Though free markets unleash productivity and innovation, they are still bound by economic laws. The most important law is that market price reflects market demand. Because half of every population is below median income, market-quality housing commands market prices. As a result, markets alone will never satisfactorily house a nation's poorest citizens. Thus, whether people buy or rent, housing is typically affordable to only half of the population. Those citizens who flood the world's growing metropolian areas, however, are overwhelmingly poor: they arrive in cities that were built for smaller populations, and whose formal-sector housing producers can only build housing that these urban immigrants cannot afford.

The result is a spontaneous community of self-built or informally built homes—the shanty towns, settlements, and ever-expanding slums that sprout like mushrooms on the outskirts of cities in the developing world. People who move to the city act by impeccable economic logic: they follow the money. Seeking to maximize income, these citizens willingly consume the least expensive space they can, which is often just a room in a larger informal structure. Left alone in the marketplace, the impoverished create and inhabit slums because that is their only available and economically sensible option. It has been this way for over two centuries: London in 1795, Boston in 1855, New York City in 1905, and Mexico City in 1995, to name but a few, all experienced a rapid growth of overcrowded informal housing.

The Four Essential Roles of Government

Slums are a reflection not of market failure but of societal failure. Economists since John Stuart Mill have realized that, if production operates by inexorable economic principles—only profitable ventures are undertaken and only economically sustainable ventures survive—the distribution of wealth is a societal, and hence governmental, choice. If the international public wants healthy cities, the poor must have access to housing in homes they can afford. Since market forces will never provide housing they can afford—and they never will have the ability until they cease being poor—it is up to government to stimulate the creation of sustainable affordable housing.

As nations advance, government plays several roles, summarized by the mnemonic acronym LEaPS: Law, especially as it pertains to property; Enabling environment for capital formation and capital flow; public-private Partnership as the cost-effective vehicle for delivery; and Subsidy at the margin to go where pure market forces will not. Each level builds on the one before; each is more complex than its forebear; and each can be no better than its predecessors' cumulative success. While paces may differ and boundaries between stages may blur, a nation's quest for affordability follows a predictable four-stage evolution.

In London, England, converted Victorian-era slums still exist as government-subsidized “council housing.” The government, under the Labour Party leadership, has been trying to find more methods of providing affordable housing to millions of lower-class British citizens. Photo courtesy khaosworks.

Initially, there is the rule of law. Affordable housing is real property, and if property is not protected by the full weight of law and government, it will not be built, renovated, invested in, or maintained. Without laws that bind the governed and their governor, renter and owner, investor and builder, it is impossible to construct any economically sustainable model of affordable housing creation.

This process starts with land and the strength of private enforceable title to land. In Kenya, for example, the now-discredited previous government crowded the poor into enormous slums while expropriating vast swaths of developable land that the former president's cronies and extended family still hold. In Kibera, Nairobi's largest slum, home to one in five Nairobians, citizens live in a community only a few miles from downtown, where there is no formal title to land and no contractual right to any structure, only rent payments to local headmen based on verbal claims and midnight enforcement for a family's right to squat in a ten by ten foot room. Law in Kibera is tribal and local. So absent is the Kenyan government from any aspect of Kiberan life that one might as well erect border gates at its entrances and deem it a foreign country that has internally seceded from its parent nation. It is a distillation of disinvestment and exploitation, the ultimate poverty warehouse, and a place where inhabitants' main goal is something as basic as clean water or proper sanitation.

Governments must lead by protecting private property from those who might seek to prey upon property owners such as future governments or their own corrupt officialdoms. When governments effectively protect private property, citizens invest in housing with their cash, their enterprise, and their sweat. When governments do not, as in Zimbabwe in 2005, capital and citizens flee, causing a country to sink into poverty, violence, and eventual anarchy. Unfortunately for Kenya, recent land reform initiatives have stalled with the defeat of the proposed new constitution.

The second role of government is in fostering an environment conducive to capital. The rule of law assures that one who owns a home may keep it. To sell it—and more directly to build a new home or improve an existing one—its owner needs more capital than the typical individual possesses. Capital flows into enterprises as long as it sees prospective economic return. Housing is particularly challenging for capital to assess because housing has the longest return cycle of any asset class, ranging into decades; and, unlike other assets, it is not portable, so the lender cannot readily repossess it. Non-portability causes the lender to have to evaluate collateral and reclaim possession on site, adding cost and risk to the credit decision and lending process.

To develop capital, governments need sound macroeconomic policy, a currency not prone to massive deflation, reliable capital markets, means of aggregating financial instruments and selling financial investments, a robust banking and investment banking system, and a diversity of real estate capital forms—such as mortgages, loans, and bonds. Governments can stimulate these markets through state-established housing finance entities such as Mexico's Sociedad Hipotecaria Federal (Federal Mortgage Company) and Thailand's Government Housing Bank or smaller secondary market makers like Malaysia's Cagamas.

In Egypt, for example, the Egyptian government and the US Agency for International Development are struggling to reform an anachronistic deeds-owned system that compels a buyer to maneuver through a 77-step registration system before emerging with a secure title to an urban property. Typical Egyptian home financing is seven years or less, provided by the builder or seller rather than a bank. As a result, homes transfer infrequently, which leads to huge mismatches between Cairo households’ current housing needs and their housing consumption. Governments must cut through red tape to create capital and financial markets that enable speedy and low-cost exchanges of future promises for present capital. When appropriate markets are in place, people finance housing and are willing to borrow large sums for long periods in order to own homes.