Complete Control

by Ken Gibb

In January 1989, long-awaited rent deregulation in the private rented sector came into effect across the UK for new tenancies, normalizing freely contracted market rents as the basis for private tenancies. Lease lengths under assured tenancies were standardized and the era of rent controls in the UK appeared to be over.

While the private rented sector did not really demonstrate recovery and growth for another decade or so and not strongly before 2000, most of the subsequent growth has been through the remarkable success of buy to let landlords. If there has been a policy failure in investment terms it has been the inability until very recently to encourage larger scale corporate landlords and institutional investment.

However, rental market growth has brought problems including concerns about affordability, tenant-landlord problems and the instability associated with six monthly leases. Before the last general election UK Labour promoted a case for longer lease lengths traded off with indexing rent increases for the length of the longer contract. Meanwhile in Scotland consultation leading to legislation is underway to reconstruct the private tenancy lease, including the possibility of some form of new rent restrictions.

It is in this context that longstanding polarized positions on rent controls are being dusted down and rearticulated. This week, Retties posted a blog setting out a variant on the traditional economics critique of controls. Andrew Meehan’s piece raises two main issues for me: one, the extent to which the analysis is sound; and, two, the questions it raises for economics and economists.

Meehan sets out the fall and rise of private renting in the UK, the standard economics critique of rent controls buttressed by a few choice quotes from economists and a straw man argument that we cannot rely on the German case as a defence of rent controls for the UK. What is the essence of his argument?

• Decline of the UK PRS is associated and probably caused by rent controls after 1915. I think this underplays mortgage market growth supporting affordable home ownership and the waves of new council housing that followed – these things are all connected but it is not the case that all happened because of one albeit important cause.
• There have been different kinds and levels of rent controls (hard and soft or first, second and third generation rent controls) with different effects and consequences; however, the supply and demand analysis is based on a very simple absolute rent ceiling type of argument.
• The conclusion is that rent controls and the end of no fault possession will reduce rental returns, development and risk social bias and legal disputes. To the extent that new regulations usher in political risks and uncertainty that would clearly be bad for investment but if it is able to create a stable environment that may encourage long term income generation based models of renting (rather than on capital gains) – this may actually help support a better quality sector.

Let’s go back to the analysis. A conventional demand and supply curve model with a price ceiling set below the equilibrium rent will cause misallocation of resources, shortage and deadweight loss – it must do so by its own internal logic. That is why, as someone with economics training, I am all too familiar with and have sympathy for the argument that rent controls that are set in this way are bad for housing supply, investment and tenants. Exactly the same argument applies for setting a national minimum wage above the equilibrium wage in a competitive labour market – it will cause a degree of unemployment.

A rent ceiling below the equilibrium rent will reduce new investment and encourage disinvestment to the extent that landlords can get possession. They may also choose to maintain profit levels by reducing maintenance spend – hastening quality declines and probably also worsening relations with their tenants. And there is not only a redistribution of profit between landlord and tenant, there is a redistribution of welfare between current tenants enjoying lower rents and those excluded because of shortage and disinvestment – a classic insider outsider problem. The welfare benefit enjoyed by the tenant in situ may also mean that they do not move when their housing requirements change simply because they have less economic incentive to encourage mobility.

But it is fundamentally an empirical question as to whether these textbook effects occur in this way and, moreover, whether other features of the regulations, may cause further confounding or reinforcing effects.

The interesting reflections on the standard model of rent controls for me are: first, is it an accurate representation of the market and second, is it an accurate representation of actual rent regulation in practice? With Alex Marsh, I was involved in compiling a reader on housing economics which include a series of interesting papers on rent controls analysis including two excellent studies by Richard Arnott and by Bengt Turner & Steve Malpezzi. It is worth pointing out that while Arnott and Malpezzi are quintessential neoclassical microeconomists – their conclusions on the impacts of controls on rents are not nearly as straightforward as the received wisdom would suggest. The discussion below draws on those two papers.

Is the textbook picture consistent with how the market actually operates? Perhaps not. Supply (particularly) and also demand are more inelastic or unresponsive that the standard model would suggest – which means that the deadweight loss may not be as large nor the short term shortage (it depends on the empirical parameter values). Also, leading housing economists have studied rent controls and thought it quite appropriate to depart from the conventional model. Richard Arnott for instance makes a convincing case to model the rental market from an imperfect competition and not a perfectly competitive model. Equally, Turner and Malpezzi, conduct an international evidence review and make a case for the use of bargaining models under asymmetric information and other models based on contract theory – because these are more useful and realistic settings to study rent regulation in private rental markets.

Arnott argues that there are models of rent controls that may benefit the overall working of the housing system. The empirical evidence is often flawed and real world models are so different from the textbook that they need to be carefully analysed in their own right. And that is the point – it is fundamentally an empirical question as to the impact of such regulations. Turner and Malpezzi agree that empirical analysis of the newer conceptual models are rare but that is increasingly what is required and suggests that we cannot simply rule these regulations out on the basis of economics 101. We should certainly be skeptical about new regulations but there is much distance between the abstract market model framework and a more nuanced representation of an imperfectly competitive market and how actual rent/ tenancy length/ rules for possession policies would actually operate in practice.

I am squarely against badly designed policies that have detrimental effects and consequences. Rent controls have had and can readily produce such bad effects. However, policies that seek to reduce tenant exploitation through licensing good landlords and policing or correcting the behaviour of bad landlords – may have administrative costs but they can set a floor that most would widely support (ie the social benefit exceeds the cost). At the same time, negotiating a context for longer leases and for those contracts to have subsequent indexing of rent increases within that contract, alongside reasonable rules over possession and eviction – need not be anti-investor or anti-landlord, particularly over time. Limiting rent increases to inflation plus X% for the life of a longer tenancy but not the initial contracted rent may also be helpful for the housing system as a whole, create much more certainty for all players in the housing system and in the long term provide genuine competition and choice for those who would rent housing.

Of course, the policy proposals may be different to what I have discussed above and we have to consider objectively whatever policy plans emerge and look critically at their empirical content. It remains to be seen if and to what extent the textbook model of rent controls will be relevant.

Note: Alex Marsh and Kenneth Gibb, K (editors) (2011) Housing Economics Volume 5. Sage: London. The original papers were by Richard Arnott (1995) Time for revisionism in rent control?, Journal of Economic Perspectives vol. 9 (1), 99-120; and , Bengt Turner and Steve Malpezzi (2003) ‘A Review of Empirical Evidence on the Costs and Benefits of Rent Control’, Swedish Economic Policy Review, Vol. 10, 11-56.