Thursday, 17 March 2011

Over-elastic housing supply

What with all the complaining that people like me do about there not being enough new house building to keep up with demand, it is easy to forget that there can also be such a thing as too much housing construction. If the housing market is working well, there shouldn't be a big problem - new supply feeds into lower prices and builders stop building. But, as the Economist said recently:
when it comes to the biggest house-price bubble in history, theory does not get you very far. In some places the boom was big enough and irrational enough to suppress price signals from lots of new supply. Instead, availability of land simply fed speculative activity, which has made the popping of the bubble much more painful.
Much of the pain is felt in the labour market. The speculative frenzy got lots of people building houses, and then suddenly the last thing anybody wants is a new house built. This is more or less what happened in Nevada, which resulted in this:

It was a similar story in Ireland and Spain - see the Economist story for all the gory details [1]. In all these areas and perhaps particularly in Ireland, there was an additional layer of damage to the government's finances, when the revenues from construction income taxes and new home stamp duty suddenly dried up, contributing to the fiscal black hole Ireland is struggling to fill.

So while it's probably not much consolation to the many, many people who can't afford to buy or rent somewhere suitable, we in the UK may have inadvertently avoided a worse recession through not building too many homes. But I wouldn't go hugging your nearest NIMBY just yet - even though we don't know where the sweet spot of optimal housing supply is, I'm fairly sure we're nowhere near it at the moment.

[1] The OECD have also picked up on the potential problem of over-elastic supply in this working paper

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