Intention and Incentive

One of the worst mistakes people make in politics is judging programs by their stated intentions and not by the incentives and constraints that between them drive the actual outcomes.

Consider price controls.  A typical example is rent control.  The idea is very noble sounding:  ensuring that people have “affordable” housing.  However, look at the incentives that it creates.

One incentive is that people who have this “affordable” housing may end up using more than they would otherwise.  A person might keep a larger apartment than he would otherwise use if he had to pay more or who might rent alone where otherwise he would take a roommate.  Or a person might take an apartment of his own when otherwise he would live longer with parents or other relatives.  Or they might live father out from the city and accept a longer commute.  Thus the incentive is to increase the amount of housing demanded at the rent controlled prices over what they would be in a free market.

On the flip side, however, people who own the apartment buildings find them less profitable.  Now, some people might consider this no big thing–after all, if those “fat cat” landlords make less money, who cares? The problem is with the incentives this creates.  For one thing, that increased quantity demanded means that if a tenant is dissatisfied and moves out, there are plenty more waiting for that space.  There’s less incentive to maintain the building.  Quality deteriorates.  Oh, the law requires certain things (running water, heat, that sort of thing) to be provided so they have to keep that up, but if the cost of providing those things exceeds the revenue that can be generated under rent control, it becomes practical to just abandon the building, and leave it to the creditors.  But even more.  Buildings wear out (or get abandoned and end up having to be condemned), especially if they’re not generating sufficient revenue to pay for proper maintenance.  New buildings get built.  And when someone looks at building a new structure, they can use much the same resources to build an office building or an apartment building.  Since office buildings are rarely covered by rent control, there’s far more incentive to turn those construction resources to office and other commercial structures than to places for people to live.  Thus, the quantity of housing supplied is lower under rent controlled prices compared to what they would be in a free market.

Reduced quantity supplied and increased quantity demanded, the very definition of a shortage.  It is no coincidence that any place where meaningful rent control is instituted (meaningful in that the rent controlled prices are lower than they would be in a free market) you soon end up with housing shortages.

Indeed, nearly any government program to “lower cost” works the same way.  The incentives created lead to a reduction in the quantity supplied and an increase in the quantity demanded–shortage in economic terms.  This is because government programs rarely address the issues that cause the cost to be high.  It simply refuses to pay the cost.

Another issue of incentives vs. intentions is in various government bureaucracies.  Government programs are generally created to “solve” a particular problem.  Yet very little incentive is given to the organization, and those within it, to actually do so.  Failure to solve the problem rarely gets a government bureaucracy disbanded or even cut back.  Indeed, when the size and scope of a government organization is largely driven by how dire the “problem” it was created to “solve” is, the incentive is not to solve it, not even to make it better, but to convince the decision maker that the problem is “worse than we thought” and deteriorating.  I, indeed, have pointed out that same principle in action in the case  of public education.

Further examples of this in action should easily come to mind.

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12 thoughts on “Intention and Incentive”

  1. “It is no coincidence that any place where meaningful rent control is instituted (meaningful in that the rent controlled prices are lower than they would be in a free market) you soon end up with housing shortages.”

    It’s worse than that. In many cases they institute rent control when there are already housing shortages, and the incentives you point out mean that it will never get solved while rent control is present. The fact that this means that the enforcement bureaucracy never gets smaller suggests that this may be considered a deliberate feature rather than a bug by the instigators

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  2. Yeah. You don’t DARE move out because you can’t move in again at the same price. So another “incentive” is destroying one of the best ways to get better jobs and move up in your career, which is mobility.

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  3. This in a nutshell is why we need to get rid of Trump. As a slumlord himself, he understands how to make his cronies rich though rent control and other government interference in the market. With a Democrat as President the poor will matter once again and not be used like pawns for the rich to get richer.

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  4. As my Econ prof once said (standing on his desk for emphasis): “Nothing refutes the law of supply and demand!”

    If you want to lower prices, increased supply is your best bet. It is hard to control demand.

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    1. This is why a lot of the big fortunes in history have come from folk taking something expensive and finding ways to make it less expensive. Rockefeller, Ford, Carnegie, the list goes on and on.

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  5. As my Econ prof said – standing on his desk for emphasis – “Nothing refutes the law of supply and demand!”

    If you want to lower prices – supply is your lever. Very hard to change demand: people want what they want and need what they need.

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    1. As a note for new folk coming in. First time someone comments, their comment goes to moderation. Once I approve one future comments appear without moderation. So if you’re new and your post doesn’t show up, bear with me. I’ll get to it.

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  6. Another thing rent control does… incentivizes the building owner to “go condo.” As a rental property owner in a rent-controlled area, you collect diminishing inflation-adjusted rents while paying increasingly higher maintenance costs. But if you go condo, you sell the apartments to the tennants (making THEM responsible for the interiors of the apartments.) You get to monetize part of your investment right away. Then you set up a management company to maintain the common structure and the “maintenance fees” you charge the tennants for this are not controlled at all. Seems like a no-brainer.

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  7. It simply refuses to pay the cost.
    Of course, when gov’t *IS* willing to pay the cost, it doesn’t help much. After all, they‘re not paying it out of their own pockets, but out of YOURS.

    And, yes, incentives never work quite as planned (unless appealing to the bases of desires) because the people who want to fix everything have a lot of formulas and hypotheses and numbers and education and… not a lick of understanding of human nature.

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