LRB Podcast on Labour’s economic policy

Thank you for this, and for your piece of 21 November.

With respect to the housing issue – which strikes me as being absolutely central – it should be noted that increasing supply may not result in a material fall in prices. Indeed, it may make absolutely no difference to the trajectory of prices.

For example, house prices increased in almost parabolic fashion in countries like Ireland and the USA in the decade prior to the GFC, despite the massive concurrent increase in the housing stock in those countries. Therefore, increasing supply without dealing with the other sources of house price inflation may amount to pushing on a string.

Far too much of the commentary on house price inflation, it seems to me, is about supply and demand dynamics, rather than about the other salient (and arguably more important) factors. Naturally, it is convenient for developers, and their hirelings in the media, the legislature or in think tanks to argue that it is the Attlee/Silkin/Abercrombie planning settlement of 1947 which has led to such high prices. Certainly, many planners have advanced similar arguments, and have been doing so for a long time (such as the late Peter Hall in ‘The Containment of Urban England’ (1973)). The more often this mantra is repeated the more it is believed.

However, it should be noted that the UK did not have any house price bubbles prior to 1971-73 or prior to 1980. Supply did increase significantly, but also very erratically, even during the inter-war period. It is not clear it always kept pace with population growth. But then house prices increased rapidly, and at times almost vertiginously, during the 1980s when the population was stagnant or falling.

So something must have happened which altered the whole housing market. As I see it, it was the creation of a fiscal preference to owner occupation in the 1960s followed by the liberalisation of residential mortgage credit during the 1980s. These two factors, when combined, secured almost uninterrupted house price inflation after 1980, with only the break being the ERM experiment and its aftermath.

In chapter 2 of book V of ‘The Wealth of Nations’, Adam Smith noted that everyone is in a landlord and tenant relationship, entailing the payment of rent; it is just that the owner occupier is his/her own landlord and tenant, and so a rent (or ‘imputed rent’) is paid by the owner occupier as tenant to the owner occupier as landlord. That imputed rental income should be taxed. And it was taxed, initially by Lord North in 1777, then by the Younger Pitt in 1799-1802, and then as Schedule A of the income tax from 1803-15 and 1841-1963.

Schedule A was the Inland Revenue’s largest earner well into the 1950s. Prior to WW2 it was based upon a system of quinquennial valuations. Every five years a surveyor would assess the imputed rent for each unit of owner occupation based upon the operation of the local leasehold market. The final valuations occurred in 1935-36. In 1940 valuations were suspended by Kingsley Wood, as surveyors were overwhelmed by war damage assessment claims, the arrears of which took nearly a decade to work through after 1945.

By the mid-1950s revaluation had become politically problematic. RICS was apprehensive about the resumption of Schedule A assessments (it was low margin work), and the burgeoning building society movement was rapidly increasing the number of people who would be caught by Schedule A (owner occupation was c. 29% in 1950, but c. 41% in 1960). The Liberals were the first party to advocate the abolition of Schedule A in 1955, followed by Labour in 1959. The Tories were the laggards (despite noises being made routinely in party conferences) because of Treasury and Revenue influence, although the Revenue under Alexander Johnston became more sympathetic to abolition as the efficacy of Schedule A gradually declined.

Then, in 1962, the Tories suffered a shock defeat in the famous Orpington by-election, during which the Liberal candidate (Eric Lubbock) made some play of fears about Schedule A revaluation. A Central Office post-mortem concluded that concerns about Schedule A had been decisive. This coincided conveniently with Macmillan’s determination to push Maudling in the direction of a ‘dash for growth’, and Schedule A was abolished in 1963.

Labour had its own plans for taxing wealth, and had directed Nicholas Kaldor to devise a capital gains tax. Kaldor (who was very concerned about the impact of increasing consumption on current account) envisaged CGT applying to the primary place of residence. However, in a committee chaired by the chief secretary, Jack Diamond, it was decided to create an exemption for the primary place of residence (officials were apparently concerned about the impact on people retiring from London to the country). CGT came into effect in 1965.

Thus, there was a fiscal preference to owner occupation. However, this did not of itself lead to a bubble, although prices crept up for the rest of the 1960s.

In 1971 the Bank of England published its ‘Competition and Credit Control’ policy following the recommendations of the Radcliffe report (1959), which proposed that bank rate be the sole determinant of the availability of credit, and that quantitative controls, which had been applied by means of an informal agreement between the authorities and the big five retail banks, be discontinued. The growth of the Eurocurrency markets after 1955 had led to the rapid expansion of secondary lenders (who were not subject to quantitative controls) at the expense of the market shares of the big five.

Competition & Credit Control coincided with another dash for growth, and the combination of rising inflation (against which housing wealth would be a hedge), increased availability of credit and the fiscal preference led to the first major housing bubble. However, bank rate had to rise rapidly in 1973, which led to the secondary banking crisis, the ‘lifeboat’ and the imposition of the supplementary deposit scheme (or ‘corset’), which was intended to restrict credit.

However, the growth of the Eurocurrency markets was such that the corset soon came to be decreasingly effective. In 1977-79 exchange controls were wound down, and then abolished, essentially obviating the corset.

Then, in 1980, the Treasury (advised by Lawson as financial secretary) permitted the retail banks to intrude in force on the residential mortgage market. Prior to 1980 that market had been the virtual preserve of the building societies, who could only lend what they had in deposits. By contrast, the retail banks could create mortgage credit almost ex nihilo.

Therefore, ever since 1980, house prices have chased credit, and credit has chased house prices.

Very soon after 1980 the banks’ loan books came to be dominated by residential mortgages, which were perceived as ideal collateral. For a long time housing, a non-productive asset class, has taken up more than 80% of the loan books of the banks.

This perforce starves productive enterprise of credit at a time when innovation has often become more capital intensive. The result has been endless stagnation in productivity growth since about 1990 (once the temporary gains from the shake-out of the 1980s had been spent). This, in turn, has depressed wage growth. Paradoxically, this phenomenon has made owner occupiers that much more anxious to secure their unearned and untaxed capital gains for their future security. It has become self-reinforcing.

Nor is that all. The ‘wealth effect’ derived from house price growth enables many owner occupiers to live beyond their incomes. Housing equity is a hedge against increasing unsecured debt, and can be extracted by means of equity withdrawal schemes. This permits a higher level of consumption, invariably on imported goods (exactly what Kaldor feared). Current account has been in deficit for almost the entire period since 1980, and the deficits have tended to increase.

Current account and capital account must add up to zero. A deficit on current account must be matched by a corresponding surplus on capital account, which is generated by means of the sale of UK assets to foreigners. In this way the UK has – ironically – become a colonial economy, in which revenue streams are diverted overseas as a consequence of high levels of consumption on imported goods financed by capital gains in the housing market. The ensuing alienation may have been a significant factor with respect to the 2016 referendum.

Of course, housing is essentially a zero sum game sector, in which the equity of present owner occupiers is ‘earned’ by immiserating successors in title and tenants. This is especially problematic, as most workers are now defined contribution pensioners, who have no insurance against inflation and no guaranteed returns. They must therefore save far more than their often defined benefit predecessors in title, but their ability to do so is crowded out by the burden of redeeming ever larger mortgages. There is therefore a real risk of a massive increase in pensioner poverty within the next decade or so, as many people risk running out of capital only a short time into retirement.

The untaxed and unearned capital gain is arguably the root cause of almost every public policy failure, whether in health, education, defence, social security, etc. Again, Ireland and the USA provide evidence for this. In Ireland the residential mortgage market was liberalised between 1986 and 1992, but this did not result in the housing bubble (though prices rose gradually in the early 1990s); rather, the bubble commenced in earnest from 1997 when CGT on the primary place of residence was abolished. In the USA residential mortgage market was liberalised in 1982, and again there was no housing bubble until after 1997 when CGT was abolished on the first $250,000 worth of gains (or $500,000 for a couple).

It is evident that the restoration of Schedule A is politically impossible, but it seems to me that there are two options which might mitigate the problem. The first is the restoration of quantitative controls over lending to the residential mortgage market. If all lenders were required to devote a portion of their lending to productive enterprise (especially for export) within the UK, and if they were required to increase this gradually (say, by 2% p/a) at the expense of lending to the housing market, then it might have the benefit of moderating house price inflation without necessarily compromising the banks’ collateral (and so causing another banking crisis) and it would divert capital towards production, thus improving productivity growth and wages, and so breaking the self-reinforcing doom loop, and it might encourage import substitution and so help restore equilibrium to current account.

The second would be the creation of a national care service covering both social and residential care, financed by general taxation. If people felt that they had real security in old age, and that their dependants would not be compromised by social and residential care costs as at present, then they might cling less tenaciously to their capital gains. The social care crisis is intimately entwined with the housing crisis. Social and residential care is so much more expensive because people have to self-insure (by contrast with the national risk pool which is the NHS), self-insurance being always far more costly than collective insurance, and the costs of this self-insurance engender real fear. I find it remarkable that politicians, especially those on the Left, have not pressed for the nationalisation of social and residential care on the grounds that it would be a saving for the nation as a whole.

Absent a few paragraphs in Martin Chick’s ‘Changing Times’ (2019), for which I lobbied Martin Daunton many years’ ago, and a few stray remarks in pieces by Avner Offer, the fiscal preference and the liberalisation of credit have barely been discussed. Given the enormous impact upon the UK’s political economy, I find this a remarkable, and remarkably discreditable, omission on the part of contemporary historians and the wider commentariat.

Apologies for the length of this comment.

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