Today, I was reading news stories about hand-sanitizers and masks being sold online for ten times their normal prices amidst the worldwide coronavirus outbreak. Given the circumstances, apparently Google and Amazon are prohibiting sales on their platforms at exorbitant prices. They are private companies so I have no qualms about what they decide to do, but their responses reminds me of historic efforts imposed by the government to control prices of various goods and services.
These price control efforts I’m thinking of are mandates like “anti-price gouging laws” that prohibit sellers from raising prices of products beyond a government-set percentage in case of a natural disaster, “rent control laws” that make it illegal for landlords to charge rent over a certain allowed annual percentage increase, and “minimum wage laws” that set the floor for how low of a wage an employer is allowed to pay to its employees.
On the surface, these issues seem pretty simple. Charging a high price for necessities that people need in times of a natural disaster, increasing the rent on someone struggling to pay rent, or hiring unskilled workers for the benefit of business-owners while taking advantage of cheap labor, all seem wrong. In a perfect world, we wouldn’t have to do any of that. But the world is not perfect, and a lot of discussions I have been having around this topic tend to miss an important aspect: what would we be giving up by implementing such laws? Are there unintended consequences? Are the decisions being made as a result of weighing the pros and cons to make sure that we are not causing unintentional harm? To help me understand the topic, I have been researching counterarguments against price-control measures, because the opposing views are not often talked about in the liberal state of California where I live, even though these are things well worth considering. My goal is that we can all think critically about such laws in order to be an informed voter, because these issues often come up in local elections.
Let’s start with rent control by considering the case of San Francisco, a city notoriously known for its lack of housing and exorbitant prices despite its rent control laws.
According to the citywide ordinance in San Francisco, an owner of a rental unit may not increase the rent by more than 5% annually against a current tenant. Given the current severe housing shortage in San Francisco, there is a drastic difference between how much a landlord can charge a tenant who already lives in a unit and wants to stay, compared with how much a potential new tenant moving in is willing to offer for the same unit. Rent control laws are popular among the public because the name suggests that it should control the rent, making it affordable for more people to live in that area. Because of that, many politicians in the past have implemented them to gain the support of the voters. However, a careful study of the topic reveals that rent control laws are ineffective at best in what it claims to do (to control the rent), and actually result in the opposite effect. Rent control is the main driver in rising rents, homelessness, and gentrification in an area, harming people, especially the poor.
To understand the topic better, it helps to first to put ourselves in the shoes of the landlords, such as an owner of an apartment complex. Remember that rent control law results in a large price difference between what future tenants are willing to pay, and what a landlord is allowed to charge the current tenant. As a result, the owner has all the incentives to kick out the current tenant for a new tenant. But that is often difficult to do, so the next best thing is to convert the rental unit into other forms of investment, such as commercial buildings or luxury condos for sale, which will command very high prices and offer a better investment opportunity than being a landlord. Such an incentive placed city-wide by an ordinance leads to an even greater shortage of rental units in the city, as more and more rental units get converted to serve other purposes, while very little new rental-units are being built in the city. Even as the city is expanding and businesses are moving in which should also have a corresponding demand increase for housing, investing in rental units is not as attractive as other forms of investment. The resulting shortage almost always means higher prices in the long run for the remaining rental units due to low supply and high demand. As prospective tenants bid up the prices for their chance to move into the city, rent becomes exorbitant. The people hurt most by rent control laws are the poor. Many rich future tenants pay bribes to the landlords to secure rental units. Some tenants even secretly sublet their unit at market price significantly above what they are paying to the landlord. In fact, my friend was recently paying $1600/month to his roommate to share a unit in San Francisco in which she has lived before him, signaling that the fair market value for the unit should be around $3200. Despite that, his roommate was paying significantly less than that to the landlord, because the landlord was forbidden by law to collect the profit from the arrangement between my friend and his roommate. No wonder that less and less investors want to supply rental units in such a city. As an investor, if I cannot collect the fair profits from my investments, I will forego the opportunity to invest in something else with my capital.
So a law designed to make housing affordable for people has the exact opposite effect as it causes a shortage and drives up the cost of housing. The story is much the same in other places that have implemented rent control: New York, Los Angeles, Washington D.C., and Oakland which are all facing increasing rent and homelessness.
Compare them to Tokyo, a large city with no rent-control laws. Tokyo has enough housing for people of all income levels because supply of housing has steadily increased in proportion to its population-growth historically. In Tokyo, a low-wage worker earning an equivalent of about $10 per hour can afford to live in one of the cheaper rental units in the city whose market rate is around $400, or about 25% of his monthly earnings, as long as he is okay with not living in the most convenient areas of the city. He would also likely have to live in a very small studio unit, and take a few more subways to get to work than the rich who tend to live in more central areas. It may not be the most ideal living situation, but it is comfortable enough, and it sure beats being homeless or having to live hours away from your place of employment, as workers in San Francisco often must do.
Speaking of homelessness, Tokyo has a homelessness population of about 1 per 10,000 residents. Compare that to New York city and Los Angeles, with a dismal 67 and 40 homeless persons for every 10,000 residents, respectively.
Anti-Price Gouging Laws
Let’s turn our attention to price-gouging laws. In California, its anti price-gouging statute prevents a merchant from raising the price of any item by over 10% in response to a declared emergency, such as a natural disaster. In theory, such a law sounds good, as it should keep items affordable for the poor, who tend to be the most vulnerable when disaster strikes.
However, forbidding prices to go up ignores the fact that in case of a natural disaster, the demand for certain products can rise significantly in a very short amount of time, driving up the market rate for various products. The very definition of what used to be “normal” does not apply anymore, as there is a new normal price determined by the sudden spike in demand. If merchants are not allowed to raise the price of these products, these products will immediately sell out, and their prices will rise any way through the secondary and black markets, as people who make it to the stores first will hoard these items, often to stock up for emergency or to sell them at a much higher price that people are now willing to pay given the new circumstances, leaving little for the poor for a chance to get the products. An anti-price gouging law cannot fight the market forces to control the prices as it intends to do.
What is the effect, then, of such a law? It turns out that it is very similar to rent-control laws mentioned above. When a law prevents price of a product to rise in response to the current market conditions, producers of that product don’t have a strong enough incentive to produce more of that product, and the merchants of that product who operate in multiple regions to divert its normal supply chains to provide more of that product to the area where price is rising, signaling the highest need. Because of the lack of incentives on these key players in the market, laws preventing price hikes lead to a severe, ongoing shortage of the product in question. A price hike may be unfortunate, but as long as incentives are allowed to fluctuate freely with changing market conditions, high-prices prevent people to hoard an item unnecessarily in the short term, and prices come down quickly as more suppliers start providing the product to the affected area. This is a much more desirable effect than an ongoing shortage.
For example, an ongoing shortage of masks in an area devastated by a wild fire could mean life and death for many of its residents, and it is tragic that anti-price gouging laws can indirectly kill people by failing to incentivize the market forces to bring more masks to the area. It is one thing to be skeptical of free market forces when it comes to topics like health insurance and the environment which have externalities that the market fails to address, but a whole another to ignore its efficiency of providing a high-demand product in a high-demand area. Free market forces act significantly faster to solve a simple shortage than a government bureaucracy trying to supply the product in such a scenario. The government does not have the right connections to the producers and the merchants to devise an effective policy overnight to save the lives of these people, while a web of producers, delivery services, and retail stores responding to the market forces are very effective to quickly divert products to areas in need.
Economists are often criticized for simplifying the world with sketches of supply and demand curves on a napkin to explain such phenomena, but there is an important wisdom to be gained by trying to understand how supply and demand works at the most basic level. I liken it to future mechanical engineers who study about frictionless inclined-planes in their introductory physics course, even though no such object exists in the real world. The education obtained here is nonetheless crucial to the career of this future engineer or the future voter in understanding more complex topics.
Anyone who studies the history of price controls cannot deny that government-imposed price control measures have consistently led to severe shortages any time the market price for any product goes above the price allowed by law. The gasoline shortage during the 1970’s oil embargo, the shortage of apartments in rent-controlled cities, food and basic necessities in Venezuela under Hugo Chavez’s policies placing a cap in their prices, the shortage of doctors in countries where the government imposes how much a doctor can charge for various services, are all examples of this. It is just difficult to see the causal negative effect of these policies because under normal circumstances, market prices for most services and products do not go above the level imposed by the government. When it does suddenly many years later, the politician who implemented such an erroneous and mistaken economic policy (often with praise from the citizens at the time of implementation) is usually long gone from the office, as society is left to deal with the devastating consequences, wondering why the shortage does not get solved even as people suffer.
Minimum Wage Laws
Finally, let’s turn our attention to minimum wage laws. Perhaps this is the most controversial of the three price control laws I mentioned today, because it affects the most number of people on a daily basis. It is also the most complex of the three, with its long-term effects not completely understood given the complexities of the labor economy. The key difference between a minimum wage law and the other two laws I mentioned above is that a minimum wage is a “floor” placed on the price of labor setting a certain minimum, as opposed to price-control measures such as rent control and anti-price-gouging laws, which are “ceiling”s setting some maximum level.
The typical Econ 101 textbook states that a price floor results in surplus, while a price ceiling results in a shortage. So the minimum wage law, which effectively sets a floor on wage, should cause a surplus in the available labor, meaning higher unemployment rates. The simple explanation may miss some key insights because of the long-term effect on the well being of the economy when people, especially the young, forego working for other high value activities such as education. Also, it is possible that businesseses may be underestimating the value of a worker and underpaying them. Paying too much for a worker hurts the bottom line for obvious reasons, but paying workers too little could also be damaging too if the wages are so low that a job loss does not hurt, in which case those workers have little incentive to be actually productive at work.
The key argument for minimum wage law is that by setting the minimum to a “livable wage” to meet the basic living conditions, poverty should be eradicated. It sounds beautiful in theory.
But at the same time, it doesn’t take the most intelligent economist to see that you can’t just raise the minimum wage to any price you wish. For example, raising the minimum annual salary to $100,000 for everybody sounds great at first if we can all earn a six-figure income starting tomorrow and live in abundance. But if such law were to be implemented, any employee who does not produce that kind of profit for the employer with his or her skills will be laid off soon, as there is no reason whatsoever for the business to keep such a person on staff. Engineers, doctors, and lawyers already earning a six-figure salary will likely keep their jobs, while many people will lose their jobs, at least temporarily, as the economy slowly adjusts to inflate the price of everything to negate the effect of a higher income, at which point people can be employed again.
So by common sense, we can’t set the minimum wage to $100,000/year without causing massive unemployment in the short run and inflation in the long run. So what is the result of a more realistic minimum wage, such as $15/hour, that many proponents argue for?
In the short term, it will not change much of anything for most people in their mid-careers, because they are already earning wages well above $15/hour anyway. The only people initially affected by the law are people currently working for under $15/hour. By the same logic as the example of the $100,000/year minimum wage above, with a $15/hour minimum wage, companies will have an incentive to layoff anyone whose work and skill does not produce a profit to the business equivalent to $15/hour. These are mostly people in entry-level jobs with little experience nor knowledge on how to do the jobs effectively yet, such as students or people straight out of prison working at their first job.
Even though the proponents of minimum wage often cite how impossible it is to raise a family on minimum wage, it is important to recognize that a majority of people working minimum wage jobs are actually not raising families. They tend to be young, inexperienced workers working their first job to gain a footing in the world of work. For such people, an opportunity to work and build experience, regardless of any wage, may be more important than a higher wage, and a minimum wage law inevitably means that some of them will be unemployed because their market wage is worth less than what the law allows.
Of course, young people finding a difficult time finding employment can forego work now and focus on their education which also lead to future opportunities, and that is not a bad thing. So I don’t know whether the overall effect of minimum wage laws on society are positive or negative in net, although I suspect the effects are pretty small considering the vast size of the economy as a whole and the wages of people which are mostly above minimum wage anyway. Minimum wage workers represent only about 0.1% of the economy in terms of number of workers. Regardless, to those few workers, a minimum wage law may mean a disruption to their career, because the law may prevent an employer to hire a worker at a price that they both agree on as being beneficial to both parties. There are certainly instances when workers will be willing to take a wage below the mandated minimum because they can benefit from the work experience. If the law unintentionally prohibits such a contract between a business and a potential hire even though both parties are willing, it has done harm to those parties.
One irony of the minimum wage law is that its proponents are often economic liberals (in the American sense) who generally favor government intervention to control business sizes. They claim that corporations are getting too large and that is bad for competition. But they fail to recognize that minimum wage laws favor large corporations, as they are the ones who can afford to pay a higher wage, while small businesses are more likely to go out of business because they tend to have much smaller profit margins and thus are hurt the most by having to pay a higher wage.
Proponents of minimum wage laws should critically think about these trade-offs before coming to any conclusion.
My goal in analyzing price control laws today was to frame the conversation as a trade-off between pros and cons after having understood both sides viewpoints, rather than an emotional argument about right and wrong which will never lead to good policies. These are nuanced topics with no one right answer, so being aware of the implications is crucial. Policies and their effects are not simple to understand. It is not about implementing what satisfies our emotions. Every policy has trade-offs that must be considered. Have we thought about what those might be? If not, let’s think them through. After we’ve done so, are the trade-offs worth it? These questions must be driving our conversations.