Defining Ideas

Economics 101 In Labor And Housing Markets

Monday, March 4, 2019
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A few simple premises of economic theory have the power to generate a wealth of powerful and instructive insights. Nowhere is that more true than with the law of supply and demand, which starts with two basic assumptions: as the price of a good increases, so does the supply—and as the price increases, the demand starts to fall. In an unregulated market, when the downward-sloping demand curve crosses the upward-sloping supply curve, the market is in equilibrium—the point where supply meets demand at a given price. The only task for a government under this austere model is to make sure that various contracts, whether for labor, housing, or any other good/service are fully enforced, while leaving the terms of those agreements to the parties themselves. Happily, this system of freedom of contract is self-regulating, so that the price or wage of particular goods and services can quickly adjust to changes in supply or demand, or both. A dynamic market thus always moves to reestablish an equilibrium in the face of unanticipated external changes. 

Unfortunately, these readjustments do not happen when artificial limits are set on prices or wages. In the housing market, for example, maximum limits on rents make demand outstrip supply, leading to housing shortages. In the labor market, a minimum wage leads to an excess of demand for jobs and a shortage of openings. The greater the deviation between the mandated maximum or minimum price and the market equilibrium price, the greater the potential shortages. Wasteful queues form for high-wage jobs and low-rent housing. Private machinations and political intrigue quickly follow, as desperate tenants and workers switch into high gear to evade the price and wage restrictions ostensibly enacted for their benefit. 

The above account is too often dismissed by those who claim that unregulated markets lead to market failures. How can people make intelligent choices if they lack full information about all the available options? How can small players function in markets dominated by large firms that have an unfair bargaining advantage? And what is to be done about the entrenched prejudices on grounds of race and sex against women and minorities? These perennial concerns demonstrate that markets are not perfect. But that doesn’t mean markets should be regulated by the government. The cure for the first problem is to seek out private sources of information, often through third parties, like brokers and websites. For the second and third, the solution is to preserve free entry so that new entrants can reduce the market power of established players.

Comparethe recent performance in labor markets, which have become less regulated, and housing markets, which have not. On the labor side, the common progressive complaint is that market imperfections caused the slow wage growth patterns of the Obama years—and the solution to this problem was thought to require ever more regulations governing minimum wage, maximum hours, and unionization. The result, though, was stagnation, as the very rules that were intended to protect workers imposed implicit barriers to their entry into labor markets. 

Along came the Trump administration and matters quickly reversed. Trump’s election did not precipitate major changes in the statutory law. To be sure, some regulations were removed, but the major changes took place below the radar, for the key difference in the Trump era has been the lax enforcement of existing regulations. Government actors got out of the way. Fewer investigations and lawsuits had two huge payoffs. The first was a reduction in compliance costs that all too often block entry into labor markets. The second was an implicit repeal of many of the legal restrictions on contractual freedom that were hampering new activities in labor markets. Now, free from the implicit regulatory tax—which places the heaviest burden on those at the lowest end of the income spectrum—the markets have returned to life, upending all the erroneous interventionist presumptions of the Obama era.

So we now face the enviable task of understanding the “Hottest Job Market in Half a Century.” One major class of beneficiaries is unskilled workers who are now receiving substantial wage increases to become apprentices in areas of high demand—like in shipyard welding. The benefits of this job market extend to ex-consdisabled workers, and high-school drop-outs once thought to be relegated to the sidelines. Women as well have returned in large numbers to the labor force with a rise in employment in health care and educational markets. And manufacturing, which was once thought to be in decline, has also seen steady increases. An open market is far better at generating jobs than its two main rivals: Trump’s protectionist agenda and the legislation championed by progressive Democrats who insist that only government intervention can heal wounded labor markets. 

Housing markets are often a different matter. These are heavily regulated at the local level, where a combination of zoning and anti-growth taxes and regulation block free entry. As the population starts to move into hot economic markets housing shortages develop. Smart cities like Houston do not cripple housing markets. But elsewhere, the NIMBY (not-in-my-back-yard) forces are strong enough to block new housing construction, such as effortsin Berkeley to prevent the construction of multi-family units in residential neighborhoods. In progressive jurisdictions, furthermore, activists often demand new developments fold in some affordable housing, under which the landlord must rent some units at below market rates in order to be able to rent others at market rates. Both of these measures retard growth in the housing market, which in turn leads to steep rent increases that provoke sharp reactions, such as the ill-fated Seattle proposal to tax large firms like Amazon in order provide aid to the homeless.

The latest sign of this pathology is the first state-wide rent control law now about to be passed in Oregon. As these statutes go, Oregon’s law looks to be a model of restraint. The legislation caps rent increases at 7 percent per year, plus inflation. In addition, new construction is exempted from the rent control ordinance for the first fifteen years, in order to increase the supply of housing. The best that can be said for these proposals is that in their current form they pose relatively little risk of market dislocation, because the market rates are likely to stay below the caps for much of the time. The same may not be true with respect to other provisions of the legislation, including those that limit the ability of landlords to evict tenants, even at the expiration of the lease. On this point, the Oregon legislation introduces elaborate “for cause” conditions that purport to spell out the acceptable reasons for eviction, including the desire for higher occupancy or needs to renovate the premises. One high cost of these limited provisions is that landlords in multi-unit dwellings are not in a position to evict problem tenants at the end of their leases, which could easily lead more desirable tenants to pick up stakes and move elsewhere. 

The long-term implications of any rental control law are, however, always problematic. If the statute does little or nothing to alter market forces, why pass it at all? One immediate risk is that landlords might respond strategically to the law by raising rents above market levels prematurely if they think that future demand will push market-rate rents up against the statutory ceiling. In addition, the current version of the statute could easily slide into a more extreme policy. As the Wall Street Journal notes, housing construction in Oregon has not kept pace with the population influx. And to this day, Oregon still imposes “urban growth boundaries” that reduce the available sites for new construction. Combined with existing zoning laws, shortages in the state housing market are likely to persist or even intensify. If so, the supporters of the rent control statute could make the case for further reducing the allowable annual increases of the rent, shortening the exemption period for new housing, and narrowing the grounds for eviction on leasehold termination. 

These risks are especially strong because under modern American law landlords have virtually no constitutional protection under the takings law against aggressive rent control laws, such as New York City’s rent stabilization ones. It is always difficult to evaluate the impact of potential legislation, but there has to be some concern that the new and shifting landscape in Oregon will chill new construction, which will only exacerbate the housing shortage. If the Oregon movement spreads, higher regulation in the housing markets could undo much of the good done by the boom in the labor markets. The basic principles of supply and demand speak as strongly for deregulation in the one market as in the other.


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