Sunday, September 29, 2019

The Third Man - Price Controls and Shortages

Trying to control prices often leads to shortages and distortions in the marketplace.

It's funny, but mankind never seems to learn from its mistakes.  Every year some legislator tries to introduce a bill rounding Pi off to three, thinking that they can alter the laws of mathematics with the laws of man.  But of course, such things are simply impossible to do.

Similarly, even though ideas like communism and fascism have shown to not be workable, every so often somebody comes up with the idea that maybe if we had a totalitarian government, things would get done or maybe if we resorted to communism, where everyone was supposedly equal, the world would be a paradise.  And of course, these things never work out.

When someone has absolute power, they quickly become tyrants - Hitler and Kim Jong Un are not anomalies.  There is no such thing as a "benevolent dictator".   And communism breaks down when humans behave like humans - selfish.  So a dictator of the proletariat is installed to clean things up, and you end up back with fascism.  Stalin was not an anomaly, either, but the predictable end-result of communism.

And this isn't a matter of leftist versus rightist,  Democrats verses Republicans - or whatever - all parties are equally guilty in this regard.  Remember it was Richard Nixon who enacted wage and price controls in the early 1970s in response to staggering inflation, which was largely due to the price of oil skyrocketing as result of the Arab Oil Embargo.  The entire American economy was dependent on oil, so when the price of oil went up, the price of everything increased as well. The resulting effect was something called stagflation and it affected the American economy and the American mindset until even today.

And speaking of today, a new generation of socialist Democrats want to impose price controls on our economy.  Bernie Sanders proposes a nationwide rent control scheme where rent will be controlled by the government.  However, it has been shown in the past that rent control really doesn't work out, except for a very lucky few people who end up in rent-controlled apartments.  In New York City, after the war. there was a shortage of places to live, and prices skyrocketed.  New York enacted rent control laws.

But what evolved over time, was that those were lucky enough to get a rent-controlled apartment never let go of them because they were rented for far less than market value.  People would keep these apartments and sublet them to others or try to pass them down through other family members.  There was some very embarrassing articles in New York Magazine illustrating how many celebrities had rent control pied-à-terre apartments that cost them only a few hundred dollars a month even though the market value of those apartments was well into the thousands.  A system designed to help "the little people" ended up helping some very wealthy people, instead.

One of the most famous examples of how price controls don't work and how abolishing price controls restores balance in the marketplace occurred in Germany after World War II.  During the Nazi era, prices were controlled during the war, as most wartime economies do.  The Nazis also did this so they could purchase war materials for below-market Value.  It is perhaps another reason why they lost the war.

After the war, the Occupying Allied Forces kept these Nazi-era price controls in effect, and many unionists, manufacturers, and left-wing political types wanted to maintain these price controls, thinking erroneously that the government could dictate prices to the economy.

Of course, the net result was dramatic shortages of basic everyday supplies, including medicines. When the official price for a good was well below its market value, people would buy things and hoard them and then resell them on the black market.  And the black market is just the market.  You can try to outlaw things, but they will still end up being sold - often at a much higher price.  Hence, why we have a thriving market for illegal drugs in this country, even though technically they are outlawed.

This black market for everyday commodities was a primary plot device in the movie The Third Man starring Orson Welles.  Wells played an unscrupulous black marketeer who bought medicines such as penicillin and watered them down and resold them on the black market, the net result being that young children died from infections because of ineffective medication.

But within a few weeks in 1948, the entire black market collapsed. What happened was that more advanced thinkers in the German economy came into power and a new allied commander was sent to supervise the occupied territories. They reformed the currency, eliminating the Reich-mark and replacing it with the Deutsche-mark and thus reducing the amount of currency in circulation.  They also eliminated almost all the price controls overnight.

Initially, the result was chaos.  Once people realized they can charge whatever they wanted for products, they raised prices through the ceiling.  And of course, the prices were too high, and thus no one would buy.   But as prices were allowed to float, people were incentivized to produce and ship their products to the marketplace in the large cities.  Within a few weeks, prices stabilized and supplies increased, hoarding disappeared, and shortages disappeared as well. The German economic miracle took off.  Germany today is the strongest economy in the European Union.

What is so staggering about the German experiment is that the shortages and difficulties in the economy disappeared not within months or years, but within weeks and days after these price controls were eliminated. As one German Economist famously quipped, "don't just sit there, undo something!" As it turns out, government intervention wasn't what was needed to solve the crisis, but rather a removal of government intervention that was creating the crisis in the first place.

We saw a similar effect during the stagflation era.  We all like to credit Ronald Reagan for "deregulating" the airline and trucking industries, but these actions were initiated by the Carter administration.   Within a few years, the cost of shipping goods decreased dramatically.  No longer did you need permission from the ICC to drive a truck from point A to point B.   And the cost of air travel plummeted - and became a form of transportation for the everyman.  Of course, this meant that well-entrenched monopolies or duopolies came crashing to the ground - airlines had to compete on price for the first time, and many went bankrupt.

But through the 1980's, the economy recovered and then took off during the 1990's.  The regulations that were in effect back then would be unthinkable today - the amount of government intervention in the marketplace was staggering. Today, we are attacking the very idea of licensing taxicabs.  I wonder how many people protesting for rent control would like to give up Uber and go back to riding in a medallion cab?

People want to institute rent control or have the government force builders to create something called "affordable housing" -  and the reasons for doing this are not too hard to understand.  Housing has always been a huge portion of everyone's budget since the dawn of time.  When I graduated from college and was trying to find a job, it staggered me that almost half my after-tax income went toward paying rent.  The prospect of even owning a home seemed impossibly far off.  But then I found someone to live with, and that cut the rent in half and together we worked toward a common goal.  Within a few years we bought a house and within a few more years, we had an office building and then investment properties. It's amazing how things can change, quickly.

But if you would have asked me a few years before, when I was struggling to pay the rent on my first apartment in Washington, I would have told you that the entire system was sacked against me, and was unfair.  Back then I swore I would never be able to afford a home of my own, much less afford anything at all, with the staggering cost of rent taking such a huge portion of my monthly budget.

For some reason, the current generation thinks that their experience is novel.   Or maybe not - maybe politicians just understand that the cost of housing has always been an issue, and one way to pander to people - besides offering free college, loan forgiveness, and free money - is to offer them the prospect of cheaper rent.  They tell young people today that they're paying more in rent than previous generations, when in fact they're paying pretty much the same, or in many cases, maybe even less.

Certainly, in very popular cities such as San Francisco or New York, you're going to pay an enormous amount of money in rent. And again, wages are also higher in the cities as well.  But other parts of the country, you can live very inexpensively, and the range in prices from major cities to rural areas is rather staggering. A million-dollar home in one part of the country is worth barely $100,000 in another.  As they say in real estate, location is the key.

When prices go up, people seek out alternatives.  New York is too expensive?  Swallow your pride and move to New Jersey.   Apartment too costly?   Do what I did, and find someone to live with - a roommate or a significant other.  When shortages occur, people seek out alternatives, much as they did in postwar Germany, bartering for food. When the laws prevent people from seeking out alternatives, however, folks can end up in a jam.   And in places like San Francisco, zoning laws are often preventing people from building more housing and increasing housing density.

We sold our home in Alexandria and the builder - who bought every home on the block - knocked it down and put up two homes in the place of each one he bought.   Our house - like others on the block - was on two deeded lots and the land was worth more than the house.  Some decried the change to higher-density housing.  But the alternative of people moving further and further out into the suburbs, driving for hours in polluting cars and plowing under more of the countryside, was not an environmentally correct answer.   Increasing housing density in cities makes more sense, in that it increases the amount of housing stock, and decreases the amount of energy used for commuting and travel.

If rent controls were enacted, it would act as a disincentive for people to rent out apartments.  Most landlords would be smarter to turn their apartment buildings in the condominiums and thus avoid the problems of rent control. This would further remove more properties from the rental market.  As a result, even more shortages would occur.  Those who did manage to secure a rental apartment at a rent controlled price would not be incentivised to move away and buy a place of their own, but would rather hang on to that apartment, possibly trying to illegally sublet it at real market rates, and pocketing the difference. This is not some wild theory but rather the experience of what happened with rent controlled apartments in New York City in the past.

If the landlord is not making money on the apartment, he certainly has no money left over to pay for repairs or improvements.  Thus, there is no incentive to maintain a building but rather to let it decay into a ghetto slum. We saw huge sections of New York City turn into slums as a result of this type of rent control. People fled the city and moved to places like Long Island or Jersey or Staten Island, where suburban subdivisions popped up nearly overnight. This exodus from the cities continued until most apartments "aged out" of the rent control system as their tenants (and descendants) passed away.   Rent controlled apartments are now about 1% of the total inventory, although a lot of landlords have since signed up for "rent stabilized" programs, where they are offered tax breaks in return for certain rental guidelines.

Of course, in addition to tenants seeking other alternatives, high rents cause employers to act as well. Companies in silicon valley have relocated or located satellite offices in less-costly cities, such as Austin, Texas, and Boulder, Colorado - but often in the process, end up increasing rents in those cities, of course.  There is no easy answer to any of this.

And that right there is the problem - politicians are offering easy answers to complex problems, and easy answers are almost always the wrong answers.  It doesn't take any thought to put up a platform that says, "We'll cut the cost of rent by telling people what rents should be!" or that they will make college more affordable by making it free - or make healthcare free by having hospitals send the bills to Uncle Sam.   The back-end of these "solutions" gets messy.   Who pays for all of this, in the end?  It is easy to dictate to the market what prices are, it is a lot harder to get the market to go along with this, particularly when producers stand to lose money at the dictated prices.

A reader writes:
As Thomas Sowell said:  
The first lesson of economics is scarcity: there is never enough of anything to fully satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.  
Good point.

Cars are expensive.  Why not pass a law making them all cost $10,000? The government could do this, and argue that the "Commerce Clause" allows them to do so.   But within a few months, all the car factories would close, as one company after another goes bankrupt.   The remaining cars in circulation would become priceless - and a black market would develop.  It is an idiotic idea, of course, but no more idiotic than "rent control."

Sadly, people don't get this.  We are told that the homelessness problem in places like LA and San Francisco (where homelessness is still less than 1% of the population!) is a result  of rents being too high.   That is, of course, a bald-faced lie.   The homeless are living in tents because of their drug and mental health problems.  These are not people "looking for jobs" and "trying to get by" - if they were, they'd leave the area and move to somewhere else.

It just seems to me that we are being sold a bill of goods here. We are told we have these insurmountable "problems" that no one can solve, except by abolishing our Constitution (or amending it) and instituting socialist big-government policies.

I am not sure that this isn't just a big power-grab.   Perhaps the biggest in our history.

But then again, you don't get elected these days, unless you can convince people that everything is a crises.