Saturday, July 27, 2013

Price Controls

WHEN THE WELFARE STATE SPENDS RECKLESSLY, runs chronic deficits, expands credit, and prints more money, prices begin to soar. Invariably the government blames business, especially Big Business, and hints darkly at price controls.

But being a self-styled “liberal” government, it begins by suggesting only “voluntary” controls. It draws up “guidelines.” Prices of course continue to rise, because the government is printing more money, thereby reducing the value of the currency unit.

The government’s next step is to select as its special target some big corporation (or industry consisting mainly of big corporations) and demand that it roll back some price increase it has just announced. The big corporation is selected for attack, of course, because it is easy to arouse popular prejudice against it. It can either be denounced as a monopoly or accused of “administering” prices.

The favorite scapegoat in the United States for the last twenty years or more has been the steel industry. Though the total value of the steel produced yearly in this country amounts to only 2 per cent of the gross national product, the government, whenever it attacks steel prices, contends that steel enters into a multitude of products, that a steel price increase is “pyramided” throughout industry, and so sets off a chain reaction of inflation. This argument will not bear serious analysis, but that has never prevented its repeated use.

One minor irony is that though the government publishes a monthly index of consumer prices, and a monthly index of wholesale prices, and that though the former is a weighted average of some 400 selected prices and the latter a weighted average of some 2,000 prices, the monthly government report never tells the reader just how many of these prices rose and how many fell in the month reported. It is true that it sometimes gives partial enumerations. Thus, in its report on wholesale prices for March, 1968, it tells us: “Prices were higher for 110 of the 225 industrial product classes; there was no change for 85 and declines occurred for 30.” But if it told us that of the 2,000 individual prices it records of all items, about 1,000, say, went up in a given month, 740 were unchanged and 260 declined, the public would instantly see the absurdity as well as the injustice of the government’s selecting one price rise among 1,000 price rises, or even a price rise in one industry out of price rises in 110 industries, for special denunciation and attack.

A rise of nearly all prices, or of most prices out of tens of thousands, indicates the operation of a common cause. That cause is the monetary policies of the government itself. Prices do not rise today because businessmen have suddenly become greedier than they were yesterday. We may assume that sellers operating either under competition or monopoly were already charging as much as they could successfully get. The problem is to explain why they can charge more today than they did yesterday, or more this year than last year. If nearly all can charge more, this means that some general condition has changed.

Government price control attempts to ignore this change. That is why government price control always works harm. Attempts to hold down or roll back prices, when they do not merely lead to black markets and quality deterioration, must reduce and disrupt production and distort the balance and structure of production. (Artificially depressed prices, of course, also stimulate demand for the items subject to them.)

When the price of one item, say some necessity such as bread or milk, is held below the price that supply and demand would set in a free market, it reduces the comparative profit margin in making that product and soon creates a shortage of that product. This is exactly the opposite result from the one the government price-fixers had in mind. If, in the effort to cure this, the government tries to hold down the prices of the labor, raw materials, and other factors that go into producing the price-controlled product, the price control must be extended in ever-widening circles, until the government finds itself trying to fix the price of everything.

As there are probably at least 10 million separate prices in the American economy, and as this implies something on the order of 50 trillion cross-relationships among prices, the government sets itself a fantastically impossible task. But this does not mean it cannot do immense harm to the economy when it nevertheless undertakes this task.

It is ironic that even a “labor” government, once it undertakes price controls to try to prevent the consequences of its own monetary inflation, is finally forced to face the fact that it cannot do this unless it is also prepared to control and hold down wages. This is what happened in England. But a government’s wage-control orders are enormously harder to enforce than its price-control orders. If the wage control is real and rigid, the unions simply defy it; so it finally becomes riddled with loopholes and exceptions, which cause the price control either to do increasing damage to production or to break down.

A special case of price control is the attempt to hold down interest rates, either on loans to business or on home mortgages. At the beginning this looks easier than other forms of price control. It merely seems necessary to issue more money to increase the supply of loanable funds. But when interest rates are reduced in this way, two consequences follow. The lower interest encourages more borrowing, which tends to raise the rate again. And the increased amount of money and credit starts pushing up prices and wages. This forces businessmen to borrow still more, if they want to continue to buy even the same volume of inventories and employ even the same number of workers as before, to do the same volume of business.

And if, as a result of the increased volume of money and credit, prices have risen, say, 5 per cent in the last twelve months and are expected to rise 6 per cent in the next twelve months, lenders begin to realize that when they get 6 per cent nominal interest on their money they are in reality getting no interest at all.

This is one reason why interest rates in the United States in 1968 and 1969 soared to record high levels. It is precisely the government effort to hold them down that forced them up. This is just one more illustration of how government controls eventually bring about precisely the opposite effects of those intended.

Arthur M. Okun, the last chairman of President Johnson’s Council of Economic Advisers, ignoring the fact that unions cannot successfully raise wages or businessmen prices unless monetary inflation permits it, called on business and labor to practice “voluntary restraint” and stop raising prices and wages. But if employers and workers did exercise “voluntary restraint,” and deliberately charged less or asked less than they could get in a free competitive market, they would in fact be doing the community a disservice.

The demand and supply of each of thousands of different commodities and services are changing every day. When an increase in the money supply does not falsify the result, the goods and services in most demand rise in price while those in least demand fall. So the profit margin in supplying the goods in greater demand increases while that in supplying the goods in less demand falls. This causes more to be produced of the goods in more demand and relatively less to be produced of the goods in less demand. Thus the tens of thousands of different goods and services produced in the nation tend constantly to be produced in the changing proportions in which they are most wanted.

Prices are indispensable signals to producers and consumers. They must tell the truth about supply and demand. “Voluntary restraints”—and still more, government “guidelines”—falsify the signals and disorganize and unbalance production.

Monetary inflation is a dreadful thing. But what does immensely more harm than the inflation itself is the attempt to conceal or suppress its consequences through price and wage controls.

Man vs. The Welfare State

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