Market failure on a grand scale: housing and productivity in the UK

Northwest_Kowloon_reclamation_area_no._6_public_housing_estate_construction_siteProductivity growth in the economy makes advances in living standards possible. As output per hour increases workers can, at least in theory, make some sort of choice between an increase in wages and an increase in leisure time. They could either produce and earn more for constant hours of work, or possibly earn the same for reduced working time and increased leisure.

Rising productivity also potentially allows profits to rise, which can be reinvested in production, or used to pay dividends or interest and repay loans used to finance investment.

Of course, the workings of the market economy and the way rising productivity is distributed between wages, profits and other forms of income are more complex than this stylized description. The balance of power between different groups in society has an effect on the distribution and appropriation of wealth and income. It is here that economics is more appropriately known as political economy, which takes account of these broader factors beyond the purely economic. But back to productivity.

Productivity performance in the UK since the financial crisis hit has been dismal. Economists have invariably been puzzled by this, and have cited a variety of factors, such as weak investment or low wages leading to a labour-intensive bias in expanding output etc. This poor performance has meant that while employment has grown strongly since the recession, a large proportion of the new jobs created have been low paid, part-time or self-employed. While much of the latter may represent new business start-ups, it remains the case that a significant proportion may be involuntary. These will also tend to bring increased insecurity, lower earnings and poorer future prospects than working for a larger organisation; of course, some may succeed but the point remains.

One other reason cited for the UK falling behind other rich nations in terms of productivity has been the housing market. Housing across the UK has become increasingly unaffordable, particularly in London and the South East but also elsewhere. The ratio of house prices to average disposable incomes has reached around 15 times. Although interest rates remain very low, making mortgages more affordable, the squeeze on wages alongside rising house prices has compounded the problem.

Unaffordable housing must be playing a part in reducing labour mobility across the country. Workers on even reasonable wages may find that they cannot afford to move from, for example, the north of the country, where housing costs are lower, to the south, let alone London, where they are much more expensive.

If labour mobility has fallen, employers will be less able to hire workers with the skills they need to grow their businesses and increase efficiency. This will tend to slow growth in productivity and output. Thus despite the UK’s vaunted ‘flexible’ labour market, the state of the housing market is creating a more rigid labour market. This represents a significant market failure which needs to be remedied.

The current government claims that it is committed to expanding the supply of housing. If this is done on a large enough scale, this could put downward pressure on prices, increasing affordability and improving labour allocation by making it easier for workers to move between regions and jobs. However, it seems doubtful that the Tories are doing enough, and a number of their policies are likely to simply increase demand and not supply, putting further upward pressure on house prices.

A major building programme of social housing led by the public sector may well be needed, if the private sector proves unable to respond to the construction needs of the UK. A possible alternative to this may be some form of public-private partnership. But the need for a construction boom in affordable housing remains. Without it, the allocative function of the labour market will continue to underperform, and growth in productivity and output in the UK will continue to be constrained.

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