All the money just keeps going round the same old houses

Rightmove recently reported that asking prices for houses in London had surged 10% in one month. Yes, one month. Less dramatic increases also occurred in other parts of the UK. The culprit was the government’s help to buy scheme. This provides state subsidised loans of up to 20% of the value of properties worth up to £600 000. It is ironic that the main effect of a scheme is to boost the wealth of homeowners, when its stated aim is to help those not yet on the housing ladder. Ironic, but entirely predictable for anyone familiar with supply and demand.

By providing capital for aspiring homeowners, the help to buy scheme boosts demand for housing. Given the supply of housing is relatively inelastic, the effect of this is to increase the price. If, hypothetically, the government had borrowed the money and built houses, supply would have increased and the price would have come down. A more natural result if you wish to assist aspiring homeowners. Why didn’t the government do this? The answer is that this would have caused net borrowing to increase. Whilst the help to buy scheme is still costly for the state, it does not enter into these figures, as the money is borrowed and then lent on (initially at a 0% interest rate) rather than spent. To understand why the government did not want net borrowing to increase, you have to understand the coalition’s economic policy since 2010.

In 2010 the coalition came to power. The budget deficit was high, evidence of Labour profligacy they claimed. There was no alternative to an agenda of austerity. Much like the help to buy scheme this flew in the face of dominant economic thinking. The greatest economist of the 20th century, John Maynard Keynes, had stated “the boom not the slump is the time for austerity.” Austerity in a slump would just contract demand and depress the economy further. Since interest rates were at 0.5%, rates could barely be lowered further to offset austerity. Of course the advantage of low interest rates was that the cost of borrowing was cheap. The government could have availed of this opportunity to invest in housing or infrastructure at incredibly low cost, and meet both the short and long run needs of our economy.

But they did not. They cut the deficit somewhat aggressively in their first two years in power. The result was sadly predictable for Keynesian economists. The economy re-entered recession and five years on from 2008 we still have not recovered to our pre-recession level of output. That make this the slowest recovery in this country since records began. To give partial credit to the government, having dug themselves and the country in a hole, they have now stopped digging, at least temporarily. Net borrowing has been broadly flat this year. However, they could hardly U turn, and increase the deficit when they had banged on about Labour profligacy and there being no alternative to austerity for two years. So, instead we have the help to buy scheme which quietly stimulates the economy in an unfair and ineffective way. Unfair, because the benefactors are those with the most money in property. Ineffective, because they are the least likely to spend their increased wealth. The retreat from austerity has had some effect though. The economy has belatedly spluttered back into life. Laughably, George Osborne has used this to claim the critics of austerity were wrong all along.

Keynes himself had stated that even a highly questionable programme of public spending was superior to the sheer waste of unemployment in a recession. “If the Treasury were to fill old bottles with bank-notes, bury them at suitable depths in disused coal-mines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again, there need be no more unemployment and, with the help of repercussions, the real income of the community, and its capital wealth, would probably become a good deal greater than it actually is.”  Almost prophetically the quote goes on “it would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.” The same could of course be said of the help to buy scheme.  Whilst ill-designed it is an improvement on the government’s initial agenda of austerity. This really isn’t saying much though. In the last three years we could have done a lot better.