The correct way to argue with Milton Friedman

by Daniel on August 19, 2004

I’m pretty sure that it was JK Galbraith (with an outside chance that it was Bhagwati) who noted that there is one and only one successful tactic to use, should you happen to get into an argument with Milton Friedman about economics. That is, you listen out for the words “Let us assume” or “Let’s suppose” and immediately jump in and say “No, let’s not assume that”. The point being that if you give away the starting assumptions, Friedman’s reasoning will almost always carry you away to the conclusion he wants to reach with no further opportunities to object, but that if you examine the assumptions carefully, there’s usually one of them which provides the function of a great big rug under which all the points you might want to make have been pre-swept.

A few CT mates appear to be floundering badly over this Law & Economics post at Marginal Revolution on the subject of why it’s a bad idea to have minimum standards for rented accommodation. (Atrios is doing a bit better). So I thought I’d use it as an object lesson in applying the Milton Friedman technique.

Let’s see what Alex Tabbarok has to say:

” If tenants benefit from a law that says apartments must have hot water then surely a law that says tenants must have hot water and a dishwasher benefits them even more, right? What about a law that says tenants must have hot water, a dishwasher and cable tv? By now the students have cottoned on to the idea that the rent will increase. Once you realize that the law causes the rent to increase it’s no longer obvious if tenants benefit or if landlords are harmed.

We can work out what happens with sone numbers. Let’s suppose that after much bargaining the tenant and landlord have agreed upon the rent and the amenities – each party to the contract is profit maximizing, doing as well as they can given market conditions and the interests of the other […]”

Hold it right there.

“No. Let’s not suppose that”

Specifically, let’s not suppose that all the negotiations between tenant and landlord have been sorted out in a reasonably equitable manner. Let’s suppose instead that those negotiations are going on right now.

It is really quite rare to find a buyer’s market for rented accommodation. Even if there is a slight oversupply of rental units for sale, time is almost always on the landlord’s side, because waiting is typically much more inconvenient for the party that has to wait without a house to do wait in. In general, when tenants and landlords are negotiating over the potential Pareto gain that could be made from renting the house, the landlord ends up capturing most or all of the surplus. The hot water and habitability laws are simply aimed at skewing things a bit in favour of the tenant and putting a floor on how bad a deal the tenant can end up accepting. It’s a standard game theory result that something which reduces your options can benefit you by reducing the number of bad options that you can end up agreeing to (most famously, the secret ballot has to be compulsory, because if you had the option to reveal your vote, you could be intimidated), and habitability laws are there for exactly this purpose. Mystery solved, through application of the Friedman technique.

This sort of issue (the way in which legal frameworks shape negotiations over the gains from economic interactions) was right there at the start of the law and economics movement with Ronald Coase. Which is why it’s a mystery to me that modern law ‘n’ economics courses appear to have abandoned them in favour of rinky-dink numerical models with politically convenient deregulatory conclusions.

{ 77 comments }

1

epist 08.19.04 at 12:29 pm

While you’re right to point out the dubious assumptions here, a further problem with Tabarrok’s piece is that he argues that habitability standards would drive rents up because the criterion we would use for determining what makes it into a habitability standrd would be something like “such a provision would be good in some way”. Thus dishwashers, etc., which would be good, would have to be included in the standard. This is obviously false. Any plausible standard would be much stronger than that. He claims over at Kevin Drum’s blog (where I have a much windier post saying roughly the same thing) that this silly argument was merely designed to get students to think about how habitability standards would increase rents. Perhaps, but a foolish way to do it, if you ask me (although no-one did).

2

Paul Gottlieb 08.19.04 at 12:43 pm

Reducto type arguments are deeply beloved by bright 10-year olds, because they seem clever and give one a sense of intellectual power. Most peope outgrow those feelings and learn to argue realistically, the rest become Professors of Economics at the University of Chicago.

Paul Gottlieb MBA CHicago 1972

3

Adam Scales 08.19.04 at 1:17 pm

I’m not sure I understand the objection here. I agree that little actual bargaining takes place and that habitability laws attempt to substitute a raft of minimally acceptable terms into what would otherwise be unconscionable adhesive contracts.

But I do not see where CT or Atrios is disputing Tabbarok’s basic point: habitability terms are not costless and may not reflect the parties’ preferences. And, at some point – for him the dishwasher, for someone else, perhaps free removal of snow from the tenant’s steps – such rules leave particular tenants worse off.

I think it is a tough argument that we should dispense with these laws, particularly in view of the reality that few tenants can effectively bargain over lease terms. Perhaps abolition is Trabbok’s view, but he does not seem to be making THAT argument here. Instead, his (so far unrebutted) argument is that consumer-friendly implied terms may miss the mark. Extending his argument slightly, they could be wrong by 1) incorrectly guessing what such items are worth to all consumers, or 2) incorrectly guesing what they are worth to some subset of consumers, who will not be able to opt out in order to vindicate their preferences (and save money while freezing their toes and eating off disposable plates).

Please tell me what I’m missing here.

4

John James 08.19.04 at 1:22 pm

“Even if there is a slight oversupply of rental units for sale, time is almost always on the landlord’s side, because waiting is typically much more inconvenient for the party that has to wait without a house to do wait in.”

No, let’s not suppose that.

First, oversupply of rental properties is, in fact, quite a common occurence. In London, for instance, residental rents are on average 10% lower than they were 3 years ago.

Secondly, most landlords have loans and interest to pay on a monthly basis, so any hanging around costs them greatly.

It seems to me that your own logic suffers just as much as Friedman’s does from flawed assumptions.

5

Brock Sides 08.19.04 at 1:37 pm

the rest become Professors of Economics at the University of Chicago.

Just to keep the record straight, Prof. Tabarrok is a professor at George Mason.

6

john b 08.19.04 at 1:44 pm

In London, for instance, residental rents are on average 10% lower than they were 3 years ago.

As someone whose friends rent houses in London, and who’s currently looking to rent a house in London, that unsourced factoid seems, err, non-intuitive. Any evidence?

7

Tom T. 08.19.04 at 1:56 pm

Following up on John James’ point, I have seen a couple of news stories about the local rental market (Washington DC) having softened, pushing landlords to offer more amenities, because low interest rates have drawn so many former renters into home ownership. I have no idea whether it’s true, and I have no citations for the group.

I don’t think this detracts from Daniel’s basic point, however, which is that one should be aware of and challenge the assumptions in any argument (or counter-argument). This strikes me as a universally applicable principle, not limited to Milton Friedman or economics.

8

praktike 08.19.04 at 2:02 pm

Eh.

I thought outright mockery was the superior rebuttal technique.

9

Martin 08.19.04 at 2:03 pm

10

Tracy 08.19.04 at 2:14 pm

How can you say that when landlords and tenants are negotiating over rental properties, the landlord winds up with most of the surplus? I’ve been renting all my adult life and I’ve never felt this. Even setting aside the landlord who used to leave jars of homemade jam outside the kitchen door.

Your argument that tenants have to find a place to rent, while landlords can wait, is not convincing. As a potential tenant I have used the following strategies:

1) Look for a new place while still living in old place. On finding new place, give notice on old place. (Or arrange for one tenancy to start when old one has finished)

2) Stay with family or friends while looking for flat.

3) In London, move into room in a house on a non-fixed lease, while looking for flat.

On the other side, most private landlords have mortgages and the rates to pay, and want to get a new tenant in quickly to keep covering their costs. If you were paying $280 a week on an empty house, you’d probably feel some urgency about the issue. And if the house is freehold, they’re still facing rates and the opportunity cost.

As a tenant, the chief floor on how bad a deal I accept is my ability to refuse to sign and go looking for a new flat. Anyone who is psychologically incapable of refusing to sign a rental contract has more problems than can be tackled by rental regulation. And the beauty of refusing to sign is that it can cover things that government regulation can’t, like the place being too far to bike to work, or not having a view of the harbour, or whatever else you happen to want in a home. Or the landlord’s particular wants – I think the jam-making landlord I mentioned above was mostly in the business in order to have more garden to grow roses than she could otherwise afford.

Of course, I’ve never lived in a place with rent control, so I’m used to plenty of rental properties. But if that’s going to be the base of your argument that all the benefit goes to the landlord, then the obvious solution is to get rid of the rent control.

11

Barry 08.19.04 at 2:25 pm

Brock Sides:
“Just to keep the record straight, Prof. Tabarrok is a professor at George Mason.”

I think that that is where the Chicago wannabe’s go. Along with Texas A&M.

12

digamma 08.19.04 at 2:31 pm

My current landlady gave me one rent-free month as an incentive to sign a year’s lease. The apartment downstairs has been empty since I moved in in May. The government doesn’t force her to include hot water and heat with the rent, but she does. I’m pretty sure central Vermont (where heating is far from cheap) is a renter’s market.

13

dsquared 08.19.04 at 2:32 pm

First, oversupply of rental properties is, in fact, quite a common occurence. In London, for instance, residental rents are on average 10% lower than they were 3 years ago.

John, I’d also like to know where you got this figure. The ODPM data certainly don’t suggest this, and nor do the ARLA or IPD numbers. Admittedly, most of these series are only published annually, but there hasn’t been a collapse of this kind in 2004 to date. My guess is that you’re working off the FPDSavills index, which only really refers to what Savills calls “prime” London property. Even then, your statement is misleading; rents at the top end fell by 10% in the final quarter of 2001, have been basically flat ever since and have recently begun to crawl back up. If you’re trying to tell me that there’s an oversupply of rental properties in London, there’s a limit to how long I’m gonna be able to keep a straight face.

Even in a period of falling rents, btw, the negotiations still usually favour the landlord, simply because the cost of waiting (maybe a month or two’s void) is less for him than the cost of having no home.

Without wanting to get into a dick size contest here, I would tentatively venture that I am in a Raoul Capablanca situation with respect to this issue; if there was a chance that you knew more than me about residential property letting in London, then I would probably know you. The fact that you’re grossly exaggerating the importance of voids to residential property investment suggests to me that you don’t.

Adam: where I am disagreeing with Tabarrok is in his contention that habitability laws don’t benefit tenants, in general, and specifically his contention that landlords increase rents to recapture the costs of making properties habitable. As I’ve indicated, it’s far more likely that the laws work by improving the tenant’s bargaining position, and that there is thus a transfer of surplus from the landlord to the tenant.

14

kevin quinn 08.19.04 at 2:42 pm

It doesn’t seem to me such an outrageous assumption that the rental market is reasonably competitive. Then the point is simply that amenities which are efficient – which are valued by buyers at more than the cost of providing them – will be provided without any regulation, as it would be in the interest of the landlord to provide them.

15

dsquared 08.19.04 at 2:44 pm

Martin: Your search seems to me to turn up a lot of references to 2002, when rents did fall in prime London property.

Tracy: I don’t understand what your point is about rent control. Other than that, I’ve been on both sides of landlord/tenant negotiations, and so I’m happy with the assertion I’ve made.

Digamma: I don’t think many people would consider central Vermont to be typical of rental markets. Not urban enough.

Omnes: GMU is, to my way of thinking, a lot better than Chicago. Chicago is these days the home of mindless neoliberal orthodoxy. GMU is the home of some decent Austrian economics and is at least doing some original work rather than calculating third differential saddle point equilibria of models that were wanked dry by Samuelson forty years ago.

16

anon foo 08.19.04 at 2:46 pm

Offtopic/tangential: Once upon a time, I rented a room without even a shower, but I was glad too, since the rent was only a quarter what I could otherwise get :-)

17

DeWayne 08.19.04 at 3:02 pm

For the chattering classes: two economists find themselves at the bottom of a deep pit. They each look skyward judging their depth and dilemma. One says to the other, “well, first lets assume a ladder…”

18

Mats 08.19.04 at 3:03 pm

Now, if people were to live in apartments without hot water, they would probably be more likely to catch infectuous diseases, which might spread even to people in better apartments. You don’t actually have to be an economist to unsterstand that. Thanks anyway for a highly interesting post!

19

John James 08.19.04 at 3:25 pm

Daniel, I was referring to the FPD Saville survey, a potted version of which I read in the Metro a while back. No, I don’t have the date.

So, I don’t doubt your superior knowledge of the conditions of the London rental market, which you managed to convey with such equanimity. Nevertheless, you do acknowledge that in parts of London, rents have fallen.

Your argument was not, however, about the specifics of anyone area. You built into it the assumption that, as a general matter oversupply of rental units is a rarity, and that for tentants it is therefore invariably a seller’s market. What is the basis of this assumption? If you answer me that, I will shut up.

20

geeno 08.19.04 at 3:30 pm

Actually these laws are directed at “Slum Lords”.
People with bad credit histories or felony records are often stuck renting from whomever is willing to rent to them. Most landlords consider them bad tenants and won’t rent to them. Slum lords would step in and give them a place to whole up for high daily or weekly rents in buildings that wouldn’t even pass building code inspections. Since most housing in the worst neighborhoods ended up in the hand of a few absentee landlords, they would frequently collude on rents and amenities, etc.
These laws were passed to make sure that such housing was ,in fact, habitable. Naturally, with the high profit margins gone, most of these properties have been dispersed to smaller landlords thus restoring traditional market forces in the tenament market.
On the whole, I would say these laws were quite effective at their original purpose and should be retained to prevent a reversion to the previous state of affairs.

21

Katherine 08.19.04 at 3:34 pm

Well, the habitability requirement is a better assumption about people’s preferences than the employment-at-will assumption, that’s for damn sure.

22

geeno 08.19.04 at 3:40 pm

Also, collecting rent isn’t the landlord’s only priority. None of the posts so far (my own included) has addressed racism in the housing market. There ARE landlords that won’t rent to “those people” – whoever they are. That automaticly narrow “those people’s” housing inventory and undercuts their negotiating position. Economics doesn’t exist in a vacuum.

23

Katherine 08.19.04 at 3:41 pm

Also, people tend to sign contracts with a general assumption that the other party won’t be allowed to really screw them over. There is little scrutiny of the fine print, and little actual bargaining. This isn’t as true of leases as some other products (those long clickable disclaimers with software programs, the fine print on the back of your airline ticket…) but it’s still true to an extent. And before conservatives start in on renter’s “personal responsibility”, they should note that it would actually be much more inefficient to spend a lot of time bargaining in these situations than to assume that people want heat and hot water.

24

Dave 08.19.04 at 4:04 pm

You can argue this one from an economic standpoint, and I think the “slippery-slope” argument does fail miserably.

However, this is the kind of thing the libertarians are just *wrong* about. I am far from being a socialist, but I believe the government has an obligation to establish an absolute minimum standard of living for all citizens. Sure, there are people who would work for $2/hour, but we don’t let employers pay that little. There are people who would pay for an apartment without electricity or running water, too, but we don’t allow it.

Why don’t we allow it? For one, the government usually ends up picking up the basic standard-of-living cost for these people anyway (this is also the practical argument for government-subsidized health care). But what it really comes down to is that there’s a certain standard of treating people below which we just don’t find acceptable. I don’t see anything wrong with that, either, in a modern, enlightened society. Let the markets be damned.

As an aside, establishing a minimum standard of living also defeats the slippery slope. The argument being presented by the libertarians is that hot water is “good”, so we mandate it. Since a dishwasher is also “good”, we would then mandate that, too. However, if the standard is “absolute minimum acceptable standard of living”, then it’s easy to make an argument for electricity and hot water, but not dishwashers and air conditioning (well, except maybe in Phoenix).

25

sd 08.19.04 at 4:28 pm

Daniel,

I used to do consulting work for a residential real estate holding company and I can assure you that you are absolutely wrong in asserting that it is “quite rare to find a buyer’s market for rented accommodation.”

Rents in the vast majority of US markets are down significantly from their peaks several years. ago. Even with an improving economy, there are only a handful of MSAs with higher rents than this time last year.

Remember, real estate is a wasting asset. If I own an apartment, for every week that it sits empty I lose 2% of the revenue on the unit for the year, but my costs of owning and operating the unit fall only by the tiniest of amounts. A month of vacancy likely means I lose money on the unit for the year. Time is, most assuredly, not on landlords’ side.

True, if I’m a propspective tenant and I only have one possible option for where to live (Oh shit, there’s just one apartment left in all of New York!), then my not having a home for a week is worse than the landlord not having 2% of his yearly revenue. But that’s not the world I live in.

26

Lynne 08.19.04 at 4:31 pm

We don’t live in a society where you can trust landlords to do the right thing regarding tenants. Or vice versa. If this idea was implemented, I shudder to think what sort of accommodations and health problems would come out of it in the end.

I am obiviously not an academic, but I do enjoy this blog. What I can’t understand is why some of these academics (Friedman, Chomsky) get the attention that they do. They seem like raving nutjobs to me. Why give them such platforms?

27

Sam 08.19.04 at 4:36 pm

I disagree, based on personal experience and family history. The first house I remember living in would not have passed any habitability standard that a Western society would propose.

We lived in this house from the time I was 2 until I was 5, so I don’t remember it clearly. When my parents were looking for a place to live, my father went to talk to a man who rented out trailers for $30 a month. Now trailers—especially rental trailers—are near the bottom of the housing market. But what was my dad’s question? “Do you have anything cheaper?” As it turned out, the man did—he just didn’t expect anyone to want to live there. It was a two-room shack, with no indoor plumbing and no insulation and board walls. But yes, he would rent it for $15 a month. My parents cleaned out the 9 pickup loads of accumulated trash and stapled all the carboard they could find to the walls, and lived there for three years. Clearly, my parents PREFERRED to live in this shack than to pay the additional rent that indoor plumbing and insulated walls required. I don’t see why they shouldn’t have been able to make that choice.

28

Guy 08.19.04 at 4:41 pm

It’s also pretty clear that if landlords have private information about the property in question (a la the Lemons Problem), effective government intervention can increase social welfare. Guaranteeing (by law) a minimum standard for certain apartment characteristics may be such an intervention. (Which I guess is sort of what Atrios/Duncan said.)

29

Tracy 08.19.04 at 5:14 pm

Dsquared – you may stand by your assertion. It still completely fails to convince me. For a start, I have no idea how you’re measuring surplus, since a lot of the benefits of having a home are non-monetary. When you were a tenant, did you really believe that if rents rose by $1 you’d move out and live on the street?
The rent control point was that rent control decreases the number of flats available, and thus makes things more difficult for people looking for a flat. I’ve heard some horror stories about flat hunting during the early 1980s price freeze in NZ. And from the landlord side too. It’s one thing to have a lot of tenants to chose from, it’s another to have your phone going constantly from anxious callers.

Dave – a great-great aunt of mine, born before electricity, refused to have any installed despite the fact that her children were willing to pay for it, and lived out her days by candlelight and wood fires – cue all the sterotypes of “if God had meant us to fly he’d have given us wings” and “if it was good enough for Captain Cook then it’s good enough for me”. Should the government have forced her to get electricity installed? She always kept the house spotless, so it wasn’t a health risk.
And I have spent a fair bit of time off camping, without electricity (though frequently, an over-ample supply of running water). Should the government ban me from doing that?

As for the caveat emptor – there is an interesting study of the history of common law and liability that notes that as, over time, houses got more complicated, the common law decisions shifted from caveat emptor to liability for the landlord to ensure that electricity and other complicated things were correctly installed and working. Which makes economic sense, as the landlord is best placed to know if the electricity is working. But these are different things – the question of who the rights should first be signed to, vs banning people from negotiating other options.

30

Bernard Yomtov 08.19.04 at 5:23 pm

As has been poined out at Drum’s site, this sort of rule is valuable when an apartment suddenly loses hot water, because the water heater fails, for example, since it forces the landlord to repair the situtaion in some sort of timely way.

31

son volt 08.19.04 at 5:25 pm

The slippery slope would seem to be the crux of the matter. Just because someone is willing to live in a structurally unsound building doesn’t mean we shouldn’t have building codes.

A leaky roof, no locks on the doors, etc., are matters of health and safety. A dishwasher and cable are matters of comfort and convenience. Hot water is close to the dividing line, but firmly on the health side of it.

32

Dave 08.19.04 at 5:28 pm

Clearly, my parents PREFERRED to live in this shack than to pay the additional rent that indoor plumbing and insulated walls required.

The problem with this – and there’s nothing wrong with your parents’ choice, btw – but the problem with this is that if enough people made the same choice, the results could be disastrous. Inadequate plumbing, lack of climate control, and poor housing have social, health, and economic costs that go far beyond the tenant or the landlord.

If you want to go back to the time of Hoovervilles, you’re welcome, but I’ll pass, thank you.

33

dsquared 08.19.04 at 5:45 pm

nd that for tentants it is therefore invariably a seller’s market.

The phrase I used was “in general”, not “invariably”, and I think that clears up most of the objections on that issue.

34

Matthew 08.19.04 at 5:57 pm

London: a heaven for the renter! Low prices, quality properties, good legal protection for tenants… No wonder there are so many people living there!

35

brian 08.19.04 at 6:16 pm

Daniel, you’re making no sense at all. Tabarrok allows for the case where the landlord has greater negotiating power and skill.

case 1: evenly matched. the good is provided at $125 over what the rent would have been. The landlord loses $25 because he is forced to pay $150. The tenant loses $25 because he values it at $100. Net detriment to humanity: minus $50.

case 2. the tenant is stronger. The landlord loses $50 because he is forced to pay $150 but can only receive $100. the tenant gains nothing because he values it at $100 and pays $100. Net detriment to humanity: minus $50.

case 3. the landlord is stronger. the landlord extracts $150 and pays $150 so no benefit. The tenant pays loses $50 because he values it at $100. Net detriment to humanity: minus $50.

Of course the price can be lower than $100 if the tenant is very strong, but the landlord will just find that unreasonable and rent to somebody else knowing that if one person likes hot water it stands to reason that there are other people who like it too. Likewise the price can be higher than $150 but then the tenant will just walk because he knows that another landlord can go to the same supplier and get it installed for $150.

If Tabarrok is wrong, then you will get the Nobel prize almost for certain since I believe the 1991 prize to Coase endorsed the idea that some but not all minimum standards are bad for welfare.

Of course it’s politically convenient to misread Tabarrok and do a strawman attack.

36

BIgMacAttack 08.19.04 at 6:32 pm

Surplus or lack of housing units who cares?

If there are many buyers and sellers the market is competitive.

Price schmice. Surplus or shortage doesn’t mean a market is or isn’t competitive it just makes for different prices. And in a competetive market sellers have no such power. Right?

Clearly there are many buyers and sellers.

I don’t think it is outrageous to ask Daniel for his evidence that the market is not competitive.

But I am not holding my breath.

I cannot believe I am saying this but Atrios made a good point. Such laws might save us transaction costs. I think they probably do.

That has to be weighed against the consequences for people like Foo. They are forced to pay more or cannot rent at all.

That twinky you are eating is a health hazard. The social costs are quite high. Please put it down or we will pass a law and make you. Also people who believe in god and who go to church live longer, happier, lives. Please get to church. The social costs of your atheism are just too high for me to bear. Here comes a law to make you. (The social costs of the reasoning of the social costs folks is what is really costly.)

37

brian 08.19.04 at 6:36 pm

Actually, I believe he was awarded the prize for saying that all property rights (who must grant whom with what) do not affect production (of housing for example) when there are no transaction costs. Of course the assumption of no transaction costs does not render the discovery useless because for many activities, the transaction costs are small enough not to change the outcome.

38

Walt Pohl 08.19.04 at 6:49 pm

Lynne: Friedman and Chomsky made influential contributions within their areas of expertise. (Which doesn’t mean we should listen to them on any other subject.)

39

BigMacAttack 08.19.04 at 6:57 pm

walt pohl,

The general subject seems to have something to do with economics.

Let us assume Friedman more or less agrees with Tabbarok.

Shouldn’t lynne perhaps at least consider listening to Friedman instead of dismissing him as a nut job?

40

dsquared 08.19.04 at 7:11 pm

Brian: As you can read above (the clue is in the words used, as well as their spatial organisation into sentences), my point is entirely that the laws have the effect of making cases 1 and 2 more common and case 3, which would otherwise be the rule, less common. To the benefit of tenants and the detriment of landlords. Feel free to be as rude to me as you like, though; what the hell, it’s Thursday.

41

jrv 08.19.04 at 7:36 pm

The crux of the matter is one of public goods. A contract is a private good between two autonomous parties. However, mister shack-man may choose to live in the shack SO LONG as this choice does not endanger the public good. The question of disease risk starts to become a shaky one however. Science can demonstrate extremely small risks to the public good, but not all of these risks are worth regulating. Cost-benefit analysis is absolutely essential. In any case, the initial argument about ‘no buyers markets’ was ridiculous. And the whole premise of this line of how to argue against ‘Milton Friedman’ is even moreso. Every school of thought takes into consideration a series of assumptions. It just so happens that Friedman has a superior set of assumptions to those of his non-economist idiot friends.

42

Jack 08.19.04 at 7:37 pm

Most of the goods required by building standards are capital expenditures very small in relation to the price of the building.

The standard serves to ensure that the capital investment is justified and makes the benefit available to renters at the cost of maintenance without the necessity of paying the landlord a risk premium on the investment.

That is a consideration that should be built into the welfare calculation as should the public health benefits. These are not present in Prof. Tabarok’s examples .

I also suspect that building regulations at the low end of the market function more as a wealth tax than an income tax in that most of the cost will be worn, indeed have been worn, by the capital value of the housing stock and won’t translate losing hot water into beer money. If such regulations were repealed today in the short to medium term many people would end up paying the same rent and taking the boiler maintenance costs which would amount to a one time transfer of wealth to landlords. In other terms the inefficiency of wealth taxes is much lower than that of income taxes and the welfare calculations might not go as simply as the fag packet calculations on show here suggest.

It is also surely wrong to assume that there is no market impact on state regulations. Most of these regulations are old and have been set at a level that does not include mandatory dishwashers and plasma screens for a reason. If the law was excessively onerous there would be a larger black market and popular pressure to relax regulations. Government regulations can be immensely helpful to industry, with medicine, water and aviation just some of the areas where we would not be keen on a totally free market.

43

jr 08.19.04 at 8:16 pm

Frequently the reason people lose arguments to economists is that they don’t know anything about any field other than economics. In this instance, a bit of social history, public health, and epidemiology would help. Housing codes were not enacted and are not intended to alter the balance of power in negotiations between landlords and tenants. They are designed to ensure minimum safety and health standards to protect populations (particularly children and the elderly) that are particularly vulnerable to disease and other harm. Unpolluted running water, and in particular hot running water, is one of the greatest advances in public health in history. Without it, lice, bedbugs, and disease proliferate. Other residential code requirements — numbers of persons per room, need for windows in bedrooms, plus more recent requirements like remediation of lead paint — are all intended to protect the public health. Does anyone think that it’s okay for landlords to rent units without toilets, so that tenants have to shit and piss in the alley? If not, then we’re all in agreement that habitability requirements are a good thing. If the econ professors want to be involved in working out what the standards should be, then they can become public health specialists; otherwise, they should go back to their offices where they can suck wisely on their pipestems.

44

Jane Galt 08.19.04 at 9:56 pm

Daniel, your contention that there’s almost never a buyer’s market for rental housing is certainly true in London and New York, but in most of the rest of America, it seems not to be true. And in New York (and London, from what I understand, though I know little about that market), one of the main reasons that it is a seller’s market is that government restrictions, in the form of zoning, community boards, rent control, and so on, have artificially reduced the supply of housing.

45

Jason McCullough 08.19.04 at 10:46 pm

“It just so happens that Friedman has a superior set of assumptions to those of his non-economist idiot friends.”

If you consider “assume I’m right” superior.

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Walt Pohl 08.19.04 at 10:53 pm

Bigmacattack: True, but even if Friedman’s position on this question were totally nutty, he would still be an influential economist for other reasons.

Jrv: This is economics, not mathematics. We’re ultimately interested in facts, not assumptions.

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Brian 08.19.04 at 10:58 pm

dsquared, it looks to me that Coase’s Theorem is what Tabarrok was writing about. It’s pretty unlikely that you will get the Nobel prize for proving Coase wrong.

Admitting case 1 is merely possible, which you have, is the same as admitting Tabarrok and Coase are right.

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Kimmitt 08.19.04 at 11:01 pm

It doesn’t seem to me such an outrageous assumption that the rental market is reasonably competitive.

I would state that it is — an unregulated rental market would fail two of the more important assumptions. The first is relative homogeneity of product — rental properties vary wildly in their capacities, location, aesthetics, et cetera. The second is full information — it would be quite difficult and time consuming to fully ascertain the quality of electrical wiring, plumbing, fixtures, et cetera. A regulated market at least starts to address the second problem, which turns the rental market into a monopolistically competitive market (with some submarkets that approach true competition), which is a lot better, from an economist’s point of view.

Anyway, what’s being missed here, I think, (including by me at first) is that the very issues which have been brought up — externalities, informational asymmetries, and transaction costs — are going to be discussed later in the course. If Prof. Tabbarok intends to reexamine this model using the new tools granted by each of these sections, it could be a reasonable teaching tool.

I still think that the complexity of the situation makes it a lousy one with which to attempt to illuminate economic principles. But the possibility exists that it is merely a bad example and not an attempt to indoctrinate.

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dsquared 08.19.04 at 11:01 pm

I’d add, of course, that the issue is completely asymmetrical; episodes during which there is an oversupply of rental accomodation do not typically lead to the immiseration of landlords.

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dsquared 08.19.04 at 11:23 pm

Brian: no it isn’t.

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Brian 08.19.04 at 11:27 pm

Please explain why it isn’t. I have re-read Taborrok’s original post and it is clear to me that the students originally felt unequivocally that the tenants were better off and that his point is that there are cases when they are worse off. Case 1 is one such illustration. You have admitted case 1 is possible. Thus my conclusion stands.

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dsquared 08.19.04 at 11:57 pm

Because the entire point of the law is to make case 1) less likely. This is the second time I’ve repeated this point.

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Kimmitt 08.20.04 at 12:01 am

dsquared, it looks to me that Coase’s Theorem is what Tabarrok was writing about.

Not . . . really, no. Coase’s theorem has to do with private solutions to externality problems. This problem includes informational asymmetry and transaction costs, which pretty much bar any application of Coase’s theorem.

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brian 08.20.04 at 12:07 am

Dsquared, you have contradicted yourself. First you wrote: “the laws have the effect of making cases 1 and 2 more common”. Later you wrote “the entire point of the law is to make case 1 less likely”. I think you are confused.

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dsquared 08.20.04 at 12:10 am

The secret to understanding that, Brian, is to understand that, because you can’t be bothered to be polite to me, I can’t be bothered to keep track of your numbering system.

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brian 08.20.04 at 12:27 am

I don’t think info asymmetry is a problem when landlords and tenants know what is the typical expectation of counterparties in the market. The landlord knows he might get lucky and find a spendthrift but he knows it’s a waste of time to put an ad in the paper offering housing at an absurd price. Transaction costs do not bar the application of Coase theorem when the costs are small enough (ie: my $1000 rent costs me $1500 because of fees, and the landlord collects a mere $500 because of fees he has to pay, in which case $100 to $150 for hot water is irrelevant because there will be no deal.) The cost of an externality is just an application of the Coase theorem. Think of the hot water is a positive externality.

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brian 08.20.04 at 12:44 am

dsquared, You have simply misinterpreted Tabarrok and have gone off on a tangent.

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brian 08.20.04 at 12:54 am

Making case 3 (strong landlord negotiating position) less likely, I agree might be one of the effects of the law. However, in case 1 (evenly matched power) the tenant is worse off and in case 2 (tenant has power) the tenant indifferent.

If the law eliminates case 3, you have case 1 and case 2. That is you have a detriment to the tenant or no change in the tenant’s position. Either way, Tabarrok’s students were wrong when the initially said it was good for tenants.

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Tom T. 08.20.04 at 1:30 am

episodes during which there is an oversupply of rental accomodation do not typically lead to the immiseration of landlords.

Locally, again, it is relatively common for residential developers to go bankrupt during difficult times. I suppose that’s not quite the same thing, though.

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Alex Tabarrok 08.20.04 at 2:28 am

The argument does not rely on perfect competition, which I never assumed, and also goes through straightforwardly with monopoly.

My analysis here:

http://www.marginalrevolution.com/marginalrevolution/2004/08/from_hot_water_.html

or read Glen Whitman’s admirably clear post:

http://agoraphilia.blogspot.com/2004_08_15_agoraphilia_archive.html#109296017978229833

Alex Tabarrok
Department of Economics
George Mason University

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Kimmitt 08.20.04 at 2:37 am

Brian, I’m not trying to be difficult, but I don’t think you have a lot of familiarity with these terms.

In order:

I don’t think info asymmetry is a problem when landlords and tenants know what is the typical expectation of counterparties in the market.

This really isn’t true; the classic example of information asymmetry is the hiring process, where a company has an incentive to misrepresent how tiring a job will be, while an employee has an incentive to misrepresent how good an employee he or she would be. Both parties are quite familiar with the expectations, and both parties make their manipulations with those expectations in mind.

Transaction costs do not bar the application of Coase theorem when the costs are small enough (ie: my $1000 rent costs me $1500 because of fees, and the landlord collects a mere $500 because of fees he has to pay, in which case $100 to $150 for hot water is irrelevant because there will be no deal.)

Theory predicts that the margins on a rental are going to be reasonably small — about six percent of the value of the property, per annum. If a property is worth, say, $100k (keep in mind that we are generally talking about “bad” properties which would consider leaving out a hot-water heater in the first place), the landlord expects to clear about $6,000 per year, plus or minus. A $500 fee per prospective tenant (keep in mind that the landlord will show the property to more than one tenant) is going to add up very quickly — which will give the landlord an enormous incentive to hide flaws. If he were successful in doing so, the tenant would only discover the flaws after moving in, at which point the tenant would have to endure either the significant cost of litigation or the significant cost of moving again . . . there would be a tremendous incentive to cheat. And that’s if the inspection only cost $500 a pop; in the absence of codes, et cetera, it’d be likely to be extremely expensive.

Think of the hot water is a positive externality.

The whole point is that the price of the hot water is included in the transaction cost. The Coase Theorem would involve neighboring landlords paying the landlord to supply hot water, on the assumption that the improved hygiene associated with the hot water would lessen the probability of (for example) a property-value-destroying plague of tuberculosis. Which has not been discussed.

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brian 08.20.04 at 4:33 am

The more difficult you are the more I will learn, so thanks. I will have to think more carefully about what you have pointed out.

Not that you care but, even if the coase theorem is not applicable, I’m not convinced that asymmetric info and transaction costs are the real reason.

Regardless, the simple arguments I put forth in cases 1,2,3 still show that the tenant does not benefit from the hot water statute.

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Kimmitt 08.20.04 at 5:14 am

…under the (absurd) assumptions that hot water costs as much as given and that the tenant values it as little as given, and not taking externalities or transaction costs into account.

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dsquared 08.20.04 at 1:13 pm

Brian (and Alex).

You’re resting your case that the laws make the tenant worse off on something like the following preference ordering for tenants:

(Strong tenant negotiating power, no laws) > (Strong tenant negotiating power, laws).

What I’m saying is that:

(Strong tenant negotiating power, laws) > (Weak tenant negotiating power, laws) => (Weak tenant negotiating power, no laws)

And noting that

(Strong tenant negotiating power, no laws)

is not an equilibrium of the game. If (no laws), then (Weak tenant negotiating power).

Therefore the best outcome that the tenant can actually achieve is (strong negotiating power, laws), and any superiority of Brian’s hypothetical case 1 (or case 3, I really don’t give a damn) is irrelevant.

Alex: As far as I can see, your case would not work if one assumed that the landlord was a monopolist. A monopolist sets his prices according to the marginal revenue curve, not the marginal cost curve. Thus a law which required him to provide costly goods would not change his price unless it priced him out of the market altogether.

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BigMacAttack 08.20.04 at 3:46 pm

Wow! Thank you very much.

Alex Tabbarok -

I cannot get to your site right now but I am pretty sure that in your original post you said something like the landlord cannot charge more than the cost or he would already be charging more. Doesn’t that pretty strongly imply perfect competition?

And under perfect competition doesn’t the landlord charge $150 no matter what?

Glen Whitman -

‘Then the price will rise by some fraction of the added cost, even though the consumer does not value the amenity at all.’

I don’t think that is true with a monopoly. If the landlord is already maximizing profit and the product value does not change, wouldn’t rising or changing the price decrease profit? If nothing changes and the landlord has already set a profit-maximizing price wouldn’t changing that price decrease profits?

dsquared -

If the value of the product changes, goes up, why can’t the landlord set a higher price and pass at least the entire cost along to the consumer? (Unless you have rent control)

If the value of the product doesn’t impact the price the landlord uses to maximize profit what is stopping the landlord from making up the difference by reducing other amenities not covered by the law? Like repair time waits or landscaping etc?

Point out some way the market might not be perfect. Lack of perfect information always seems to work. Assume some level of monopoly price control. Back up your claim with a few anecdotes. Prescribe government regulation. It is a recipe for endless government regulation.

The opposite might also be true. But as a starting point for a market with 1,000s or more sellers an assumption of competition seems to be the more reasonable starting point.

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brian 08.20.04 at 4:14 pm

kimmit, it’s trivial to see why Tabarrok is right.

Every day, people pay dearly for options. Companies buy options on aircraft and people fork over hard-earned money for options on the Chicago Board Options Exchange. The hot water statute deprives tenants of one of their options. Therefore he is poorer.

Also, the pricing assumptions are not absurd because they are almost, but not quite, the only ones worth discussing. If hot water can be supplied at $100 and the tenant values it at $150 then both the landlord and the tenant will try to get it installed and both will be competing for the $50 profit or consumer surplus (depending on whether you are the landlord or tenant) and the presence or absense of the statute is unimportant and so I didn’t discuss it earlier.

What is important is the legal environment for the welfare of the people who value the hot water for much less.

As for asymmetric info and transaction costs, if you want to suppose these are big factors, you fail to recognize that hot water and rent are just illustrative tools. We can easily change the illustrative tools to something financial (low transaction costs) and foreign (most dollar investors are equally disadvantaged in estimating default risk of Cambodian bonds, so asymmetric info is not a big problem).

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Brian 08.20.04 at 4:30 pm

dsquared, actually the stuff above about the options should have been addressed to you, not Kimmit.

The weak tenant as a group will not prefer the law because, some among them will prefer no hot water, and those that prefer hot water will have the option of self-supply when transaction costs are low. (Since you can’t buy hot water at the drop of a hat, the illustrative tools might need to be changed.)

Also, in addition to possibly wanting to help tenants, the policy makers will probably want to think about the detriment to humanity, which is minus $50. We don’t know if the policy makers want to help tenants but it’s a pretty safe assumption that they want to help humanity, so no statute.

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baa 08.20.04 at 4:37 pm

Tabarrok was making a simple point: Sometimes, a minimal requirement will hurt tenants. This is obviously true (as per the “$50 for shoes example”), and I don’t think D^2 is denying it. (Are you?)

D^2 seems to be making a more complex point: even though minimal requirements sometimes hurt tenants, there are reasons having to do with power structure of negotiations that may make minimal requirements overall beneficial. I don’t think Tabarrok is disputing that, nor was it his main point.

Can’t we all just get along?

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brian 08.20.04 at 4:39 pm

The thing about Cambodian bonds is wrong. I can’t think of an example right now.

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dsquared 08.20.04 at 5:08 pm

Bigmacattack: You asked:

If the value of the product changes, goes up, why can’t the landlord set a higher price and pass at least the entire cost along to the consumer?

Because, if the landlord was a rational monopolist, he would already be extracting the maximum price possible.

Brian: You wrote:

The hot water statute deprives tenants of one of their options. Therefore he is poorer.

In which case, I can only ask you to come back when you have taken a class in game theory and we’ll discuss the matter then. Removing an option can make someone richer, in precisely the way I specified.

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BigMacAttack 08.20.04 at 5:49 pm

dsquared,

Ok.

Then.

If the value of the product doesn’t impact the price the landlord uses to maximize profit what is stopping the landlord from making up the difference by reducing other amenities not covered by the law? Like repair time waits or landscaping etc?

(I think when a product’s value changes the price you set to maximize revenue changes but if not then what about the above?)

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Adam Stephanides 08.21.04 at 6:09 pm

Where did the assumption that the landlord is a monopolist come from? Saying that the rental market is a seller’s market is not at all the same thing; viz. Manhattan, which is emphatically a seller’s market but afaik not a monopoly.

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Sebastian Holsclaw 08.21.04 at 7:20 pm

Silly Adam, dsquared clearly meant ‘let us assume the landlord is a monopolist’. And you aren’t to challenge assumptions unless they are put forth by Friedman.

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brian 08.22.04 at 6:17 pm

dsquared wrote: “It’s a standard game theory result that something which reduces your options can benefit you by reducing the number of bad options that you can end up agreeing to”.

To which I asked who died and made dsquared the omniscient paternalistic boss of all?

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Mike Huben 08.22.04 at 10:00 pm

And thus Brian conceeds that his ideological legs have been cut out from under him, and resorts to the libertarian equivalent of a raspberry.

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brian 08.22.04 at 10:06 pm

That post made no sense Mike. I’m not a libertarian and I haven’t said anything ideological in this entire thread. It was all arithmetic truism.

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Micha Ghertner 08.23.04 at 8:22 pm

Huben’s right (that’s gotta be a first for me). This is a discussion of economics, not ethics. If Brian’s second to last objection is valid, then there would be no need to do economic analysis at all; we could simply consult libertarian principles and that would be that.

The question here is whether government regulation is a net plus or net minus. Injecting libertarian ideology into the discussion only confuses the issue, and makes it less likely that those who ideologically oppose libertarianism will take the economics seriously. Which, incidentally, is evident in a number of comments in this thread and in Kevin Drum’s thread. If you expect non-libertarians to take economics seriously even when it leads to libertarian-friendly conclusions, you must be willing to take economics seriously even when it leads to non-libertarian friendly conclusions.

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