Saturday, 28 September 2013

Land, oil, gas, rents, price caps etc

1. The knee-jerk industry response to Red Ed's musings about price caps for energy prices was that "We can't help it if world market prices for oil and gas go up, if you impose price caps that's tantamount to forcing us to sell at a loss and we'll have to shut down".

Well, maybe they would, maybe they wouldn't, but that is only if the UK were to do this in isolation. Because while the world market price (WMP) for oil or gas (O&G) is whatever it is, that price is far in excess of the actual cost of getting it out of the ground (AC); so any price cap which Labour dream up would be lower than WMP but higher than AC.

But what if most governments formed an oligopsony and agreed a universal price cap: nobody is allowed to pay more than $x for a unit of imported O&G? As long as $x is in excess of AC, then we can assume that exporters will continue exporting as they can still make real profits.

2. This leads me to my next topic, which is the truism that when the economy does better, demand for O&G increases disproportionately, and because supply is relatively price insensitive in the short or medium term, O&G prices increase super-proportionately.

Which is a vicious circle for importing countries. Let's say that at current GDP levels, 5% of our GDP output (call it £1,500 billion a year) is spent on importing O&G (call it £75 billion a year).

If GDP goes up 10% to £1,650 billion, then O&G prices go up by a lot more, say 20%, so we are now importing 10% more OG at a 20% higher price, £75 billion x 1.1 x 1.2 = £99 billion, which is 6% of our GDP; or £24 billion of that extra £165 billion GDP (15%) disappears abroad, to be recycled when exporting countries buy up assets in the UK.

3. Economists tend to see land/location rents and O&G prices as two separate topics (apart from those insane economists on far left and far right who deny that land rents even exist), although they both come under the same general heading of "land" or "natural resources". Land Value Taxers agree that both are suitable subjects for taxation, but also tend to see them under separate headings, or suggest taxing them for subtly different reasons.

But remember that land/location rents are merely a function of average net wages minus the costs of a basic minimum living standard; so a small percentage increase in GDP or wages leads to a much larger percentage increase in land/location rents - even though the landowner's actual costs (AC) have not changed and what he is providing has not changed (he is sub-licensing the same government-granted exclusive right to access to land).

Similarly, O&G prices are a function of how well the global economy is doing, and the costs of extraction are fairly fixed, so a small % improvement in global GDP leads to a larger % increase in O&G selling prices and, mathematically, an even larger % increase in the pure profit/rental element (WMP minus AC).

So ultimately it is the same thing - if the economy grows, landowners get a larger and disproportionately larger share; and O&G exporters get a larger and disproportionately larger share. If your landlord is a Russian or Saudi Arabian, it's all the same as far as he is concerned.

4. Finally, price caps.

Let's apply the logic from Part 1 above to land/location rents. Although most housing market commentary talks about changes in selling prices, it is rental values which drive the markets, they are the Maypole around which house prices dance.

We know that while rent caps work in the short term, in the medium and long term they lead to all sorts of unwanted side effects.

But what if the boot were on the other foot? What if we look at the demand side, not the supply side?

In other words, instead of the government preventing individual landlords from charging "market rents" (being average local net wages minus basic living costs), the government made it illegal for any tenant household to spend more than 10% of its gross income on rents, or for first time buyers to spend more than 10% of their gross income on monthly mortgage repayments?

It wouldn't actually need government action if tenants/first time buyers themselves would wake up and organise themselves, i.e. form an oligopsony and agree among themselves that "nobody pays more than ten per cent on rent"?

5. For the sake of this discussion, let's assume that the average tenant household in the UK pays £9,700 in rent and the average tenant earns £28,000. On average, a tenant household has one-and-a-half earners, so has gross income of £42,000.

If only a small number of tenant households did it, then they would have to downsize, but what if every tenant household did it? They can't all be forced to downsize. Every landlord would want to attract the highest-earning tenant household (as at present) but the highest-earning tenant household in turn would want to live in the nicest house.

So our high-earning tenant household with gross income of £100,000 now know that they only have to pay £10,000 a year in rent instead of £20,000 or £30,000. Their landlord will be a bit miffed, and when the tenancy comes up for renewal, he will try and find a tenant household earning £110,000; but that even higher earning household will only be paying £11,000 for something much nicer so won't want to down-size etc.

The upshot of all this is that gross rents will fall by half or so; our average tenant household will be paying £4,200 for an average sort of house which costs the landlord a lot less than £4,200 to maintain and insure, so he is still making some money; but pure land/location rents, the excess of gross rents over actual costs will fall disproportionately (to a few hundred pounds per home per year in most places).

But - and this is the important point - very, very few tenant households would end up moving. The highest earners remain in the nicest homes, the average earners in the average homes and the lowest earners in the cheapest homes. So the allocation would still be a free market allocation - if you want to live somewhere nicer, then try and get a better job or a promotion, or do more overtime etc.

6. Remember, this is a cultural thing.

There is no hard and fast rule on what a basic minimum standard of living is, we can only work out the annual cost thereof by observation, even though we do not know what this basket includes (and it is almost certainly different things for different households).

If it simply became tradition or custom that "nobody spends more than ten per cent on rent" then the amount spent on "everything else" would go up accordingly and over time, this would become the new basic minimum. We know that output would increase (less money disappearing into the LMBH) and with higher output, unit costs would decrease (same fixed costs divided by larger number of units of output).


Kj said...

The buyer´s cartel seem to be something that is hard to uphold, and so does the law. But I like the thought of rents being reduced to a minimum ofcourse.
What about discouraging money spent on rent through the income tax system? I.e. you pay progressive tax the more you pay in rent/interests?

We had price-controls in the towns here up until the early 80s (index regulation of purchase-prices/rents). It worked, but a lot of money changed hands under the table. OTOH, the under-the-table value couldn´t ever be mortgaged, and hence were always within the means of normal savings from wages.

Mark Wadsworth said...

Kj, any buyer's cartel is hard to uphold, as is the law, but "the law" and "generally accepted custom" go in hand in hand.

If "the law" says something that people actually agree with, then enforcing it is relatively easy. It will enforce itself if every tenant abides by the law and does not exaggerate his income when going for a tenancy.

Yes, there would be some tenants who lie about their income in order to be able to rent a nicer home than they should be renting, but if their peers disapprove of this behaviour (such people are traitors to their peers) then maybe it wouldn't happen very much.

It's like LVT but starting from the other end, maybe it would work.

As to "discouraging things through the tax system" the Homeys saw that one coming forty years ago, which is why VAT does not apply to anything land based - such as farming, residential construction, renting or banking.