But if the events of the past two years have taught us anything, it is that economic theory is a poor guide to practice.
Economic theory is in fact an extremely good guide to practice.
Consider, for example, this shortage of housing you are speaking of in the article. The ever rising prices underlying the boom and bust.
A small dose of economic theory tells us that it isn\’t in fact the price of houses that has been rising nor is it houses per se that have been booming and busting.
The cost of building a house has been pretty static (inflation adjusted that is), if not falling slightly over the years as with just about every other physical good that is manufactured. We do get better and thus cheaper at making things over time.
At a guess (and a vaguely informed one but no more than vaguely) you can whack up a nice three or four bedroomed house for £100,000 today. Certainly, I\’ve a quote on my desk for a Portuguese builder to put up a two bedroomed for me at €80,000.
It\’s also not the price of land that has been rising nor contributing to the boom and bust. Even now prime agricultural land is about £ 5,000 an acre and current planning guidelines are that there should be 5 or 6 houses on such an acre (I think that\’s right, 14 to the hectare isn\’t it?). So the cost of land is some £1,000 per house as a nice round number.
So why is the average price for a house something like £160,000? For a four bedroom perhaps £220,000 or more?
Because there is a third part of the system. The cost of permission to build upon a certain piece of land. that\’s what takes a house from a replacement cost of roughly £100,000 to that £220,000 or whatever it is.
Economic theory says that, in the absence of supply restrictions, we would expect a house to be valued at or around replacement cost. For if prices rise above this then some people will start to provide more houses. Assuming, of course, that there is no supply constraint.
But we do have such a supply constraint, it\’s called the planning process. Until we remove that constraint then we\’re going to continue to have this problem of high house prices.
Amazingly, someone\’s even written a paper detailing a scheme to get us out of this problem. Here, at the Adam Smith Institute. Land Economy.
Remove the restrictions upon what you may build and where and we\’ll have solved the boom and bust problem and also the high prices problem.
See, economic theory is useful.