The Price System: Real estate, rent controls, and housing crises
- jasonsix3
- Jun 1, 2023
- 7 min read
Updated: Jul 31, 2024
This article is an excerpt from the full article 'Economics in One Lesson: An Analysis of Basic Economics' which analyses the work of Henry Hazlitt.
The Price System
How are prices determined in a complex modern economy? What is the price of fish, and how much should you pay for fuel? It’s a question answered differently by different economic theories, though arguably the most successful answer comes in the form of the ‘free’ price system.
Under the ‘free’ price system, prices are determined (or regulated) by the changing relationship between supply and demand; higher demand for goods and services leads to higher prices charged by producers, while lower demand leads to lower prices. The value of any item is its ‘value in exchange’, that is, what might be received in exchange for the item (whether money or other goods and services). Most economies have a ‘mixed’ price system, where government departments or bodies (or essential industries) are able to set prices which affect demand and supply.
Resource allocation decisions are made much easier under this system. For example, investment flows towards the production of goods that are profitable and in demand, and away from those that are less so. In this way, the system helps balances the goals of producers, who allocate their resources to achieve the highest profits, and consumers, who want to buy more of the goods they need.
The idea of the modern price system is opposed by theories such as the labour theory of value, which contends that the value of a good or service is not what is determined by the market (producers and consumers engaging in relatively free exchanges), but (very broadly) by the amount of labour expended producing it; value is determined more by the inputs into a product, rather than the value of what can be demanded in an exchange.
Arguments
Price-fixing involves setting a maximum or minimum price for a good or service. A maximum price for an essential commodity, for example, can increase demand and reduce supply (as prices are not allowed to fluctuate with consumer purchasing power and goods become more affordable to more consumers), reduce producer profit incentive (including all producers in a particular supply chain), and even result in shortages, the opposite effect of the original policy intention. In extreme cases, rationing of goods might be required, and price would become only one component of ‘who gets what’ (the other component being the will of the authority in charge of allocating rations).
Rent control is a policy of setting maximum prices for rent in situations where the supply of housing is too low. Rent control discourages investment in building new homes because it reduces potential rental revenues, and discourages landlords from performing maintenance on existing properties. Artificially low rent prices can allow people to ‘waste space’ by occupying larger accommodations than they need. If owners are allowed to raise rents due to inflation, occupiers can, and often do, adapt by sharing or occupying smaller housing.
Analysis
People who can't afford permanent housing rely on the profit motives of investors who possess sufficient capital to build new homes for them to live in. This might be seen as a structural problem in an economy, or a necessary feature that funnels new generations of workers into a nations’ labour force (who must work to afford permanent housing). Very high housing prices can create long-term renters with less financial security and lower standards of living, including those who - despite earning a decent wage - cannot afford, or must defer buying, permanent housing.
A lack of available housing is sometimes described as a ‘supply issue’, or an inability to build enough dwellings for a given population. This claim often minimises demand pressures caused by very high levels of net immigration[6] that outstrip the efforts of even the most productive property developers. First home buyers in Australia, for example, are now impacted by rising interest rates and unwavering demand sustained by recent arrivals seeking a home.
Recent data illustrates the difficulties faced: in Australia there was a startling 23.7% increase in Property Price Index across capital cities for the twelve months to Dec 2021, and an average price of residential dwellings of $920k[10]. 66% of households owned a home with or without a mortgage (down from 71% in 1994), and 31% rented. Over the twenty years to 2020, housing costs increased 50% for home owners without a mortgage, and 50% for private renters. 20% of households owned more than one property, and 4% owned four or more (that’s around 1 million households and at least 4 million properties owned by them) [11].
Another issue, the impact of which is sometimes disputed, is the amount of property owned for investment purposes. These properties are made unavailable for purchase by owner-occupiers. From the 2022 Rental Affordability Index (RAI), published by National Shelter, SGS Economics & Planning, the Brotherhood of St Laurence, and Beyond Bank Australia:
“Nationwide, the proportion of households renting is on the rise, having increased from 26 per cent to 31 per cent between 1995 and 2020.
…In Australia, this shift towards renting, and increased rental costs, is driven by a range of factors. The introduction of the capital gains discount in 1999, combined with negative gearing has dramatically increased the number of investors who compete with homeowners for available property and kept more households out of home ownership and trapping them in the rental market. Recent interest rate conditions and widening income inequality reinforce this effect.
…Investors have pushed out would-be homeowners, so more households with middle to higher incomes are renting for longer. This impacts lower income renters by driving up rents
…While not a main driver of rental affordability, in some inner-city areas, there are many apartments sitting vacant as an investment. For investors, vacant properties are often held on to for long term capital gains. This reduces the availability of rental properties to households.”
Creating demand through immigration can be an effective way to stimulate the production of ‘higher density’ dwellings in inner-city areas that are often built upon the remains of traditional quarter-acre blocks (I'm sure there's a touching metaphor in there somewhere about the pains of rapid social change), though these dwellings are generally smaller and less desirable than detached homes. Such policies may also encourage locals to leave their home region and travel elsewhere to seek lower-cost housing; this could have a politically-desirable effect of re-distributing population to regional centres.
Foreign investment in residential real estate is historically not well understood in Australia [7], and the most reliable source of information comes from the Foreign Investment Review Board (FIRB), though even this information, which is widely cited in the media [8], comes with significant caveats:
“The statistics contained in this Annual Report do not measure total foreign investment made
in any year, nor do they measure changes in net foreign ownership levels in Australia. They
reflect investor intentions (not actual purchases) to acquire Australian assets that are subject
to the Act. They can be skewed by very large investment proposals and multiple competing
proposals for the same target.”
Despite the lack of clarity, steps have been taken in recent years to enhance the scrutiny of foreign investments, notably by the Foreign Acquisitions and Takeovers Fees Imposition Amendment Bill 2020 [9].
Rent controls are back on the political agenda in Australia, with the NSW branch of the Greens proposing to freeze rental prices and protect tenants against unfair evictions, describing the unaffordability of rental prices as a ‘market failure’ [12]. The policy outline accuses investors of exploiting a housing supply shortage and the party plans to create more public and affordable homes. Such policies require would greater government intervention, and would, according to Hazlitt, undermine market mechanisms that provide incentives for investors to build more housing.
Which is the right view of housing affordability? Is it up to the market to correct the shortage of supply, or must the government protect tenants from avaricious investors? Are unlucky renters feeling the pinch because of bad policy, or is there an elephant in the room? Perhaps, as in many situations involving opposing ideologies, the solution will require some compromise.
Arguments
A minimum wage is a type of price control for labour, intended to provide a ‘living wage’ and prevent unscrupulous employers from paying below-market wages.
Hazlitt argues that setting a price floor for the cost of labour can eliminate jobs that would otherwise be available below the minimum wage, causing unemployment for workers who cannot compete above this rate. More importantly, as higher wages increase the costs of production, this cost might be passed on the consumer through higher prices and cause them to buy fewer goods or substitute products (and harming some producers). Alternatively, the result might be the production of fewer higher-cost goods or services and job losses.
People who cannot compete at the minimum wage (those whose labour is not valuable enough at this price) must rely on government welfare payments. Hazlitt argues that if the welfare rate is too high, workers are disincentivised from seeking employment at all. He suggests that the best way to raise wages is by increasing labour productivity and value through training and education to encourage investment in industry, capital accumulation, business expansion, and greater profits.
Analysis
Should a low-skilled employee who is uncompetitive at the minimum wage be left to earn a meagre existence from low-paid work below a minimum wage? Do we have an obligation to protect people who have low mobility or little education (such as students or those without marketable skills) from the price system?
For Hazlitt it’s necessary to be cruel to be kind by allowing more flexible arrangements between employers and employees; workers are then free to respond to incentives and negotiate the best deal available to them. Within a system that requires people to create value in employment or business (and in which opting-out and escaping to live in the mountains is rarely an option), requiring those with few options to choose a bad one (in the form of a wage that affords a low standard of living) seems, on balance, unfair.
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