Understanding the Meaning of 'Power'

(Bloomberg View) -- If you read articles written by folks on the political left, you’ll see the word “power” used a lot. This might seem natural for people schooled in sociology or the humanities, where it’s generally assumed that some groups have power over others because of the way society is set up. But economists don’t typically think that way. For economists, it’s not enough to note that one person is able to do something to another; to really address the situation, we need to know why. For someone trained in economics, there are multiple types of “power,” and understanding each one requires a very different approach.

The issue of housing is a great example. My friend Mike Konczal has a recent piece on renter eviction, in which he uses the word “power” no less than 11 times. It’s a good article. But it uses the word “power” to mean three different things -- market power, political power and option value.

Market power is when either natural or governmental forces allow an industry to become so concentrated that competition starts to break down. A monopoly is the classic example of market power -- if network effects or a government edict push out all but one company, that company will be able to set whatever prices it wants. In doing so, it will extract a lot of undeserved value -- what economists call rent -- from the market.

But you don’t need a monopoly to have some market power. An oligopoly -- just having a few companies in an industry -- can be similar. Today, many economists are now worried that industries in the U.S. are becoming too concentrated. Also, a monopoly doesn’t have to be national in scope -- a hospital could have a local monopoly on emergency-room services, since everyone drives to the closest hospital in an emergency.

In the housing market, market power would come from having one landlord in an area. That landlord, being the only game in town, would be able to overcharge tenants. But in reality, few cities have this kind of concentrated real estate ownership. So market power isn’t that big a problem for most renters.

A second kind of power is political power. Groups of people with similar interests can forms a highly effective lobby and push the government toward advancing their interests at the expense of others’. Housing is probably a good example of this. Local landowners can band together to block new development in their neighborhoods, using zoning restrictions, environmental protection laws and a variety of other tools. If demand for housing in the area goes up but supply stays fixed prices will increase. This will result in rising rents and higher property values.

This can be especially hard on poor renters who aren’t protected by rent control or long-term leases. And if rent control does exist, it raises the incentive for landlords to evict residents any way they can. So if there were a surge in evictions it might be partly because of certain groups flexing their political power.

A third type of power is something that economists don’t call “power” at all -- though maybe they should. This is when contracts or other economic arrangements give discretionary power to one of the parties. If I’m your boss, I can fire you for a large number of reasons. You also can quit. But either way, my salary won’t be affected -- and yours will.

In economics, this isn’t called power -- it’s called “option value.” An option is the ability to make a choice. For a financial option, that choice could be whether to buy or sell a certain stock at a certain price in the future. For a real option, it could be the choice of whether to fire a worker.

Option value exists for landlords and renters too. A landlord can choose to evict a tenant for a variety of reasons. In California, the Ellis Act gives landlords a fair amount of discretion in this regard. As Konczal’s article and others document, the cost to someone who gets evicted is huge -- hassle, insecurity, the cost of moving, disruption of personal networks and the shame of being kicked out onto the street. The option contained within the housing contract -- both the explicit lease a renter signs and the more general system of legal rights and cultural norms surrounding renting -- allows a landlord to make a tenant pay all those costs.

That’s real power. Maybe economists should start using the term “option power” to describe this.

But the deeper point is that market power, political power and option power are three very different things, and require different approaches. Market power can be tackled with antitrust, or with direct regulation (as in the case of local utility companies). Political power is harder to address, and counteracting it often requires either popular movements, or interventions from higher levels of government. And if option power is unfair, it has to be addressed by changing the housing contract -- mandating different terms for leases, changing cultural norms or altering the laws about when landlords are allowed to evict.

In other words, when you hear the word “power,” don’t take to the streets before thinking carefully about the kind of power in question.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story: Noah Smith at nsmith150@bloomberg.net.

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