Rent regulation, Krugman, Yglesias and reality

A couple of years ago, when the city rent regulations were up for renewal, I wrote an analysis for Met Council to rebut Paul Krugman's standard but flawed complaint against rent regulations. In it I supressed a key force in the development market largely because it seemed at the time too pessimistic. But this morning it occured to me that there's much more to be said about it, and it's worth saying, especially now when there's no rent battle.

First to recap: Krugman's column was focused on San Francisco without recognizing -- or perhaps not knowing -- legal and market distinctions between that city and ours crucial to a clear understanding of the market and regulations here.

On his classic liberal economic view of rent regulations, it is assumed that regulations dampen development, suppressing supply so raising rents. It is also assumed that deregulation will push out current residents, increasing the supply of rentals, so lowering market rents. Rent regulations, on this familiar view that Krugman followed, are the cause of the city's housing crunch and the consequent excessively high market rates.

In the Met Council piece, I showed that both of these assumptions are false in New York City. Because they do not apply to new construction, NYC rent regulations do not dampen development. On the contrary, they are one of the very few incentives to develop in this city, rather than just price up existing apartments, a much cheaper option than construction. Deregulation prices up existing rents, so it de-incentivizes construction. So the first assumption is plainly false.

The second assumption is a bit less plain. When tenants are evicted by a rent hike, the tenants typically don't leave the local rental pool. Employment, family or cultural preferences tie them to the locality (for us, the larger metropolitan area). Instead, many move to cheaper neighborhoods, where, especially in a city where the supply is limited, they increase the demand for housing in those neighborhoods, raising rents there and in turn displacing the prior tenants.

The overall effect is one of musical chairs, not surplus. When everyone has found a seat and settled in, the rents should be exactly as high as before. And as long as newcomers arrive, the rents will continue to rise. with no relief to existing tenants.

The economic difference will be an increase in the aggregate funds available for rent as the formerly regulated tenants devote more of their income to rent and those who can afford more rent move up into those deregulated apartments. The increase goes to landlords.

If deregulated tenants have less disposable income as a result, they may contribute less to the consumer economy or contribute more to the workforce. Both are undesireable: the former dampens the economy, the latter, if it's significant, lowers wages in the workforce, which can also dampen the economy and increase inequality.

Both Krugman and Yglesias agree that construction would ease the market. That is certainly true, as far as it goes (and that is as far as I went in the Met Council piece). But this is liberal market utopianism: deregulate and the invisible hand of the market will provide through the balancing of the individual interests of both developers and residents. There is a diminishing return on construction. Once the supply exceeds the demand, construction will end and developers will seek greener pastures. Developers are mobile, so the construction market in NYC depends on the construction market elsewhere. The tight market everywhere serves the rentier.

Worse, NYC, unlike most places in the world, has a well of demand with no visible bottom. Build it and the wealthy will come. Upzoning, Yglesias' solution, brings newly constructed units to NYC but does not ease market rates, it merely upscales the city. Since apartments respond to cultural fetishes, the more new units constructred, the more old neighborhoods become attractive. A city, like any cultural artifact, defines itself by a value structure of differences as well as of uses suited to distinct motivations. The Lower East Side, once a ghetto (explicitly named as such in maps in the 1920's) for industrial labor and a place to avoid as a utilitarian necessity, now attracts urban youth who would find a penthouse in a glass building culturally sterile.

If, in NYC, new luxury rents were set at market rate and then regulated thenceforward, the incentive to construct might not be too much curtailed. But this will yield more luxury constuction, not more affordable housing, nor easing of the rental market.

When New Yorkers complain that the rents are too high, they forget that landlords charge the highest possible rate that tenants are willing (or, at the bottom, can) pay. Rents are "high" because renters (those above the bottom) want to pay (the bottom have to pay). They are at a negotiating disadvantage, since landlords hold multiple options including warehousing, while renters are mere individuals, unorganized.

If Krugman and Yglesias are wrong -- that is, are deregulation of rents or zonings ineffectual -- is there any way to lower rents? Regulating profit margin might work. It has an interesting precedent in city government. (Thanks to Bill Cashman who pointed this case out to me). Abu Dhabi, the owners of the Chrysler Building, pay its land owner, Cooper Union, the assessed real estate tax on the land. As a non profit, Cooper Union pays no tax. So the rent on the land is in effect determined by the city and state. The Rent Stabilization Board also regulates landlord profit, but it doesn't do this individually, and landlords' books are not open.

A simpler answer would be to place all land and buildings into public hands. If the city could extract a reasonable rent from the 1%, they'd easily be able to manage effectively the current NYCHA properties and even build more affordable housing. If renters were allowed to strike, landlords would eventually abandon their buildings and the city would inherit them. Too bad it'll never happen. It's the only sane solution to "the rent is too damn high!"