by John Myers as key proposal of his YIMBY campaign. The proposal involves allowing individual streets to vote on giving themselves permitted development rights, to build upwards to a maximum of six storeys and take up more of their plots. [4]

Any arbitrary political use or density restriction implies a loss of prosperity. Not so much for land owners, but for everyone who might end up using it. It is absolutely crucial to grasp this point. The landowners benefit from a windfall only once, temporarily, if and when political restrictions are lifted. As utilization goes up, so does, initially, the land value. However, the land value component for each apartment goes down. But, with a general liberalisation, all land values will eventually fall as more land enters the competitive market. Current land values are hugely enhanced by the permissions they receive if they receive them. This aspect will fall away when permissions are no longer required. We saw how this worked in another market, the value of New York taxi medallions (licences) after competition was opened up saw their value fall steeply. Within an established laissez faire system, after the capitalist revolution, the land owners can only earn an appreciation if the district keeps growing and prospering and their locations then gain a relative advantage over competing districts and locations. No one will be able to rely on any monopoly status granted via the planning authorities' restriction of market entry.

Developers and their investors can only profit to the extent that they anticipate needs and desires, innovate their product offering and efficiently manage delivery and operations. There is nothing wrong with profits. They can only be earned where real use values are produced for competitive prices. The fallacious vilification of profits is the intellectual Achilles heel of the outmoded educated elites’ left-liberal consensus. The slogan that resources should be allocated according to needs rather than profits relies on a perversely false dichotomy. This is because it is precisely and only the profit and loss system that offers (if it is allowed to function) a fair, objective, truly democratic, and incorruptible mechanism for steering resources towards real, individually expressed and confirmed needs, backed up by purchasing power and thus desert on the basis of rendered services.

Profits imply that resources are combined and utilized in ways that create a relative net benefit. Losses, on the other hand, imply a waste of resources in comparison with profitable ventures. In competitive markets, which would emerge if the government withdraws from the scene, profits are earned in step with the innovativeness of the product. They only ever constitute a small part of the overall value added. Yet, they are crucial because they motivate developers. There is no guarantee that profits are earned at all in development. The profit and loss system disciplines developers to produce homes that are desired by tenants or buyers for prices they can afford and are willing to pay. This is no trivial achievement and it requires the solicitation of savings to be invested and a lot of tenacious disciplined management. This will only be provided if incentivized by the prospect of earning a profit for both developers and investors/savers.

The profit motive disciplines entrepreneurs to concentrate on people's real needs and desires, in contrast to the entrepreneurs' proud do-good missionary zeal to change the world. While this zeal, which animates most entrepreneurs, contributes to overall societal creativeness, it is the profit and loss principle that contains the 'democratic' principle here. It curbs run-away hobby-horse enthusiasm and ensures that investments serve the public's effective (rather than imagined) interests. Again, profits only emerge together with consumer surplus and constitute only a small part of the overall added value which successful entrepreneurs effectively gift to society.

Besides general land-use and density restrictions, the imposition of restrictive housing standards is yet another counterproductive political impediment to housing prosperity. Urban entrepreneurs and their architects have no room for innovation at all in the housing sector. Planners impose land uses, overall numbers and, in the case of residential uses, they impose unit mixes, i.e. how many studio flats, 1 bedroom flats, 2 bedroom flats, 3 bedroom flats etc. are to be built. They set how many units can be accessed via a lift lobby, they impose minimum unit sizes for each category, minimum room sizes for all rooms, as well as micromanaging facilities like bathrooms, washing machines, balconies etc. The masterplan usually prescribes building heights and building outlines which need to be strictly adhered to. Facades are subject to restrictions in terms of the amount of permitted glazing areas, and the architectural articulation and material expression is also subject to the planners' approval. There is hardly anything left to be decided by the entrepreneur and their architect. Competition via creative product innovations is being blocked. Developers solely compete with respect to who is best at negotiating deals with the planning authorities, who have considerable discretionary powers to strike deals. Insider knowledge about local planners and councillors delivers the key competitive edge here, not value or design. Unfortunately, in the current system it is in these 'political' negotiations where profits are made or lost, especially with respect to the negotiated imposition of affordable housing quotas. Resources are diverted into these negotiations which, in the parlance of public choice economics, must be classified as 'rent-seeking' efforts. The beneficiaries are special interests protected or privileged by the politicians and their planners. However, the overall resulting misallocation of time, labour, land, and capital resources imposes a deadweight loss on total social production.

In the current market situation, the most problematic of these impositions are the restriction of the number of small units allowed per development, and the imposed minimum unit sizes, especially for the smallest units.

Currently studio flats below 38sqm are not permitted. Yet, units half that size, built at an earlier time, are rare and thus at the moment overpriced, hotly desired commodities, for rent or for sale. Lifting this prohibition would allow a whole new (lower) income group, which is now excluded, to enter the market. This move would both boost overall unit numbers and affordability. That this obvious move is not seen or indeed resisted by the very same left-leaning politicians and commentators who otherwise proclaim to represent the interests of lower income groups can perhaps either be put down to an ideological position where a world without state paternalism cannot be imagined other than as utter chaos. Or it is part and parcel of the instinctual attempt to protect the (real or imagined) interests of the politically decisive median voter, to the exclusion of all others.

The maths of lifting these restrictions is promising: Consider a large residential development project, those like the recently completed Elephant Park in London. In a private conversation the developer's project manager suggested that they could have doubled the overall number of units on his site and still have a great, marketable product. Let's assume, as should be highly likely, that a lifting of the unit mix prescriptions would lead to many more studio flats, probably to a development exclusively dedicated to studio flats (due to years of undersupply). This could deliver at least another doubling of unit numbers. Finally, we know that studio apartments could be sold or rented at 50% of their current size. Thus, we arrive at an 8 fold increase in residential units, serving a market of young professionals that is vital for London's economy. There are no rational, pragmatic arguments that stand against such a scenarios, especially since many large sites (like Elephant Park) can be redeveloped densely without infringing on any existing rights of light. So the debate about standards becomes quickly emotional and rhetorical with phrases like "rabbit hutches" and "slums" standing in for arguments. The question who exactly is being protected by these standards remains unanswered. It obviously can't be the prospective tenants or homeowners who are now prevented from enjoying an offer they would choose if available. Many people who don't understand how markets work seem afraid that the liberalisation of standards implies that people are then 'forced' to live in 'rabbit hutches'. Markets never work via force, but only always via being forced to adjust to consumer preferences. Those who are now making the hard choice between paying 80% of their income on a central flat versus commuting from afar, will in the liberalized future appreciate new options and perhaps choose to pay only 60% for a smaller but more central flat. For many young professionals who are out and about networking 24/7, a small, clean, private hotel-room sized central patch serves their needs perfectly well. They don't need paternalist politicians with outmoded standards to protect them. Real protection for all those who cannot draw on subsidies but rely on purchases in the market can only come from a total liberalisation of the market, i.e. from market competition among suppliers.

I suspect there is another unspoken reason why the liberalisation (or reduction) of these obviously hurtful minimum standards in the low income private sector segment are being politically resisted.

If freely chosen and privately financed market solutions develop a whole segment with much lower space standards, then the legitimacy of the current standards for subsidized social housing provision will be undermined. State provision requires standards and if housing giveaways are larger than what some of those who finance these giveaways via their taxable income are willing to afford for themselves, then the system's legitimacy is indeed in deep trouble. Social tensions and conflicts will result. Then social housing standards would also have to be reduced, at least in central locations, a politically risky proposition. I am raising this point not to discourage the liberalisation of standards. Hard political choices and societal adjustments will have to be made to solve the housing crisis. I am making the point to indicate one more problem of the social housing rationing system: it seems to stand in the way of the necessary liberalisation of standards.

These arbitrary housing standards are a scandal that compromises all our cities and lives by blocking the discovery process of the market and by taking away vital choice and drives up prices. These infringements on free choice make all of those who would otherwise purchase or rent products that are smaller or otherwise violate the ludicrously detailed housing standards, poorer.

That the housing situation is a huge priority for many of us, is brought home by the fact that most of us are willing to pay a very large part of our total income on our homes, up to 80% in many cases of young professionals for whom centrality of location is vital.

This restrictive state interference, taking away many options that would otherwise allow the market to tailor and optimize our residential conditions in accordance with our individual life requirements and desires, is a huge problem.

There are further detrimental types of state intervention in the housing market: Rent controls and other "protections" politicians sell to tenants. Rent controls and other "protections" are no solution. Quite the opposite: they lead to wasteful maintenance patterns and withdraw supply from the market. The negative effects of rent controls have been observed and measured for decades but as Sam Dumitriu of the Adam Smith Institute points out in a recent article: despite a the near-unanimous opposition to rent control from economists, politicians persist in proposing rent control policies. [5]

Rent controls lead to the misallocation of residences, as it traps tenants in places they would otherwise exchange for better suited places, i.e. they remain locked up in their unsuited current places that would otherwise be freed up for better suited newcomers. This also hampers labour mobility which is an important factor contributing to society's economic success.

Outright rent control is only the most conspicuous interference in the rental housing market. However, there are many more impediments that have been imposed with the good intention of protecting tenants from 'greedy' landlords. Apart from contemplating the fact that landlords are no greedier than car, bicycle or banana merchants, we should realize that the best long term protection for current and future tenants lies in the competitiveness of the market for rental housing.

In a free market, landlords have to compete as much for tenants, as tenants do for apartments. To call for rent freezes or for laws making long tenancy terms mandatory, or for laws protecting tenants from quick eviction when failing to pay their rent etc. only seems to protect tenants. Yes, current tenants can be temporarily protected. That's what is immediately visible. But the analysis has to be pushed a few steps further to see the losers and that their losses outweigh the temporary gains of the 'winners'. Ramping up those restrictions implies that plans for additional rental properties will be aborted and supply stops growing and eventually even shrinks, as houses will eventually be withdrawn from the rental market.

Rolling back these restrictions would probably bring quite a lot of supply that is currently held back and sits empty into the market, implying an increase of supply and a lowering of rents. Landlords should be free to offer and compete with tenancy terms, catering for various customers with various priorities. Long tenancy terms, for instance, tend to exclude anybody without long term secure employment, whereas flexibility in terms of tenancy terms would give people with less stability a better chance to rent the flats that suits them best. The rental market will thrive - for the benefit of both tenants and landlords (which often represent the interests of pensioners) - once full freedom of contract is granted here. The state should mind its business, namely the enforcement of these contracts. Rent control and state-imposed tenant protections only reduce supply and thus ultimately drive prices up.

As mentioned above, rent control immobilizes people, it hampers labour mobility and so reduces total social productivity. Social housing is rationed housing, and because the allocation process is so slow and uncertain it too reduces labour mobility.

Further, the rationing of homes via the affordability system implies an even more fundamental misallocation of residences than rent control. Any rationing forgoes the market rationality that always allocates resources to those who –from the standpoint of society's total social production– best utilize them.

This is a crucial point to grasp. Central locations should be allocated to those whose productive lives are most enhanced by being thus positioned, i.e. those who operate at the centre of our network society, attending early morning meetings , after work networking events,weekend conferences, and professional lectures. By preventing this, extensive daily commutes impose significant costs on the economy and contribute to the UK’s low productivity levels.

In a free market, workers would compete for locations. More productive workers that contribute more to the total social product will be able to out-compete less productive workers. This is especially the case if the former are willing to spend a larger part of their income on a central location because they know (and only they themselves can know) it enhances their career, productivity and income. So two factors –the individuals' productivity and the importance of central residential location for the respective individuals' productivity– interact in determining the allocation of residences to workers in such a way that this scarce resource of (central) residences is most efficiently allocated, in the interest of society's overall prosperity. Any interference with this market allocation process implies a relative reduction in overall prosperity.

Despite this insight of economic science into the efficiency of market resource allocations, known for over 200 years, political interference in the market process remains endemic in many arenas. This is especially so in the housing sector where rationing has, to a considerable extent, supplanted market allocation. The whole system of so called "affordable housing" constitutes a massive interference with market processes that costs our society dearly and is one of the contributing causes of the whole affordability crisis it is intended to alleviate. It does so only very superficially, if one thinks through the chain of economic effects beyond the first trivial conspicuous but deceptive fact that some people receive houses at artificially suppressed prices, it makes housing on average less affordable.

Sadiq Khan seems intent on ramping up 'affordable housing'. He wants to see housing rationed according to political prerogatives, up to 50% of all new housing provision, which thereby makes the remainder (which has to cover the subsidies) all the more unaffordable. No wonder that the income eligibility threshold is ramped up continuously also. So-called ‘affordable housing’ creates a vicious interventionist spiral.

By subsidising the residences of privately employed 'key workers' we only allow their salaries to be lowered, thus benefiting those who use their services. This might often be people who could, would and should pay more for these services. By subsidising public sector "key workers" we are further privileging a pressure group that seems already comparatively privileged. This is not only inefficient, but also unfair.