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’.