Ep67 Real Talk on Rent Control: Its Pros and Cons

Key Concepts

Rent Control: A government regulation that limits the amount landlords can charge for rent.
Steelman the Argument: Presenting the strongest possible version of an opposing argument to better understand its merits.
Straw Man Argument: Misrepresenting an opponent's argument to make it easier to attack.
Housing Shortage: A situation where the demand for housing exceeds the available supply.
Price Adjustment: The mechanism by which prices change in response to supply and demand.
Demand Effect: How changes in price influence the quantity of a good or service consumers are willing to buy.
Supply Effect: How changes in price influence the quantity of a good or service producers are willing to sell.
Shrinkflation: Reducing the quantity of a product while keeping the price the same, effectively increasing the per-unit price.
Maintenance: The upkeep and repair of housing units.
Redistribution: The transfer of wealth or income from one group to another.
Distortionary Effects: Economic consequences that alter the natural functioning of a market.
Search Frictions: Costs and difficulties associated with finding a new apartment or tenant.
Moving Costs: Expenses incurred when relocating from one residence to another.
Market Power: The ability of a firm or individual to influence market prices.
Hold-up Problem: A situation where one party in a transaction can exploit the other due to specific circumstances.
Commercial Leases: Rental agreements for business properties, often with long-term clauses and options.
Rational Decision Makers: Individuals who make choices based on logical reasoning and self-interest.
Market Failures: Situations where the free market does not allocate resources efficiently.
Externalities: Costs or benefits that affect a party who did not choose to incur that cost or benefit.
Embedded Option: A contractual feature that gives one party a choice or flexibility not available to the other.
Burden of Proof: The obligation to prove a claim.
Second Best Theory: The idea that in the presence of market imperfections, interventions may not necessarily lead to a better outcome.

Rent Control: Examining the Arguments

This episode of the All Else Equal podcast, hosted by Jules Van Binsburgen (Director of the Lauder Institute and Finance Professor at Wharton) and Jonathan Burke (Finance Professor at Stanford GSB), delves into the complex issue of rent control. While acknowledging that most economists consider rent control a detrimental policy, the hosts aim to "steelman" the argument, exploring the strongest possible justifications for its implementation.

Historical Context and Economic Consensus

The discussion begins by referencing a seminal 1940s article by Milton Friedman and George Stigler, which compared housing shortages in Chicago and San Francisco. After the 1906 San Francisco earthquake destroyed half the city's housing stock, there was no shortage due to a free market price adjustment. Conversely, Chicago, with no destruction, experienced a significant housing shortage due to rent control. This historical example serves as a foundational argument against rent control, highlighting its tendency to create shortages rather than alleviate them.

The Demand-Side Effects of Rent Control

When prices (rents) are artificially capped, demand for housing increases. This is because lower prices make housing more attractive, leading individuals to:

Choose to live together in apartments.
Rent out rooms in their existing properties.

This increased demand, coupled with a fixed or reduced supply, exacerbates the shortage. The San Francisco example illustrates that even with a reduced housing stock, price adjustments ensured everyone was housed, albeit in smaller spaces or shared accommodations.

The Supply-Side Effects of Rent Control

Rent control significantly disincentivizes the supply of new housing and the maintenance of existing units:

Reduced Incentive for New Construction: If new apartments are subject to rent control, developers have less economic incentive to build, leading to a long-term decrease in housing supply.
Deterioration of Existing Stock (Shrinkflation Effect): Landlords, facing capped rents and tenants unlikely to leave due to the cost of finding new, controlled housing, have little incentive to invest in maintenance. This leads to a decline in the quality and effective quantity of housing available. As Jonathan Burke puts it, "the landlord knows the tenant will never leave because if they let they would have to pay a lot for a new rental place. So the landlord says to the tenant, 'Screw you. I'm not fixing anything.'"

New York City is cited as an example of a city with significant negative experiences with rent control.

Long-Term Consequences and Supply Restrictions

The long-term effect of rent control is a persistent undersupply of housing, keeping free-market prices high. This is often compounded by government regulations that artificially restrict supply, such as strict zoning laws and building regulations, as observed in San Francisco. The argument is made that removing these regulations would be a more effective solution to high rents than rent control.

Arguments in Favor of Rent Control (Steelman)

Despite the strong economic arguments against it, the podcast explores potential justifications for rent control:

Redistribution of Wealth:
- Argument: Rent control is seen as a mechanism to redistribute wealth from landlords (assumed to be rich) to tenants (assumed to be poor or unable to afford housing).
- Critique: This argument is challenged on several grounds:
  - The assumption that landlords are rich and tenants are poor is not universally true; there are rich tenants and poor landlords.
  - Even if redistribution is desired, rent control is a highly distortive method. More efficient methods like taxation are available.
  - The redistributive goal comes at the cost of reduced long-term housing supply and quality, ultimately making everyone worse off.
Market Failures and Search Frictions:
- Argument: The housing market is prone to failures, including search frictions and moving costs for tenants. These costs can give landlords market power, allowing them to exploit tenants.
- Critique:
  - Landlords also incur significant search costs (empty apartments, lost rent). It's not clear tenants bear greater costs.
  - Even if tenants face higher costs, commercial leases demonstrate that long-term contracts and lease options can mitigate hold-up problems.
  - The assumption that individuals are irrational and cannot negotiate such contracts is questioned. The argument that government intervention is superior to individual negotiation is also doubted, as government bureaucrats are not always rational.
Behavioral Reasons and Emotional Attachment:
- Argument: Tenants may have emotional attachments to their homes, especially after raising children, which landlords do not share. This can give landlords leverage to exploit tenants.
- Critique:
  - This issue can be addressed through long-term leases (e.g., 20-year leases, common in Europe).
  - The absence of such long-term leases in the US is attributed to a higher propensity for labor mobility, not an inability to contract.
  - Tenants could opt for contracts that give them flexibility to leave, but this would come at a higher price (an "option premium"), which most prefer to avoid, seeking government intervention for a "free" benefit.

The Burden of Proof and the "Do No Harm" Principle

A crucial point raised is the "burden of proof." In medicine, the principle is "first, do no harm," meaning intervention is only justified with sufficient evidence of benefit. The question is posed: should the burden of proof lie with those advocating for change (rent control) or those defending the status quo?

The hosts lean towards the former, arguing that while markets are imperfect ("second best"), the proposed solution must demonstrably improve upon the existing suboptimal system. Simply pointing out market imperfections is insufficient.

The Role of Externalities and Price Setting

The discussion touches on externalities in the real estate market, such as the "good" versus "bad" tenant dynamic. However, it's argued that market-based solutions, like observing tenant history and offering long-term contracts, can address these without government intervention.

The difficulty of accurately setting prices to correct externalities is highlighted. Without a market, determining the "correct" price adjustment is speculative, and interventions can easily lead to overcorrection and worse outcomes. The historical track record of government price-setting is generally poor.

Conclusion: The Overwhelming Costs of Rent Control

In summary, while acknowledging the policy motivations behind rent control, particularly the desire for redistribution and addressing perceived market failures, the podcast concludes that the economic arguments against it are substantial. The potential benefits, even when "steelmanned," are unlikely to outweigh the almost certain negative consequences, including:

Reduced long-term housing supply.
Deterioration of housing quality.
Distortion of market signals.

The hosts emphasize that the primary dysfunction in many high-rent cities is not a lack of rent control but rather an undersupply of housing, often exacerbated by restrictive regulations. The most effective solution, they argue, is to increase housing supply by making development more feasible.

The episode concludes by thanking listeners and promoting the podcast's availability on various platforms.