The Chernobyl Disaster and Rent Control

The Collapse of a Socioeconomic Experiment: The Soviet Union

The Union of Soviet Socialist Republics, better known as the Soviet Union, was established in 1922 as a federation of 15 republics located in parts of Europe and Asia, whose political and economic system was dominated by a communist political party.

Influenced primarily by the ideas of Karl Marx, and later those of Vladimir Lenin, the Soviet Union had a philosophy of government based mainly on heavy intervention in the economy, centralized through a one-party state. This model of government aimed for a socioeconomic organization characterized by centralized control of the means of production and the absence of private property, among other features.

With a history marked by controversial social events, the most devastating of all would occur on that tragic day, April 26, 1986. Eighteen kilometers from the city of Chernobyl, at the Vladimir Ilyich Lenin Nuclear Power Plant, an accident with fatal consequences would take place. A hydrogen explosion inside the core resulted in the destruction of the containment vessel of the plant’s Reactor 4, which in turn caused a fire and the release of fission products into the atmosphere. All of this led to one of the greatest nuclear and environmental disasters in history. Although there are widely varying theories regarding the actual death toll from the accident, one of the latest studies by the World Health Organization estimates that it caused a total of 9,000 deaths, resulting directly and indirectly from the effects of radiation.

Aside from the incident at the nuclear power plant, the true catastrophe of the Soviet Union unfolded over several decades of repression and the imposition of a regime marked by atrocious human rights violations—a regime that, in addition to proving to be a resounding economic and social failure, cost the lives of millions of people.

According to some sources, Mikhail Gorbachev himself, who was the organization’s leader in 1986, reportedly stated that the Chernobyl accident was one of the main causes of the Soviet Union’s collapse. Without a doubt, it marked the beginning of the end of a social experiment that ultimately became one of the most terrifying episodes in the modern era of human history.

A Familiar Socioeconomic Experiment: Rent Control Law

A few days ago, details were released about a bill to be introduced by members of the Frente Guazú Party, titled “RESIDENTIAL RENTAL LAW.”.

In the explanatory memorandum, the preamble to the bill refers to the constitutional right set forth in Article 100 of the Constitution—the right to housing. The bill, among other arguments, states that housing is a right and that, therefore, it cannot be subject solely to “mere” rules of supply and demand.

The main provisions of the bill are as follows: 1) Restrictions on landlords; 2) Price controls; 3) Expropriations; and 4) Subsidies.

Prohibitions. Primarily, landlords are prohibited from discriminating when renting out housing (based on gender, race, sexual orientation, etc.). In addition, the law establishes a minimum size for rental units, among other provisions.

Pricing. Charging commissions to real estate agents is prohibited. A regulatory framework is established that sets the rental price based on the minimum wage and the size of the rented space. For example: for one-room dwellings built more than 10 years ago, with a floor area of 9–20 m², the lowest rent is set at 25 % of the minimum wage.

Expropriations. The law provides for the expropriation by municipalities of private urban properties that have tax debts and have been “abandoned” for a period of two years or more.

Subsidies. It also establishes the right to receive a subsidy from the government, with the creation of a “State Rental Assistance Fund” intended to cover repairs to expropriated properties and rent payments for families and individuals who are given priority under the law.

This bill contains many questionable provisions, such as expropriations and subsidies. In this article, however, we will focus on the fundamental issue: rent control. This issue warrants a legal and economic analysis, as its effects directly conflict with the proposal to be presented to Congress.

Let's take a look at what these effects are all about.

Pricing and Market Distortions

The proposal presented runs counter to basic—yet vital—principles of a free-market economy, which hold that prices should be governed by the laws of supply and demand, rather than by discretionary price-setting by the government.

Although at first glance it might seem that setting rental prices serves a socially “just” purpose, the truth is that the potential economic consequences could be more harmful than the benefits. Economic theory recognizes that price controls, in this sector as in others, could create certain market distortions with serious consequences.

The first distorting effect relates to the demand side. The law stipulates that prices be set below market prices—that is, that rental prices be lower. Logically, this could achieve one of the law’s intended effects: increasing demand and enabling more people to secure housing. However, the problem arises when prices are so low that “excess demand” occurs, which supply is unable to meet.

The next question is this: What happens when there is excess supply? This means that supply has the “upper hand” in business. Faced with an endless number of potential candidates, the landlord has the option to choose among them. This leads—contrary to what the bill proposes—to discrimination, nepotism, bribery, and even, in extreme cases, a black market for rentals that operates outside the law.

Furthermore, inefficiencies could arise in that the allocation of resources (housing) is not based on who values them most. That is to say, based on who is willing to pay the most. For example, a single person might end up renting a home larger than they need, simply because the price is very low and they have the purchasing power to do so; thus, they might be taking up space that a large family could need.

All of this, not to mention the excess demand that, at some point, supply will be unable to meet. This situation, which also runs counter to the law’s intent, will ultimately leave many people without housing.

The second distorting effect is related to supply. The law creates a system of “disincentives” for production. The lower the set prices are, the smaller the profit margins for housing developers will be. Naturally, this will mean that producers have insufficient incentive to invest in the rental business. The sector will cease to be attractive to businesses. Eventually, this will not only lead to a reduction in supply—which will further worsen the situation described above—but will also result in a lower-quality supply. Since profit margins will be lower, suppliers will be forced to reduce investment costs. Consequently, the products offered will tend to be of lower quality.

Third and finally, given this scenario of a supply shortage and unmet demand, the only viable way to make up for lost ground is… to raise rental prices again! These could even be higher than the originally offered (and regulated) rates. As we can see, this is a disastrous and counterintuitive consequence, one that runs counter to the law’s stated social objective.

Finally, one last question remains. If there is a social problem in which many people lack access to housing—as is currently the case—then how can we make rents cheaper and more affordable for everyone? The free-market economy has offered an answer to this question. And the only—sustainable—path is to increase supply through mechanisms that incentivize production. Since, to the extent that it is profitable for producers to invest in the business, there will be greater supply. And as supply increases, the quality of housing will improve, prices will fall, and consumers will have more options to meet their needs.

Failures Around the World

Beyond the theoretical framework—which may involve a margin of error in the model and its predictions—empirical experiences, such as those lived by the Soviet people over several decades of the last century, are even more important and telling.

This is what happened in several cities that implemented this “solution” to the social housing problem.

New York, Boston, and San Francisco are among the major U.S. cities that have implemented rent control policies—without success. Data from U.S. experts reveal the following figures under this regulatory framework: in New York, 21% of tenants occupied units with a different number of rooms than they needed. In Boston, there was evidence of deteriorating property maintenance. Outside of rent control, housing units were 6% less likely to experience these problems. In San Francisco, rent control reduced the housing supply by 15%.

Europe, for its part, was no exception. Paris and Berlin are the most recent and representative examples. Paris experienced a decline identical to that seen in San Francisco, with a 15% drop in supply. This translates to nearly 10,000 homes that were no longer listed. In Berlin, the market itself put the brakes on the implementation of the regulation, with the percentage of rental properties priced above the legally mandated cap ranging from 66% to 95%.

It is worth noting that rent control in these cities involves conducting a preliminary market study and, in most cases, setting a “cap” on rent prices to prevent price gouging. This differs from the national bill, which aims to set a single price. This makes the national proposal much less flexible and more disruptive to the market.

Conclusions

The proposal to be presented to the National Congress, judging by the way it seeks to address a social problem, has fundamental technical flaws that could affect and distort the market. This, in turn, rather than solving the problem, will worsen it in the medium and long term, to the point where reversing the process would entail a longer and more complex path.

According to experts in the field, rent control is one of the least controversial and best-understood topics in economics. Rent control laws contain conceptual flaws from the perspective of economic theory, which have been proven by experience in major cities around the world. Our cities will be no exception. Setting housing prices is not a solution for achieving lower prices and increasing supply. At the very least, it is not a sustainable solution over time. And it could have harmful consequences for our society.

Just as was the case for several decades with the Soviet Union—which demonstrated that populist governments only lead to famine and apathy among the people—rent control around the world has taught us that this socioeconomic experiment is also capable of having serious consequences for people’s well-being.

Knowing the outcome, who would be willing to repeat history and trigger another explosion at the Chernobyl nuclear power plant?

As the Swedish economist Assar Lindbeck once warned in one of his provocative statements: “Along with bombing, rent control is the most effective way to destroy a city.”.