Thursday, February 9, 2012

The Infamous Example of Rent Control in Introductory Economics

The latest post by Jodie Beggs rehashing the standard story about rent control has me quietly steaming.  It’s not her fault, of course: she is simply regurgitating what has become a mandatory morality tale, an unavoidable rite of passage in Econ 101.  You know the drill: in their misguided desire to be fair to the poor, the authorities have set a ceiling on rents below the market-clearing price, and the result is excess demand in the short run and reduced supply in the long run.  Now that you have mastered the supply and demand diagram, you are so much smarter than they are.

I’m agnostic about rent control myself (it depends entirely on the context and the details), but for me this story is a poster child for the ideological rigidity of economics as it is taught to impressionable youth, not the superiority of “the economic way of thinking”.

There are two huge holes in the textbook argument.  The first is that it overlooks neighborhood effects—literally.  The most compelling argument for rent control is neighborhood stabilization, the idea that social capital in an urban environment requires stable residence patterns.  If prices are volatile, and this leads to a lot of residential turnover, the result can be a less desirable neighborhood for everyone.  Thus the quality-adjusted supply curve is partly a function of price (or at least price stability in a dynamic model), and the S and D curves are not independent of each other.  You’ll notice that not a single textbook treatment of rent control mentions stabilization as an objective, even though this is a standard element in the real-world rhetoric surrounding this issue.  Again, I’m not taking a position, just saying that the representation you get at the introductory level is an ideological construct, not an honest analysis.

The second hole is that rent control ordinances are normally replete with measures intended to maintain supply incentives, like price increases tied to investment in housing quality or simply spreading out increases over a longer time so tenants are able to adjust.  Again, these measures may succeed or fail, but a simple horizontal line in a one-period S&D model doesn’t begin to address them.

In fact, advocates for rent control have taken Econ 101 (most of them), but they just disagree on how large the positive and negative impacts are.  The purpose of economics should be to help us think clearly about the matter—for instance by identifying the potential empirical data that could adjudicate between competing arguments—but in its textbook form it is a ritualistic way of curtailing thought.

UPDATE: Standing in the shower, my mind drifted back to Orwell: "Free markets good!  Price controls b-a-a-a-a-d!"


Shane Taylor said...

Well said. In my experience, if I say to an economist, "That is a bad argument against X," they often hear "There are no good arguments against X." But the real trouble with Econ 101 thinking, as I think you just clarified, actually has less to do with what should be done than with how we decide. The fault lies in the insufferable arrogance of dictating to everyone that there is only one rational way of thinking about these problems, and discrediting, as either malignant or benighted, anyone who protests that Econ 101 is question-begging BS.

ProGrowthLiberal said...

There are two other things about Jodie’s post that bother me:

(1) “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’m not surprised that a free market conservative would say this but I am surprised she did not give Walter Wessel credit for this idea.

(2) “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.”

Well her blog did mention San Francisco, which did have an opportunity to increase the supply of housing when the Presidio during the 1990’s. But real estate development plans submitted were so overly ambitious that the City turned them down. Greed on steroids got in the way of more sensible ways of increase San Francisco’s housing supply.

ProGrowthLiberal said...

The Huffington Post allows Jodi Beggs a column on Social Security? Check it out and then tell me why?!

kevin quinn said...

Another big gap: the Principles texts I have seen rarely point out the importance of the assumption of competition for the result that price ceilings are inefficient. When they get around to talking about monopoly, they don't show how a ceiling can then be welfare-enhancing, qualifying what the earlier chapters presented as THE TRUTH about price controls.

Shag from Brookline said...

Consider what happens with gentrification to neighborhoods when rent controls are eliminated: Where do the poorer tenants go?

eric said...

Thank you for pushing back. In my experience (I've lived in NYC, Cambridge and Brookline), rent control has some downsides, but they are outweighed by the benefits. The elimination of rent control in Boston Cambridge and Brookline (accomplished by a statewide ballot question that took local control away from those three municipalities, which were the ONLY three in the commonwealth to have rent control!) made all three places noticeably more homogeneous and yuppified.

Piyo said...

"In fact, advocates for rent control have taken Econ 101 (most of them), but they just disagree on how large the positive and negative impacts are. "

I'd wager a lot of money that this is incorrect. Most people who think rent controls are good have no economic training whatsoever.

Similarly, if you survey actual economists (who probably want to find market failures more than anyone), I'm sure you'll find most of them think rent controls are generally a terrible idea.

So, sounds like you're "steaming" because someone is trying to help a lot of people without economic training understand why most of those who do have "weird" opinions. Yeah, sounds awful.

JG said...

(1) “... 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?”

This is funny.

I lived in a rent-stabilized building in one of the best areas of Manhattan for years. In this building of apartments worth from $250,000+ up to a whole lot more...

1) One rented for $125 per month to a guy who traveled the country betting on horses. He was in NYC mainly when the NYC tracks were open. Paying $125 per month he could afford that lifestyle without having a regular job.

2) Another rented for $250 a month to a NYU professor who used it only occasionally when he decided to spend a night in the city.

3) A third tenant put two apartments together -- like Charlie Rangel did four -- paid combined $650 rent, then rented out half of one of them for over $1,000. While this was illegal on its face, when the landlord sued at great expense the court said it was OK. (It is impossible to prove illegal rental when rent is paid in cash, and the tenant is saying he's just letting a friend stay there.)

4) A seven-room two-bath apartment had four rooms and one bath blocked off from use by its lone tenant who inherited rent control rights from his parents. He was a waiter, and was able to afford the 7-room apartment on his waiter's pay and tips because he was paying $300 a month. He didn't want to be bothered with the upkeep of the other 4 rooms, so he had them blocked off.

Oh, please, somebody "have me by the balls" like this!!

Of course it all ended. The landlord was forced out of business by all this and sold the apartments in the building to tenants (like me) and investors, at a "must sell" discount. (Yea, me!)

All the apartments went off the general rental market. (There's a "supply incentive" for you.) Though us individual apartment owners can rent to who we want for what we want, no regulation.

It's been the greatest investment I'll ever make! With regulations having killed all new housing construction and rent regulations driving apartments out of the rental market, while demand for housing rises, the value of the apartment has been going up! up! up! ever since I bought it, all through the "home price bust".

But I'll put the story of that in another comment...

JG said...
This comment has been removed by the author.
JG said...

OK, my former landlord was forced out of business by NYC rent regulation, and to sell to me the duplex apartment I live in, in one of the best areas of Manhattan, at a deep-discount, "must sell" price.

Yea, rent regulation! Yea, me!

It's value goes up! up! up! as regulation stops dead any growth in the area's supply of housing -- reduces it, see my former landlord! -- while demand keeps rising. What home price collapse? :-)

(The only better investment I can imagine is NYC taxi cab medallions, which are even more regulated!)

Now here is the dirty little secret of rent control: it helps us rich people at the cost of the poor.

The gain from rent control goes up! up! up! with passing years, as fair market rent rises but yours doesn't -- just as income rises with passing years.

The result is that **all** the net benefits of rent control in NYC go to the well off people in the red hot zone of Manhattan (like me!), who are upper-age, upper income, pay miniscule rents, and will never leave their apartments, so their gains get bigger every year, and/or who are real estate investors there who own apartments amid a dearth of supply.

The people *screwed* by rent control are the young and poor who need to find an apartment on the market, but who learn there aren't any because supply has been killed, and who don't have the experience and connections needed to game the system -- or who have to pay an astronomical rent for one they are lucky enough to find, or who have to settle for the Bronx or outer Queens or some place. No Manhattan for them!

In unregulated housing markets the price of the housing on the market is the average price of all housing. Everybody gets the same deal.

In regulated housing markets like NYC the incumbent oldsters get below-average rent while the young in need of housing pay above-average rent. And the richer pay the former, while the poorer pay the latter.

Whenever rent regulations come up for renewal in NYC, who is it that militantly rises and organizes to defend them?? *Not* the poor -- its *us rich* in that red hot area of Manhattan, that's who drives the politics of NYC rent control.

Of course, we say we do it to help the poor, out of the goodness of our hearts. You care for the poor, don't you?

And you buy it! :-)

Yea, price controls! They are making me rich.

And though I know it is at the cost of those poorer than myself, my profit soothes my guilty conscience nicely.

JW Mason said...

This post is exactly right. The only thing I would add is that the goals are not just to maintain stable neighborhoods, but also income-diverse neighborhoods, and also to recognize the legitimate interest of long-term tenants in their homes.

If you look at the responses to the poll question at the Booth site, they're a real distilaltion of what's wrong with economics. My favorite (tho it's so hard to pick): "Rent control will have similar effects to any price control." Yup, that's economics for you -- all markets are exactly the same!

(Also, JG is nuts. There's been *tons* of new housing put up in NYC over the apst few years.)

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