Housing finance

Demand vs supply-side subsidies

Across African cities, the costs of formal housing construction are far outstripping what ordinary residents can afford. Although a typical household in a large African city would struggle to afford a house of over $15,000, construction costs average at over $42,000. This affordability gap in the formal market has led to the growth of informal settlements that often lack the clear land ownership and infrastructure required for rising productivity and liveability. This brief discusses the costs and benefits of demand-side and supply-side housing subsidies in tackling this affordability gap 1 2.

  • Demand-side housing subsidies aim to increase consumer purchasing power for housing, either in the form of rent subsidies, or home purchase subsidies. They are typically more efficient than supply-side subsidies as, all other things being equal, they do not cause distortions in the market related to where and how housing is provided.
  • Supply-side housing subsidies are aimed at financing housing construction 3. These subsidies can be a more useful mechanism to lower housing production costs, particularly where local construction industries are underdeveloped and subsidies are integrated into a policy package to grow the local construction industry over time. However, international experience has shown the challenges of incentivising developers to use these subsidies effectively to provide suitable housing in well-located areas.

Both demand and supply-side subsidies can be a useful policy tool to address targeted specific issues in the housing market; for example, where a certain section of the population’s incomes are just too low to afford housing or where the construction industry cannot quite supply a certain segment of the market profitably.

However, when these subsidies are implemented in the context of restrictions in the land and construction sectors that fundamentally raise housing costs beyond affordability at current income levels, these subsidies are likely to be at best insufficient and at worst a hand-out to developers. Restrictions, such as excessively stringent land-use regulations, typically result in a market where suppliers do not respond to price increases by increasing the quantity of housing available. In the presence of this housing supply inelasticity, demand-side subsidies are likely to result in price rises and supply-side subsidies are likely to crowd out the supply of unsubsidised housing. Policy will therefore need to go beyond subsidies to tackle the fundamental constraints in land and construction markets behind an inelastic housing supply, and subsequent high housing production costs relative to incomes.

Key messages

  1. Subsidies can be a useful tool if used to target specific housing market segments, but can’t tackle the fundamental reason behind the affordability gap: high housing construction costs.
  2. High housing construction costs are often caused by artificial distortions in land and construction markets – reforming these can have a much deeper and sustainable impact than subsidies.
  3. If implementing subsidies, demand-side subsidies are more efficient, but well-targetted supply-side subsidies can enable profitable housing providers to emerge in the longer-term.