An excellent meeting at the Resolution Foundation this morning discussed this point, following their new report, "The growth mindset: Sizing up the Government’s growth agenda" by Emily Fry & Gregory Thwaites.
1. The new government is commited to building more houses. It says this will boost growth, see their note 27.
2. Let's first be clear on levels and growth. Will building more houses boost the level of GDP? As Rupert Harrison on the panel said, this is what most people think.
To most people, building more houses means allowed more
people wearing hard hats producing some output. Surely that that must boost
GDP? Part of the job of economists,
aside from quantifying things, is to point out unintended consequences. It is
of course true that building more houses, with nothing else changing will raise
measured GDP. Part of the components of GDP is investment come up and housing
is an important share of investment. So
the question is will anything else change? As Rupert Harrison pointed out, All
the estimates we have for the current economy is that it is running at full
capacity. That means that any additional activity in housing simply transfer's
activity away from other parts of the economy. In other words, what one might
loosely call unintended consequences, turn out to be the key effect. Thus there
is no effect on the level of GDP Via this mechanism.
This mechanism is a demand mechanism. That is to say, the
mechanism most people have in mind, of more people wearing hard hats building
buildings, is a mechanism whereby there is increased demand for resources in
the economy, and that increased demand raises GDP common sense GDP measures the
resources that the economy is producing. As is clear in this example, GDP will
only rise if the increased demand is matched by supply (Or if there is surplus
capacity in the economy set the increased demand does not displace any existing
activity).
3. So what is the effect on supply? This is where the
resolution foundation report very helpfully does the mathematics.
Their Figure 5 below sets out the data.
The extra new housing that the report identifies turns out
to be around 1.1% of the stock of housing. This in itself is an interesting
number and shows the value of undertaking these calculations. The announced target, of 1.5 million homes sounds
like a large number. But this is an extra 60,000 homes per year over and above
what we are already building. The key point is that there are around 30 million
dwellings already existing. That's the additional building is around 0.3% of
the stock of existing buildings. Thus the question is: what is the effect on the supply side of the economy of increasing the
stock of existing buildings by 0.3%?
Is that we need to know how much extra output we get from a
certain percentage change in the capital stock. Such extra output comes from
the fact that increased capital stock raises the flow of capital services that
are available for people to use in the economy.
The answer to that question sounds like an engineering
answer. But this is where the economics of growth accounting comes in useful. If
firms are behaving in any way rationally, they will equate the marginal product
of capital to the real cost of capital. So for example if it costs British
Airways $20 million to rent a Boeing 737 for a year they wouldn't bother to
rent it unless they could make at least 20 million dollars per year in revenue.
But the real cost of capital is, in
turn, the rate of return to capital which is something that statistical
authorities calculate, for the UK, non-Continental Shelf firms, this is about
10%.
So there are two ways of getting to the percentage change in
GDP: either the rate of return times the change in capital per unit of output,
or the rate of return, expressed as a percentage of the baseline Y/K ratio, times
the percentage change in capital. For the
latter, the Y/K ratio for the economy as a whole is around 3, with the housing
share of the total economy capital stock of 40%. So that the rate of return as a percentage of
the baseline Y/K is 0.1*3*0.4 = 0.12. If
we then multiply that by the %change, of 0.3%, we get a % increase in growth of
0.03%.
Update.
Another method is this (see Frontier economics, note 6 and the note to Table 3). The elasticity is the rate of return times the K/Y ratio. In the steady state, I=deltaK. So K/Y is (I/Y)*(1/delta). I/Y is about 0.2. Delta is about 0.07. This gives an elasticity of about 0.3
