The Economics of First Generation Rent Controls
In the annual Labour party conference in Brighton, Jeremy Corbyn continued with the 2015 and 2017 manifesto promises of rent controls to stem the adverse consequences of the UK Housing crisis on renters in big cities, felt most harshly by the young. Differing from the Miliband manifesto proposal of capping the rate of increase to a measure of inflation, the current proposals are relative caps on increases over a given tenure – usually referred to as second-generation rent controls. Labour seem to have the public’s backing; a 2015 YouGov poll found almost two-thirds of the public supporting price ceilings, with almost half of Conservative voters and four-fifths of Labour voters backing the measure.
Part of the Corbyn’s reasoning for presenting this policy is to provide greater financial stability to the young, especially in such tumultuous times. This may be a welcomed approach: slightly more than 4m adults between the ages of 25-34 find themselves in “serious financial difficulty”, with 17 percent saying they would struggle if their monthly mortgage or rent increased by £50, according to a recent report published by the Financial Conduct Authority (FCA), a UK financial regulator.
Recently, the Consumer Price Index (CPI) – the Bank of England’s preferred measure of inflation – rose to 3 per cent, outpacing wage growth. This, coupled with the recent bank rate rise of 25 basis points resulting in even higher mortgage prices, results in more and more people being pushed into the rental sector with lower relative wages. In a 2016 survey by NGM, a consultancy, found that around one third of respondents who lived in rented accommodation reported that their rental payments were 30 per cent or more of their pre-tax incomes.
Data from the Office for National Statistics (ONS) show a 23.3 per cent rise in prices of Private Housing Rentals (PHR) in London since 2011, with 11.9 per cent in the rest of the country – whilst the number of houses being built annual has halved in the past 50 years. The latest Financial Stability Report published by the Bank of England finds that the share of households in the private rental sector doubled to 20 per cent in the 14 years to 2016.
First-generation rent controls act as price ceilings on the levels that landlords can charge their tenants. Following the theoretical considerations of the dominant neoclassical school of thought, a market which is said to be operating in equilibrium will have the quantity supplied of housing be met by the quantity demanded – the price at which they meet can be referred to as the market rate. The introduction of a price ceiling – set below the market rate – increases the quantity demanded for homes as rental prices are lowered. This increase in demand may come from various groups, such as those still living with parents; those living on the outskirts of the rent-controlled zones; or those assessing the choice between rent and ownership.
Though as the price is lowered, so follows the supply of housing. Price acts as an incentive for suppliers to enter to market to reap some profits by indicating that there is an excess demand of consumers – a shortage – looking for homes. The immediate supply-side consideration of a rent cap is on the “Marginal Landlord”, a term used by the Institute of Economics Affairs (IEA) to describe the individual on the fringe of deciding whether to rent out that extra bedroom, the downstairs basement, or purchase a second property. These landlords are more sensitive to price changes as the property is already built – the variable of time is somewhat removed.
The notion of price sensitivity is an important one. An argument in favour of rent controls is to do with the limitation placed upon the current pool of housing to response to changes in price, thus having little impact on the supply of housing, so the theory goes. The development of new housing involves several years of construction and several layers of planning permissions, meaning the supply is fairly unresponsive to short-term fluctuations in rental prices – in jargon, supply is relatively price inelastic in the short-run.
The argument weakens when considering that some landlords might take their properties out of circulation altogether, if the opportunity cost of the equity held in the property increases – in other words, if the alternative uses from the value of the property outweigh the cost of the new rent cap.
The actual implementation of these policies may not be the only consideration when assessing their harm. As mentioned the construction of new homes spans several months, if not years. Suppliers will be looking ahead of time to assess the viability of a new housing project, which includes assessing the current political climate. Data from Ontario, Canada show a marked decline in the construction of PHR (Figure 1) as discussions over rent controls spread to the mainstream in the run up to the 1975 election, where rent controls were a dominant talking point; the mere mention
of rent control implementation may indeed worsen the shortage.
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There is also strong evidence to suggest that rent controls may worsen the quality standards of PHR. Cost-cutting efforts are typically an approach landlords take in response to slimmer margins, by reducing the frequency or extent of renovations and repairs. An Act passed in 1947 in Mumbai (then Bombay) capped rental prices to the rate from seven years earlier, a form of second-generation rent controls which may turn into first-generation if the base year is not updated. In Mumbai’s case, the base year had not been updated. In the 50 years to the modification of the Act in 1999, the growth in rental properties was abnormally low. The occupants of these rent controlled apartments “not only live in dilapidated buildings but die when they collapse in heavy rains”, wrote a World Bank report from 2010.
There may also be greater room for discrimination in such an environment. Healthy competition in the housing market means the cost of discriminating against any given individual is quite high and renters have the option to switch to alternative landlords. Rent controls increase the relative monopoly power of any given landlord, allowing more room for a range of discriminatory practises without the economic downsides involved.
Part of the solution lies in the Greenbelt, a policy approach which cordons off large pockets of land surrounding several of Britain’s cities such as London, Oxford, and Bristol, preventing any urbanisation and housing construction. Much of this land is unused, or underemployed –the designated “areas of outstanding natural beauty” and “ancient woodland” are only a fraction of the Greenbelt. Lobbies pushing for the status quo argue on the basis of shoddy ecological grounds, usually to the benefit of property owners in the area.
The mid-20th century policy shields more than a fifth of Greater London’s total mass from any housing construction. Economists typically attribute London’s vast housing crisis to limitations imposed by the Greenbelt. The Adam Smith Institute and the IEA, two London-based free-market think tanks, attribute the restrictive planning legislations on the primary cause for London’s existential housing shortage. Barney Stringer, a regeneration expert, reckons liberalising 60 per cent of the green belt within 2km (1.2 miles) of a railway station would create room for 2m homes.
It appears there is as much consensus among economists on the effects of rent-controls as there is among Scientists on the causes of climate change: a poll commissioned by IGM, a Chicago-based research centre, found that 95% of economists polled disagreed with the premise that rent controls in cities such as New York and San Francisco have had a positive impact on affordable housing.
It is beyond the depth of the article to assess the chronic issue of housing in the UK and the plethora of options that academics and policymakers have put forth, some with varying success. There is an element of the demand-side of the economy which is also relevant to the issue at hand; improving the financial stability of young Britons and increasing access to the housing market is best achieved through increases in an abnormally stagnant productivity rate and creative ways to tackle an education system frequently ranked at the bottom of the OECD.
Millennials are the first generation since the 19th-century to do worse than their preceding generation. Popularity and public support, however, should not be the only considerations when throwing around the suggestion of rent controls.