Price controls don’t work … again
When prices soar, those in government often look everywhere for blame — except the mirror.
Inflation causes prices to rise, which in turn causes citizens to become angry about those rising prices. Those citizens, in turn, look to their government to diagnose the problem and come up with a solution.
Governments are usually the worst places to look to solve problems for a lot of reasons, but like a quack doctor, it’s often because they misdiagnose the problem and thus come up with a “solution” that appeases the masses but makes the problem worse.
And that’s usually the problem with inflation. We’ve seen everything blamed, from supply shortages to “corporate greed,” but almost never does anyone in charge blame the rapid increase in the money supply, which rose 43% from January 2020 through December 2021. An increase in money growth almost always leads to an increase in the price level as too many dollars are put into the economy, chasing after too few goods.
As a result, politicians devise popular, but misguided, solutions. A favorite is to implement price controls — simply ban companies from raising prices. If they legally can’t raise prices, then consumers don’t feel the brunt of inflation, and everyone is happy (except those greedy corporations, who just don’t make as much profit). At least, that’s the theory.
So the Reuters headline “Hungarian government scraps price cap on fuels as shortage worsens” came as no surprise to any economist who pays attention. In December 2021, dealing with rising inflation (Hungary’s inflation rate is 21%), the country’s authoritarian leader Viktor Orban instituted price controls on gasoline and other fuels.
To the surprise of no economist, what followed was shortages. The story noted that nearly one-fourth of gas stations in the country were out of fuel, that it was impossible to find foreign suppliers of fuel at the low prices Hungarian suppliers could pay.
The United States experienced the same — long gas lines, stations out of gas — when Richard Nixon instituted price controls in the 1970s. Price controls caused major problems after World War II. They even had a hand in bringing down the Roman Empire.
When a price ceiling is installed, prices are not allowed to do their job of conveying information to buyers and sellers. Buyers respond to the artificially-low prices by not curtailing their consumption, because a low price signals “buy more.” Meanwhile, sellers have difficulty finding enough supply at prices where they can even break even, much less profit. If the price to obtain the goods wholesale — in this case, fuel — is higher than the price one can legally sell for, they will simply stop selling it.
When there is a surge in quantity demanded and a depression in quantity supplied — both due to the artificially-low price — the inevitable result is a shortage. Prices are not just an amount consumers pay for a good or service, they are signals that convey information to both buyers and sellers.
When prices are prevented from doing their job, they cannot convey that information. A price allowed to rise to its proper market level will tell buyers to buy less and conserve. For whatever reason, the good is in shorter-than-normal supply. But it also conveys a signal to sellers to supply more. The profit motive will direct sellers to move supplies where the prices are highest, and thus most in need. As a result, the increase in supply will bring prices down, help solve any shortages and serve consumers.
With price controls, consumers still have to pay a high price for the good, but that price isn’t necessarily measured in dollars. Instead, it’s measured in time. In this case, consumers have to spend time searching for a gas station with available fuel, or spend that time sitting in line. Time, too, has a cost. It favors those who have the ability to wait, who often are not the lower-income buyers the price control is most intended to benefit.
Whether rent controls, wage and price controls or anti-gouging laws, price controls always deliver the same predictable outcome — not enough quantity supplied, too much quantity demanded, shortages, lines and black markets. No serious government would ever entertain them. Let markets and prices do their job.