After the sub-prime bubble in the United States, one would assume that policymakers have learned that governments need to be cautious about encouraging the accumulation of debt in specific areas of the economy. Not in the United Kingdom, it seems. Ed Balls, the Labour Party’s shadow chancellor, presented his plan to boost the supply of affordable housing at his Party’s conference in Manchester on Monday.
While the specifics differ, the plan would set in motion in the exact same patterns of behavior as the Community Reinvestment Act and other pieces of legislation, which fostered home ownership in the United States. Without sharing the details, Mr. Balls wants to use the revenue from 4G auctions to build 100,000 new affordable homes – “creating hundreds of thousands of jobs and getting [British] construction industry moving again.” The shadow chancellor also proposed a stamp duty holiday for first-time buyers of properties up to £250,000.
Even if one ignores the fiscal implications of his plan, the idea to throw more money at the construction sector is an awful one. Firstly, the plan is not aimed at helping poor people – the UK already has a very generous supply of social housing, larger than Sweden or Denmark. And it’s not clear that the country suffers from an absolute shortage of housing, as some 450,000 housing units are unoccupied, according to a 2010 research project done by the Guardian.
Secondly, Mr. Balls’ plan is completely oblivious to the actual mechanics of the housing market. The vast majority of home buyers have recourse to mortgages. Encouraging home ownership through tax breaks invites more debt into an economy that is already suffering through painful deleveraging. Worse yet, it invites it specifically into a sector that does not have a very good track record.
In the United States, tax incentives similar to ones suggested by Mr. Balls were key in the build-up of the crisis we are living in today. ”If you had a choice between putting $50,000 into the stock market or spending that money on a bigger house, tax policy would rationally push you toward the bigger house, since any eventual gain would be tax-free,” wrote Nicole Gelinas, a scholar at the Manhattan Institute, specialized in the economics of the housing market.
Because debt financing is fragile, we should be wary of policies that favor the creation of private debt in any segment of the economy. Whenever economic shocks hit, debtors are forced to make substantial adjustments to their spending in order to honor their obligations. Often, that requires large spending cuts in times of economic downturns, with potentially debilitating effects on the whole economy.
In This Time is Different, Carmen Reinhart and Ken Rogoff argue that excessive accumulation of debt – private or public – leads to financial and economic crises. And, when things turn bad, the distinction between private and public debt gets murky as governments tend to absorb large portions of private debt, as they did in Spain and Ireland.
Private debt levels in the United Kingdom are at historically unprecedented levels, hovering at around 450 percent of GDP – almost twice as much as in the United States and matched only by Japan. To encourage the accumulation of more private debt, through tax incentives given to home ownership for example, is irresponsible, particularly given that we are still counting casualties of the last big debt-driven bubble in the West.
As the Treasury’s earlier promise to guarantee £10bn of bonds issued by housing associations suggests, Mr. Balls’ ill-advised plan is only a symptom of a broader, cross-partisan, problem plaguing Britain. Politicians of all three major parties see the crisis as a temporary demand blip, compounded perhaps by the unfortunate fiscal dynamics. But that perspective leads to misguided policy prescriptions.