The GCC prepares for another boom year with price controls

12 January 2007
To the dismay of free market thinkers, Dubai has announced that annual rent increases for most properties will be limited to 7 per cent in 2007. This compares with the 15 per cent cap last year and is in line with Abu Dhabi's rent limit last year.

The decision addresses more than one issue. The first is the growing resentment among people on fixed and low incomes about the soaring cost of living. It addresses business complaints about the impact rent is having on skilled labour costs. Capping rents will also close the gap between published inflation figures and the far higher cost of living increases in parts of the GCC.

Economists will quibble for several reasons. Fixing one price without capping others could send confusing signals to investors and consumers. It might undermine confidence in investing in residential property since government intervention makes forecasting trends more difficult. Dubai and others will be under pressure to continue the popular rent rise cap and even to lower the ceiling. If it is right to limit residential rents, why not fix office rent increases too? And when can rent controls ever be removed?

Economists hate price controls since they challenge the belief in free market efficiency that has been at the heart of their thinking since the neo-liberal counter-revolution began more than three decades ago. Previously, market failure justifying government intervention was seen as the rule rather than the exception. The opposite view has generally prevailed since then.

Objections to price controls are generally microeconomic. In the GCC, they are justified by macroeconomic factors. Since the end of 2003, the value of the region's oil, its principal asset and income-earner, has more than doubled. This has stimulated an unprecedented boom as government and business rationally adjusted their consumption and investment to the fact that the GCC is at least twice as rich as it was. It is not caused by an anomaly in a single sector or a passing perversity. This is a pervasive and lasting trend.

Increased demand should stimulate supply. But you don't have to be an economics professor to realise production only instantly adjusts to a sharp demand increase in free market heaven, not in the real world. In the GCC, the supply bottlenecks go well beyond housing. They encompass roads, water and power production, schools, hospitals and even beach clubs. The result is that the dirham cost of living for middle-class expatriates in Dubai has risen by at least 40 per cent since 1 January 2004.

This is wrongly classified as inflation since, strictly speaking, inflation is the result of sustained monetary disequilibrium. In fact, the cost increases are at least partly a one-off adjustment to the new GCC economic realities coupled with bottlenecks. Preventing the former will create damaging market distortions. But softening their impact by phasing them over time is justifiable: measures to contain excesses caused by supply shortages make complete sense.

For sound political reasons, GCC countries have decided to maintain the dollar currency peg. This means, however, that their exchange and interest rates reflect the needs of the US' slowing economy rather than their own booming ones. GCC exchange rates, as a result, are lower and interest rates higher than the real GCC economy justifies. Price rises are the consequence.

The conventional solution when monetary measures are unavailable is to turn to fiscal policy. But there could be no more foolish thing than for GCC countries with budget surpluses to cut spending, particularly on capital projects, as a way of containing consumption and cost increases.

Now that the idea of close currency and monetary union has effectively been consigned to the scrapheap (see Cover Story), individual GCC governments this year will have greater freedom independently to tackle the cost-inflation issue. There is also a need for government-guaranteed institutions providing long-term housing finance to working families and measures to stop consumer and credit card loans leaking speculatively into GCC equity and property markets.

Controls are not only the right and most effective way of tempering price pressures caused by the special circumstances applying in the GCC. They should be extended sensibly and coherently to a wider range of goods and services in the hot economies of Qatar and the UAE until normal conditions apply or an independent GCC exchange policy comes. Neither is an early prospect. That means controls on rents and other goods and services will be around for some time yet. And they are, on balance, a good thing.

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