How does the housing market affect UK productivity?

Where we live – and how much that costs us – affect our ability to work, to find suitable jobs and to access good schools. House prices also influence whether money is invested in property or in developing businesses. All this means that the housing market has a big impact on national productivity.

Workers’ productivity, globally, has been growing slowly in this millennium. In the UK, low levels of productivity have been a pressing policy challenge for at least the past decade and a half (Gal and Egeland, 2018).

Figure 1: Growth in average output per worker (2009-19, 2014-19, 2020-21)

Source: Office for National Statistics (ONS)

Research on the reasons for this poor performance has often failed to look at how people’s housing costs, locations and living conditions might affect their productivity – for example, through their proximity to jobs that match their skills.

Across the economy as a whole, housing prices can influence productivity levels by encouraging or discouraging investments in technology, innovation and new businesses.

The sustained failure to explore the economic consequences of housing systems and outcomes arises from the complex nature of housing, housing markets and their inherently ‘local’ dimension.

For example, the UK government’s paper on ‘levelling up’ analysed regional economic change and, separately, suggested important housing policy investments (Department for Levelling Up, Housing and Communities, DLUHC, 2022). But at no point did it explore how housing outcomes affect regional/metropolitan differences in productivity.

What can we learn from thinking about housing and productivity together?

Housing is a ‘multi-attribute’ capital asset that is spatially fixed, complex to build and makes up significant proportions of households’ spending and investment. The housing system is made up of multiple elements, including designing, financing, building, maintaining and exchanging homes.

In advanced economies, housing typically absorbs 20-25% of household incomes. It has also become both the largest asset held by households and the largest component of household debt.

Housing is a major economic system – at neighbourhood, metropolitan, regional and national scales – and its functioning and outcomes shape productivity and capital allocation in the overall economy. Looking at housing activities, attribute outcomes (including rents and prices) and overall resource allocation on housing can help us to understand the effects that these have on productivity (Maclennan et al, 2021).

The logic of the approach is that households choose a set of attributes – including dwelling size, structure, quality, neighbourhood amenities and location relative to household activity sites (such as workplaces or schools) – that have an associated price and asset characteristics.

Existing research has done too little to establish how these factors shape household capabilities to accumulate and use different forms of capital, including social and human capital (people’s education, skills and networks of relationships) as well as housing wealth.

These linkages between housing attributes, household capabilities and the growth drivers of human capital, business capital and creative/innovative systems constitute the complex interface between housing and productivity.

On a more aggregated scale, the housing market is a resource allocation system that matches households to housing, and investors to housing investments. It also shifts resources between housing and other economic sectors, and may do so more or less effectively.

A case can be made that in many of the advanced economies, housing and economic policies have provided incentives to raise house prices, rather than fostering innovative technologies and human capital.

Although governments generally fail to address such questions about housing programmes, recent studies in the UK (CBI, Confederation of British Industry, 2020), Canada (Toronto Board of Trade-Woodgreen, 2021) and Australia (Maclennan et al, 2021), and by the OECD (2021), suggest that business, trade unions and housing lobbies now recognise how housing outcomes can limit productivity improvements.

How does housing affect productivity levels?

One significant way in which housing can affect productivity relates to access (or lack of access) to high-productivity places (Maclennan et al, 2021). The key issue is that there is a shortage of affordable housing in central urban areas and that high house prices (and rents) limit the ability of workers to move to productive places where high-wage jobs are concentrated and distributed (Hsieh and Moretti, 2019). Economic analysis of this problem has primarily been done by US scholars (Glaeser and Gyourko, 2018), and followed by researchers in countries like Australia and Canada (Jenner and Tulip, 2020).

This trend erodes the benefits of being able to get workers with the right skills into appropriate vacancies (labour matching) and limits the learning effects that underpin agglomeration economies (whereby employees and firms co-locate).

While multiple explanations of the current lack of available housing are strongly contested, the consequences of shortages and of high land and housing prices are more widely agreed.

In most advanced economies, renters are more likely to move – they exhibit higher rates of residential mobility– than those in other types of housing. Workers who are unhindered by the costs of buying or selling property are more likely to maximise their productivity levels by moving to wherever the best work opportunities are available.

Studies confirm that for a wide range of income groups, market access to rental housing facilitates labour mobility across, as well as within, different housing markets. It also promotes effective adjustments to economic shocks such as pandemics or financial crises (Whelan and Parkinson, 2017).

But it has been reported that the propensity of those living in the private rented sector to move has fallen by more than half in the last two decades in the UK (Judge, 2019).

In recent years, renter mobility means that it has been easier for skilled workers/renters – especially those working online – to leave metropolitan areas when the high rents made it unaffordable to stay. This has especially been the case since the start of the Covid-19 pandemic.

Similarly, when younger renter households could not afford to buy centrally located homes or larger homes where they could form partnerships and have families, they relocated – either to more remote suburban locations or to ‘second tier’ cities (Brook, 2017; Judge, 2019).

The UK has substantial skill mismatches between workers and vacancies (Gal and Egeland, 2018). Denser, or ‘thicker’, labour markets within metropolitan areas – where there are lots of vacancies in one location – mean that firms face low costs of search and hiring, and can quickly hire (and replace) workers that have the specific skills required. Better matches between jobs and skills raise productivity.

Workers, in turn, can shift – without incurring the costs of relocation – to the jobs for which they have the relevant skills. Subsequent knowledge sharing increases their human capital, permanent income and future productivity. As a result, the labour market works more efficiently where affordable housing options are available.

One study estimates that in the Sydney metropolitan area, the outward displacement of younger households – who are aspiring to home ownership – to remoter, lower cost land and housing led to significant productivity losses for the Sydney and New South Wales economies (Maclennan et al, 2019).

Policy-makers making transport decisions have recognised the effects on productivity associated with time ‘lost’ in longer commutes, but they have failed to take account of the larger losses from poorer labour market matching. As a result, these factors have been excluded from housing investment decisions.

The broad interactions between housing choices and transport systems shape workers’ access to employment concentrations and city cores. Poor connections between homes and workplaces (which reflect housing as well as transport outcomes) are a key reason why UK cities are less productive than their European equivalents (Foster, 2022).

Compared with European cities, where 67% of the population can reach the city centre by public transport in 30 minutes, only 40% of people in large UK cities can do so (Rodrigues and Breach, 2021).

Too often policy-makers see these patterns as a consequence of transport investments rather than the outcome of the location of housing supply. As a result, much greater local and national emphasis on joint housing-transport policy and planning is required.

By reducing the size of the labour pool for businesses, as well as restricting workers’ access to high-productivity jobs and activities in city centres, poor matching of housing opportunities and public transport accessibility in big cities weakens agglomeration effects and productivity. Ineffective transport also risks increasing greenhouse gas emissions.

Through the pandemic in the UK and similar economies, smaller housing markets (in well-connected towns and rural areas) initially saw faster growth in demand for housing (as people ‘searched for space’) and supply than traditional metropolitan core markets when working from home became a choice for more skilled workers. Bigger cities continued to recover faster in 2022.

Even if some people switch permanently to working from home, the emerging evidence across advanced economies is that around two-thirds of workers are back in the office for at least significant proportions of the working week. Further, city centres and access to them through well-connected public infrastructure will remain critical to urban economies even if there are reduced demands for office space.

The pandemic has permanently altered, inter alia, working habits and housing choices. But it has not permanently diminished the significance of agglomeration effects in productivity or economic growth. Indeed, higher fuel costs and net-zero targets are, in the longer term, likely to drive increased demand for denser, more work-accessible housing locations.

In addition, increasing numbers of younger, recently redundant individuals in rental housing are – with the removal of Covid-19 support measures – having to search for jobs from positions of no permanent address and homelessness.

One study finds significant productivity losses from the ‘no address’ entry barrier to employment (Boyle et al, 2022). This research emphasises the importance of knowing more about the employment and productivity consequences of poor housing outcomes.

What are the links between housing and the formation of human capital?

Housing lobbies and policy-makers have seldom looked at the evidence on how housing may affect an individual’s acquisition of skills (the development of human capital). Wide-ranging studies make the case that housing can affect residents’ outcomes on health and education (Meen and Nygaard, 2010). This is particularly the case for children from low-income households and young people.

This matters as these outcomes are widely established as significant influences on an individual’s capability to acquire and use human capital, and thus the productivity of labour. But within the wider research on housing, its effects on the formation of human capital often lack rigorous empirical confirmation, reflecting the complexity of the causal chains involved.

Further, it is challenging to make definitive claims about which housing attributes and processes affect the formation of human capital. Housing research in the UK, and indeed most countries, has never had the resource support of data, trained economists and research infrastructure to investigate obvious links that have been pursued by researchers in health and education.

The framework that examines housing outcomes, human capital and productivity can be applied to look at how different housing outcomes could individually or jointly influence economic growth and productivity. These outcomes include distance from workplaces, housing quality, insulation standards, space for home-working and schoolwork, internet and other connectivity, and neighbourhood environment.

The critical question in this context is whether the attributes associated with housing choices affect labour productivity directly and/or whether this occurs via indirect effects such as education, health and other outcomes.

Key prima facie housing effects on productivity have been identified at different stages of an individual’s lifecycle. For example, overcrowding – which currently affects around 3.5% of all households in England – can lead to negative outcomes in relation to child safety (DLUHC, 2022), health (Wilson, 2021) and learning capabilities. Further, the likelihood of these effects being transmitted throughout an individual’s lifecycle has been identified (Office of the Deputy Prime Minister, 2004).

There is also evidence that young children in families that have to move house frequently (through rental housing options) fall behind the school performance of their more stably housed peers very quickly (Hutchings et al, 2013). Worryingly, many never catch up before leaving school a year or more ahead of their more prosperous fellow pupils.

As children progress into their teenage years and become aware of their growing independence, life outside the home and within immediate social networks becomes important. Living in poor places reinforces poor educational performance through peer group effects. This, in turn, can make labour market entry more problematic (see the extensive discussion of such ‘neighbourhood effects’ in van Ham et al, 2014).

Housing economics has long stressed the importance of tenure options – the type of housing property rights an individual has, for example, ownership or rental. There are potentially important ‘confounding’ income and other effects but there are also links between parental housing tenure and the acquisition of human capital by their children.

For example, studies have shown that children whose parents are homeowners have educational and related outcomes that are more conducive to developing human capital. They receive better school grades (Barker and Miller, 2009), they have higher rates of high school graduation (Aaronson, 2000), they are better behaved (Grinstein-Weiss et al, 2012) and they have lower rates of criminal conviction (Blau et al, 2019). (A comprehensive review of research on this issue in the UK context is in Cross, 2020.)

For adults, several mechanisms could raise homeowners’ productivity through effects on life satisfaction, self-esteem, a sense of status, and control arising from the experience of freedom at home (Lindblad and Quercia, 2015).

Another study, which looks at Australia, shows a ‘tenure effect’ whereby secure homeowners are happier and more productive than precarious owners and renters (Wood et al, 2022).

But for both adults and children, few studies disentangle the critical interaction and selection aspects of parental income, housing tenure and neighbourhood effects.

Besides the possible impact of the housing attributes discussed above, there are also studies highlighting that housing service provision, experience of property quality and aspects of neighbourhoods have significant correlations with measures of health and wellbeing (Rolfe et al, 2020).

Other recent studies argue that poor quality homes, inadequately heated housing, insufficient adaptation and poor maintenance all have negative effects on UK households’ health (Institute of Health Equity, 2022; The Good Home Inquiry, 2021).

Rising housing costs may also affect the work-leisure choices of older households. For example, in economies like Australia, there are growing proportions of older households who are still paying mortgages (Ong et al, 2019). At the same time, for those fortunate enough to have accrued significant housing wealth, rising house prices can have counterproductive effects on labour market participation.

Recent research from the Australian Housing and Urban Research Institute shows that ‘higher house price growth leads to a reduction in labour market participation and hours of work for older women (precipitating early retirement) and younger partnered couples (substituting from market work to non-market carer activities)’ (Atalay et al, 2016).

How does housing affect capital allocation?

In a market economy, the allocation and reallocation of workers and capital (assets such as machinery or technology) to the firms that can use them most effectively is an important determinant of productivity (Restuccia and Rogerson, 2017).

House prices may influence both household resources (by raising levels of housing wealth) and information signals (indicating super-normal profits in the housing sector) that reallocate capital efficiently and, as a result, improve productivity (Cette et al, 2016; Meen and Nygaard, 2010).

More specifically, rising housing prices affect resource allocation. First, households can use their increased housing wealth to take additional borrowing to fund non-housing investments (the collateral channel). Second, investment flows may be diverted to housing from other, more productive activities such as business start-ups or expansion (the investment or crowding-out channel).

The collateral channel proposes that housing assets could be used to finance firms through home equity extraction and/or using housing to guarantee firms’ borrowing (Bahaj et al, 2020; Reuschke and Houston, 2016).

Using UK microdata, researchers have explored the relationship between increases in the values of the homes of company directors and investment in innovations. They find that a £1 increase in the values of homes grew the firm’s investment by £0.03 (Bahaj et al, 2020).

The collateral channel has also established significance for potential entrepreneurs and the formation and growth of small firms (Reuschke and Houston, 2016). These companies contribute disproportionately to employment and output growth. Housing can be used as collateral that enables households to relax borrowing constraints and have better access to credit and thus start a business.

In contrast, other studies find that rising house prices ‘absorb’ more capital into the housing sector and crowd-out non-residential investment. The higher, less volatile rates of return in housing could induce even the most productive non-real estate companies to invest in property, thus limiting investment in other higher-productivity (but lower return) activities (Miao and Wang, 2014).

Housing investment can be a sector with both high returns and few technology spillovers. This can impede real economic development and result in a decline in productivity.

There is evidence suggesting that firms holding more real estate assets are less productive. One study argues that rising real estate values disproportionately relax collateral constraints for low-productivity firms, which tend to hold a large share of their assets in property (Doerr, 2020).

This research also shows that within an industry, a rise in average real estate values leads to a decline in productivity, which may be due to resources being allocated towards low-productivity firms in this sector (Doerr, 2020). This entails more capital leaving productive sectors and decreasing productivity by slowing down capital accumulation and technological innovations.

Economic policy-makers should be aware of these observations and pay more critical attention to the productivity damage arising from sustained, systemic increases in house prices.

There is a charge to answer that the productivity struggles of the UK, Australia and Canada in the last two decades reflect, in part, that macro-policy decisions have driven an economic system based on taking the rewards from scarcities (a ‘rentier economy’) rather than growth driven by innovation and effort (an enterprise economy) (Piketty, 2018).

What are the current gaps in research?

Better housing outcomes and faster, more stable growth are achievable for countries and metropolitan regions. Although the earliest advocates of housing for the poor stressed the work capability as well as fairness implications of better housing, more recent debate has focused on fairness and generally eschewed consideration of the effects of housing on productivity. Similarly, policy-makers have often played down the economic consequences of poor housing outcomes.

Within governments, across housing, finance and other departments, there is an urgent need to grasp the housing/productivity question. Equally, across different orders of government, national/federal, state/provincial and municipal/metropolitan entities need to address their programmes to create synergies that will fashion more productive outcomes.

More collaboration and multidisciplinary work is required in research, with better panel and geographic information system (GIS) data to track programme effects, across those who research housing, health and education.

It is important to continue to develop an applied economics that pays attention to the ‘stylised facts’ of housing market operation. Governance and research conducted in silos, plus unduly reductionist economic analysis, leave us struggling to capture the potentially important productivity consequences of housing processes and outcomes.

Where can I find out more?

Housing constraints and spatial misallocation: Article in the American Economic Journal: Macroeconomics by Chang-Tai Hsieh and Enrico Moretti.
Raising productivity and housing the economy: Chapter 14 in Productivity and the Pandemic by Duncan Maclennan, Julie Tian Miao, Linda Christie and Jinqiao Long.
The engagement of home-based businesses in the digital economy: Article by Darja Reuschke and Colin Mason in Futures.