President Biden recently announced a system to put a 5% cap on annual rent increases by large landlords. Rent control is a notoriously ineffective policy. The reason is simple: rent control discourages new housing construction because it makes that construction less profitable. And shrinking housing supply is exactly what we’re doing don’t do it ask if our goal is the spread of affordable housing. In fact, only 2% of economists surveyed he admits that rent control has had a positive effect “on the amount and quality of affordable rental housing in the cities they have used.”
In an effort to avoid this outcome, Biden’s proposed pricing will not apply to new units. At first glance, it seems like this policy would bring the best of both worlds. It aims to reduce the price of existing units without discouraging the construction of new units. However, while this proposal is an improvement over the old rent control, it suffers from two problems.
First, it threatens to generate policy uncertainty. Imposing rent control with exemptions for new units still shows that policymakers are willing to pay rents for older units. Importantly, however, the new units become the old units. If developers are worried that policymakers will continue to favor rent increases on older units, they have reason to fear that any new units they build will end up under the cap. As a result, they will not stop building new units because their long-term expected profits are decreasing.
Second, even if new construction is ineffective, rent control unfairly segregates housing. Markets move resources to their highest value use. Suppose the seller has one bag of ice left. Alice needs ice to cool her son’s insulin. Bob needs ice to chill his daughter’s Mountain Dew. All things being equal, Alice will beat Bob in the snow—and this is a valid result. Better for his son to inject cold insulin than for Bob’s daughter to cool Mountain Dew. But if price controls reach the price Alice can make for ice, she cannot outbid Bob and may end up with ice instead.
Housing is no different. Let’s say Caroline is an exceptionally talented surgeon who has landed a lucrative job at a large city hospital. Looking for houses nearby. Dave is a professional YouTuber who records his content in an apartment near a hospital, although he can do his work anywhere. Without rent control, Caroline could outbid Dave for the apartment, which would be a viable outcome as well. It is more important for a surgeon to live near a hospital so he can operate than for a YouTuber to live near a hospital because he enjoys local coffee shops. But if rent controls reach the price Caroline can afford for the house, she can’t outbid Dave and may end up owning the house. And if Caroline can’t find a place to live nearby, she may not be able to accept the job. This result is not only bad for him, but also bad for the patients who would benefit from his surgical knowledge. So while rent control and exemptions are better than rent control without exemptions, they still cannot match the productive and distributive virtues of the free market.
Christopher Freiman is Professor of General Business at the John Chambers College of Business and Economics at West Virginia University.
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