IT MIGHT SURPRISE MANY PEOPLE TO DISCOVER THAT GOVERNMENT ACTIVITY very often redistributes income or assets towards the rich or at least to those who already own assets, who tend to be better off than average. This happens for two reasons. First, some lobbyists manage to bribe or coerce governments in some countries, particularly those with a tradition of corruption, to give them favours at the expense of the general population. This is the type of corruption covered in Chapter 9 of this book. But there is also a second way in which governments can exacerbate inequality. This is through the so-called ‘law of unintended consequences’.
This is surprisingly often the case. And although it is rare that these effects reflect lobbying by the rich specifically to boost their income or wealth, it is undoubtedly the case that rich people who have managed to obtain a privilege of some kind apply pressure to preserve the status quo when it is in their interest.
I focus here on three examples: (1) rent controls (looking specifically at Stockholm); (2) planning or zoning controls (looking mainly at the UK and the US); and (3) quantitative easing (examples from the US, Eurozone and the UK). In addition I look at the impact of indirect taxation on the cost of living and hence on the real living standards of the poorest households.
Rent controls
Rent controls are a great deal if you are a tenant in a rent-controlled house or flat. But the lack of market-determined rents does mean – if there is an appreciable gap between rents paid and those that would exist in the market – that there is likely to be less investment in rental property. In turn this is likely to create shortages of housing and can lead to homelessness. Meanwhile, for those who do own their properties, the resulting housing shortage is likely to push up prices and lead to an accumulation of wealth for those who already have wealth. A standard analysis of the social cost suggested that the welfare loss from the existence of Swedish rent controls was as high as SEK 20 billion in 2012.1
Whereas in most other countries, where rents are controlled they are controlled at a local level, in Sweden rents are controlled at a national level.2 Rents (these data are from 2015) are 1,050 kronor (£80) per square metre a year on average, so a single bedroom apartment of 65 sq m is about 5,700 kronor a month, or £420, according to Statistics Sweden. On average, rents cost about a quarter of people’s income.
Rent regulation is a part of Folkhemmet, which reflects the old system of Swedish Social Democracy that uses high taxes to reduce income disparities and to fund a comprehensive welfare system. Rent rules were designed to protect tenants from losing their homes in times of increased demand and to reduce segregation. In Sweden, 37% of all apartments were owner-occupied in 2012, with renters occupying the rest.
The regulations, which were enacted in the 1960s and cover most rental units, have benefited millions of Swedes who currently pay an average rent of 4,980 kronor ($720) a month for a one-bedroom apartment. The average monthly cost for owner-occupied apartments in the city of Stockholm is 63% higher than for rental housing, according to preliminary data from an analysis by the Swedish Union of Tenants. The union, which negotiates rents with landlords, aims to keep payments below 25% of its members’ disposable incomes.
Each year, rent rises are negotiated between the tenants’ association, representing 350,000 tenants, and the Stockholm property agency, representing 5,000 private rental companies. Over the past decade, rents have risen by 19% – not far ahead of inflation, which was about 12%. The 2014 rent rise for the city was 1.12%
However, the system has been experiencing acute pressures. Building of rental homes almost dried up after a financial crisis in the early 1990s, and there is a dire shortage of properties. Demand is such that it is almost impossible to get a direct contract.
With nearly half of all Stockholmers – about 500,000 people – in the queue, it can take 20 or 30 years to get to the top of the pile. Rents in new build apartments are higher because the companies have been exempted from rent controls, although quality is said by some to be higher. Low rents in the municipal sector mean many properties require renovation and repair.
The result is a thriving rental property black market, with bribes of as much as SEK 100,000 per room to obtain a direct contract. Many people sublet space in their rental apartments. A tenant who advertised a tiny closet for rent found there were many potential takers.
Stockholm City Council now has an official housing queue, where 1 day waiting = 1 point. To get an apartment you need both money for the rent and enough points to be the first in line. Recently an apartment in inner Stockholm became available. In just five days, 2,000 people had applied for the apartment. The person who got the apartment had been waiting in the official housing queue since 1989.3 To quote a 2016 BBC report, ‘The city’s queue for rent-controlled housing is so long that it is being considered by the Guinness Book of Records. On average, it takes nine years to be granted a rent-controlled property – and that jumps to two decades in some of the most popular neighbourhoods.’4
Swedes tend to stay put in their apartments and discourage builders from constructing properties for lease. This has exacerbated a housing shortage that has sent prices and private debt to record levels in Sweden.
A growing number of builders, landlords and analysts are calling for the government to scrap rent regulations to alleviate the housing shortfall. Home prices have more than doubled since 2000 and Swedish households with mortgages owe their creditors an average of almost four times their disposable income. The central bank and the International Monetary Fund have warned that soaring debt levels make the economy vulnerable to a severe shock if unemployment rises or prices collapse. The IMF in its 2016 annual consultation with the Swedish government has called for Sweden to phase out the system of rent controls in order to encourage more efficient use of housing.5
The Swedish Financial Supervisory Authority capped mortgages at 85% of property values in 2010, raised capital requirements for banks, and is considering forced amortization, requiring borrowers to make principal repayments, to try to stem debt growth. The regulator is also considering lowering the mortgage cap, introducing loan-to-income limits, and restricting the use of floating mortgage rates.
‘If you want to further address the issue of household indebtedness then you probably have to look at all types of measures that are directly aimed at households,’ said Uldis Cerps, executive director for banking at the FSA in Stockholm. ‘It’s a broad set of issues we’re presently examining.’
While the growth in household borrowing slowed to a 20-year low of 4.5% in the middle of 2012 following the mortgage cap, it has since accelerated as housing prices have continued to gain, though increasingly strict mortgage rules have caused house prices to fall back slightly in late 2017.6
The combination of low rents and a lack of vacant units means that Swedes with apartments in attractive areas have little incentive to move. Some have more space than they need, which adds to the housing shortage. This inefficient use of housing has led to a shortage of 40,000 units, the Swedish National Board of Housing, Building and Planning estimates.
So the Swedish system of rent control leads to immense shortages of housing, a disconnect between those who have won the lottery and obtained a rent-controlled flat and others who have to pay the market price, sharply rising house prices and an increase in asset values for the rich who own property.
What is clear is that only a relatively small part of the population, about a third, gain from this. The rest all end up having to pay extra in the marketplace.
The real winners are the companies and the private individuals who own property, whose property goes up much more rapidly in value than any other investment. It is difficult to think of a measure better designed to enrich those who are already rich at the expense of the poor and less privileged. And yet it is an extreme example of the law of unintended consequences – the rent controls which have done so much to increase inequality were intended to reduce it!
Planning to create a shortage and raise prices
Tight planning controls have much the same economic impact as rent controls. They create an artificial shortage of property – typically housing – and hence force the cost of housing upwards.
Few would be so silly as to impose such controls for no good reason. And there are genuine reasons for controlling land use – particularly in a country such as the UK with a relatively high population density and some stunning vistas that could easily be spoiled by developments.
To quote the travel writer Bill Bryson:7
… stand on the eastern slopes of Noar Hill in Hampshire and you have a view that is pretty well unimprovable. Orchards, fields and dark woods sit handsomely upon the landscape. Here and there village rooftops and church spires poke through the trees. It is lovely and timeless and tranquilly spacious, as English views so often are. It seems miles from anywhere, yet not far off, over the Surrey Hills is London. Get in a car and in an hour, you can be in Piccadilly Circus or Trafalgar Square. To me that is a miracle, that a city as vast and demanding as London can have prospects like this on its very doorstep, on every side.
Bryson goes on to attribute this to the green belt, which is a planning policy preserving a belt of landscape, partly agricultural and partly woods and trees, around London and some other towns and cities in the UK (Bryson says England but the legislation is wider). Bryson attributes this to the 1947 Town and Country Planning Act, which he praises.
Technically Bryson is wrong – the green belt policy for London long predated the Town and Country Planning Act because it was first put forward as policy by the Greater London Planning Committee in 1935 in response to the ribbon development satirised as Metroland.8
But Bryson is eloquent in his desire to preserve the green belt in an unchanged form, regardless of any economic argument for the other side:
The Economist magazine, for one, has for years argued that the green belts should be cast aside as a hindrance to growth. As an Economist writer editorializes from a dementia facility somewhere in the Home Counties: ‘The green belts that stop development around big cities should go, or at least be greatly weakened. They increase journey times without adding to human happiness.’
Well, they add a great deal to my happiness, you pompous, overeducated twit. Perhaps I see this differently from others because I come from the Land of Shocking Sprawl. From time to time these days I drive with my wife from Denver International Airport to Vail, high in the Colorado Rockies, to visit our son Sam. It is a two-hour drive and the first hour is taken up with just getting out of Denver. It is a permanent astonishment to me how much support an American lifestyle needs – shopping malls, distribution centres, storage depots, gas stations, zillion-screen multiplex cinemas, gyms, teeth-whitening clinics, business parks, propane storage facilities, compounds holding fleets of trailers, FedEx trucks or school buses, car dealerships, outlets of a million types, and endless miles of suburban houses all straining to get a view of distant mountains.
Travel twenty-five or thirty miles out from London and you get Windsor Great Park or Epping Forest or Box Hill. Travel for thirty miles out from Denver and you just get more …
Bryson gets very upset about The Economist’s views on the green belt, but one senses that he sees any organ with economist in its title as already damned and so he reserves his main bile for articles making a similar point in The Guardian: ‘If it was only The Economist calling for the destruction of the green belt, my despair would be manageable, but lately The Guardian has decided to come down on the side of dismemberment.’ He also castigates planning expert Paul Cheshire from the London School of Economics who argues (also in the Guardian, to Bryson’s evident despair), ‘What green belt really seems to be is a very British form of discriminatory zoning, keeping the urban unwashed out of the Home Counties.’ Bryson’s response is at least self-deprecating: ‘Well, let me say at once that I have uttered huge amounts of tosh in my time, but I take my hat off to Prof Cheshire.’
Bryson clearly feels strongly, but most balanced policymakers would consider both sides of the argument rather than just one.
Every independent review of the factors driving the high cost of housing in the UK from the report which I personally wrote on behalf of the CBI and the RICS in 1992,9 to the official housing review written by my successor as CBI Chief Economic Adviser, Kate Barker,10 to the Future Homes Commission Report chaired by my former boss Sir John Banham,11 has confirmed that the UK’s unusually restrictive planning laws are one of the key factors leading to extremely high housing costs.
One of the UK’s specific problems is that to a considerable extent the planning process is under the control of local people. These, especially in the more sparsely populated rural areas, are those for whom the scarcity value of their own property would be reduced if development took place – it is not surprising that they vote to minimise such development and hence boost the scarcity value of their own property.
The high cost of property very substantially adds to inequality. In the US the lowest income groups spend 42% of their income on housing (it is very approximately 20% for the highest income groups). In the UK the figures are much more stark. The lowest income groups spend 60% on rent if they rent privately.12 This massive cost reflects the lack of housing supply. As I pointed out in The Flat White Economy, ‘A report by Cebr and London First in October 2015 has shown that lack of housing is costing the London economy at least £1 billion per annum. In September 2015 the accountancy firm Deloitte reported that 5% of its 2014 intake of trainee accountants had to share bedrooms because of the cost of housing while in January 2015 the Guardian reported a 74% increase in the number of young people looking to share a bedroom (for economic reasons…).’
Housing shortages caused by planning restrictions have a double impact on inequality. First, they push up rents which are a much higher proportion of budgets for lower income groups. Second, they push up the value of owned property. Since property is disproportionately owned by the wealthier groups (the survey of multi-millionaires for the first edition of Prospect magazine showed that about 50% of all of City bonuses and equivalent windfalls were invested in the housing market), an increase in the value of housing boosts the wealth of the rich.13 So inequality is increased twice by this measure.
It is quite clear that a balance has to be struck between reducing the impact of inequality of planning and the preservation of attractive views. Both are important and their relative importance can vary. Arguably in the coming years, the relative importance of reducing inequality will increase.
The conflict between the desire to preserve attractive views and the desire to mitigate the impact of planning on inequality is clearly greatest in a small relatively densely populated island like the UK. Yet an interesting analysis has emerged which shows that even in the US, where the population density is much lower, planning policy is having an impact on inequality.
What the study shows is that for most of the past 100 years, per capita incomes in poorer US states have grown more rapidly than incomes in richer states, narrowing the gap between them. Over the past three decades, though, the rate of convergence has slowed sharply. It has become more difficult for poorer states to catch up with richer states. In a paper presented at the Municipal Finance Conference, Peter Ganong of the University of Chicago and Daniel Shoag of Harvard attribute this slowdown in convergence to increasingly tight land use regulations in wealthy areas.14
Their argument is that historically much of the convergence in income across states was driven by the migration of labour from poorer states to wealthier states. This migration held down wage growth in richer states and boosted wage growth in poorer states. This historical pattern was disrupted by increasingly strict land use regulations. Regulation boosted housing costs in richer states so that migration was no longer an attractive option for low-skill, low-wage workers. But migration remained attractive for high-skilled workers, and they continued to move to wealthy places
Ganong and Shoag link this changing migration pattern to local housing regulation, using an innovative measure of land use regulation drawn from state appeals court records. They show that in higher income places where land use regulations were not tightened, convergence continued at its historical rate.
The authors also contend that the divergence in the migration patterns of skilled and unskilled households contributed additionally to rising income inequality. Specifically, they calculate that the increase in hourly wage inequality from 1980 to 2010 would have been approximately 10% smaller if convergence in economic growth across states had maintained the pace observed from 1940 to 1980.
This research highlights the important role played by land use regulation in explaining regional migration patterns, slowing convergence, and increasing inequality. So, even in a country like the US which is much less densely populated than the UK, planning policy is increasing inequality.
My impression is that planning restrictions are not normally pushed by those who are deliberately trying to push up their property values directly. But I’m sure that when there is pressure to alleviate housing shortages by adjusting planning regulations to permit the building of more houses, one of the interests brought to bear to prevent these adjustments is the desire of those who have already climbed up the ladder to prevent others from doing so. So in this way inequality is aided and abetted by those preventing development. And some play a cunning trick of masquerading as campaigning for environmental protection when in reality all they are doing is trying to keep up the value of their houses.
Inequality from quantitative easing
It may surprise some people to discover that a monetary technicality such as quantitative easing has an impact on the distribution of income, but this is widely believed to be the case.
The origins of quantitative easing are in the perceived lack of demand that results from the international situation. Global imbalances are the major explanation for this, with the high Chinese savings ratio and the German fiscal surplus as major driving forces. I covered this in one of my Gresham Professorial Lectures15 and it has been the underlying explanation of the Federal Reserve Bank’s economic policy (see articles and books by Alan Greenspan and Ben Bernanke). There is a counter-view which puts the blame on monetary policy in the developed economies, but there seems to be less evidence to support that view.16
Quantitative easing has been widespread in Japan, the Eurozone, the UK and the US. It could only be pursued in a country or economy that could command sufficient reputation for its currency to survive the policy (it is in effect the same policy adopted in Zimbabwe with disastrous results, since the Zimbabwean currency did not survive), and it needs to be implemented in essentially non-inflationary times.
The story goes like this – if someone in the world saves too much, for balance someone else has to dissave an equivalent amount. The Chinese (and some others including the Germans) save much more than they invest domestically, so others have to borrow too much. Many governments have ratios of debt to GDP that ring alarm bells (though whether these are really high is an interesting conundrum, especially if debt can be written off). So the private sector has been encouraged to spend more and save less by the combination of ultra low interest rates and bond repurchases though central banks.
Initially these have encouraged dissaving and more spending, but after a time the private sector has come up against even more restrictive prudential limits on borrowing than governments. However, one element that has continued to make it possible for ultra low rates and quantitative easing to work even after a long period has been asset price inflation. With many assets (especially property), provided their prices can be boosted sufficiently, increased borrowing can be encouraged.
The problem with this is that boosting asset prices makes the rich richer, makes property less affordable to poorer groups, and hence boosts inequality of wealth. By contrast, the main alternative of boosting infrastructural spending if anything reduces inequality17 but is subject to the constraint of governmental debt credibility.
So the policy of using ultra loose monetary policy to boost growth at a time when government investment is constrained has negative distributional consequences. On the whole, in many circumstances I would argue that the boost to growth justifies the increase in inequality of wealth but it is unfortunate that the circumstances are such that this is necessary. The problem now is how to get out of the ultra loose monetary policy that was introduced a decade ago for what were thought to be cyclical reasons. It is not clear that this will be easy or painless.
Impact of government spending on indirect taxes affecting the cost of living
One other way in which the public sector impacts on the living standards of the poorest groups is through the high cost of public services.
Discussion of whether the public sector is less efficient than the private sector is full of academic studies purporting to show private sector inefficiency. One suspects political bias. My practical knowledge of private sector contractors providing services to the public sector is that they can be efficient but this depends on having strong and consistent public sector clients. Private contractors will generally put in a low initial price in the hope of making profits on contract variations.
However, there is data on trends in efficiency, which is a different question from that concerning the absolute levels. While there might be reasons why it is difficult to compare absolute levels of efficiency between the public and private sectors, these should not preclude analysis of trends in such efficiency.
Cebr has done an analysis of relative public and private sector productivity for the UK. For the UK as a whole, total productivity for the whole economy (including in the public sector) rose by 20.7% between 1997 and 2013 despite the much publicised weakness after 2008.18 Meanwhile public sector productivity rose by only a measly 1.2% in total over the same period.19
Had productivity in the public sector risen at the national average rate since 1997, the level of public services provided in 2015 could have been provided while spending only 36.5% of GDP in 2015 instead of the 43.6% that we actually spent. And this is not a silly calculation. When I was giving my Gresham Professorial lectures a few years ago I showed that the public sector in the UK cost more than twice as much in relation to GDP as those in Singapore and Hong Kong, which achieved higher life expectancy, better education and better public infrastructure than we did in the UK.
In cash terms, the cost from lack of public sector productivity performance is over £150 billion, which could have contributed to lower taxes or to improved services or most likely a mixture of both. The £150 billion could have more than eliminated VAT (which generated net receipts of £121.3 bn in 2016/17) had it been applied to that purpose. There is general acceptance that indirect taxes are regressive and so worsen inequality (see the discussion of tax progressivity in Chapter 5).
With a high cost of government adding to the tax burden and hence squeezing the cost of living, it is clear that poverty at least and quite possibly inequality is being added to by the cost of the public sector in the UK. Might this also be true elsewhere?
Conclusion
This chapter has shown how the public sector can exacerbate inequality through the law of unintended consequences. This is especially likely to be the case if interventions are made without thinking through the likely market effects on behaviour.