It’s always nice when Hugo Chavez, President of Venezuela, or his allies introduce new economic policies. Not so nice for the citizens of Venezuela, but nice for us because they are easy to critique. This time around, it is the imposition of rent controls as reported by the Washington Post.
The new law would expand previous rent freezes to include direct pricing regulations by the government. In addition, any tenant that has been living in a home for 20 years would have the right to buy that home. According to President Chavez, this new program is for “the benefit of the majority”. (The whole issue of social welfare is a topic for an entirely different blog.)
Pick up any introductory microeconomics textbook, however, and you will get a different analysis of the effect of rent controls – a form of price ceilings. Ceilings are designed by politicians to prevent prices from rising and, for them to be effective, they must be below the market clearing price. At prices above the clearing price there will be a surplus and when there is a surplus, prices fall.
When prices are set below market clearing, the number of buyers exceeds the number of sellers. Adam Smith (1776) recognized that prices rise in his circumstance to clear the market. The number of units that people are willing and able to buy is equal to the number of units that others are willing and able to sell when price is allowed to adjust.
The problem with rent controls is that they do exactly the opposite of what they are intended to do. If landlords cannot earn a reasonable rate of return on their investments due to price controls, they will stop building new rental units. Landlords that are currently renting accommodations will find that their revenues are falling and will not be willing or able to properly maintain their rental units. The quantity and quality of rental units will fall.
At the same time, the cost of renting falls below the cost of ownership and more people choose to rent. Others, who were sharing accommodation, now seek units for themselves. This increase in people seeking units, coupled with landlords reducing the availability of units creates a shortage of affordable housing. This is exactly the opposite result that the government was trying to achieve.
The story gets a little worse however. Because there is a shortage of affordable housing it takes longer to actually find a suitable place. The time spent searching for living accommodation imposes an opportunity cost on renters and is a non-productive use of resources. Search costs reduce the total output of the economy.
President Chavez, and other politicians must realize that in the battle between the Invisible Hand and government policy, the Invisible Hand usually wins.
Subscribe to:
Post Comments (Atom)
I totally agree. This is only going to spell disaster for the country. Granted, if rent controls are removed, most of the citizens would probably have to experience short term housing issues as new accommodations are constructed. Eventually prices will equalize to a place where the "majority" can afford the rent while at the same time landlords are able to make a profit from building and running apartments.
ReplyDelete