Last week, I introduced you to the IGM Forum economist polls. This week’s question is about rent control:
Local ordinances that limit rent increases for some rental housing units, such as in New York and San Francisco, have had a positive impact over the past three decades on the amount and quality of broadly affordable rental housing in cities that have used them.
Those of you who have taken Econ 101 would probably not be surprised at all but one of the responses. (What were you thinking, Bengt Holmstrom?) For context, let’s do a little review of price ceilings:
(There is a mistake in the numbers in part of the second video, and you may or may not be able to see the annotations that correct it. Consider yourself warned.)
In summary, price ceilings (i.e. mandated maximum prices, of which rent control is an example) create shortages because the artificially low prices lower the incentives for producers to produce and sell stuff and, at the same time, increase the amount that the consumers want to buy. In other words, this:
Without the price ceiling, the market converges to price P* and quantity Q*. With the price ceiling, only Qs units of housing are rented (since the decrease in the quantity supplied due to the lower price is the limiting factor in this market). Granted, the units that do get supplied get supplied at a lower price, but all this means is that some people get a good deal and some people (even some people who were willing to pay the original market price) get, quite literally, in the case of rent control, left out in the cold.
That said, let’s think about the potential logic of price ceilings for a moment.
In general, economists use willingness-to-pay (i.e. the demand curve, which technically combines willingness and ability to pay) as a proxy for how much an individual values an item. Under this assumption, goods in a free market go to those who value them the most, and those who don’t purchase simply don’t value the good at an amount that justifies paying the market price. This can make interpersonal comparisons difficult on a philosophical level- for example, maybe Bill Gates is willing to pay $20 for a pound of cheese simply because he is swimming in money and doesn’t care, and I am not willing (or perhaps able) to pay $20 for a pound of cheese. It would be a little nonsensical to conclude on the basis of willingness-to-pay in this case that Bill Gates is more of a turophile than I am. (Yes, that is actually a word. I had originally used a gallon of milk in the example, but then I googled “lactophile” and was disturbed with what I found.) This comparison would be less problematic if societies weren’t faced with income inequality, but life isn’t “fair” in that way.
Nonetheless, the “goods go to those who are willing and able to pay” principle works pretty well for things like iPads, TVs, and motorcycles, and economists are quick to tout the efficiency of free markets in these cases. On the other hand, we as a society have pretty much decided that it’s not okay to not be able to afford a place to live. It’s also hard to argue that homeless people must just like living outside more and thus don’t value housing as much non-homeless people do. Rent control, for the most part, is a (potentially well-intentioned but misguided) attempt to make housing affordable for people who obviously value it but would have a hard time paying for it otherwise.
I say misguided because the rent control policy makers seem to have overlooked several key insights:
- It takes two parties to make a transaction happen, and it doesn’t matter how theoretically cheap housing is if landlords aren’t willing to provide it. (In general, it seems easy to forget that people can’t have as much of an item as they want at a low price.) It’s a little strange to me that the rent control laws aren’t coupled with some policy aimed at increasing the supply of housing.
- When the rent control policies take the form of limits on price increases, they actually act as short-term incentives to overprice housing units in order to get a higher starting price point.
- In the diagram above, we implicitly assumed that the reduced supply of housing was going to the people with the highest willingness-to-pay. There’s no guarantee that this would happen, and, to the extent that willingness-to-pay reflects the ability to pay rather than the inherent value of the housing, it’s likely not what the policy makers want to have happen. (Who among us doesn’t know someone whose wealthy parents keep the $700 a month 3-bedroom apartment in Manhattan because, well, it’s a $700 a month apartment in Manhattan?) This is probably one of the few scenarios where we’d want the cheap goods to go to those with the lowest “willingness” to pay, but the law doesn’t actually encourage that practice in any way.
- Rent control appears to be an attempt at some sort of fairness, but it seems in a way more fair for everyone to pay a higher price than for some people to get cheap stuff and others to get nothing, especially when the law doesn’t determine who the winners and losers are.
At the very least, I’m surprised that there isn’t more means testing (i.e. having to show that you are low income) in order to qualify for rent control, but I suppose that would just encourage landlords to discriminate against low-income tenants. A more nuanced policy would likely provide subsidies to low-income individuals and families, but subsidies cost money whereas price controls are “free.” (And yes, I am aware that subsidies are inefficient, but I am also aware that societies are often willing to sacrifice some efficiency for a more fair outcome.) This is reason #824 why policy is hard.
Anyway, back to the question. Techhhhhnically speaking, if none of the housing in an area was deemed “affordable” before the price ceiling, then the price ceiling could, I suppose, increase the quantity of affordable housing. (In fact, Pinelopi Goldberg specifically points this out.) In most realistic cases, however, the rent control laws are going to make builders think twice about putting up residential properties and make potential landlords think twice about getting into the rental business. The quality of affordable housing certainly isn’t going to improve, since landlords have rent-controlled tenants, as one of my advisors once put it, “by the balls,” since what are they going to do if the landlord doesn’t fix stuff or renovate? Move and lose the benefits of the rent control?
I hope this explains why Dick Thaler answered the question with “Next question: Does the Sun revolve around the Earth?” Though his comment does make me wonder why he only put a confidence level of 3 on his answer. Maybe I should send him a book on Galileo.