The problem with price controls

Putting a cap on the goods that are rising in price sounds great in theory and has been popular with politicians in past. The imposition of these controls is designed to stop prices from rising whilst allowing civilians to purchase the same amount of goods that were previously being consumed. With this said, price ceilings have failed in achieving their aims for a plethora of reasons – most notably as they contradict basic economic theory regarding supply and demand. This has been witnessed with both goods pricing and rent controls. Yet, politicians continue to advocate for price controls despite their historical record of exacerbating the initial problem they were designed to resolve.

Rent ceilings

The imposition of rent ceilings has been a popular solution to rising house prices. One such example would be the introduction of rent control in Egypt during the 1960s. A woman who lived through this period reported on the problems that this created in 2006.

“The end result was that people stopped investing in apartment buildings, and a huge shortage in rentals and housing forced many Egyptians to live in horrible conditions with several families sharing one small apartment. The effects of the harsh rent control is still felt today in Egypt. Mistakes like that can last for generations.”

Economic Facts and Fallacies

Whilst the immediate result of imposing rent ceilings is positive, the situation quickly deteriorates. Rising prices would normally occur, were there no government intervention. As a result, demand decreases as fewer individuals can afford the higher prices of homes. Suppliers and investors are incentivised to build more homes due to the higher profit margins that come with higher prices. As there are more homes, prices are forced downwards due to the competition between different estate agents. Eventually, the price decreases, returning to its original level due to the increased supply and lower demand.

However, Egypt, Sweden, Hong Kong, Australia and other nations that similarly imposed disastrous rent controls experienced a far different outcome. As the demand for homes remained high, with prices unable to adjust accordingly, a shortage of houses available occurred. Civilians couldn’t find homes as there was little incentive for investors to facilitate the construction of houses due to the low return on investment; thus, fewer homes were being built.

Rent ceilings also decrease the quality of the homes on offer. Over time, buildings wear out, requiring maintenance and repair to maintain their current conditions. Under normal market conditions, landlords compete amongst each other to entice home buyers to purchase their respective homes. However, as a shortage of homes occurs with rent controls, there is little incentive for landlords to attract tenants through renovation and quality housing. As a result, maintenance and repair are neglected, making buildings wear out faster, further exacerbating the issue in the future.

The oil crisis of the 1970s

In 1973, Arab nations launched an oil embargo on many Western nations, including the likes of the US and UK. Unsurprisingly, this created a shortage of oil barrels, with the price of oil rising 300% between October 1973 and March 1974, from $3 to $12 globally. As a result, Richard Nixon famously established a maximum price for an oil gallon, as the US government slapped price controls on crude oil intending to prevent prices from skyrocketing for consumers. This was an unmitigated disaster, with gasoline lines that snaked for miles on end becoming a common-place sight after the policy implementation, as gas stations frequently found themselves with neither oil nor gas.

Had gas prices been allowed to rise, the incentive for new capital to be invested into oil discovery and more efficient oil transportation would have existed, due to supernormal profit margins that entrants into the market would experience. Whilst prices would initially rise, over a long period, the increase in supply from new market entrants would quickly drive prices down due to competition, thereby resolving the initial issue. In this way, price ceilings leave consumers considerably worse off due to the lack of supply relative to demand that invariably follows.

Ultimately, price controls in any manner, whether that be through rent or goods and services, have proven to exacerbate the problem they were intended to resolve. Rent ceilings in many Western nations have created housing shortages, alongside the declining quality of existing housing, given the lack of incentives for landlords to renovate ageing buildings and attract homebuyers. A similar story occurs with price ceilings on goods and services, witnessed during the 1970s US oil fiasco, which resulted in gas lines forming at most stations across the nation. As is the case with most government intervention, the problem only becomes worse.