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davywavyI was slagging off the idea of rent controls the other day, and someone challenged me. “How do you know they won't work?”, they asked. “Do you have a crystal ball?”
“No”, I replied. “I’ve got a history book.”
About six months or so ago, Ed Milliband grabbed the news cycle for a few days by proposing a cap on energy prices, which have risen solidly since the introduction of the carbon change levy in 2000 and are now as high in real terms as they were before privatisation in the early 1980s. There were several days when this led political debate and so now, twelve months from an election and with nothing that looks like an economic policy, he’s decided that going round pointing at things which have gone up in price and looking sad will suffice in place of one – and so we got the announcement last week that an incoming Labour government would introduce an inflationary price cap on rents.*
I can see why it might be popular. Rents have gone up a lot over the last decade or so and many people feel aggrieved by this – and are happy to blame greedy landlords - but there’s one huge problem. Price controls don’t work. In fact, they make bad situations worse. Price caps inevitably lead to shortages of the very thing whose price is being controlled. However, I understand that it might not be immediately obvious why this is, and hence this post.
To illustrate that price controls don’t work, it’s instructive to look at them in history. Possibly the most famous instance of price controls is the Edict of Diocletian issued in the Roman Empire in 301AD. The edict was issued after a lengthy period in which the Roman Empire had debased its currency and raised taxes to help pay its liabilities (hang on, I’m totally seeing a pattern emerging here) and the people were angry that price inflation was high (it is estimated that average inflation had been about 9% annually for 30 years beforehand). Diocletian blamed greedy merchants for these rises and the Edict set prices on a whole raft of commodities and made it illegal to raise them further. The effect was entirely predictable.
Lactantius of Nicomedia reports that “He attempted an edict to limit prices...men were afraid to expose anything for sale and scarcity became excessive and grevious”. The edict ended up being largely ignored and people turned to barter rather than cash transactions. Perhaps most soberingly to the modern reader, when the failure of the Edict became clear Diocletian didn’t do anything like try and fix the currency or alter his other policies – instead he passed laws allowing for the persecution of religious minorities and the seizing of their assets by loyal citizens.
Yeah, top marks for Emperoring, Diocletian.
Other historical examples of price controls exist; in the United States gasoline prices were capped during the 1970s and supply collapsed in 1979, in California in 2001 they capped electricity prices and the state got blackouts (and Enron took them for a fortune by promising electricity at the agreed price and then not delivering). The most famous example lately has been Venezuela capping the price of toilet paper and then running out six months later. In response the Venezuelan government, rather than lifting controls and doing something about supply, introduced what they called the “Fair Prices Law”, which made it illegal to put up prices of loads of other stuff. The riots started six weeks later.
Rent caps have even been tried once already in the UK between 1977 and 1988, during which period I’m reliably informed the amount of private rental accommodation available on the market fell by 84.5%.
It seems that every time price controls are imposed by fiat (examples exist of controlled prices being introduced in agreement with the supplier which have worked), scarcity of the thing being controlled has ensued.
So why?
To understand why, you have to remember that money has no intrinsic meaning or value in isolation. It is a representative medium of exchange, and so only has any meaning in conjunction with the thing it represents. In that representation, money becomes the vector for the transmission of information. The price of something, represented by money, transmits information on how much people want to buy something, and how much of it there is: that is, supply and demand. As prices move, what they are doing is looking for equilibrium between the demand and the supply. If prices rise, what this indicates is that the demand is greater than the supply. When the price stabilises that suggests that buyers and sellers are in equilibrium, and when it falls there are more sellers than buyers. In liquid markets, like property, the price tends to range over time and never finds an absolute parity**. What tends to happen is that when prices go up people make more of the thing in demand because they see there’s money to be made from it, and when prices go down they produce less, thereby helping equilibrium develop.
The thing is, when you introduce a price control you introduce false information about how much supply or demand there is. In other words, you lie.
When a price is capped below its natural equilibrium, what happens is the information transmitted indicates that there is less demand or more supply for the good than there actually is – and the result of that is that people produce less of it. And then you get shortages as demand exceeds supply and you run out. Like toilet paper in Venezuela. Supply reduces to accommodate the demand implied by the artificially lowered price, and then when demand doesn't fall and the price doesn't rise the only way it can be accommodated is by a reduction in quality.
And that’s why rent caps are a bad idea. Milliband has said the cap will be inflationary but rent inflation is not consistent across the country. Rental inflation in Greater London is double that of the national average, and that is happening for a reason: lots more people want to live in London than there are places to live. At some point this would normally reach equilibrium. Either enough properties would be constructed to meet demand or prices would rise to a point where people look at London and think “Screw that, I’ll go and live somewhere else”. This has obviously not yet happened. In fact the increase in the number of people demanding somewhere to live in London is outpacing the increase in the number of places to live in London by a figure roughly double that of inflation – i.e. if inflation is 3%, then 6% more people arrive looking for somewhere to rent in London than there are new properties entering the market.
What should be concerning you is that Ed Milliband wants to lie about that.
And that’s why price caps cause shortages. It misrepresents demand, meaning that people will look at London and think “that looks affordable” whilst at the same time supply is being told that fewer people want to live in London than actually do.
Now I’ve seen some people justify the policy on the grounds that it would hurt landlords – and yes, it probably would. As I said above the number of private landlords fell the last time this was tried. But the thing is it would hurt people looking for somewhere to live even more. A Landlord would get less back on his investment but a tenant would find that there isn’t anywhere for me to rent, or what available property is available is low quality as the landlord’s reduced return means he hasn’t bothered doing the refurbishment. If your political objective is to hurt landlords there are ways to do this without price controls. When Ronald Reagan, hardly a bastion of the hard left, removed price controls on fuel in the US in 1981 he followed it up with a windfall tax on suppliers as prices jumped.
Since 2000 the UK has seen its population rise by something like a million more people than residential spaces have been constructed. Over the same period house prices and rental rates have risen considerably. That is not a coincidence, and Labour Party is not to relax planning laws or anything like that. It’s just to lie to the market about how many people or houses there actually are, and blame the consequences on landlords. This is worth mentioning, as another justification for price controls has been to suggest they would make property more affordable to first time buyers. The problem is that it won’t. We aren’t building enough and we still have right to buy, meaning that the situation will be:
1) The number of available rental properties will fall
2) The government will still be paying people to buy houses, whilst
3) Not building enough to house the population.
If anyone would care to talk me through why that situation would result in prices falling I’m all ears.
The only sustainable way to reduce prices is to either reduce demand or increase supply, not to pretend to have done so. Reducing demand for somewhere to live would effectively entail putting ‘em all on a boat and sending ‘em home like Nick Griffin wants, and I can’t see any way that’s going to happen without considerable bloodshed. So the only solution - but also a problem - is to increase supply by building houses. Lots of houses.
Lots and lots of houses. On green fields and woodlands and parks and brownfields and historic sites and old factories and on and on and on. Tower blocks and houses and flats and bungalows all over the place.
And I’ll tell you one more thing: twelve months from an election, nobody is going to be suggesting that.
*I’m not sure it’s going to be that effective as a policy- when they suggested an energy price cap it dominated the headlines. This new policy was the 5th item on the Today Programme news and has subsequently sunk without a trace.
** In a market bubble the increase in demand is not rational but nobody says the market is rational (except the guys who just won the Nobel Prize for the Rational Market Hypothesis, but what do they know?) because a market has people in it and people aren’t rational things.
“No”, I replied. “I’ve got a history book.”
About six months or so ago, Ed Milliband grabbed the news cycle for a few days by proposing a cap on energy prices, which have risen solidly since the introduction of the carbon change levy in 2000 and are now as high in real terms as they were before privatisation in the early 1980s. There were several days when this led political debate and so now, twelve months from an election and with nothing that looks like an economic policy, he’s decided that going round pointing at things which have gone up in price and looking sad will suffice in place of one – and so we got the announcement last week that an incoming Labour government would introduce an inflationary price cap on rents.*
I can see why it might be popular. Rents have gone up a lot over the last decade or so and many people feel aggrieved by this – and are happy to blame greedy landlords - but there’s one huge problem. Price controls don’t work. In fact, they make bad situations worse. Price caps inevitably lead to shortages of the very thing whose price is being controlled. However, I understand that it might not be immediately obvious why this is, and hence this post.
To illustrate that price controls don’t work, it’s instructive to look at them in history. Possibly the most famous instance of price controls is the Edict of Diocletian issued in the Roman Empire in 301AD. The edict was issued after a lengthy period in which the Roman Empire had debased its currency and raised taxes to help pay its liabilities (hang on, I’m totally seeing a pattern emerging here) and the people were angry that price inflation was high (it is estimated that average inflation had been about 9% annually for 30 years beforehand). Diocletian blamed greedy merchants for these rises and the Edict set prices on a whole raft of commodities and made it illegal to raise them further. The effect was entirely predictable.
Lactantius of Nicomedia reports that “He attempted an edict to limit prices...men were afraid to expose anything for sale and scarcity became excessive and grevious”. The edict ended up being largely ignored and people turned to barter rather than cash transactions. Perhaps most soberingly to the modern reader, when the failure of the Edict became clear Diocletian didn’t do anything like try and fix the currency or alter his other policies – instead he passed laws allowing for the persecution of religious minorities and the seizing of their assets by loyal citizens.
Yeah, top marks for Emperoring, Diocletian.
Other historical examples of price controls exist; in the United States gasoline prices were capped during the 1970s and supply collapsed in 1979, in California in 2001 they capped electricity prices and the state got blackouts (and Enron took them for a fortune by promising electricity at the agreed price and then not delivering). The most famous example lately has been Venezuela capping the price of toilet paper and then running out six months later. In response the Venezuelan government, rather than lifting controls and doing something about supply, introduced what they called the “Fair Prices Law”, which made it illegal to put up prices of loads of other stuff. The riots started six weeks later.
Rent caps have even been tried once already in the UK between 1977 and 1988, during which period I’m reliably informed the amount of private rental accommodation available on the market fell by 84.5%.
It seems that every time price controls are imposed by fiat (examples exist of controlled prices being introduced in agreement with the supplier which have worked), scarcity of the thing being controlled has ensued.
So why?
To understand why, you have to remember that money has no intrinsic meaning or value in isolation. It is a representative medium of exchange, and so only has any meaning in conjunction with the thing it represents. In that representation, money becomes the vector for the transmission of information. The price of something, represented by money, transmits information on how much people want to buy something, and how much of it there is: that is, supply and demand. As prices move, what they are doing is looking for equilibrium between the demand and the supply. If prices rise, what this indicates is that the demand is greater than the supply. When the price stabilises that suggests that buyers and sellers are in equilibrium, and when it falls there are more sellers than buyers. In liquid markets, like property, the price tends to range over time and never finds an absolute parity**. What tends to happen is that when prices go up people make more of the thing in demand because they see there’s money to be made from it, and when prices go down they produce less, thereby helping equilibrium develop.
The thing is, when you introduce a price control you introduce false information about how much supply or demand there is. In other words, you lie.
When a price is capped below its natural equilibrium, what happens is the information transmitted indicates that there is less demand or more supply for the good than there actually is – and the result of that is that people produce less of it. And then you get shortages as demand exceeds supply and you run out. Like toilet paper in Venezuela. Supply reduces to accommodate the demand implied by the artificially lowered price, and then when demand doesn't fall and the price doesn't rise the only way it can be accommodated is by a reduction in quality.
And that’s why rent caps are a bad idea. Milliband has said the cap will be inflationary but rent inflation is not consistent across the country. Rental inflation in Greater London is double that of the national average, and that is happening for a reason: lots more people want to live in London than there are places to live. At some point this would normally reach equilibrium. Either enough properties would be constructed to meet demand or prices would rise to a point where people look at London and think “Screw that, I’ll go and live somewhere else”. This has obviously not yet happened. In fact the increase in the number of people demanding somewhere to live in London is outpacing the increase in the number of places to live in London by a figure roughly double that of inflation – i.e. if inflation is 3%, then 6% more people arrive looking for somewhere to rent in London than there are new properties entering the market.
What should be concerning you is that Ed Milliband wants to lie about that.
And that’s why price caps cause shortages. It misrepresents demand, meaning that people will look at London and think “that looks affordable” whilst at the same time supply is being told that fewer people want to live in London than actually do.
Now I’ve seen some people justify the policy on the grounds that it would hurt landlords – and yes, it probably would. As I said above the number of private landlords fell the last time this was tried. But the thing is it would hurt people looking for somewhere to live even more. A Landlord would get less back on his investment but a tenant would find that there isn’t anywhere for me to rent, or what available property is available is low quality as the landlord’s reduced return means he hasn’t bothered doing the refurbishment. If your political objective is to hurt landlords there are ways to do this without price controls. When Ronald Reagan, hardly a bastion of the hard left, removed price controls on fuel in the US in 1981 he followed it up with a windfall tax on suppliers as prices jumped.
Since 2000 the UK has seen its population rise by something like a million more people than residential spaces have been constructed. Over the same period house prices and rental rates have risen considerably. That is not a coincidence, and Labour Party is not to relax planning laws or anything like that. It’s just to lie to the market about how many people or houses there actually are, and blame the consequences on landlords. This is worth mentioning, as another justification for price controls has been to suggest they would make property more affordable to first time buyers. The problem is that it won’t. We aren’t building enough and we still have right to buy, meaning that the situation will be:
1) The number of available rental properties will fall
2) The government will still be paying people to buy houses, whilst
3) Not building enough to house the population.
If anyone would care to talk me through why that situation would result in prices falling I’m all ears.
The only sustainable way to reduce prices is to either reduce demand or increase supply, not to pretend to have done so. Reducing demand for somewhere to live would effectively entail putting ‘em all on a boat and sending ‘em home like Nick Griffin wants, and I can’t see any way that’s going to happen without considerable bloodshed. So the only solution - but also a problem - is to increase supply by building houses. Lots of houses.
Lots and lots of houses. On green fields and woodlands and parks and brownfields and historic sites and old factories and on and on and on. Tower blocks and houses and flats and bungalows all over the place.
And I’ll tell you one more thing: twelve months from an election, nobody is going to be suggesting that.
*I’m not sure it’s going to be that effective as a policy- when they suggested an energy price cap it dominated the headlines. This new policy was the 5th item on the Today Programme news and has subsequently sunk without a trace.
** In a market bubble the increase in demand is not rational but nobody says the market is rational (except the guys who just won the Nobel Prize for the Rational Market Hypothesis, but what do they know?) because a market has people in it and people aren’t rational things.
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Date: 2014-05-08 08:06 am (UTC)I think the basic idea has merit, but the way they announced it, and the way they wrote it up for the media, made me even more suspicious than normal of their economic illiteracy. There are a lot of things that could be done to improve the PRS for both tenants and potential landlords, and many of them need to be done together, but this very much looked like a back of a fag packet appeal to twentysomething renters who never studied economics 101.
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Date: 2014-05-19 03:55 am (UTC)