Ubu sets prices

The French government is about to pass a law (so-called Duflot II) that establishes rent control for 70 % of privately-owned rental housing. The local representative of the government will regularly set a rent ceiling which will not exceed 20 % of the median rent in the area. Owners who have an “exceptional” house will have to ask for a derogation (once again) and demonstrate to government officials that their house is indeed exceptional.

This law is intended to address the problem of housing shortages  in selected areas (only these selected areas represent 70 % of the total supply).  No, there is no typo in this sentence. The supposedly educated elites in charge seem to believe that when demand exceeds supply, reducing the price by law helps.

In the face of such abysmal idiocy one’s first reaction is clearly to remain speechless.  But some economist has  to speak out…

How does the private housing market currently work? First, it is extremely heterogeneous. Even in a given area, apartments differ a lot by quality. So far we do not know how the bureaucrats who will set the dreaded local median rent will operate. How large will the relevant geographical area? How will apartment quality be imputed? Clearly apartments with vastly different market values will be forced into the same price. Second, even controlling for quality there is substantial price dispersion. The more expensive apartments stay longer on the market and the owner can pick among fewer applicants. The opposite holds for the cheaper apartments. These have many applicants, and the owner will usually pick the most solvent one.

The immediate impact of the reform will be to force the price of a large fraction of housing below its market level. Since the ceiling is indexed on the median in the area, these were the most expensive ones in relative terms. So the reform is not so much about reducing rents overall as about truncating the upper tail. These apartments were more expensive than average for a reason. Either quality was higher or the owner preferred income over applicant quality. In both cases, when the price is forced down, the apartment will either be withdrawn from the market or it will have more applicants. As pointed out above, this means that those who will get the apartment will be richer.  Poorer people who could have rented the apartment because they liked it and were willing to pay the price will simply be forced into lower quality products.

In the short run, the reform is simply making life harder for the very people it is supposed to help.  Similarly, a ban on renting rooms smaller than 9 square meters by the preceding government (amidst hateful  speeches against supposed “sleep merchants”), subsequently heightened the student housing crisis (the evil sleep merchants would no longer rent the rooms that the good people in government outlawed).

In the long run, the private rental market, which is already undersized, will likely disappear.  Investment in quality will fall because the owner will be able to reflect it in the rent only if Big Brother says it is OK.  There will be a race to the bottom in quality, because quality will be poorly measured by the officials and this will be a device to raise the effective (quality-adjusted) rent while complying with the law. If, as a result the median rent eventually falls — which is far from certain since withdrawing houses from the market will per se lead to rising prices — this will only make things worse as it will negatively impact the official rent cap.  (And furthermore one will be under the illusion that the law has worked in reducing rents while this would be incorrect adjusting for quality)

People with enough cash for an upfront payment will buy (you need to put 30 % of the value to be able to buy a house, because of regulation). Others will suffer in the jungle of public, rationed, rent-controlled housing and end up with a place they don’t like, in a neighborhood they don’t like, and be stuck with it for the rest of their life. More apartments will be rented through informal channels such as relatives or the black market.

The reform denotes pure contempt for individual property rights as well as ignorance  of even the most basic economic principles.

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