One of the most important economic news in recent days is the government’s intention to take an initiative to Congress to limit rent by a maximum price before this summer. It is not a trivial measure, but rather a public policy that has historically failed and that only 2 percent of the most eminent economists on the international sphere support.
Effects of setting price ceilings
Henry Hazlitt, in his famous work Economics in One Lesson, points out that “when the government tries to set maximum prices for only some items, it usually chooses certain basic products, arguing that it is essential that the poor can acquire them at a reasonable cost” (p.155). At first glance, the introduction of that price ceiling may seem an act of simple charity, so to oppose such state intervention would be an inhuman position. In fact, this characterises the demagogic policies that the socialists implement day by day: subordinate the measure to a criterion of morality, so rejecting it makes you, de facto, immoral. Socialist politicians are not stupid. They know perfectly well that fixing maximum and minimum prices in the market always leads to its imbalance and that, however, in the short term, it can bring them electoral revenue and the consolidation of votes. In the long run, though, the truth will come to light, through the disastrous effects of policies based on populism and not on logic.
What will these effects consist of? In the first place, this maximum price will be considered the reasonable, and anything who is above it, regardless of the changes in production conditions or demand that arose after the approval of such measure, will be deemed irrational. However, as anyone with minimal knowledge of economics can understand, keeping the price of a good or service below the market is not neutral: its demand will increase (since it is cheaper), and its supply will decrease. The end result: scarcity. Likewise, this decrease in supply will cause fewer productive factors to be used to generate this good. If the entrepreneur is no longer compensated for producing it due to the low profit margins it provides, the productive factors that were used, such as labour, will no longer be used for this function. In other words, setting maximum prices often results in higher unemployment. And even if it does not become excessive, the wages of people who could keep the job will have to fall, the same way prices do.
By keeping prices low, those with the most purchasing power indirectly benefit
At this point, where supply has contracted and unemployment, most likely, has increased, the Government will come up with the “brilliant” idea of granting subsidies so that the production of that good is reactivated. Thus, they will think, producers will offer that item and consumers will buy it —because the maximum price is still in force. However, when it comes to subsidies, one always forgets the other side of the coin: nobody gets something for nothing. According to this logic, each person, in his role as a taxpayer, as Hazlitt would say, subsidises himself in his role as a consumer. Furthermore, by keeping prices lower than it would be expected in a free market, this, indirectly, benefits those who have the most purchasing power (and who, even at a higher price, can get that good), at the cost of the economically weakest.
Main effects of maximum prices in the housing market
Thus, what seemed to be a measure moved by the best of intentions leads to a real problem. Supply decreases, demand increases, shortages arise, unemployment increases, wages fall, and all this ends up affecting other sectors of the economy (if wages decrease, less money will be devoted to savings and, therefore, consumption).
But what happens in the specific case of the rental market? First, as we have already explained, the housing supply under this regime will decrease. This will inevitably entail rationing (not everyone who wants to will be able to rent a home) and this allocation will occur based on discrimination against one another:
- Tenants who do not really need a property will end up occupying it, due to its low price.
- Mobility or rotation will be reduced: people with a rental contract will not want to part with it, for fear of not finding another apartment.
- Race, religion, income or sexual orientation may become criteria used by landlords (those still on the market) to select tenants in the face of such high demand.
Likewise, and since the maximum price is setting the maximum profitability that can be obtained, the owners will stop investing in new homes to lease them, or they will not reinvest in improving those that they already own. Or, if they did, it would be to revalue them for their subsequent sale. As keeping them for rent would no longer be profitable, the supply of these properties will eventually decrease.
Limiting rents has historically failed
During the first half of the twentieth century, many cities in America and Europe implemented a rental price control system. After the Second World War, due to its ineffectiveness, most of the cities that had applied it eliminated it. However, it persisted in New York. The consequences were disastrous:
- Many buildings became uninhabitable and were eventually abandoned.
- The beneficiaries of the rents were mostly upper-middle class (and not lower-class, as was intended with price control).
Not surprisingly, it didn’t take long for New York to repeal this lousy regulation.
The rental problem in Spain
Rentals in Spain have a problem, and it is called an offer. There is very little for the great demand that exists. Specifically, in Madrid, in 2015, there were 2,500 empty apartments, of which much more than half have already been put on the market, so there are practically no more vacant homes. Therefore, the price of rents is rising 1) because the economy is improving and, above all, 2) because it is not building. And, following the strictest law of supply and demand, when the former is scarce compared to the latter, under normal conditions, prices rise.
In the past housing bubble, the problem was just the opposite: much more was built than was necessary. Supply far exceeded demand and was not absorbed by the market. Thus, entire suburbs became true ghost towns.
Given the seen, the solution will not go through regulating the market. Rather, the situation will worsen; the recipe is to liberalise land and build.