The correct way to argue with Milton Friedman

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).

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.

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.

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.

http://www.google.co.uk/search?hl=en&ie=UTF-8&q=%22london+residential+rents%22&meta=

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.

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.

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.

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…”

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.

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

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.

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.

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.

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.

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.

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.

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.

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.

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?

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.

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.

“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.

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.

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.

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.

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.

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.

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

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.

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.

…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.

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.

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.

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

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?)

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.

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

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.