Price controls: economic bombardment
The United States reporting its highest annualized inflation rate in 40 years has become a monthly occurrence — to the point where it’s not really even news.
The rising prices are outpacing wage growth and far above the super-low interest rates, eating away at savings while monthly expenses gobble up larger and larger portions of a family’s budget.
Naturally, there will be calls for solutions. One that has been gaining steam in some circles is price controls.
Especially with a political class that is consistently ignoring money supply growth as a primary cause and believes an economy can be micromanaged from Washington, price controls seem to be a worthwhile solution. Frustrated with rising prices? Just decree prices can’t rise anymore.
Problem solved, right?
Price controls prevent prices from serving their primary function — communicating information to buyers and sellers about the availability of goods and services. That information guides our decision-making. If the price is high, it tells us to — at least temporarily — buy less, while also guiding producers to supply more. A low price does the opposite, communicating to buyers there is an abundance of the good and to sellers to not produce as much. As Friedrich Hayek succinctly pointed out, “in a system in which the knowledge of the relevant facts is dispersed among many people, prices can act to coördinate the separate actions of different people in the same way as subjective values help the individual to coördinate the parts of his plan.” In other words, prices coordinate our actions without us having any knowledge as to why prices are what they are, but allow us to act as if we had perfect knowledge.
Price controls obliterate that concept and replace them with government planning. What planners expect to happen is that they dictate a price and it will be that way across the economy. One of my favorite ways to start every day is with a cup of coffee, which currently runs about $8.50-$10/pound. But let’s say a Bureau of Price Administration dictates that coffee, say, be sold at no more than $5/pound. What the BPA expects to happen is that all retailers will simply reduce their prices to $5/pound and carry on as normal.
What will happen is two things. First, consumers will buy more coffee than they otherwise would have, because the price is now lower and it costs them less than it would have at the previous price of $8.50-$10/pound. But more damaging will be the supply side. Any firm for which the cost of producing coffee is greater than $5/pound will simply stop producing coffee. There will be far less coffee brought to market, and certainly far less variety. High-quality and more exotic — and thus more expensive — blends will simply no longer be produced and offered for sale. The end result will be less coffee being available to buy, and eventually, a shortage.
But what’s interesting is the price of coffee has changed due to the price control, but the cost of obtaining coffee might actually be higher. Because finding coffee is now more difficult, the money saved in spending fewer dollars per pound is instead spent in time — going to multiple grocery stores to try to find shelves with coffee on them, standing in long lines when coffee becomes available, or even following the supply truck to the store to try to beat other consumers to the small stockpile of coffee. Ultimately, black markets will develop and truly motivated consumers will pay the market price for coffee there, which will likely be higher than the original price before the controls were placed. Of course, that will also entice more motivated sellers to purchase the available supply to re-sell at a higher price. Essentially, they make the profit, rather than the original seller.
Price controls also prevent goods from going where they are least-needed to where they are most-needed, because there is no incentive to move goods from a low-price area where they are in abundant supply to a high-price area where they are scarce, simply because there are no high-price areas.
The moral of the story is that every government action to try to interfere with the economy comes with unintended consequences, which often are worse than the “malady” trying to be corrected.
This carries through so many other areas of the economy. Rent control became trendy again recently. Oregon and California recently passed statewide rent control measures. After a stringent rent control measure passed in the Twin Cities, developers immediately began pulling back on apartment supply. It’s a reason even socialist economist Assar Lindbeck said “In many cases rent control appears to be the most efficient technique presently known to destroy a city — except for bombing.”
In cities where there are rent controls, there is often a shortage of apartments, which drives up demand and thus prices for substitutes — non-rent-controlled apartments, houses for sale, suburban housing — and thus making the housing market worse, not better.
We should’ve learned our lesson when Truman imposed wage and price controls after World War II, leading firms to get around them by offering fringe benefits instead of wages, leading directly to the employer-provided health insurance Leviathan we have today. We should’ve learned when Nixon imposed them in the 1970s, and gas lines resulted. We should’ve learned from the many examples going back to the Roman Empire. But because most people’s conception of history begins the day they were born, they ignore all of those.
Price controls are the effective equivalent of dropping a bomb on the economy. They create shortages, black markets, long lines and prevent goods from going where they are needed. Simply put, price controls are among the worst ways to deal with inflation.
Andrew Smith is an economics instructor at New Palestine (IN) High School and Vincennes University. He is the Vice Chair of the Libertarian Party of Hancock County, Indiana.