The desirability of rent controls
Posted December 10, 2007on:
- People do not become happier from a larger, or better quality house and so a lower quality – lower price equilibrium would be preferable.
- Given this, lower prices will increase the supply of property over time by getting owners to put more small apartments in a given building.
- As it is harder to find an apartment temporarily people are forced to commit to a region for a longer period of time, which may provide a positive externality, or help to solve prisoners dilemma issues through the use of a repeated game.
If you cannot be bothered reading my long, boring post on the issue, then you can just say whatever you think about the above points in the comments 🙂
Commonly economists state that price controls are sub-optimal, as they lead to a shortage (demand exceeds supply), and propagate black market activity. Now I haven’t made an opinion yet, I’m going to go through and discuss each of these points in the way that they first strike me, then we can all chat about it 🙂
Point 1 troubles me, if we don’t value larger properties more than small properties, then why the hell do we pay a higher price? This strikes me as A) a normative judgment and, B) one I don’t really believe. Sure you do become accustomed to your property to a degree, but using myself as an anecdote, I am far happier in a large property than a small one, as I have room to put all my books out :). I feel that in this case, the price does take account for the way people value the property, so the only reason we may want a low price – low quality equilibrium is if we believed their was a negative externality from someone owning a larger or better quality house.
There are two ways I can see this externality coming about. 1) Your house is so big that it takes up space someone else could have lived in – this externality is discussed in the second point, and 2) someone owning a big house increases the marginal cost of you not owning a big house. In the first externality type, the landlord will invest to maximise their return over the space. As a result, the person with the large house must value that space (or at least not having someone else there) more than the other potential tenant valued it (or at least this is what the investor believes). So if we correct this externality we are reducing welfare, as we are taking the space away from the person who values it most.
The second type of externality occurs when people value the size of their house relative to other people, in this case if someone else gets a big house, you feel you have to even though you don’t get any inherent benefit from the larger house . This is a fair point, however the issue with this type of externality is that it is subjective. The cost of a smoker to national healthcare is a quantifiable externality, how wealthy people make you feel is not. When I spend time thinking about social planning, I try to avoid punishing overtly subjective externalities.
Furthermore, I’m not sure that the lower price – low quality equilibrium is a good thing. There are significant positive externalities to people living in good quality houses (health externalities, workers are more productive when they are not being kept up all not because of a lack of sound-proofing), which we would miss out on in this case.
In the second point we are told that there will be an increase in the supply of property. Now in the short-run the supply of property on the market is relatively fixed (as long as the rent covers the landlords variable costs), so the lower price will lead to a slightly lower quantity of property. However, over-time landlords can sell properties and they change their properties. If the landlord sell their property to an owner-occupier then we have no worries, someone else has come into the market to live there. As property is an asset, the landlord might decide to convert their property to focus on another investment group where the rents are not fixed, most likely office building. However, in the second point the author says that property may be converted such that there are more units in a smaller space, after all if rent is fixed then doubling the number of units will double the yield associated with a block of land (assuming we get tenants).
As a result, the assumption here is that landlords will make each rental unit smaller and this effect will dominate the substitution between investment types effect, implying that a lower price will lead to a greater supply of property in the long-run. We have to then ask why didn’t landlords do this earlier? As the author assumes that demand does not fall in the size of the property, the landlord could have cut up properties and sold them at the same price.
If we are willing to assume that demand does rise in house size/quality then we need to assume that any increase in supply that may occur (it is by no means ensured) is worth more to society than the loss of consumer surplus. This is the same as the first externality in point 1, which we said was not optimal.
Point 3 was made by a different author. This introduces a new social cost to the fore, specifically that quick rental arrangements lead to short-term tenants who have no reason to co-operate if prisoner dilemma type problems (or co-ordination problems) appear in their society. In this case, the social benefit from having tenants stay longer is positive, but is it enough to make up for the loss of consumer surplus, the loss of profit for the landlord and the inefficiency of potential black market dealings?
Overall, I’m not convinced that rent controls are desirable. However, the structural issues they put forward are important, and there are conceivable equilibrium where rent controls would be socially optimal. As other bloggers say these issues are important for fully analysing policy, as economists we have to be willing to use our tools to analyse how the structure of the game might change.