Everybody's Talking About Affordability Policy. But How's That Supposed to Work?

Here's a framework on which to build out the policies and the big-tent politics.

The affordability crisis, as it is often referenced, is clearly one of the most important economic challenges faced by American families today and, as such, one of the most pressing political challenges. It tops surveys of the most important issues. Zohran Mamdani’s political rise is closely linked to it. Every time we sit down with politicians, it’s the first thing they bring up. It is closely related to the “it” policy book—Klein and Thompson’s Abundance. It was a huge focal point for us in the Biden Administration, and was one reason Trump got re-elected, which makes it even weirder that his administration is pushing hard in the wrong direction—they’re actively making life more expensive.

In this post, we lay out some of the basic economics of the affordability crisis, as a foundation for thinking about policies to ameliorate it. While it may seem simple—if people can’t afford the basics, just give them the money they need to get them, or provide it to them “in-kind” (give them money to buy health insurance or give them health insurance directly)—it’s not, and giving people money isn’t the answer (it’s part of the answer in some of the cases).

What’s the Problem?

Let’s start by defining the problem. For many years now, people have argued that, given their incomes, affording the basics is increasingly tough for them. “Basics” generally include housing, childcare, higher education, healthcare, and groceries, though that’s just the high-level list. E.g., if you’re talking about the lack of housing affordability, you’re also talking about the rising cost of utilities and home insurance. Higher education is also a discussion about the burden of servicing student loans.

The next question is how real is the problem? The journalist Annie Lowry has been on this beat for years, and has amply documented the reality of affordability constraints (she was the first to label it a crisis; here she discusses the issue in depth with Ezra Klein).

It’s easy to show that certain prices have risen faster than average, as has been the case for many items on the list above. For example, overall CPI prices are up 35% over the past decade, while rent is up 52%. This implies that other prices have grown slower than average, a non-trivial point that often gets lost is this debate. TVs and other electronics, for example, are far more affordable than they used to be.

But Lowrey goes deep into not just the changes (inflation) but the levels (actual dollar amounts) of what things cost (her article ran in 2020, so some of these numbers are dated, but we don’t think updating would change the conclusion):

The “cost burden” of health coverage climbed through the 2010s; just from 2010 to 2016, family private-insurance premiums jumped 28 percent to $17,710, while median household incomes rose less than 20 percent. That meant less take-home pay for workers. Deductibles—what a family has to fork over before insurance kicks in—also soared. From 2010 to 2016, the share of employees in health plans with a deductible jumped from 78 percent to 85 percent. And the average annual deductible went from less than $2,000 to more than $3,000.

It is key, as she does above, to talk about prices in tandem with incomes, though this too turns out to be more complicated than it sounds. Yes, if incomes are growing faster than prices, life becomes more affordable. But in the Biden years, it was clear that people viewed real income gains as something they earned and deserved, while price increases were something bad that someone else was doing to them. And there’s logic to this. If my earnings go up 5%, I feel great that my productive contribution is being rewarded. But if prices also go up 5%, my deserved good fortune is being swept away by outside forces.

At one level, the rise of affordability politics can be viewed as of a lot of people asking policymakers to do something about those forces. So, what are they? If policy is to address the affordability crisis, we should understand what’s behind it.

Price Gouging vs. Pricing Power

Price gouging has evolved as a go-to explanation for the crisis, one that has gained considerable political traction over the years. But many economists—not all!—ourselves included, find the term nebulous and not very useful. Many states have narrow price gouging laws that prohibit businesses like gas stations from jacking up prices during emergencies. That’s wrong, and we should have national laws to prevent it. But what we have in mind is a more persistent force that isn’t about businesses temporarily exploiting a disaster to gouge consumers, but instead reflect a more fundamental pricing-power issue in the market.

Pricing power occurs when businesses have the power to set their prices above their costs and is especially problematic when demand is inelastic (you gotta have it). This effect proliferated following the pandemic, when firms didn’t just raise prices enough to meet higher input costs, but exceeded that benchmark, boosting their profit margins.

Here we collide with the first big economic challenge to addressing the affordability crisis. We don’t like that pricing-power, margin-inflating dynamic any more than you do, but in traditional economics, that’s just a price signal, and an important one at that. It’s supposed to signal other suppliers to get into that market, or for existing competitors already in the market to compete with lower prices to grab new market share and claw back some of the excess profitability from the firms flexing their pricing power. It’s why they say “the cure for high prices is high prices.”

This sounds a lot easier and more seamless than it is. There are barriers to entry often raised by incumbent firms (more precisely, by the politicians on their payrolls), such as excessive and expensive licensing, permitting, or patenting requirements (Dean Baker has long documented this phenomenon as an explanation, e.g., for why it is so hard for foreign doctors to practice here). Warren Buffett is famous for investing in companies with economic moats – network effects, switching costs, proprietary technology – that dull competition. And, as the economist Thomas Philippon argued in his book The Great Reversal, industrial concentration, maintained by pervasive corporate lobbies, thwarts the competitive effects assumed by the simple model.

But the more immediate issue is that it is neither illegal nor unusual for firms to flex pricing power. Charging “what the market will bear” is a hallmark of capitalism. In this regard, affordability advocates who want to mess with prices crash into a foundational pillar of our system.

You’re Telling Me We Either Have To Give Up on Market Pricing Or Solving the Crisis?

So, is that it? We either have to give up on the power of price signals—which truly is a powerful force, an information aggregator that does a ton of important lifting for us—or give up on solving the affordability crisis?

Of course not. That is a false choice and there are straightforward policy solutions for the crisis. Our goal here is not to tick through those specific solutions, though that will be forthcoming (and many others are doing so) and we give examples below. It is to provide a framework with which to evade the pincers of the false choice of choose one: price signals or affordability.

The first and most powerful solution is to recognize that some goods and services, particularly necessities in a wealthy society, should not be considered wholly market goods and should thus get a hall pass from the market-signaling regime. Health care provides the clearest example: if I show up sick at the emergency room, they have to treat me.

That fact takes this vital service at least partially out-of-the-market. It’s why about half of our healthcare spending is public (32% federal, 16% state/local). Of course, healthcare remains solidly on the affordability crisis list so our current policies in this space are demonstrably insufficient. We return to that later, but the “at least partially” phrase above is a big part of the explanation.

Expanding this framework is the key guidepost for meeting the affordability crisis. If a majority believe that being fed, housed, and insured against illness are basic human rights (and majorities do believe that) that are not adequately met by markets alone, then we have a clear rationale to craft policies to ensure such needs are met.

Given that in our society, families must work to survive (despite Congressional R’s nonsense to the contrary, as if Medicaid pays your rent), if significant shares of parents lack the resources to have their children well-cared for while the parents work, this too is a market failure requiring policy intervention.

If pathways to upward mobility are blocked by unaffordable educational opportunities, that too goes on the list.

Second, the competitiveness agenda—undoing the “rents” (excess profits)—that Philippon correctly attributes to corporate power—is another essential part of the solution, as is the abundance agenda: taking down regulatory barriers to increased supply that do more harm than good (figuring out which is which here—which regs are important and which are not—is harder than it sounds).

This Isn’t Radical. Many Economies Work This Way.

If you’re thinking that all the above is just common sense, we agree. But if that’s the case, why are we talking about an affordability crisis? It seems clear that solutions to the crisis can theoretically coexist without sacrificing price signals.

Of course, the devil’s in the details; once we go down to more granular policy levels, this gets harder. And it’s far from cheap. I’ve heard affordable housing advocates suggest that if we can just free up more zoning, affordable housing will flourish. The research we’ve seen suggests that land-use reform is absolutely necessary, but it’s not sufficient.

And it isn’t just theory. Though some other advanced economies are starting to face similar problems, they all lag way behind us (ahead of us?) in this regard, in that they’ve long had systems in place to better ensure the affordability of at least healthcare, childcare, and higher ed, if not always housing.

The blockages in our political economy are more political than economic. We’ve taken health care partially out of the market but not wholly and thus we have this extremely challenging—at this point, we’d say dysfunctional—hybrid wherein even well-insured consumers could not be more frustrated with the system. Introducing a public option would be sensible but whenever it comes up, the private providers go bonkers and activate the politicians they support to start earning their lush paychecks.

The New Politics of Affordability

Yet it seems increasingly clear that there is a politics taking shape to address the crisis. Again, it is literally the first subject we hear from those holding and seeking office, at all levels of gov’t. Tapping this new, powerful force thus requires the following:

—Arguing, as FDR did lo these many years ago, that families living in the richest country in the world have a right to not just basic necessities, but to pathways to upward mobility, most notably life-long educational opportunities. (There is a fiscal component to this that we take very seriously, but let’s not jam too much in here.)

—That means elevating and applying the competition (breaking down entry barriers and moats that impede vigorous price wars), abundance (increasing the speed with which we build by retiring outdated regs, including land-use restrictions), and direct affordability (subsidizing basic necessities) agendas.

One last economic point re that last bullet. There’s important sequencing here. If we subsidize under-supplied components of the affordability crisis, much of the subsidy will simply get capitalized into the price. So, we’ve got to get the timing right.

Of course, frameworks like this are not granular agendas; the latter are a lot trickier (e.g., Q: how does rent control fit it here? A: it needs to be tightly targeted or it can discourage new construction; Q: what about Mamdani’s public groceries? A: they’re probably more a solution for food deserts than grocery prices, but there are other good policy ideas in this space, about which more to come…).

But it’s smart to start with the framework and build out from there. We know, at least in broad strokes, what we need to do to meet the affordability crisis. We can fill in the details as we go.

Finally, there’s the politics. We think they are wide and inviting, meaning there are many entry points for politicians from all ideological directions, though there is no entry for those in the pockets of companies that are squeezing rents out of the status quo. Abundance-style deregulation can be right-coded, though there’s nuance here, as noted, and a deregulation that overly discounts, e.g., environment protections, has no place in this agenda. Demand-side subsidies tend to be more left-coded, but the supply-first sequencing must be respected. And everyone who’s not being paid to think otherwise should support greater competition in concentrated sectors. That’s Adam Smith 101 (Smith, in fact, consistently and loudly inveighed against monopoly power)!

You want to tag rent-seeking corporate monopolists? Have at it! You want to go after progressive regulations that are past their sell-by date? Go get ‘em! You want to play against type and flip the usual script? Good idea!

In other words, the affordability agenda is the big tent issue of the moment wherein pragmatism trumps ideology, and good, old-fashioned, roll-up-your-sleeves-and-fix-something-people-care-about trumps Trump’s incompetence.