Rent caps are not usually effective. Delores Johnson / The National
Rent caps are not usually effective. Delores Johnson / The National

Rent controls are a waste of society's time and resources



Rent controls are a policy favoured by many governments, including those of the Arabian Gulf countries, with the goal of helping low-income families access affordable housing.

In our last article, we explained why rent controls create housing shortages and diminish housing quality. In this article, we dig deeper into the damage caused by rent controls, highlighting how they waste tenants’ valuable time and resources.

If rent controls create shortages, how is the shortage resolved? Who gets lucky and who does not?

When price controls are implemented in their strictest, purest form, consumers enter a rationing queue, such as waiting for a place in a prestigious school. The queue creates a war of attrition — those who are willing to wait longest are most likely to get served. Some people give up immediately and go without; other, less fortunate people enter the queue but quit after a considerable waiting time, once they realise that they do not possesses the patience of others, or perhaps because they have more important demands upon their time. If you visit any country with rent controls, you are likely to witness significant waiting lists on housing units, possibly mediated by the government to ensure a transparent and fair process.

In essence, therefore, consumers go from paying for a good purely financially in a regular market without price controls, to paying for a good using a combination of money and time in a market with price controls.

This hybrid payment alternative does present a key potential advantage, which is that it may result in a more egalitarian distribution of housing. In certain situations, low-income households may be systematically richer than high-income households in their ability to wait in line, somewhat compensating for their financial disadvantage.

However, queuing to resolve a shortage suffers from a fundamental disadvantage compared to purely financial payments, which is that the waiting time constitutes resources permanently lost by society. In contrast, under purely financial payments, when buyers bid prices up, a buyer's loss transforms into a seller's benefit.

To illustrate this more clearly, consider the following example. Sabah owns an apartment and has two potential tenants, Sabika (rich); and Yusuf (poor). Sabika is willing to rent at up to Dh100,000  a month, while Yusuf is willing to rent at up to Dh20,000  a month. In the absence of rent controls, the market rent will rise until it exceeds Dh20,000, forcing Yusuf out of the market, limiting his housing options as a direct result of his limited wealth.

To assist Yusuf secure housing, the government imposes a rent ceiling of Dh10,000. Sabah creates a virtual queue to decide who gets the apartment between Sabika and Yusuf. After three months, Sabika — who is less patient — gives up, and Yusuf rents the apartment.

Without rent controls, every dirham that Sabika paid directly benefited Sabah, meaning that there was no wastage. However, under rent controls, the three months of waiting time expended by Sabika and Yusuf did not benefit Sabah. Therefore, at the societal level, the price of ensuring that the poorer person had a chance of securing housing was everybody waiting three months.

This process of frittering away the benefits of a market exchange by having people engage in wasteful ways of resolving shortages is known as “rent dissipation”. The gains from trade are eroded to nobody’s benefit, just like the loss of speed from friction or air resistance. In Communist countries, rent dissipation was not merely time-based - people queuing for basic commodities endured the physical discomfort of waiting in adverse weather conditions, enduring boredom and being away from their families.

Wasteful queues are not the only ways to resolve shortages, however, and alternatives exist that involve no rent dissipation, such as lotteries. Sabah could have instantly drawn lots, saving Sabika and Yusuf three months of waiting.

Yet in practice, for a variety of reasons, lotteries are either not used, or are abused. In all countries with rent controls, there is a grave risk of corruption in the allocation process — people will pay overt or covert bribes to jump ahead in the queue, or to get a “lucky” draw in the lottery. Alternatively, those who are politically connected might be better placed to take advantage of the system.

Unfortunately, most of these abuses typically hurt low-income households the most, since they have the smallest ability to pay bribes or secure favours from those in charge of housing allocation decisions. Thus, under certain conditions, low-income households, who are often the purported beneficiary of rent controls, end up suffering the triple whammy of facing a housing shortage, being cheated by corruption in the rationing queue and enduring lower quality housing when they do eventually secure a unit.

Despite these grave risks, why do governments and people still laud rent controls? And is there a more effective alternative? We discuss these issues in our next article.

We welcome economics questions from our readers via email at omar@omar.ec or through Twitter at (@omareconomics).

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Thalassaemia is part of a family of genetic conditions affecting the blood known as haemoglobin disorders.

Haemoglobin is a substance in the red blood cells that carries oxygen and a lack of it triggers anemia, leaving patients very weak, short of breath and pale.

The most severe type of the condition is typically inherited when both parents are carriers. Those patients often require regular blood transfusions - about 450 of the UAE's 2,000 thalassaemia patients - though frequent transfusions can lead to too much iron in the body and heart and liver problems.

The condition mainly affects people of Mediterranean, South Asian, South-East Asian and Middle Eastern origin. Saudi Arabia recorded 45,892 cases of carriers between 2004 and 2014.

A World Health Organisation study estimated that globally there are at least 950,000 'new carrier couples' every year and annually there are 1.33 million at-risk pregnancies.

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Mercer, the investment consulting arm of US services company Marsh & McLennan, expects its wealth division to at least double its assets under management (AUM) in the Middle East as wealth in the region continues to grow despite economic headwinds, a company official said.

Mercer Wealth, which globally has $160 billion in AUM, plans to boost its AUM in the region to $2-$3bn in the next 2-3 years from the present $1bn, said Yasir AbuShaban, a Dubai-based principal with Mercer Wealth.

Within the next two to three years, we are looking at reaching $2 to $3 billion as a conservative estimate and we do see an opportunity to do so,” said Mr AbuShaban.

Mercer does not directly make investments, but allocates clients’ money they have discretion to, to professional asset managers. They also provide advice to clients.

“We have buying power. We can negotiate on their (client’s) behalf with asset managers to provide them lower fees than they otherwise would have to get on their own,” he added.

Mercer Wealth’s clients include sovereign wealth funds, family offices, and insurance companies among others.

From its office in Dubai, Mercer also looks after Africa, India and Turkey, where they also see opportunity for growth.

Wealth creation in Middle East and Africa (MEA) grew 8.5 per cent to $8.1 trillion last year from $7.5tn in 2015, higher than last year’s global average of 6 per cent and the second-highest growth in a region after Asia-Pacific which grew 9.9 per cent, according to consultancy Boston Consulting Group (BCG). In the region, where wealth grew just 1.9 per cent in 2015 compared with 2014, a pickup in oil prices has helped in wealth generation.

BCG is forecasting MEA wealth will rise to $12tn by 2021, growing at an annual average of 8 per cent.

Drivers of wealth generation in the region will be split evenly between new wealth creation and growth of performance of existing assets, according to BCG.

Another general trend in the region is clients’ looking for a comprehensive approach to investing, according to Mr AbuShaban.

“Institutional investors or some of the families are seeing a slowdown in the available capital they have to invest and in that sense they are looking at optimizing the way they manage their portfolios and making sure they are not investing haphazardly and different parts of their investment are working together,” said Mr AbuShaban.

Some clients also have a higher appetite for risk, given the low interest-rate environment that does not provide enough yield for some institutional investors. These clients are keen to invest in illiquid assets, such as private equity and infrastructure.

“What we have seen is a desire for higher returns in what has been a low-return environment specifically in various fixed income or bonds,” he said.

“In this environment, we have seen a de facto increase in the risk that clients are taking in things like illiquid investments, private equity investments, infrastructure and private debt, those kind of investments were higher illiquidity results in incrementally higher returns.”

The Abu Dhabi Investment Authority, one of the largest sovereign wealth funds, said in its 2016 report that has gradually increased its exposure in direct private equity and private credit transactions, mainly in Asian markets and especially in China and India. The authority’s private equity department focused on structured equities owing to “their defensive characteristics.”

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Key changes

Commission caps

For life insurance products with a savings component, Peter Hodgins of Clyde & Co said different caps apply to the saving and protection elements:

• For the saving component, a cap of 4.5 per cent of the annualised premium per year (which may not exceed 90 per cent of the annualised premium over the policy term). 

• On the protection component, there is a cap  of 10 per cent of the annualised premium per year (which may not exceed 160 per cent of the annualised premium over the policy term).

• Indemnity commission, the amount of commission that can be advanced to a product salesperson, can be 50 per cent of the annualised premium for the first year or 50 per cent of the total commissions on the policy calculated. 

• The remaining commission after deduction of the indemnity commission is paid equally over the premium payment term.

• For pure protection products, which only offer a life insurance component, the maximum commission will be 10 per cent of the annualised premium multiplied by the length of the policy in years.

Disclosure

Customers must now be provided with a full illustration of the product they are buying to ensure they understand the potential returns on savings products as well as the effects of any charges. There is also a “free-look” period of 30 days, where insurers must provide a full refund if the buyer wishes to cancel the policy.

“The illustration should provide for at least two scenarios to illustrate the performance of the product,” said Mr Hodgins. “All illustrations are required to be signed by the customer.”

Another illustration must outline surrender charges to ensure they understand the costs of exiting a fixed-term product early.

Illustrations must also be kept updatedand insurers must provide information on the top five investment funds available annually, including at least five years' performance data.

“This may be segregated based on the risk appetite of the customer (in which case, the top five funds for each segment must be provided),” said Mr Hodgins.

Product providers must also disclose the ratio of protection benefit to savings benefits. If a protection benefit ratio is less than 10 per cent "the product must carry a warning stating that it has limited or no protection benefit" Mr Hodgins added.

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Cast: Priyanka Chopra Jonas, Farhan Akhtar, Zaira Wasim, Rohit Saraf

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Started: November 2017

Founders: Mounir Nakhla, Ahmed Mohsen and Mohamed Aboulnaga

Based: Cairo, Egypt

Sector: transport and logistics

Size: 150 employees

Investment: approximately $8 million

Investors include: Singapore’s Battery Road Digital Holdings, Egypt’s Algebra Ventures, Uber co-founder and former CTO Oscar Salazar

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Founder: Areej Selmi
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