Introduction
In part one of
this article, we explored a neoclassical analysis of the rent in advance
phenomenon in Ghana. While that analysis is valid, it assumes perfect
information between landlord and tenants. In the real work, there is unequal
information between landlords and tenants. This leads to a confounding result,
stemming from the difficulty in disentangling the contribution to the problem
due to pure market equilibrium effects (from the interaction of demand and
supply) on one hand and cultures that have evolve from the need to mitigate
income risk and protect the private property (income) of landlords on the other
hand. In other countries, where laws work better, tenants do not pay two or
more years’ rent in advance despite market demand for housing exceeding supply.
Moreover, an implication of the neoclassical view is that rent in advance must
vanish from the market anything that market supply of housing exceeds demand.
This has not been the case in all instances and indeed in many instances.
Rather, rent in advance appears to have evolved into a form of culture that is
embedded in landlord-tenant relationships in Ghana. Thus, in spite of its
usefulness, a neoclassical explanation is insufficient in explaining the rent
in advance phenomenon. Douglass North sums the argument above in the following:
“Why do people obey the rules of society...when an
individualistic calculus would suggest cheating, shirking, stealing, assault
and murder should be everywhere evident....Indeed, a neoclassical world would
be a jungle and no society would be viable” (North 1981: 11).
Section 25(5) of
the 1963 Rent Act (Act 220) makes it an offence for:
“[a]ny person who as a condition of a grant, renewal or
continuance of a tenancy [to] demand in the case of a monthly or shorter
tenancy, the payment in advance of more than a month’s rent or in the case of a
tenancy exceeding six months, the payment in advance of a more than six months
rent…”.
This
provision notwithstanding, the norm in the private rental housing market is
that landlord often requires two or more years’ rent in advance from tenants.
This is a complete flout of the rent law. In this part, we shall argue that
rent in advance phenomenon is a function of the quality of the institutional
and regulatory framework of any country. An in the case of Ghana, weaknesses in
information referencing and property rights and their enforcement, due to
inefficiencies and corruption in the justice delivery system, have contributed
in no small way to the emergence of the rent in advance phenomenon. Before we
zoom into the analysis, we need to understand what ‘institutions’ are, what they
are not and their role in economic exchange.
What are Institutions?
North asked an important question: “why do people obey the
rules of society...when an individualistic calculus would suggest cheating,
shirking, stealing, assault and murder should be everywhere evident?” (North
1991: 11). In a historical context, reflections on the nature
of institutions in development go back to Veblen’s (1919) reference to
institutions as “settled habits of thought common to the generality of men”.
In the literature motivated by Douglass North, political, legal and cultural
institutions shape economic exchange. A widely accepted definition is the one
provided by North (1991), who defines institutions as “the rules of the game
in a society or, more formally, the humanly devised constraints that shape
human interaction [and which] in consequence structure incentives in human exchange,
whether political, social, or economic” (North 1990: 3). In North’s
submission, institutions include “…any form of constraints that human beings
devise to shape human interactions" (North, 1990: 4). Much recently,
Kasper and Streit (1998: 30) defined institutions as “rules of human
interaction that constrain possibly opportunistic and erratic individual
behaviour, thereby making human behaviour more predictable and thus
facilitating the division of labour and wealth creation”. Hodgson (2003)
also refers to institutions as “..durable systems of established social
rules that structure social
interactions”. These social rules include formal,
codified and enforceable rules as well as the informal norms of behaviour and
social conventions.
In the case of
the private rented housing market in Ghana, the Rent Act (Act 220) and the Rent
Control Law (P.N.D.L[1] 138) are major sources of
institutions. In the subsequent sections, we shall argue that the ineffectiveness
of these legal institutional frameworks have contributed in no small way to the
rent in advance phenomenon in Ghana.
Rent
Payment in Arrears and the Housing Market as a Credit Market
Unlike goods and services that require upfront
payments, credit markets are based on deferred payments and receipts for credit
(a form of finance) supplied today. In the real world with imperfect
information, uncertain events between when credit is granted and when repayment
is due, introduces two types of risk into the credit arrangement – adverse
selection risk and moral hazard risk (collectively called agency risk) as
explained in part I of this article. When lenders cannot distinguish among
borrowers, they ration credit, often by increasing the interest rate to
compensate for the risk posed (Stiglitz and Weiss, 1981). In the process, some
potential borrowers would be completely rationed out of the market while others
would receive just a portion of the amount requested for as a loan. Rationing
is the mechanism to mitigate agency risk[1]
such as adverse selection[2]
and moral hazards[3]
as well as the loss of revenue.
In financial markets like the credit market where
payment for goods and services are deferred, institutions complement contracts
and laws in allocating value and risks across transacting parties, and thus
structuring economic incentives to cooperate as well as to invest (Perotti,
2013). According to North (1991), institutions emerge based on transaction
costs and are devised to create order and reduce uncertainty in exchange. The
cost of transacting is determined by incomplete information and limited mental
capacity by which to process information (North 1995: 18). Thus, when it is
costly to transact and opportunism is inevitably or likely, institutions
matter.
The private rented housing market under conditions
of rent payment in arrears effectively becomes a credit market and thus subject
to rationing by landlords when they lack information to screen prospective
tenants. Rent payment in arrears means that the tenant makes payment to the
landlord for the use of the property at the end of the period. For a monthly
tenancy, this will occur at the end of the month. In his work entitled ‘The
Problem of Social Cost’, Institutional Economist Ronald Coarse postulated
in what is popular known as the Coarse theorem that in a world
characterised by perfect information, zero transaction costs, no wealth
effects, the definition and allocation of property rights (a form of
institution) is irrelevant to resource allocation (Coarse, 1960). However,
institutions in the form of private property rights and their efficient
enforcement matter in an imperfect world characterised by imperfect
information, wealth effects and positive transaction costs. In other words,
when landlords cannot effectively distinguish between prospective tenants in
terms of their ability and willingness to pay for the use of their
accommodation, as a result of not having full information about tenants, they
face an adverse selection problem which could result in the selection of the
wrong tenants who will eventually default on rent payments and obligations. In
such a case, the landlord’s property rights would be comprised if there were no
inefficient mechanisms such as efficient law and courts to enable him/her to
enforce his rights.
Property rights have been defined by Landes and Posner (1987 p.29) as an
exclusive right to use, control and enjoyment of a resource, which does not
entail further potential benefits of the transfer of property right to others.
Rao (2003, p.115) highlighted the characteristics of property rights to include
exclusivity, transferability, divisibility, duration and well-developed
boundaries of rights and enforceability. The property right structure adopted
by a society determines how much the owner’s decision actually affects the use
of something, which eventually determines the strength of the rights (Alchian
and Demsetz 1973, p.17; Jaffe and Louziotis Jr 1996, p.141). That is why the quality of the institutional
framework of countries has been found to be strongly linked with economic
development (Levine, 1995) and financial development (La Porta, Lopez-de-Silanes, Shleifer, and Vishny, 1997; 1998).
Therefore, the quality of information
sharing systems in a country influences how strong the legal system that
protects property rights should be. In a private rented property market like
ours where information about prospective tenants is hard to come by or
difficult to verify because of the lack of centralised or national information
systems like address systems and credit information systems, landlords are
prone to agency risk- adverse selection and moral hazard. Given this risk, an
efficient law in terms of both legal rules and their enforcement is required as
a substitute to information asymmetry. By efficiency, I mean, it should be easy
for landlords to procure binding and enforceable tenancy and lease agreements
at lower costs and have access to the law courts with ease to enforce their
property rights to rents when tenants default in rent payment. Unfortunately,
most landlord and tenant relationships in Ghana are not backed by proper legal
contracts that can be enforced in the courts in the first place. In fact, in
many case, there are no contracts at all. The cost of legal services is so high
that it deters landlords from procuring them. Where there are contracts, the
inefficiency and potential corruption of the courts deter landlords from using
them to recoup their rents from defaulting tenants. Institutions like the Rent
Control Department are quasi-judicial institutions that should provide
alternatives to the courts, but I dare say that they are perhaps even more
inefficient than the courts. They are perceived as communist departments
working in the interest of tenants to the detriment of landlords and investors.
Therefore, considering the high search cost
involved in collecting and verifying information about prospective tenants, the
high cost of legal services and the inefficiency of the courts and Rent Control
Departments, landlords have devised an institution and a culture of taking
rents in advance in order to remove any risk of rent loss or risk of incurring
search costs as well as legal cost involved in enforcing their property rights
in the courts or the Rent Control Departments. When a tenant pays all the rents
for a tenancy in advance, the search and legal costs may not arise. The
implication is that the weak institutional and governance frameworks are not
only a problem at the macro government level but also at the micro household
and individual level. It is this weaknesses in the information, institutional
and regulatory framework combined with a shortage of affordable housing that
have empowered landlords over tenants, who have the preferential and
conditional power to set unfavourable rules of tenancy in Ghana.
So, when Barack Obama spoke about weak
institutions in Africa being the bane of development, I am sure he was
recommending an institutional analysis of the whole fibre of interactions in
our society including landlord and tenant relationship. Today, there are three
credit-referencing bureaus in Ghana but how easy is it for landlords to access
their services? Are landlords even aware of this information services and how
useful they can be to them in screening prospective tenants? Until we begin to
understand that the rental housing market characterised by rent payment in
arrears in Ghana is a form of credit market and thus like other credit markets
require information, regulation and an inefficient legal system to function,
tenants will forever be the ‘slaves’ of landlords.
Way Forward
Going forward, rental information systems
must be established and the Rent Control law and Department strengthened and
refocused and strengthened with the needed resources both human and financial
to administer its mandate. Among other things, the refocusing of the Rent
Control Department requires a change of the name of the institutions so as not
be seen as antagonist to landlords and investors. I support Richmond’s call for
the employment of the right people to the Rent Control Department; preferably,
the Land Economists who have been educated at the Department of Land Economy of
the Kwame Nkrumah University of Science and Technology. With the right
remuneration and institutional reforms, our rental markets will improve to the
benefit of both landlords and tenants.
[1] Agency risk is the probability of loss
(cost) due to an agent's pursuance of his or her own interests instead of those
of the principal.
[2] Adverse selection refers to a situation
where sellers have information that buyers do not, or vice versa, about some
aspect of product quality.
[3] Moral hazard when a person takes
more risks because someone else bears the cost of those risks. Both
tenants and landlords face adverse selection and moral hazards.
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