On today’s show we’re talking about how Assumptions create the mother of all catastrophes.
The latest case of this is in California where they just implemented rent cap legislation. It’s no secret that the tenant population in California is swelling. California is trending to the lowest levels of home ownership in the country.
If you’ve been listening to the podcast for a while, you will know that I’m a believer in two of the fundamental laws of economics. The first is the law of supply and demand. The second is a close cousin to the law of supply and demand, and that is called the price elasticity of demand.
Price elasticity affects both the supply and the demand side of the equation.
The lack of affordable housing is not because greedy landlords are lining their pockets at the expense and exploitation of poor tenants. It’s because government has made it difficult to add new supply to the market. The excess demand has pushed purchase prices up to the point where the economics of buying or building new product and putting it in the rental market doesn’t work. So when the conditions are not conducive to investment, investment won’t happen.
The latest ill-conceived policy from California is a statewide rent cap. The rent cap is in addition to any local rent controls that may have been implemented at the local level. So if a local ordinance is in place, the local ordinance takes precedence. If there is no local rule, the new statewide rule is there as a backstop.
Why are economists so overwhelmingly against rent controls? One reason is that they mistake the symptom for the problem.
We must ask ourselves why prices are high. They are high because the demand for housing in California is high relative to the supply of it. And why is that?
California has a wonderful climate, lots of great cultural things happening. It has strong employment overall and is a vibrant place to live. People love the outdoors, the mountains, the sea. They have also made it more difficult to build new construction. The poster child for that is the bizarre story of Bob Tillman’s five-year, $1.4 million legal battle to turn his coin-operated laundromat into an apartment building shows how regulations constraining supply coupled with rising demand have driven house prices ever higher. Bob wanted to redevelop his laundromat into residential housing. Opponents of development argued that new development was forcing lower income people out of their neighbourhoods in favour of high income earning people. Here’s the problem with that argument. Unless you increase the supply, you never have a chance of lowering prices. Moreover, nobody ever lived inside the laundromat.
But, wacky as it might sound, the supply of housing is responsive to price changes—it is “price elastic,” in the jargon. As profit increases, so does the supply. When the supply increases, prices fall. If you want proof of that, just look at the explosion of properties for rent on AirBnB. If landlords can make more money in short term rentals, they will do so.
Regarding the second problem, the “swelling homeless population,” rent control will do nothing whatsoever for these folks. The problem, remember, is too many people wanting to live in a given stock of housing. Capping the price of that housing by government decree will do nothing to solve that problem. What would help is getting rid of the government regulations that restrict the supply of housing.
Prices are not problems; they are signals of problems. Trying to solve the problem by treating the signal is like trying to slow down your car by fiddling with the speedometer.