Back in the formative years of my economics education at Penn State, my principles of economics professors harped on many concepts that were essentially laws within the discipline. These included the inefficiencies brought in by monopolistic firms and the fundamental relationship between supply and demand. These were the economic essentials that every student had to grasp.
I also remember an entire lecture being dedicated to the misguided nature of a common policy tactic: rent control. On its surface, these price constraints always seem appealing but the underlying economics end up causing the opposite effect.
Why am I bringing up rent control right now? Unfortunately, policy makers around the country are taking a renewed liking to these caps as housing prices continue to spiral out of control. Lawmakers in Oregon have already passed legislation that would cap rent increases at 7% per year on top of inflation, creating the first state wide rent control. .
Other state legislatures are also considering similar rent limits. Massachusetts’ policy makers have a bill in the works that would allow municipalities to decided on their own rent policies without needing state consent (although Gov. Baker does oppose it). This would essentially overturn a ban on rent control that went into effect after a successful 1994 referendum.
Some people may see this as a viable solution. If prices are skyrocketing, limits would keep them in check right? Unfortunately, the desired result usually does not happen and in fact prices tend to rise. To understand why, here are some economics.
For those that have never heard of it, rent control is essentially a cap on the price landlords can set for their properties. It can come in many forms, such as a cap on price increases year to year or a hard ceiling for the amount of money that can be charged for rent in an area.
Now if demand for housing is exceeding supply (as is the case with most booming cities in the U.S.), prices will rise as people compete for a limited quantity of housing units, pushing rent up (Graph 1). When a rent control is factored in though, the price cannot increase with the rise in demand. This creates what is called a market inefficiency.
If prices cannot rise to meet demand, property owners have a disincentive to build since the price they would receive does not meet the full cost of production. Since demand has not changed but supply has been further limited, the gap between the two increases further, putting more upward pressure on prices.
In graph 2, R0 is rent without the control and R1 is rent with the controls.
The end result is a more limited housing supply and more intense upward pressure on prices. People end up being worse off with the controls than without them.
This phenomenon is supported by researchers from Stanford University. They examined the affects of a 1994 San Francisco rent control measure and found that the rent limits crimped supply by 15% in the long run, causing further increases in rents.
The negative effect of rent control is so widely accepted that it is used as the prime example for the failure of price controls in general (hence why my professors harped on it). Unfortunately, policy makers in Oregon and Massachusetts are ignoring the economics as each state faces worsening housing crises.
This is not to say that state governments cannot do anything to fix their housing issues. A better area to focus on is the underlying issue at hand: the lack of housing supply. A significant reason behind Boston’s crisis lies within the city’s archaic zoning laws that limit where developers can build and the overbearing red tape that makes development more expensive. These combine to create a slow and expensive building process, with the units that end up being built having luxury price tags in order to cover the high development costs.
Many cities facing housing crises face these same issues. Policy makers could focus on removing these barriers to development and help the housing supply catch up with demand. This market solution would then naturally reign in prices.
It is good to see California governor Gavin Newsom taking a stand against restrictive municipalities. His administration in suing Huntington Beach for their failure to build affordable housing as required by state laws. Other states should take note and focus on these underlying factors as well rather than push through fatally flawed rent control policies.