The Idea of a ‘Housing Market’

The Idea of a ‘Housing Market’

David Garnett

 

In 1907, referring back to the early writers on economics, Irvin Fisher, the famous American theorist and social campaigner, remarked that it appeared that if you caught a parrot and taught it to say “supply and demand” you would have created an “excellent economist”. In making this knowingly cynical witticism, Fisher was suggesting that crude market economic theory sought to explain movements in prices, wages, rents, interest and profits with the glib proposition that “it’s all a matter of market forces.” The parrot analogy (some trace a similar reference back further to the nineteenth century historian Thomas Carlyle) indicates the powerful influence market theory has had on political as well as economic thinking. In many respects markets embrace both mechanistic and ideological ideas.

 

The market as mechanism

In its simplest mechanistic conception a market can be thought of as a place where buyers and sellers meet to do business. It has long been recognised that trading markets can exist outside of a fixed location and it is therefore possible to talk about the stock market, the labour market, the property market, and so on. What all these trading markets have in common is that they bring together the forces of ‘supply and demand’. The market mechanism is sometimes referred to as the ‘price mechanism’ because the interplay of supply and demand in a freely competitive market is assumed to produce an ‘equilibrium market price’ that balances what producers are prepared to accept with what consumers are prepared to pay.

Compared with many markets, the housing market lacks coherence because dwellings are strongly differentiated by six classifications: tenure, location, type, size, condition and time. This means that unless two units of accommodation share similar across-the-board characteristics, they cannot be said to be in the same market. For example, if today there are available two physically identical houses in the same street but one is for rent and the other is for sale, despite their physical and locational similarities, they cannot properly be said to be in the same market even if they are available on the same day. Similarly, if two identically designed, well-maintained houses are both going to be advertised at different months of the year, they cannot be said to be in the same market. If one is in Glasgow and the other is in Exeter they cannot be said to be in the same market. Indeed, if one is in Prince’s Street Edinburgh and the other is in Ferniehill Road Edinburgh, they cannot be said to be in the same market. For all these reasons, the notion of there being a single, unified housing market is of limited use and indeed, when looking at statistics (such as annual increases in house prices or construction rates), such a notion may be positively unhelpful. As any estate agent knows, it is usually more sensible to think of housing supply and demand as operating in coherent sub-markets. For a discretely coherent housing sub-market to exist, there has to be what we can term a coincidence of categories. So, for example, although it is difficult to identify the housing market as such, we can clearly say that a market does exist for identical newly built, currently available, owner-occupier, three-bedroomed bungalows close to the sea in Christchurch Dorset.

 

The market as ideology

Much housing legislation has been driven by two competing political views about society’s social and economic objectives. Since the nineteenth century, the regulation of housing has always involved political arguments about the requisite roles of market forces and the state. Although a little simplistic, we might say that these debates demonstrate two different ideological positions competing to justify and direct housing policies.

Market ideology is grounded in the belief that free enterprise tends to be naturally efficient and fair and that the activities associated with the provision, consumption and exchange of housing should, as far as possible, be conducted by private individuals or firms rather than by the agents of central and local government. Market ideology tends to favour rent policies related to market prices and replacement costs rather than to people’s ability to pay or to historic costs. It also tends to advocate subsidy arrangements that put purchasing power into people’s pockets rather than those that are designed to lower or suppress market prices. That is, it tends to favour welfare arrangements that augment the incomes of poor households so as to give them more effective market power, rather than promoting policies that subsidise production or impose price controls. This is because both production subsidies and price controls are seen as distorting the market and keeping prices ‘artificially’ low by inhibiting or preventing them from rising to their ‘true’ market levels. Because it embraces the notion of ‘self-reliance’, market ideology is sympathetic to the idea that owner-occupation is deemed to be the ‘natural’ and ‘normal’ tenure arrangement for most people.

Welfare ideology is grounded in the belief that certain commodities have a social importance that is so great that the state should guarantee some minimum standard of provision for everyone. It emphasises the notion of need rather than that of demand, and it represents the value system that underlies what is popularly referred to as ‘the welfare state’. It has been instrumental in developing the concept of welfare rights and, in the housing field, is associated with the proposition that every household should have a decent home at a price they can afford. It tends to be sympathetic both to price control (or regulation) arrangements and to the provision of production subsidies designed to reduce the price of housing for people on low incomes. In general it sees an active role for central and local government in the housing system. The welfare approach to housing provision and consumption is often reinforced by the argument that the housing market is so imperfectly competitive that it cannot be relied upon to achieve society’s objectives (see market failure below). As a generalisation, market ideology tends to lead to demand-side income augmentation measures while welfare ideology tends to be more sympathetic to the provision of supply-side ‘bricks-and-mortar’ subsidies.

 

Market failure: a role for the state

Adam Smith postulated that, under competitive conditions, market forces act (invisibly) to ensure that successful producers create products and services that people need or want and can afford. This famous postulation assumed the existence of what economists now refer to as the conditions of perfect completion. It also assumed that no state regulation exists covering such things as minimum building standards. It is argued that under these ‘perfect’ conditions the forces of supply and demand will ensure that producers are unable to charge ‘excessive’ prices and that it is in their interests to produce the quantity and quality of goods and services consumers want, given their budgetary constraints.

If unfettered free-enterprise market arrangements were seen to achieve the housing policy objectives society demands, there would be no calls for government intervention in the housing system. In large part, it is the failure of market forces to deliver these objectives that has brought about state involvement in this field. This ‘failure’ of the market has been recognised by historians, market theorists and social policy analysts.

The historian’s view of housing market failure. In the nineteenth century, particularly in times of trade recession and falling wages, many tenants would take in lodgers to help cover the rent charges. In other cases, the market reacted to low wage levels by depressing rents, which in turn, reduced the ‘normal profits’ received by landlords. Under such conditions many landlords protected their investment returns by cutting back on repairs and maintenance. In this way, the unregulated market adjusted to low incomes by creating over-crowded, poor quality accommodation. Eventually these conditions were judged to be unacceptable and the State intervened to establish minimum standards for both existing and newly-built dwellings.

The economist’s view of housing market failure. Economists point out that for markets to work efficiently there must be a high degree of competition. Competition depends on the existence of large numbers of producers and consumers so that no group of market participants can influence the market price through their actions. A ‘perfect’ market would be open to all (both producers and consumers) and there would be little or no differences between the products being offered for sale or rent. The more alike two products are, the stronger will be the competitive relationship between them. Competition also depends on the participants being knowledgeable about the nature of the product and the workings of the market. Furthermore, if for some reason it is difficult for new producers to set up in the market or for consumers to compare prices, this will also have the effect of diminishing competition. In a perfect market there would be no hidden costs relating to such factors as transportation or local production difficulties.

Most of these prerequisites of competition conditions only have a weak presence in the housing system. Professional bodies, trade unions, employers’ organisations, large and influential construction companies, multi-national development companies, planning authorities, etc., all exercise a degree of monopoly power or influence and in so doing inhibit competition. The housing market is multidimensional and it is difficult for participants in the housing system to possess complete knowledge of a particular property and its market. Housing is technically complex. For example, recognition of building defects or awareness of any future planning proposals likely to affect the property, or the existence of legal constraints on the way in which the property can be used, all require a degree of skill and information that most buyers and sellers do not possess. Furthermore, it takes time and effort to get a feel for a particular local housing market. In these various ways the market participants have an imperfect knowledge both of the product and its market and this clearly inhibits competition. It is because of this lack of knowledge that many people employ exchange professionals such as surveyors, lawyers and estate agents to help them with their buying and selling arrangements. The very existence of these exchange professionals is witness to the imperfectly competitive nature of the housing market.

The market’s competitiveness is also weakened by the fact that house-building is a highly capital intensive activity that requires very specific skills of a technical, craft and professional nature. These factors act as barriers that make it difficult for new suppliers to enter the market to compete. Competition is further inhibited by the fact that dwelling units are immobile and spatially separated. Because buildings are geographically fixed, a surplus in one area cannot be used to alleviate a shortage in some other area. Similarly, a surplus of large detached family houses in an area cannot be readily used to alleviate a shortage of bed-sits for students in the same district. Competition is also inhibited by the way in which the housing system is fragmented. This reduces the possibility of achieving the coincidence of categories necessary for a coherent market to exist.

One other problematic issue pointed to by economists is the so-called ‘inelastic’ ways in which housing market forces respond to society’s needs and changes in wider market conditions. The ability and willingness of the building industry to respond to the current challenge of responding to housing shortages will depend, to a large extent, on the general long-run performance of the economy. New house sales depend on transaction rates in the housing market and, in turn, these tend to increase in times of economic growth and decrease in times of economic slow-down. Even if there is continued economic growth and a consequential general sustained demand for owner-occupied housing, the construction industry’s response to any such increase may be inhibited by a variety of specific factors that reduce what economists refer to as the price elasticity of housing supply. The price elasticity of supply measures the responsiveness of producers to a given increase in price. If prices rise by a certain percentage, and supply adjusts more than proportionately, the response is said to be ‘elastic’. Conversely, if the output response is less than proportionate to the increase in price, it is said to be ‘inelastic’. In 2003, Kate Barker, a member of the Bank of England Monetary Policy Committee which sets interest rates, was commissioned to produce a report identifying the main barriers to the production of more new housing. This investigated, among other things, why the supply of new housing is price inelastic. The report indicated that, in the future, the price elasticity of supply will be affected by such variables as the capacity of the construction industry; shortages of land; the slow and unwieldy nature of the planning consent system; and the planning restrictions themselves, including political constraints on the use of greenfield sites.

Most economists argue that housing markets are multifaceted, unusually complex and imperfectly competitive, and for all these reasons cannot be relied upon to work automatically in the interests of consumers. In addition to the housing market’s technical failure to approximate to the conditions of perfect competition, it can be said to fail to meet society’s housing objectives in another important respect: namely, it has too restrictive a view of what counts as ‘housing need’.

The social policy analyst’s view of housing market failure. Social theorists argue that market arrangements fail to take proper account of the housing needs of low-income and other vulnerable households. Market theory equates need with the notion of effective demand. In so doing, it is said to recognise only those needs that are expressed in the market place. Effective demand is defined as a want or need backed by cash. This means that under market arrangements needs can only be made ‘effective’ by purchasing the required goods or services from a market provider at a price set by the forces of supply and demand. Under such arrangements those without sufficient purchasing power are unable to make their wants and needs effective. The much-lauded freedom of choice denoted by the market notion of consumer sovereignty is restricted to those with sufficient income to pay the market price. Thus, in a free market economy everybody is free to sleep under a railway arch but only those with sufficient money can purchase a warm, dry room for the night.

Over time, to any one household, a particular type of housing can become more or less affordable. This will depend on comparative changes between the price of occupation of the dwelling in question (e.g. rent or mortgage repayment), and the disposable income of the household in question. Social analysts point out that we can only rely on the operation of market forces to accommodate the interests of low income households if it can be demonstrated that the comparative price and income changes are such that good quality housing is becoming more rather than less affordable to this group.

Some market advocates argue that the market will provide for low income groups through a process of filtering. This argument says that over time dwellings tend to decline in value and thus become accessible to people on lower incomes. Social analysts, however, point out that the effectiveness of ‘trading up’ or filtering as a means of raising housing standards hinges on the speed of value-decline relative to quality-decline.

If the value of the standing stock depreciates so rapidly that even low-income households can afford units which are still above the quality standards of social adequacy, the private market is a satisfactory instrument of public policy.’ (Lowry, 1960, p364).

Twentieth century policy makers have sought to identify broader definitions of housing need than that provided by the market concept of effective demand.

 


 

Reading

Challis P (2009), ‘What role for the public sector?’ in Pattison B and Vine J (eds) (2009) Perspectives on the Future of Housing: A collection of viewpoints on the UK housing system, Building and Social Housing Foundation.

 

Lowe S (2011), The Housing Debate, chapter 1.

 

King P (2009), Understanding Housing Finance, chapter 3.

 

Oxley M (2004), Economics, Planning and Housing.