Tag Archives: IGM

Rent control: A bad policy that just won’t die

The city council of Richmond, CA is thinking about implementing rent control in their city. Richmond is located north of Berkeley and Oakland on the San Francisco Bay in an area that has some of the highest housing prices in the country. From the article:

“Richmond is growing and becoming a more desirable place where people want to live, but that increased demand is putting pressure on the existing housing stock.”

It is true that an increase in the demand for housing will increase prices and rents. Unfortunately, rent control will not solve the problem of too little housing, which is the ultimate cause of high prices.

rent control 1

The diagram above depicts a market for housing like the one in Richmond. Without rent control, when demand increases (D1 to D2) the price rises to R2 and the equilibrium quantity increases from Q1 to Q*. However, with rent control, the price is unable to rise. For example, if the Richmond city council wanted prices to be at the pre-demand-increase level they would set the rent control price equal to R1. But with the increase in demand the quantity demanded at that price is Qd, while the quantity supplied is only Q1. Thus there is a shortage. This is the outcome of a price ceiling.

What this means is that some people will find a place to rent at the old, lower rental price (Q1 people).  But more people will want to rent at that price than there are units available, and since the price cannot rise due to the price control, the available apartments will have to be allocated some other way. This means longer wait times for vacant apartments and higher search costs. It also means lower quality apartments. Since the owners know there are more people who want an apartment than available apartments, they don’t have an incentive to maintain the apartment at the same level as they would if they had to attract customers.

With rent control, only Q1 people get an apartment. Without rent control, as the price rises more units are supplied over time and the new equilibrium has Q* (> Q1) people who get an apartment. Yes, they have to pay a higher price, but the relevant alternative is not an apartment at the lower price: The alternative is that some people who would have been willing to pay the higher price do not get an apartment.

Since Richmond has strict land-use rules like many communities in the San Francisco metro area (you can read all about their minimum lot size and parking space requirements here), rent control is adding to the housing woes of Richmond’s renters and any person who would like to move there.

rent control 2

Land-use restrictions decrease the amount of buildable land which subsequently increases the cost of housing. This is depicted in the diagram above as a shift from S1 to S2. The decrease in supply leads to a new equilibrium rent of R2 > R1 and a reduction in the equilibrium quantity to Q2 (< Q1). So land-use restrictions have already decreased the amount of available housing and increased the price.

If rent control is implemented, depicted in the diagram as the solid red line at the old price (R1), then the quantity supplied decreases even more to Qs. Again, with rent control there is a shortage as the quantity of housing demanded at R1 is Q1 (> Qs). So all of the same problems that occurred in the first example occur here, only here the quantity of housing is decreased not once, but TWICE by the government: Once due to the land use restrictions (Q1 to Q2) and then AGAIN when the rent control is implemented (Q2 to Qs). Restricting the amount of housing available does not help more people find housing, and restricting it again exacerbates the problem.

Trying to find an economist who doesn’t think that rent control is a bad idea is like trying to find a cheap apartment in a city with rent control; it can be done, but you have to spend a lot of time looking. In a Booth IGM poll question about rent control, 95% of the economists surveyed disagreed with the statement that rent control had a positive impact on the amount and quality of affordable rental housing. Yet despite basic economic theory, the agreement among experts, and the empirical evidence (see here, here, and here) rent control remains in some places and is often brought up as a viable policy for increasing the amount of affordable housing. This is truly a shame since what places like Richmond need is more housing, not less housing with artificially low prices.

Is Government the Solution?

It was thus salutary that Douglas Elmendorf, the widely respected director of the Congressional Budget Office, told a congressional hearing last week that 80 percent of economic experts surveyed by the University of Chicago’s Booth School of Business agreed that the stimulus got the unemployment rate lower at the end of 2010 than it would have been otherwise.

That’s E.J. Dionne writing in today’s Washington Post. This sort of statement is all too common: “There is consensus on stimulus. All economists agree it is unquestionably beneficial. If anything, the 2009 stimulus was too small. Case closed. Move along.” This is not a fair representation of the scientific view of stimulus.

Let’s start with the Booth School survey. Every week, the Booth School’s Initiative on Global Markets polls an ideologically diverse group of about 40 economists on a particular issue. The surveys are fascinating; I read them every week. On February 15, they put two statements to the panel and asked them to respond. The first statement reads:

Because of the American Recovery and Reinvestment Act of 2009, the U.S. unemployment rate was lower at the end of 2010 than it would have been without the stimulus bill.

It is true that, of those surveyed, 51 percent agreed and 29 percent strongly agreed with this statement. Some of the comments from those who agreed with this statement are telling. Anil Kashyap of Chicago for example wrote, “But this is an incredibly low bar.” And Darrell Duffie of Stanford wrote, “Subsidizing employment leads employment to go up, other things equal. Adverse impacts through growth incentives might take time.” These statements (and others) suggest that perhaps the question was overly-narrow.

Thankfully, IGM probed further. They asked the economists to weigh in on a second statement:

Taking into account all of the ARRA’s economic consequences — including the economic costs of raising taxes to pay for the spending, its effects on future spending, and any other likely future effects — the benefits of the stimulus will end up exceeding its costs.

This time, when the economists were asked about the longer-run, total effects of stimulus, they were much more equivocal. Less than half agreed or strongly agreed with the statement, 27 percent were uncertain, and the rest either disagreed or had no opinion. A number of respondents noted the uncertainties involved. Nancy Stokey of Chicago summed it up nicely, writing, “How can anyone imagine this question is answerable, given the current state of economic science?”

Amen. In my testimony last February before the House Education and Workforce Committee, I wrote:

There are many things on which economists agree (e.g., few dispute the merits of free trade or the long-run fiscal problems with our largest entitlement programs). Unfortunately, there is very little consensus among economists on government’s ability to jumpstart a sick economy.

The degree of disagreement over stimulus is evident when you look at the literature on the “government purchases multiplier.” The multiplier measures the amount by which an economy expands when the government increases its purchases of goods and services by $1.00. If the multiplier is larger than 1, it means that government purchases multiply or stimulate private sector economic activity. If it is between 0 and 1, it means that purchases displace or crowd out private sector economic activity. And if it is less than 0, it means that government purchases crowd out enough private sector economic activity to offset any increase in public sector activity.

In my testimony, I showed the following sample of recent estimates. Each bar shows the high and low-end estimate of a particular study.

As I wrote in February:

Note that there is a wide range in the estimates both across and within studies. If the optimistic scenarios are correct, an additional $1.00 in deficit-financed government spending spurs $2.70 in new private sector economic activity. But if the less-optimistic scenarios are correct, then an additional $1.00 in spending destroys $3.80 in private sector activity.

This misses some of the recent data. In a recent paper Valerie Ramey of UCSD, for example, uses: “a variety of identification methods and samples,” and finds that “in most cases private spending falls significantly in response to an increase in government spending.” She finds that while government spending does bring down the unemployment rate, “virtually all of the effect is through an increase in government employment.” Note that this is entirely consistent with the first IGM statement. In other words, one can believe that stimulus harms the private sector and is costly in the long run, but still think that it might have boosted (government) employment for a time. This is hardly a ringing endorsement of stimulus.

For more on this topic, see Garett Jones’s excellent (February) post here or Veronique’s post here.

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Addendum: Vero responds to Dionne’s column, adding links to lots more research on when multipliers might be large or small. And Russ weighs in here, calling for more humility. Read and bookmark both posts.