Of Public Interest

Volume 4, Number 3
February, 2002

Differences in opinion about what constitutes good public policy abound. Given this abundance, it is good to find useful ways of distinguishing between wheat and chaff. One useful distinction was first articulated in the middle of the last century, mostly by German economists and lawyers. They suggested that policy measures should be compatible with the legal framework that governs a market economy. In English, this Germanic idea goes by the name "order policy", to refer to the idea that public policy should support an orderly market economy, instead of undermining it. Most of the scholarship in order policy remains untranslated into English.

Before illustrating the significance of the guidance that order policy provides, it is necessary to address what is meant by the legal framework of a market economy. What we call a market economy refers to an arrangement whereby economic relationships among people are governed, among other things, by the legal principles of private property and freedom of contract. Order policy seeks to distinguish between those policy measures that are consistent with and supportive of these legal principles and those that are not.

Policy measures that clash with the governing framework of a market economy are a source of harm in many ways. Consider one simple policy measure that clashes with the legal framework of a market economy: rent control. With rent control, rents are no longer established through agreements between owners and tenants. Where a market price might have been, say, $500 per month, a rent control might limit the price to $400. Just think of what happens when this kind of policy measure is created. When faced with the lower price, tenants will want more and larger housing than before. On the other side of the market, owners will be less willing to supply rental housing than before because they now earn a lower return on their investment.

At the very start, the rent control measure generates a conflict among potential tenants that would not otherwise exist. Tenants want more housing than owners are willing to provide, so some tenants lose out to other tenants. Within a market economy, this conflict among tenants is resolved through an increase in price that simultaneously increases the amount of housing that owners are willing to supply and reduces the amount of housing that tenants seek to lease.

In the presence of rent control, however, the resolution of the conflict takes a somewhat different path. To be sure, imposing rent control does not ensure obedience. Rent control produces more tenants who want units than there are units available. Tenants who might otherwise go without will often seek to improve their standing in the competition for units by paying prices above the controlled limit.

These higher payments might take the form of a contracted price that is higher than what the rent control allows. But there are obvious dangers, particularly to owners, from entering into contracts of this form

because of the possible criminal penalties they would face. More likely are of many other possible ways of indirectly increasing the price. Here are just a few of the possibilities to illustrate the point: a pool and sauna that were provided without charge could now be made subject to a separate charge; a fee could be charged for what was formerly free parking; damage deposits could be greatly increased and the interest paid on that deposit at some below-market rate; and there is always plenty of scope for an under-the-table payment, what in some places is referred to as "key money."

To be sure, people who sponsor rent control are aware of these kinds of responses that their measures set in motion, and they seek to close off these escape routes as well. But look at what happens in the process. By seeking to prevent ordinary contractual relationships among consenting adults, government engages in espionage and deception against its own citizens. Entrapment becomes a mode of government operation, where public officials pretend to be tenants in the hope of eliciting offers that violate the rent control. Market relationships stimulate openness and trust within a society, but rent control and all other policy measures that are not market compatible promote distrust and suspicion within a society.

Does this extended example mean that there is no alternative to utterly free markets when it comes to public policy? Not at all, it means only that any policy enacted should be compatible with the central principles of a market economy. In this vein, a system of tax deductibility or tax credits would pass muster because these measures would not prohibit people from operating within the framework of private property and freedom of contract.

A Publication of:
Public Interest Institute at Iowa Wesleyan College
600 North Jackson Street
Mt. Pleasant, Iowa 52641-1328
Phone: 319-385-3462 Fax: 319-385-3799
E-Mail: public.interest.institute@limitedgovernment.org Web Site: www.limitedgovernment.org