It costs a relatively large amount of money to buy a house in the UK – something readers from the UK will almost certainly agree with. But economists differ over why this is. This column argues that strict planning regulations are a prime culprit for sky-high prices and that without any real regulatory change, it is the young that will suffer.
By Christian Hilber and Wouter Vermeulen*
New causal evidence on the impact of supply constraints on house prices shows land use regulation to be a major culprit of England’s current housing affordability crisis. Absent regulation, house prices would be lower by over a third and considerably less volatile. Young households are the obvious losers, yet macroeconomic stability is also impaired and productivity may suffer from constrained labour supply to the thriving cities where demand is highest.
Why land use regulation matters
Place matters for productivity and for jobs that involve the creation or exchange of ideas – cities are the place to be. Great cities attract great minds that benefit from being nearby. Glaeser (2011) documents how such agglomeration benefits, in conjunction with the benefits that urban density offers to consumers, have fuelled a stunning urban revival. However, regulation prevents some of the most successful cities from growing, thus limiting the number of people that share in their riches. The economic cost may be steep. Hsieh and Moretti (2015) estimate that lowering regulatory constraints in high productivity cities like New York, San Francisco and San Jose to the level of the median city would increase US production by 9.5%.
The social costs of land use regulation extend well beyond the misallocation of labour across places. Supply constraints render housing artificially scarce and they reduce its affordability. This has been a vital policy concern in Britain for the larger part of the past two decades, leading many to speak of an ‘affordability crisis’. Furthermore, land use regulation may raise house price volatility. For example, Glaeser et al. (2008) find that US metro areas with inelastic supply experience stronger house price growth during boom phases. This may affect the volatility of consumption and reduce stability at the macro level in turn. Against this background, it is important to understand how exactly land use regulation affects local housing markets vis-à-vis other supply constraints.
New causal evidence on the impact of regulation
The lively emerging literature on this topic, as recently reviewed by Gyourko and Molloy (2015), is hampered by lack of direct evidence on the impact of regulatory constraints on house prices — regulatory restrictiveness is usually derived from surveys or inferred from shadow prices. Moreover, the bulk of this empirical literature concerns the US. In a new paper (Hilber and Vermeulen 2016), we aim to advance the relevant empirical literature in both directions – by providing more direct causal evidence on the impact of planning constraints on house prices and by focusing on England. This focus makes sense for at least two reasons. First, house prices in England – especially in the Greater London area and the southeast of the country – are extraordinarily high by international standards, and it has been argued for a long time – but not rigorously tested – that the extremely high prices can be causally linked to the very rigid British planning system. Second, UK government statistics provide a wealth of information on direct planning decisions at the local level (for all of England), over a very long time period (since 1979) and on an annual basis. These unique data – along with other geographic microdata on land cover and topography – allow us to directly test the causal impact of local regulatory constraints on house prices, vis-à-vis physical supply constraints.
In a nutshell, in our paper we use this unique data to test our prediction that house prices respond more strongly to changes in local demand in places with tight supply constraints. In doing so, we carefully disentangle the causal effect of regulatory constraints from the effects of physical constraints (degree of development and topography) on local house prices, holding other local factors constant and accounting for macroeconomic fluctuations induced, for example, by changing lending conditions or interest rates.
Both regulatory constraints and the degree of physical development are arguably endogenously determined. To address this econometric concern, we use exogenous variation from a policy reform, vote shares and historical density, allowing us to identify the separate causal effects of all three supply constraints measures. In a similar vein, local earnings – our measure of local housing demand – may be endogenous. To address this particular concern we employ a shift-share approach to come up with a measure capturing labour demand shocks.
Figure 1 summarises our empirical findings. It illustrates the impact on house prices of removing, one by one, each of the three supply constraints in an average English local planning authority (LPA). What the figure shows is that house prices would have risen by about 100% less, in real terms, from 1974 to 2008 (from £79,000 to £147,000 instead of to £226,000) if, hypothetically, all regulatory constraints were removed. Put differently, house prices would have been about 35% lower (£147,000 instead of £226,000) in 2008 absent of regulatory constraints. The effect of constraints due to local scarcity of developable land is largely confined to highly urbanised areas such as the Greater London area. The local impact of uneven topography is quantitatively less relevant. Hypothetically removing scarcity related and topographical supply constraints would have jointly reduced house prices in 2008 by 15%. We should note here that Figure 1 understates the impact of the various local supply constraints to the extent that they were already binding in 1974, so if anything, the estimated effect of local regulatory constraints on house prices is a lower bound estimate of the impact of the British planning system.
Of course, removing all planning constraints is neither practical nor desirable. More pragmatically, if the southeast (the most regulated English region) had the regulatory restrictiveness of the northeast (still highly regulated in an international context), house prices in the southeast would have been roughly 25% lower in 2008 (and perhaps 30% lower today).
Another unique feature of the UK housing market(s) is the extraordinary volatility of house prices. Using the last full real estate cycle during the 1980s and 1990s as a benchmark, the UK as a whole was substantially more volatile than the single most volatile metro area – Los Angeles – in the US during that time period. Figure 1 illustrates that removing supply constraints would reduce price volatility dramatically. Removing all regulatory barriers would almost half the standard deviation of house prices in an average English local planning authority.
To summarise – house values in England – particularly in the southeast of the country, where productivity is highest – are amongst the highest in the world. Young households in particular increasingly struggle to get their feet on the property ladder and to afford a decent home. Our findings point to the English planning system as an important causal factor behind this housing affordability crisis. Our empirical analysis also indicates that the English planning system has made house prices substantially more volatile. The implied financial risk is most difficult to diversify for first-time buyers – the households that are also most affected by the affordability crisis.
The way forward
While our understanding of the role of various supply constraints – in particular of regulatory constraints – has been improving over the last few years, our understanding of the causes of the vast differences in regulatory restrictiveness across and within countries is still fairly limited. In future work we plan to exploit the vast variation in regulatory restrictiveness across local planning authorities in England over time (as the dependent variable) to develop a better understanding of the drivers of spatial differences in regulatory restrictiveness. This work may explore the role of local fiscal incentives to permit development and of homevoters, developers and other lobbyists. Future work could also look more carefully at different types of regulatory constraints to explore their separate effects on house prices, but also on other measures such as the effects of preservation policies on energy consumption or the role of planning constraints and real options for incentives of developers to hoard land with planning permission. Developing a better understanding of both the determinants and the economic consequences of land use regulation, in part thanks to better and better available data, would appear to be fertile area of empirical research for years, even decades, to come.
*About the authors:
Christian Hilber, Associate Professor in Economic Geography, London School of Economics
Wouter Vermeulen, Programme manager, CPB Netherlands Bureau for Economic Policy Analysis
Glaeser, E L (2011), Triumph of the city: How our greatest invention makes us richer, smarter, greener, healthier, and happier, London: Macmillan.
Glaeser, E L, J Gyourko and A Saiz (2008), “Housing supply and housing bubbles”, Journal of Urban Economics 64(2): 198–217.
Gyourko J and R E Molloy (2015), “Regulation and housing supply” in G J Duranton, J V Henderson and W C Strange (eds.), Handbook of Regional and Urban Economics 1289–1337, Amsterdam: Elsevier.
Hilber, C A L and W Vermeulen (2016), “The Impact of Supply Constraints on House Prices in England”, Economic Journal 126(591): 358–405.
Hsieh, C-T and E Moretti (2015), “Why Do Cities Matter? Local Growth and Aggregate Growth”, mimeo: University of Chicago and University of California, Berkeley.