Can Rent Control Be Salvaged?

President Biden recently announced a plan to impose a 5% cap on yearly rent increases by large-scale landlords. Rent control is a notoriously counterproductive policy. The reason is simple: rent control disincentivizes the construction of new housing units because it makes that construction less profitable. And a reduction in housing supply is precisely what we don’t want if our goal is widespread affordable housing. Indeed, only 2% of surveyed economists agree that rent control has had a positive effect on “the amount and quality of broadly affordable rental housing in cities that have used them.”

In an effort to avoid this outcome, Biden’s proposed price cap wouldn’t apply to new units. At first glance, it looks like this policy would deliver the best of both worlds. It aims to lower the price of existing units without discouraging the construction of new units. Yet while this proposal is an improvement over old-fashioned rent control, it suffers from two problems.

First, it threatens to produce policy uncertainty. Imposing rent control with an exemption for new units still shows that policymakers are willing to cap rents on old units. Crucially, though, new units become old units. If developers are concerned that policymakers will continue to favor caps on rental increases for old units, they have reason to fear that any new units they build will eventually be subject to a cap. As a result, they will be disincentivized from building new units because their expected long-term profitability is lessened.

Second, even if new construction is not disincentivized, rent control misallocates housing. Markets route resources to their highest value use. Suppose a seller has one bag of ice left. Alice needs the ice to chill her son’s insulin. Bob needs the ice to chill his daughter’s Mountain Dew. All else equal, Alice will outbid Bob for the ice—and this is the efficient outcome. It’s better that her son have chilled insulin than that Bob’s daughter have chilled Mountain Dew. But if price controls cap the amount that Alice is able to offer for the ice, she’s not able to outbid Bob and he may well end up with the ice instead.

Housing is no different. Suppose Caroline is an extraordinarily talented surgeon who has received a lucrative job offer at a big city hospital. She’s looking for nearby housing. Dave is a professional Youtuber who films his content in an apartment near the hospital, although he could do his job anywhere. Without rent control, Caroline could outbid Dave for the apartment, which, again, would be the efficient outcome. It’s more important that a surgeon live near the hospital so that she can perform surgeries than that a Youtuber live near the hospital because he enjoys the local coffeeshops. But if rent controls cap the amount that Caroline is able to offer for the apartment, she’s not able to outbid Dave and he may well end up with the apartment instead. And if Caroline is unable to secure nearby housing, she may be unable to accept the job. This outcome is not only bad for her, it’s also bad for the patients who would have benefited from her surgical expertise. So while rent control with exemptions is better than rent control without exemptions, it is still unable to match the productive and allocative virtues of a free market.

Christopher Freiman is a Professor of General Business in the John Chambers College of Business and Economics at West Virginia University.