Can Governments Lower Housing Prices?
According to a study on the best performer of 100 major Chinese cities tracked by the China Real Estate Index System, housing prices in Suzhou, the centre of the country's economic activity, rose by 5.6 per cent in February, over the price level in January 2016. Further, China has many ghost cities and the unsold inventory in many cities is huge. Reports also suggest that housing markets in Chinese cities are overheated, and that a speculative bubble may soon burst.
To curb this, authorities have been imposing strict norms.
Recently, authorities in Suzhou imposed a cap on home prices under which developers in the city will not be allowed to raise prices within three months after applying for pre-sales approvals; they will be allowed to raise prices by a maximum of six per cent in six months and by a maximum of 12 per cent in a year.
Do such measures lower housing prices?
Not many know that price controls have been around in various forms for around 40 centuries.
Lose control
Price controls were imposed in the Roman Republic, in Medieval Europe, during the two World Wars, and in the 1970s, when oil prices were rising. However, every time price controls were imposed, supply declined and goods slowly disappeared from the market.
This is no hyperbole.
Reserve Bank of India (RBI) Governor Raghuram Rajan remembers walking from one shop to another to find bread with his brother, when during the Emergency (imposed by the then prime minister Indira Gandhi from 1975 to 1977) , this common breakfast staple disappeared from the market. Similarly, if housing prices are artificially lowered, developers will resort to other measures to circumvent such regulations. For instance, they may engage in other forms of construction. Artificially lowering the prices will also make the sales in the unaccounted market more rampant. People will understate the value of houses they sell. Besides, renting may become more common till price controls are repealed.
What may happen if the upper ceiling on profits is removed? Prices will rise suddenly, but supply will also rise in the long run, lowering prices. Remember, even if the government removes such restrictions, supply of houses will not rise immediately, as construction is a time-consuming process.
When defined broadly, price controls explain many modern puzzles. It explains why a large segment of the population in major Indian cities lives in slums and why rent in some rent-controlled apartments is as low as one-thousandth of the market rent. Though price control is not the only reason for this, it is the cause to a large degree.
These are not isolated examples.
Throughout history, in all parts of the world, price controls have had such effects. In New York, for instance, rent control has destroyed housing supply to a large extent. In his study on homelessness in the US, veteran journalist William Tucker tells the story of a woman who tried to find a rent-controlled apartment in New York for a year. When she failed, she married a man who was living in a rent-controlled apartment.
In India, poor households consume less floor space than wealthy households do. But, for the limited floor space they consume, they pay more than wealthy households. Part of the reason is that poor households cannot purchase mass-produced housing, because the initial investment is too high. Moreover, wealthy households try to outbid poor households by occupying more floor space, poor households also try to outbid wealthy households.
How?
A wealthy family that lives in a five-bedroom apartment might not opt for a six-bedroom apartment if the extra room is not required. Why? A poor family is willing to pay more for its one-room apartment than a wealthy family is willing to pay for an additional bedroom. A major reason is that price controls have made supply scarce.
If the housing industry becomes less profitable in Suzhou, capital will flow to other sectors of the economy, and not to housing. Similarly, in India, real estate developers are cash-crunched because not much capital flows to such sectors. When this happens, supply will decline and housing will become more expensive than it is now.