Hardly a week goes by without hearing about some new proposal by the President or someone in Congress, or maybe the governor or a local official. If you’re like me, when you hear the proposal, you apply a heuristic to quickly decide whether you support or oppose the idea. This week, I’d like to talk about one of the most powerful heuristics I use for evaluating proposed changes that will have an impact on prices.
By far, the most common heuristic people use is “what does my team think?” Is there an R or a D after the name of the person proposing it? What does Sean Hannity have to say about it? What side is Paul Krugman on? Humans are tribal. Reality is complicated. It’s natural for people to align their views with their tribe.
Human’s tribal outlook is why you can make a very good guess about people’s views on seemingly unrelated topics if you know their views on just one of them. For example, if you favor student loan forgiveness, there is a very good chance that you also favor subsidizing solar energy, worry that we are making it too hard for some people to vote, and believe that the minimum wage should be higher. On the other hand, if you oppose gun control laws, you probably also think we should have built the Keystone pipeline, that illegal immigration is one of the country’s biggest problems, and that voter fraud is a big problem.
But what if you are one of those unusual people that wants to consider alternative viewpoints rather than just sticking with the comfortable views espoused by your team? I’m a strong advocate for reading articles from a variety of sources to understand how other people view things. It doesn’t often dramatically change my view, but it sometimes stears me to compromise views that are more politically possible. No sources are unbiased. Heck, I don’t even think that unbiased news is even possible. But a variety of biases is a decent substitute for a lack of bias. That can come from relatively mainstream news sources like the New York Times, Washington Post, Wall Street Journal, the Economist, or even sources like Fox News, CNN, The New York Post, and MSNBC if you struggle with big words. It can come from more openly opinionated sources like The New Republic, National Review, Quillette, or the Atlantic. I like the series of Real Clear sites, like RealClearPolitics and RealClearPolicy because they do a good job of aggregating stories from a variety of sources with a variety of viewpoints, but even they have their own biases. I even find it instructive to read some very non-mainstream (I’m trying to be polite by not calling them crazy) sources like Jacobin, Epoch Times, Vox, or American Greatness. I know that the trend these days is to not only avoid opposing viewpoints but to try to silence them, but understanding how other people see things is very instructive.
I see some people use arguments like “trust the science” (which is the opposite of how science works), “the science is settled” (also the opposite of how science works), or “trust the experts” (which is always shorthand for trust my experts, not the other side’s experts). It’s tempting to look to experts because none of us are experts in everything and few of us are experts in anything. But even when you want to agree with an expert you trust, you should still try to understand why their views are correct.
One of my favorite heuristics for evaluating policies applies when those policies relate to prices. People’s initial reaction is to want to directly control prices, but prices are a symptom rather than the true problem and controlling them virtually never fixes the problem. If a doctor told you that the primary treatment for your brain tumor was giving you Advil to reduce your headache, you’d get a new doctor. But when politicians tell us that the answer to high gas prices is to cap the price of gas, we’re all too often ready to agree with them. In fact, regulating the price of something usually makes the underlying problem worse. Prices are determined by supply and demand and my heuristic is to look at the proposed policy and ask how it will increase or decrease supply and/or increase or decrease demand. It sounds simple, but it is a very powerful tool.
Let me do a quick review of how supply, demand, and prices interact. The Law of Demand tells us that the more expensive something is, the less of it people will want to buy. On the other hand, the Law of Supply tells us that people will want to supply more of something as the price gets higher. The market price is where the supply and demand are balanced. The price will rise or fall as the quantity supplied at different prices and the quantity demanded at different prices change over time.
When we try to directly control prices, it can create shortages (price capped below the market price) or a glut (price floor above the market price). If you were around in the 1970s, you’ll remember long lines to get gasoline. People blamed the Arab oil embargo for the lines, but the real reason for them was a cap on the price of gasoline. OPEC reduced the supply and the price caps kept prices below the new market rate. The result was that demand was too high and supply was too low, because the price was too low to discourage demand and not high enough to incentivize enough additional supply. By itself, that doesn’t necessarily mean that it was a bad policy. Letting the market set the price would have resulted in higher prices. Perhaps people preferred allocating our scarce supply of gas to those who had the time and desire to wait in line rather than who were willing to pay the most. That’s not the policy I would have wanted, but it’s the policy that we got. Would we have gotten it if politicians campaigned on keeping gas prices low by making you wait in long lines? Maybe. But most people didn’t think through the price cap’s impact on supply and demand and so they didn’t understand that the price caps were what was causing the lines.
One of the most common complaints I hear from young people these days is about the high price of housing. Cities and states around the country have proposed a multitude of policies to help the issue. Remembering that the price is determined by the balance of supply and demand, we can evaluate those proposals to see if they are likely to help or make problems worse.
The first policy to consider is rent control. It’s a direct attempt to control prices rather than solve the underlying supply and demand issues. Knowing that the rent control sets a price cap below the market price tells us that demand will be higher than it would be without rent control. It doesn’t tell us why – some people will rent larger apartments than they would have, some people will want to move to the city because of the lower prices, fewer people will want to move away, and fewer people will want to share an apartment with roommates. It isn’t important to know the multitude of different reasons people will have for wanting more apartments. It is enough to know that the lower prices imposed by rent control will increase the demand for rental space. At the same time, those lower prices will decrease supply. Once again, that might be because new apartments won’t be built by investors uninterested in lower returns. It might be because some existing apartments will be replaced by commercial or retail buildings. The specifics don’t matter. What matters is that basic economics tells us that, while rent control might help the people that have apartments today, it will exacerbate the problem of there not being enough affordable places for people to live because renters will demand more apartment space and suppliers will supply less of it. You could have come to this same conclusion by just “trusting the experts” or “listening to the science” because opposition to rent control is one of the few things virtually every economist agrees on, but I think it is much more satisfying to understand why it is a bad idea than just going along with what other people tell you.
There are some policies that seek to make housing more affordable by subsidizing some renters. These policies have the benefit of not directly trying to control the price, but what effect do they have on supply and demand? The subsidies reduce the cost of rent for the subsidized renters. If you offer to give a renter (or potential renter) extra money for rental assistance, they're ability and desire to spend money on housing will increase. The proposal won’t have any direct effect on the supply curve (the quality that suppliers are willing to supply at different prices), but because demand has increased, the price will go up and more housing will be supplied at the new, higher price. The result of this policy will be to make housing more affordable for the people receiving the subsidies and it will increase the supply of housing, but it will also increase the price of housing. If you are getting the subsidy, you’ll probably find a way to support this idea. If you aren’t getting a subsidy and have to pay the higher rates that result from the subsidy, you’ll probably find this policy sound less appealing. Something similar happened to the cost of college when we subsidized students by making it easier for them to borrow money – more students went to college, colleges supplied more degrees, and college prices went higher.
Many local communities in California make it very difficult for people to build new houses and make it almost impossible to build new apartments. This reduces the amount of housing supplied at any given price. The result is that the market price for homes is much higher than it would be without the restrictions. At first glance, you might wonder why anyone would support a policy to make something vital like housing more expensive, but the policies are very popular. They’re popular with local homeowners who see higher prices for houses as a good thing, not as a problem to be solved. The fact that it makes it hard for their children to afford houses near them takes a backseat to the sweet nectar of increasing home equity. I must admit that if my neighbors were pushing for a rule change where I live to allow them to sell their homes to an apartment developer, I might not be a strong advocate for their proposal.
The Governor of California, Gavin Newsome, is trying to get statewide policies to overturn some of these building restrictions. If these policies make it easier to build houses, the supply of houses will increase and that will lower the price. Most existing homeowners don’t like this. It’s kind of comical to see Republicans that think of themselves as favoring free markets insisting that their government restrict what their neighbors can do with their own properties. And it is just as bad on the other side, with many staunch progressives who support affordable housing fighting hard to make sure that it doesn’t get built anywhere near where they live. Just because a policy will result in lower prices doesn’t mean that everyone will like that policy. Just look at famous Habitat for Humanity supporter Jimmy Carter’s editorial in opposition to imports of Canadian lumber because the increased supply will result in lower prices for timber farmers like him and his family. While I’m sure he meant well, his concern about costing people like himself money distracted him from the bigger picture - that lower prices for lumber will mean cheaper houses for the poor that he wants to serve. Most people’s generosity wanes when their financial interests are at risk.
Looking at supply and demand isn’t useful for everything, but it is a great tool for evaluating policy’s effects on prices. People intuitively understand it when it matches their desires – like raising taxes on cigarettes to reduce demand. But people tend to forget about supply and demand when a politician is promising to lower the prices on things they want to buy.
Even for things where the supply/demand heuristic doesn’t work, think about how the policy will change people’s incentives. Think beyond the obvious. Understand that the stated goals of a law often don’t match its actual impacts. Think about how a new rule will change people’s incentives and what is likely to happen because of those changed incentives.
In the 1850s, economist Fred Bastiat encouraged people to look past what is easily seen and see what is unseen. Don’t just see that rent control lowers the price of rent. Ask what happens next. Think about how new rules will change incentives. It doesn’t require any special knowledge or expertise to just ask yourself how a normal person would behave differently under the new rule.
One of my favorite books for advice on seeing past the obvious is “Making Great Decisions in Business and Life” by David R. Henderson and Charlie L. Hooper. It is filled with wonderful advice on how to see past the obvious and to make better decisions. It is less focused on policy choices and more about making good personal choices, but the principles are the same. David is a fascinating guy. He was a professor of economics at the Naval PostGraduate school in Monterey, California. But he’s not your typical military guy because he is also staunchly anti-war and a frequent contributor to antiwar.com. He isn’t a hippy leftist either. He regularly writes for the Wall Street Journal and battles his local government over their excessive regulatory zeal. To whatever extent you agree with his heterodox views, he’s an interesting thinker and I found his book to be a great source of insights for looking past the obvious to help make better decisions.
Good work. I didn't know you had this understanding of macro economics. I like the idea of examining "left" and "right" politiciains with this technique. You might also consider the dynamic of "top down" vs. "bottom up" policiy decisioins.