Unintended Ill-Consequences of Price Controls, Case #728,650,993

by Don Boudreaux on February 17, 2014

in Curious Task, Housing, Seen and Unseen, Work

EconLog’s new guest blogger, James Schneider, reports the findings of a new paper, forthcoming in the Journal of Political Economy, whose authors find that rent-control reduces the market value even of properties not subject to rent-control regulations.  A slice from Schneider’s post:

Rent control has numerous negative effects on the housing market. If a landlord is forced to charge below-market rent, it reduces the incentive to improve the property or even perform basic maintenance. Perhaps, even more importantly, it misallocates who lives in a property. Tenants will continue living in an apartment even though someone else has a greater willingness to pay for the same apartment. Rent control can effectively lock people into a location; someone who is enjoying below-market rent in New York City will be disinclined to pursue a job opportunity in another city.

A home’s value is not just determined by its own condition, but also by the attributes of the entire community. If your neighbor’s landlord lets his building fall into disrepair, it might negatively effect you. Over time, rent control can gradually make the neighborhood a less appealing place to live. This impact will be magnified to the extent that higher income neighbors are themselves an amenity. A forthcoming JPE piece quantifies how rent control reduces the property values of not just controlled properties but surrounding properties as well. It does this by studying what happened in Cambridge, Massachusetts, after the state legislature suddenly eliminated rent control in 1995.

There’s a lesson here for those who – entranced by the theoretical possibility that monopsony power might exist in reality and, thus, enable a scientifically crafted minimum-wage to better the lot of low-skilled workers – ridicule those of us who oppose minimum-wage legislation as a matter of economic principle.  The lesson is that buyers and sellers adjust to price controls along not only the quantity margin but along other margins as well, margins practically impossible for academic analysts and government officials to catalog, much less to analyze in any detail.

An important implication of this lesson is that the existence of what is called (far too loosely) in economic theory “market power” – be it “monopsony power” inferred only from an upward-sloping supply curve facing buyers, or “monopoly power” inferred only from a downward-sloping demand curve facing sellers – is no sound basis upon which to theorize about practical potential benefits from government-imposed price controls.  However upwardly-sloped is the supply curve of low-skilled labor facing fast-food restaurants, maid-service companies, and other employers of low-skilled workers, the demand curve facing landlords is likely at least as equally downwardly sloped.  Landlords in Cambridge, MA, faced (and still face) downward-sloping demand curves for their units – meaning that, in principle, there is some rent-control intervention that might possibly improve the well-being of all tenants and would-be tenants.

But James Schneider here reports some of the latest evidence that that simple theory justifying price controls is far to simple to apply in reality.  In practice, price controls unleash much more harm than good.  Because the varieties of possible adjustments in response to price controls are not limited in the real world to quantity adjustments as the familiar monopsony model of minimum-wage legislation assumes it to be limited, that monopsony model is an inadequate justification for minimum-wage legislation even if, contrary to fact, employers did enjoy some real and lasting quantum of monopsony power.

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