Britain’s Housing Crisis: the Unseen Barrier to Growth

Planning Policy, Credit Distortion, and the Roots of Britain’s Economic Stagnation

It's no secret that Britain’s economy has painfully stagnated since the Financial Crisis, witnessing a complete break from the pre-2010 trend where growth averaged at 1.42% per year for over a decade. Though the UK has indeed stumbled behind the G7, post-crisis lethargy has affected most of Western Europe and North America. Economists, analysts and commentators have all pulled their hair out in search of explanations, with the dominant theory that austerity has deprived advanced economies, including the UK, of vital capital. 

Ireland demotes this as a reason for stagnation anywhere, who’s experienced rapid economic growth in the face of aggressive cuts to government spending (relative to GDP). To diagnose Britain’s slow growth, we must therefore look beyond fiscal policy. 

Here, the housing market offers crucial input. From just over 4-times average earnings in 2000, a house in England now scrapes 10-times average earnings, rapidly outpacing other goods and services within the economy, which have either remained stable or fallen relative to incomes. It doesn’t even take a first glance to see that this is severely problematic. Housing unaffordability crushes upward mobility and ossifies wealth inequality. 

The housing market’s scars, however, run even further than this. Just as unaffordable housing diminishes mobility and intensifies poverty, it also impairs metrics like GDP and productivity. To give an example, sky-high urban housing costs make migrating to the cities more difficult. Since cities form the productive locus of any economy by holding the vast portion of its entrepreneurship and industry, unaffordable housing therefore directly constrains both output and productivity growth. One paper found that if New York and California scaled back planning regulation to 1980 levels, they would raise aggregate productivity by 7%, mainly because workers in those states have been unable to migrate to big cities. 

Another problem is where unaffordable housing induces economy-wide productivity stagnation. This happens because there’s only so much money that banks can lend out, such that it gets split between two categories. The first is home credit, which encompasses mortgages and loans to real estate projects. The second is loans to businesses, the productive entrepreneurship we see as responsible for growth and innovation. 

It makes sense that as housing becomes drastically more expensive, home credit starts to take up a greater share of bank lending. One study found that in 1928, home credit formed a much smaller portion of loans than it does today, ranging from 4% in France to, at most, 55% in Finland. The United Kingdom stood at 16%. By 1970, things already looked very different, where home credit ate up 52% of UK bank lending. Fast forward decades later to 2007, and the numbers are even worse. Home credit has reached 63% of total loans. For years on end, home credit has grown over four-times faster than business credit, relative to GDP, from 1960 to 2010. 

By all means, there are substitutes for traditional loans. Non-bank intermediaries, like equity markets, supply firms with capital when banks are prioritising mortgagors. But the moral of the story is clear: rampant housing market inflation has gravitationally starved businesses of credit, dealing major implications for Britain’s productivity. This follows the same mechanism whereby public debt is said to harm economic growth above a certain threshold. Since banks only have so much of it, credit allocation is zero-sum: the more lent to government bonds, the less is available for the private sector, only raising interest rates for businesses. 

House price inflation, unsurprisingly, therefore weakens productivity growth. One study analysed the effects of measures taken by Chinese authorities to restrict home purchases (in essence, forcibly directing bank loans at enterprises), discovering a 2% increase in total factor productivity within the industrial sector.

An IMF study, meanwhile, found a significant, inverse correlation between house price and productivity growth from 1988 to 2021, both at a national level (comprising Australia, Canada, the United States and Great Britain), and the provincial level within Canada. A final study confirmed that businesses which borrow from banks with a significant interest in the housing market themselves have lower investment, all thanks to higher interest rates. 

This makes any effort to restrain the housing bubble a uniquely good response to many of the UK’s most profound structural issues. The roots of unaffordable housing are debatable, but much of the political conversation revolves around ‘demand-side’ factors that frequently chastise immigrants who buy or rent houses. More technical perspectives blame Thatcher-era policies which modified lending restrictions and have since bolstered mortgage-demand. 

These are all invariably wrong, because the housing crisis is fundamentally a supply-side problem. Food demand has continuously risen, yet it costs less relative to income today than it did in 1980. This is all thanks to supply elasticity, where producers sell more into the market to capitalize on higher demand, causing prices to fall or stabilize. Why this hasn’t happened with housing is therefore the fundamental policy question. 

In theory, this could be down to private monopolies choking off supply. But the British development industry isn’t particularly concentrated, as the eleven largest housebuilders provide 40% of all new buildings. Thus, the only coherent explanation is state-imposed obstacles to developers capitalising on higher prices, and hence exerting deflationary pressures. This can only be the current planning system that involves an array of constraints on where and what developers can build, as well as granting local authorities the power to veto construction proposals. Britain’s planning system stands out as particularly obtrusive, but these inhibitions are globally ubiquitous. In his recent book, Build, Baby, Build! The Science and Ethics of Housing, economist Bryan Caplan interrogates the American case, presenting data that home prices would halve under vigorous planning deregulation. The era of lax planning, after all, saw rapid urban growth within the UK and beyond, as housing prices remained stable relative to income despite the monumental rise in city populations. 

In the 70s, Britain was termed “the sick man of Europe” as a long drawl of inflation and low growth eliminated our income advantage over Western Europe. By all accounts, this trend never reversed. To achieve economic revival, Britain must search for solutions far and wide. Planning deregulation would be a great first step to expanding businesses’ access to credit, and reinvigorating our economic performance.

About the Writer:

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Eben Macdonald is a PPE (Philosophy, Politics, and Economics) undergraduate at Durham University with a keen interest in the intersection of global markets and macroeconomic analysis. He currently serves as a Fund Analyst at Sora Capital and an Analyst at Krugman Insights, where he provides data-driven perspectives on financial trends.