Economics: Rent Control

(Written Dec. 2019)

California is having massive social and political problems right now, not least of them the homelessness epidemic. About one-quarter of the homeless people living in the United States currently reside in California, with most of those congregating in L.A. and San Francisco. State and local governments have decided to step in and attempt to curb the epidemic by introducing rent control laws. You may have heard about these before, as they have been common in Chicago and New York. Basically, a law is passed that puts an upper cap on the limit landlords can charge for rent. For example, the average rent in city X is around $4500 a month (that’s an average rent of all rentable apartments and rooms across the city), and rent controls, if enacted, would lower that price to, say, $2500 a month across the city. This is the most basic form of rent control, but keep in mind, there are different types of such laws.

California Governor Gavin Newsome just signed a rent control law that is slightly different than the example above. Each year rent increases will be capped at 5% plus inflation. Moreover, it prevents landlords from evicting people for no reason (e.g., to obtain a new tenant and raise rent). This law will necessarily stop landlords from hiking prices when there is a high demand for housing. Politicians, including Newsome, claim that such measures would make housing more “affordable” and allow more people to find dwelling spaces, thus helping to fix the homelessness epidemic. It’s a good-hearted policy, and sounds like a great idea, right?

Wrong. 

Rent control is one of the worst policies ever conceived of by politicians. Allow me to explain…

There are few things in the world that most people agree on, and even fewer things on which all people agree. Rent control is one of those things. About 95% of economists agree that rent controls are a terrible idea, and when such a high percentage of professionals agree on something, it’s worth taking note.  

If you read my last post on the price system, you’ll remember that I explained how our market operates as an information conveying mechanism. Producers know what to produce and what price to charge based on information relayed back to them through consumer choices. E.g., Apple released the Airpod Pro headphones, and they sold like crazy – with many stores not able to keep up with demand. The selling of the headphones signaled to Apple that they needed to increase production, which was what they did. Obviously, this flow of information is not instantaneous and takes time to get back to the producer. (An interesting, and probably lucrative job could be devoted to decreasing the amount of time producer decisions were relayed back to the producer). Now, what would have happened if Apple was not aware of the demand for their product? They would not know that more needed to be produced and continue to supply stores at the current level. Assuming demand stayed high, a shortage of Airpods would ensue, and if the demand were high enough, a black market would open up as people sold their used Airpods for very high prices. In other words, consumers would not be able to obtain what they want. In short, prices rise when the amount demanded exceeds the amount supplied at existing prices, but if there is not enough of the product to satisfy the demand, then a shortage will occur. 

As you can see by this basic example, when information is withheld from producers, the flow of the market is affected, and it impacts the price and quantity of goods. A similar thing happens under rent control, and more generally, price control laws. As an outside party limits prices, the market value becomes hidden (not to mention illegal), since the market cannot naturally strive for equilibrium; this leads to the creation of black markets. Furthermore, since the prices are drastically lower than in an unhindered market, demand skyrockets. But, as demand shoots up, there no longer remains housing for all of the people who now want it, and a shortage ensues. This simple economic chain becomes an open “Pandora’s box” of nasty consequences. 

Consequences 

I mentioned it previously, but I’ll do so again just because I think it is so important to understand. When prices are arbitrarily slashed, demand does not disappear, but supply does.  

Diversion of New Investment

It is a fact that under rent control, investment in new housing rarely occurs. From the time WWII ended until 1955, there was not a single new building built in Melbourne, Australia, due to the impact of rent controls on profitability. The same thing has continued to happen in California, as was shown in Santa Monica in 1979, San Francisco in 2001, and San Francisco today. Intuitively, this, and all of the other consequences I will talk about, make sense. As profits are reduced to lower levels, and many times reduced to a loss, investment will stop. No rational person invests in something that they will lose money on, nor do they invest in something with such low potential profitability when they can invest elsewhere. Moreover, as government regulations continue to bog builders down with red-tape, the hassle of construction does not become worth it. 

If there were an excessive amount of people living without housing, then my first assumption would be that more housing is needed, not that prices are too high. Along with allowing the market to adjust freely, encouraging new investment in the housing sector, providing incentives for builders to develop housing for lower-income tenets, and reducing the staggering amount of red-tape that disincentivizes investors would go a long way in solving a housing shortage. 

Surprisingly enough, rent controls benefit the wealthy more than they benefit the poor. Most of the time, luxury apartments and housing are exempt from rent control laws, and investment in these types of buildings increases as the profitability of building rent-controlled housing decreases. Office spaces and other commercial buildings are also often exempt from rent control laws; thus, the same thing happens with these types of buildings as it does with luxury housing. This diversion of investment means that under rent control, resources are not being allocated efficiently – unneeded commercial buildings are built, people aren’t incentivized to economize with regards to their living standards, and, as we shall see, deterioration occurs. In other words, because of rent control laws, the poor, and those who need housing, are not getting it.   

Black Markets

Some buyers and sellers will operate outside of the rent-controlled market and in ‘black’ (or ‘grey,’ i.e., not totally illegal) markets. The excess demand created by rent control will lead those who have the financial resources to such markets. But, because of the illegality and the risks associated with operating in illegal ways, prices in black markets rise to a level higher than in a free-market (to compensate for the risks). Sellers in such markets are motivated by the extra profit they can make and are willing to take those risks. In the 16th century, a Spanish blockade tried to starve rebels in the city of Antwerp. Since no food was getting in through the ports prices, shot up. But these high prices, and a higher profit margin, motivated people to engage in black market activity, thus smuggling food into the city. However, with no grasp of basic economic concepts, the leaders in the city enacted price controls on food, and the black markets disappeared, leading to mass starvation and defeat. 

Even though the short example is not a specific instance of rent control, the same economic principles apply. Rent controls are a form of price controls, and the same causal chain of consequences that happens when the latter is enacted also happens to the former.  

Deterioration

One of the worst consequences of rent control is the deterioration in the quality of housing. The restriction of prices sets them below the free-market level and slashes profits for landlords. Contrary to some people’s beliefs, most landlords aren’t greedy, exploitative robber barons, but skilled workers who maintain the housing and rent it out as their job. As profits go down, renting becomes more and more costly, often to the point where renting the housing space is not even worth the cost of upkeep. Wealthy tenants can afford this as they just spend their own money to keep up the housing. But, for those poor tenants who depend on the landlord for basic handyman fixes, utilities, furniture, and more….well, I guess they’re just out of luck. Furthermore, there is no longer any incentive to prevent housing from deteriorating. Because the demand for such cheap dwelling spaces is so abundant, the landlord will just rent out to people who don’t care about the deteriorated conditions. Or, they’ll discriminate against the poor and find someone wealthy enough to take care of the housing out of their own pocket. As bad as it sounds, this is the reality of rent-control.  

Discrimination

Thomas Sowell, an African-American economist at the Hoover Institute (Stanford University), has done lots of work on discrimination throughout his career. I was surprised to find out that free markets start to limit discrimination before actual laws do. That’s a topic for another piece I’ll write, but if you want to read Sowell’s work, check out my works cited below. Anyway, rent-control enables landlords to discriminate. I’m not saying that rent-control is discriminatory, rather, that it makes discrimination easier to engage in. As the demand for rent-controlled housing increases due to below-market prices, and the supply of such housing doesn’t keep up (lack of incentives to build, deterioration, etc…), landlords will be faced with a swath of different tenants to choose from – all of which are paying the same price in the eyes of the landlords. However, those landlords who want to discriminate will be able to do so because the excess supply of tenets allows the landlord to pick and choose at his or her own whim. You may think this wouldn’t happen in today’s day and age, but anti-Semitism and racism are still prevalent. 

Before moving on, I’d like to clarify my previous point even further. My main point was that rent-control makes discrimination easier to engage in. Potential tenets of a building will be subject to the biases and opinions of a landlord, or anyone with the power to decide who gets to rent the housing. Imagine a landlord with a prejudice against Jews, or African-Americans, because the supply of tenents is so high the landlord can choose not to rent to either of those groups. In a free-market, this would be much less likely to occur.         

Turnover

A problem with rent control that few see is that of turnover. As has been shown throughout the United States in recent history, as apartments and houses have their rent capped at an artificially low price, people tend not to want to leave, since their rents are such a good deal. These artificially low prices don’t force people to economize, and more living space is used than is actually needed. Think about the incentives that rent control creates for all types of people; families are not motivated to move into smaller homes as children move out, seniors are not motivated to economize their living spaces as they grow older, and so on. And why would you choose to let go of rent-controlled housing when doing so would be more expensive?   

Solutions

Strangely, the first step some politicians take when trying to solve a housing shortage is an attempt to artificially lower prices. I would think that if there were not enough houses to go around, then more should be built. Of course, many politicians or people may not know better. In that case, it’s our responsibility to explain in a rational way what the effects of rent-control would be, and how the consequences will be the opposite of the ones intended. Because of people like you, this can change. The general public needs to become more aware of economics and the effects of seemingly helpful policies. As I mentioned in my Economics: An Introduction, many people fail to trace the consequences of economic ideas and policies as far as possible. Though we are humans and can’t see every single one of the outcomes that a policy may have, it is our responsibility to look at all of the ways in which such things will impact people. Next time you hear politicians, peers, friends, or family speaking about economics, I implore you to think about the long run and far-reaching impacts of such economic ideas.  

On the other hand, history has proven time and time again that rent control has been a disaster, and within twenty minutes of picking up an introductory level economics textbook, the reasoning behind those disasters should be apparent. This leads me to believe that something else is going on here, something that seems, well, suspicious. Hopefully, within the next few months, I’ll be able to update you all on where my thoughts are. As of right now, I’m investigating what seems to be the major divide in modernity, and I think that this divide ties in with the state of our modern-day politics. But that’s another story… 

  Works Cited

Albon, Robert. Rent Control: Costs and Consequences. Centre for Independent Studies, 1980.

Associated Press. “California Governor Signs Statewide Rent-Control Law.” MarketWatch, 9 Oct. 2019, http://www.marketwatch.com/story/california-governor-signs-statewide-rent-control-law-2019-10-08.

Downtown Streets Team – Ending Homelessness Through The Dignity Of Work, http://www.streetsteam.org/causesMythsMisconceptions?gclid=Cj0KCQiA89zvBRDoARIsAOIePbA0ibWDStgZfKsQIBXLb45eBvH5tLrlJVsa74hsIR8aK5KjteUq4kAaAmECEALw_wcB.

Jr., Richard. “America’s Homeless: Victims of Rent Control.” The Heritage Foundation, 18 Dec. 2019, http://www.heritage.org/civil-society/report/americas-homeless-victims-rent-control.

Rebecca Diamond, Tim McQuade, and Franklin Qian, “The Effects of Rent Control Expansion on Tenants, Landlords, and Inequality: Evidence from San Francisco,” NBER Working Paper No. 21841 (2018).

Schuettinger, Robert Lindsay, and David I. Meiselman. Forty Centuries of Wage and Price Controls: How Not to Fight Inflation. The Heritage Foundation, 2018.

Sowell, Thomas. Basic Economics a Common Sense Guide to the Economy. Basic Books, 2015.Sowell, Thomas. Discrimination and Disparities. Basic Books, 2019.