Basic Economics Page 5
In short, nothing is a “need” categorically, regardless of how urgent it may be to have particular amounts at particular times and places. Unfortunately, most laws and government policies apply categorically, if only because of the dangers in leaving every government official to become a petty despot in interpreting what these laws and policies mean and when they should apply. In this context, calling something a “need” categorically is playing with fire. Many complaints that some basically good government policy has been applied stupidly may fail to address the underlying problem of categorical laws in an incremental world. There may not have been any intelligent way to apply categorically a policy designed to meet desires whose benefits vary incrementally and ultimately cease to be benefits.
By its very nature as a study of the use of scarce resources which have alternative uses, economics is about incremental trade-offs—not about “needs” or “solutions.” That may be why economists have never been as popular as politicians who promise to solve our problems and meet our needs.
Chapter 3
PRICE CONTROLS
The record of price controls goes as far back as human history. They were imposed by the Pharaohs of ancient Egypt. They were decreed by Hammurabi, king of Babylon, in the eighteenth century B.C. They were tried in ancient Athens.
Henry Hazlitt{37}
Nothing makes us understand the many roles of electricity in our lives like a power failure. Similarly, nothing shows more vividly the role and importance of price fluctuations in a market economy than the absence of such price fluctuations when the market is controlled. What happens when prices are not allowed to fluctuate freely according to supply and demand, but instead their fluctuations are fixed within limits set by law under various kinds of price controls?
Typically, price controls are imposed in order to keep prices from rising to the levels that they would reach in response to supply and demand. The political rationales for such laws have varied from place to place and from time to time, but there is seldom a lack of rationales whenever it becomes politically expedient to hold down some people’s prices in the interest of other people whose political support seems more important.
To understand the effects of price control, it is first necessary to understand how prices rise and fall in a free market. There is nothing esoteric about it, but it is important to be very clear about what happens. Prices rise because the amount demanded exceeds the amount supplied at existing prices. Prices fall because the amount supplied exceeds the amount demanded at existing prices. The first case is called a “shortage” and the second is called a “surplus”—but both depend on existing prices. Simple as this might seem, it is often misunderstood, sometimes with disastrous consequences.
PRICE “CEILINGS” AND SHORTAGES
When there is a “shortage” of a product, there is not necessarily any less of it, either absolutely or relative to the number of consumers. During and immediately after the Second World War, for example, there was a very serious housing shortage in the United States, even though the country’s population and its housing supply had both increased by about 10 percent from their prewar levels—and there was no shortage when the war began.{38} In other words, even though the ratio between housing and people had not changed, nevertheless many Americans looking for an apartment during this period had to spend weeks or months in an often futile search for a place to live, or else resorted to bribes to get landlords to move them to the top of waiting lists. Meanwhile, they doubled up with relatives, slept in garages or used other makeshift living arrangements, such as buying military surplus Quonset huts or old trolley cars to live in.
Although there was no less housing space per person than before the war, the shortage was very real and very painful at existing prices, which were kept artificially lower than they would have been, because of rent control laws that had been passed during the war. At these artificially low prices, more people had a demand for more housing space than before rent control laws were enacted. This is a practical consequence of the simple economic principle already noted in Chapter 2, that the quantity demanded varies according to how high or how low the price is.
When some people used more housing than usual, other people found less housing available. The same thing happens under other forms of price control: Some people use the price-controlled goods or services more generously than usual because of the artificially lower price and, as a result, other people find that less than usual remains available for them. There are other consequences to price controls in general, and rent control provides examples of these as well.
Demand under Rent Control
Some people who would normally not be renting their own apartments, such as young adults still living with their parents or some single or widowed elderly people living with relatives, were enabled by the artificially low prices created by rent control to move out and into their own apartments. These artificially low prices also caused others to seek larger apartments than they would ordinarily be living in or to live alone when they would otherwise have to share an apartment with a roommate, in order to be able to afford the rent.
Some people who do not even live in the same city as their rent-controlled apartment nevertheless keep it as a place to stay when they are visiting the city—Hollywood movie stars who keep rent-controlled apartments in New York or a couple living in Hawaii who kept a rent-controlled residence in San Francisco,{39} for example. More tenants seeking both more apartments and larger apartments create a shortage, even when there is not any greater physical scarcity of housing relative to the total population.
When rent control ended after World War II, the housing shortage quickly disappeared. After rents rose in a free market, some childless couples living in four-bedroom apartments could decide that they would live in two-bedroom apartments and save the difference in rent. Some late teenagers could decide that they would continue living with their parents a little longer, until their pay rose enough for them to be able to afford their own apartment, now that rent was no longer artificially cheap. The net result was that families looking for a place to stay found more places available, now that rent-control laws were no longer keeping such places occupied by people with less urgent requirements. In other words, the housing shortage immediately eased, even before there was time for new housing to be built, in response to market conditions that now made it possible to recover the cost of building more housing and earn a profit.
Just as price fluctuations allocate scarce resources which have alternative uses, price controls which limit those fluctuations reduce the incentives for individuals to limit their own use of scarce resources desired by others. Rent control, for example, tends to lead to many apartments being occupied by just one person. A study in San Francisco showed that 49 percent of that city’s rent-controlled apartments had only a single occupant,{40} while a severe housing shortage in the city had thousands of people living considerable distances away and making long commutes to their jobs in San Francisco. Meanwhile, a Census report showed likewise that 46 percent of all households in Manhattan, where nearly half of all apartments are under some form of rent control, are occupied by only one person—compared to 27 percent nationwide.{41}
In the normal course of events, people’s demand for housing space changes over a lifetime. Their demand for space usually increases when they get married and have children. But, years later, after the children have grown up and moved away, the parents’ demand for space may decline, and it often declines yet again after a spouse dies and the widow or widower moves into smaller quarters or goes to live with relatives or in an institution for the elderly. In this way, a society’s total stock of housing is shared and circulated among people according to their changing individual demands at different stages of their lives.
This sharing takes place, not because the individuals themselves have a sense of cooperation, but because of the prices—rents in this case—which confront them. In a free market, these prices are based on the value
that other tenants put on housing. Young couples with a growing family are often willing to bid more for housing, even if that means buying fewer consumer goods and services, in order to have enough money to pay for additional housing space. A couple who begin to have children may cut back on how often they go out to restaurants or to movies, or they may wait longer to buy new clothes or a new car, in order that each child may have his or her own bedroom. But, once the children are grown and gone, such sacrifices may no longer make sense, when additional other amenities can now be enjoyed by reducing the amount of housing space being rented.
Given the crucial role of prices in this process, suppression of that process by rent control laws leaves few incentives for tenants to change their behavior as their circumstances change. Elderly people, for example, have less incentive to vacate apartments that they would normally vacate when their children are gone, or after a spouse dies, if that would result in a significant reduction in rent, leaving them more money with which to improve their living standards in other respects. Moreover, the chronic housing shortages which accompany rent control greatly increase the time and effort required to search for a new and smaller apartment, while reducing the financial reward for finding one. In short, rent control reduces the rate of housing turnover.
New York City has had rent control longer and more stringently than any other major American city. One consequence has been that the annual rate of turnover of apartments in New York is less than half the national average, and the proportion of tenants who have lived in the same apartment for 20 years or more is more than double the national average.{42} As the New York Times summarized the situation:
New York used to be like other cities, a place where tenants moved frequently and landlords competed to rent empty apartments to newcomers, but today the motto may as well be: No Immigrants Need Apply. While immigrants are crowded into bunks in illegal boarding houses in the slums, upper-middle-class locals pay low rents to live in good neighborhoods, often in large apartments they no longer need after their children move out.{43}
Supply under Rent Control
Rent control has effects on supply as well as on demand. Nine years after the end of World War II, not a single new apartment building had been built in Melbourne, Australia, because of rent control laws there which made such buildings unprofitable.{44} In Egypt, rent control was imposed in 1960. An Egyptian woman who lived through that era and wrote about it in 2006 reported:
The end result was that people stopped investing in apartment buildings, and a huge shortage in rentals and housing forced many Egyptians to live in horrible conditions with several families sharing one small apartment. The effects of the harsh rent control is still felt today in Egypt. Mistakes like that can last for generations.{45}
Declines in building construction have likewise followed in the wake of rent control laws elsewhere. After rent control was instituted in Santa Monica, California in 1979, building permits declined to less than one-tenth of what they were just five years earlier.{46} A housing study in San Francisco found that three quarters of its rent-controlled housing was more than half a century old and 44 percent of it was more than 70 years old.{47}
Although the construction of office buildings, factories, warehouses, and other commercial and industrial buildings requires much of the same kind of labor and materials used to construct apartment buildings, it is not uncommon for many new office buildings to be constructed in cities where very few new apartment buildings are built. Rent control laws often do not apply to industrial or commercial buildings. Thus, even in cities with severe housing shortages, there may be much vacant space in commercial and industrial buildings. Despite a severe housing shortage in New York, San Francisco, and other cities with rent control, a nationwide survey in 2003 found the vacancy rates in buildings used by business and industry to be nearly 12 percent, the highest in more than two decades.{48}
This is just one more piece of evidence that housing shortages are a price phenomenon. High vacancy rates in commercial buildings show that there are obviously ample resources available to construct buildings, but rent control keeps those resources from being used to construct apartments, and thereby diverts these resources into constructing office buildings, industrial plants, and other commercial properties.
Not only is the supply of new apartment construction less after rent control laws are imposed, even the supply of existing housing tends to decline, as landlords provide less maintenance and repair under rent control, since the housing shortage makes it unnecessary for them to maintain the appearance of their premises in order to attract tenants. Thus housing tends to deteriorate faster under rent control and to have fewer replacements when it wears out. Studies of rent control in the United States, England, and France have found rent-controlled housing to be deteriorated far more often than non-rent-controlled housing.
Typically, the rental housing stock is relatively fixed in the short run, so that a shortage occurs first because more people want more housing at the artificially low price. Later, there may be a real increase in scarcity as well, as rental units deteriorate more rapidly with reduced maintenance, while not enough new units are being built to replace them as they wear out, because new privately built housing can be unprofitable under rent control. Under rent control in England and Wales, for example, privately-built rental housing fell from being 61 percent of all housing in 1947 to being just 14 percent by 1977.{49} A study of rent control in various countries concluded: “New investment in private unsubsidized rented housing is essentially nonexistent in all the European countries surveyed, except for luxury housing.”{50}
In short, a policy intended to make housing affordable for the poor has had the net effect of shifting resources toward the building of housing that is affordable only by the affluent or the rich, since luxury housing is often exempt from rent control, just as office buildings and other commercial properties are. Among other things, this illustrates the crucial importance of making a distinction between intentions and consequences. Economic policies need to be analyzed in terms of the incentives they create, rather than the hopes that inspired them.
The incentives towards a reduced supply of housing under rent control are especially pronounced when people who have been renting out rooms or apartments in their own homes, or bungalows in their back yards, decide that it is no longer worth the bother, when rents are kept artificially low under rent control laws. In addition, there are often conversions of apartments to condominiums. During 8 years of rent control in Washington during the 1970s, that city’s available rental housing stock declined absolutely, from just over 199,000 units on the market to just under 176,000 units.{51} After rent control was introduced in Berkeley, California, the number of private rental housing units available to students at the university there declined by 31 percent in five years.{52}
None of this should be surprising, given the incentives created by rent control laws. In terms of incentives, it is likewise easy to understand what happened in England when rent control was extended in 1975 to cover furnished rental units. According to The Times of London:
Advertisements for furnished rented accommodation in the London Evening Standard plummeted dramatically in the first week after the Act came into force and are now running at about 75 per cent below last year’s levels.{53}
Since furnished rooms are often in people’s homes, these represent housing units that are easily withdrawn from the market when the rents no longer compensate for the inconveniences of having renters living with you. The same principle applies where there are small apartment buildings like duplexes, where the owner is also one of the tenants. Within three years after rent control was imposed in Toronto in 1976, 23 percent of all rental units in owner-occupied dwellings were withdrawn from the housing market.{54}
Even when rent control applies to apartment buildings where the landlord does not live, eventually the point may be reached where the whole building becomes sufficiently unprofitable that it is simply ab
andoned. In New York City, for example, many buildings have been abandoned after their owners found it impossible to collect enough rent to cover the costs of services that they are required by law to provide, such as heat and hot water. Such owners have simply disappeared, in order to escape the legal consequences of their abandonment, and such buildings often end up vacant and boarded up, though still physically sound enough to house people, if they continued to be maintained and repaired.
The number of abandoned buildings taken over by the New York City government over the years runs into the thousands.{55} It has been estimated that there are at least four times as many abandoned housing units in New York City as there are homeless people living on the streets there.{56} Homelessness is not due to a physical scarcity of housing, but to a price-related shortage, which is painfully real nonetheless. As of 2013, there were more than 47,000 homeless people in New York City, 20,000 of them children.{57}
Such inefficiency in the allocation of resources means that people are sleeping outdoors on the pavement on cold winter nights—some dying of exposure—while the means of housing them already exist, but are not being used because of laws designed to make housing “affordable.” Once again, this demonstrates that the efficient or inefficient allocation of scarce resources is not just some abstract notion of economists, but has very real consequences, which can even include matters of life and death. It also illustrates that the goal of a law—“affordable housing,” in this case—tells us nothing about its actual consequences.