Low house-building levels and the unaffordability of existing homes are problems that have been plaguing Britain for decades. Yet contrary to popular belief, academic economists might have some practical answers to offer, argues Steve Davies, and illustrates his case using the “forever contemporary” thinking of Nobel-prize winner Ronald Coase.
Many think that the work of academic economists has little or no relevance to real world problems. Yet the insights of economics can show us how to resolve problems that otherwise seem intractable. A case in point is the work of one of the great economists, Ronald Coase, which shows ways to resolve planning laws and their impact on development.
There is now something of a consensus among academics and commentators that the shortage of housing (and buildings of all kinds) is one of our most pressing problems. Many others such as welfare costs and low productivity are at least partly caused by the lack of house building and the consequent high price of housing. However, this has not as yet led to any political action. The problem of course is the conflict of interest between people who want to build, buy or rent new houses on the one hand, and people who do not want new development on greenfield sites on the other. The second group have so far been able to block any action and this does not seem likely to change.
But the work of Coase shows that this deadlock is quite simply unnecessary and avoidable if we only think about it in the right way, as Mark Pennington explains. Current policy on development is shaped by conventional welfare economics, where two people engaging in a transaction can impose costs on bystanders. So a developer and a house buyer can impose costs on existing home owners and people who wish to preserve the rural environment. This is dealt with by regulations through planning laws.
As Pennington explains, Coase rejects this model. For him the costs are reciprocal – there are two sides each of whom is potentially imposing costs on the other. One wants to build houses, the other to preserve space. To the extent that one side gets its way the other suffers a loss. What we actually have is not an externality or pollution but a conflict over how to use land.
For Coase the solution was to assign a property right to one of the two sides and then allow a process of bargaining to take place. If the first group have the right then those who do not want development would have to pay them not to do it. If the second, then the developers (and ultimately the buyers) have to pay for the right to develop. Crucially it does not matter which of these two we go for: in either case we will end up with the outcome that maximises total welfare so long as the bargaining process itself is not too costly.
Fortunately, in the case of land use the cost of negotiation is low. If we applied this model instead of a complex and costly planning procedure we would simply have a default right, either to build or not, which would have to be bought out. We could make one default apply in some parts of the country and the other in the rest (although this should not matter, it might be politically astute). There would then be a process of bargaining and through this we would actually find out how much people really valued one alternative or the other (as opposed to their asserting it – words are cheap).
The result would be development in some areas but not in others and this would reflect the actual value that people collectively placed on the two competing uses and the associated moral values. This would be different in different places (unlike the inflexible present system). As Pennington points out this would also be an ethically superior outcome because it would reflect ethical and value pluralism rather than having one group’s values imposed on the rest through the political process which is what we have now.
Ronald Coase was one of our greatest and most original economists. His ideas can bring solutions to problems and conflicts that otherwise seem insurmountable. His challenges to conventional wisdom is what the Institute of Economic Affairs aims to highlight through publishing a collection of essays on Coase’s economics.
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Dr Steve Davies is Education Director at the Institute of Economic Affairs. Prior to this he was program officer at the Institute for Humane Studies (IHS) at George Mason University in Virginia.
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Note: the article represents the views of the author and not those of British Politics and Policy or the LSE. Please read our comments policy before posting.
Sad to see the name of a great economist like Ronald Coase being associated with an argument that makes no sense at all.
The Coasian bargain is relevant when both sides represent the key economic and social interests which are affected by the decision reached.
In Davies’ argument, this may well apply to one side – the developer – but not at all to the other side.
Looking at the developer side, it will often be sensible to assume that the developer represents the interests of those who will later buy the development (although, even here, we have to allow that many developers choose short-sighted, short-term, unimaginative solutions for their development, under-realising the longer term potential of the land which they buy- that’s one reason why we have, and need to have, micro-level ‘development control’ functions in local government).
However, Davies’ argument becomes incoherent when he turns to the other side – “existing home owners and people who wish to preserve the rural environment”, people who are hypothesised to want “to preserve space”. These are indeed likely to be affected by any development decision. However, they do not represent ALL those likely to be affected by the development decision. As one comment above highlights, future generations are also affected – how are their interests to be represented in the bargaining process?
More obviously, perhaps, many development decisions affect other activities in a city (e.g. housing on the city boundary helps city employers but imposes future costs on schools, hospitals, roads and public transport, etc.). Even in the vicinity of a development, many residents may consider their interests to be seriously affected (e.g. because of daylight, parking and ‘overlooking’ considerations), while others may be uninterested. Who represents these varied interests? Who would be the ‘other side’ which negotiates the Coasian bargain? In these multiple stakeholder situations it would be entirely naive to suggest that any self-organised solution (or ‘market-based’ solution) would be optimal. That’s why it has been argued by economists for a century that a public sector regulated system is superior, in principle, to the self-organised solutions reached by narrow interests, who do not represent all those affected. (This is the argument for a macro-level strategic land use control function in local government). The conditions for a Coasian solution simply do not exist in the case of land use development. It is irrelevant to propose a Coasian bargain in this case.
Of course, this does not imply that the current public sector planning system always works well, never mind that public sector regulation of land use development is currently operated in an optimal way. It seems obvious that UK planning controls have been so neutered since 2010 that development is now often seriously detrimental to existing neighbours and other city activities.
Davies purports to be concerned with finding a solution to the current housing crisis in Britain. He strangely doesn’t seem concerned with the fast growing inequality of incomes, which means that the growing class of super-rich get a large part of the land which becomes available for (re)development and that a fast growing proportion of UK population can only hope to afford housing which 30 years ago would have been regarded as socially unacceptable (‘sub-Parker Morris’). He also doesn’t seem concerned with the imbalance of private investment in the UK, which means that an increasing proportion of the population is being attracted to London and the South-East, where they impose huge costs on the public sector, although these private sector investors do not pay the costs for the externalities which they impose. Tackling both these issues would actually do something to tackle the housing crisis. Talking about bargaining solutions between narrow interests is irrelevant.
Typically the IEA ignores the interests of future generations when the environment is sold off forever for a quick buck today. Coase is an obvious solution in some cases, but it is not as straight-forward as this article implies.
PS Why won’t the IEA reveal who funds it!
Naive or cunning? The end result is that wealthy areas will have few extra homes built whilst poorer areas and areas with little housing will tend to have housing built. Over time the result is to create pockets of housing in former ‘cheap’ areas – which in turn will become objectors and drive away further development.
But one thing is achieved – the politicians might become protected from the anger of those who might have objected – vote-wise – to having housing imposed upon them. This may be the real (and only) attraction of adopting a Coasian bargain.
To achieve a Coasian system the political changes involve taking planning power away from councils and giving power to residents in some way or handing the Coasian bargain to councils who may or may not ‘represent’ the residents and may or may not distribute the planning gain. Either way any councils or resident groups deemed ‘soft’ will be inundated with developers, see their property values decline more than the compensation (if any) and soon realise the Coasian bargain is in fact a Faustian bargain. The effect will be to turn neighbouring councils and residents into hard line objectors.
If a group of residents purchased a right ‘not to develop’ on a parcel of land, would this be ‘in perpetuity’ or ‘time limited’ and if so, for what period of time?
What if no agreement is reached? Stalemate, or Arbitration?
Would this lead to development away from existing development (where people (NIMBYs) live and are prepared to invest in their immediate environment) to development in areas of open countryside where few people live?
Would a better option for any planning gain to be made by the local authority rather than the land owner?
An annual land tax levied by the local authority on undeveloped land would deter landowners from holding land that they don’t really need or value, and moderate land values to prevent them going ever upwards. The tax rate could be varied depending on the need for development. The tax money collected would allow local authorities to purchase land for necessary development. It could be combined with an objectively assessed housing land value scheme and backed if necessary by compulsory purchase (with safeguards) for essential development.