What is it about the idea of price controls that appeals to us? Whenever we are faced with the uncertainty of high inflation, nations look to price controls for relief. Today, amid the Russia-Ukraine war and with the world economy still recovering post the pandemic, this question is more relevant than ever.
Can we impose price ceilings on what private companies can charge for goods and services? What would be the consequences of doing this? This essay revisits history to answer these questions — specifically, at price controls imposed post World War II and in the 1970s when prices in the United States and European nations were rising but the output was stagnant.
The economy is shaped by dynamic processes, with forces of demand and supply coordinating the actions of millions of individuals. Market prices drive economic decisions and coordination, given that there is competition among producers and rational human action on part of consumers. Price fixing, then, distorts coordination by changing the incentives at play.
Those consumers lucky enough to get the reduced price when a price ceiling is imposed, actively consume until the quantity available is exhausted. Under price ceiling, producers no longer have an incentive to produce more quantities to meet demand. Therefore, price ceilings (and other forms of price control) disrupt the signaling and allocation mechanism of prices. Quality deterioration, shortages and the emergence of black markets are rampant under such circumstances.
Often the case for price controls is made by blaming rising prices on the greed of large corporations. This point of view can miss the broader picture. For example, consider the case of rising energy prices. Crude oil prices are set in a global market that companies often have no control over. For businesses that use crude oil as raw material, times of high inflation translate to higher input costs. This leads to an increase in prices. While larger businesses are often better placed than small and medium ones in the face of higher input costs, price controls do not hurt large businesses as much either. However, they do end up hurting small or medium businesses that lack the same advantages.
John Kenneth Galbraith, a Canadian-born American Economist, supported the use of price controls during World War II as well as post the War. Galbraith held several government posts for anti-inflationary measures during this period. War financing poses unique problems that cause high inflation like the need to use the existing means of production towards war goods. This can cut down on the production of consumer goods, but also increase employment — both of which contribute to high inflation by way of reducing supply and increasing demand, respectively.
Price controls are not limited to price ceilings or floors, but also include policies and regulations by which market prices can be modified or influenced. More subtle price controls include political pressure, tax incentives, reduction of import tariffs, ban on exports, etc.
From an Austrian economics standpoint, price controls undermine the subjectivism that underlies human action as described by Ludwig von Mises. Any attempt to impose such controls furthers the need for planning to deal with the unintended consequences of the first action, this takes us right back to the Knowledge Problem argued by F.A Hayek.
Hayek argued that the information implicit in prices is distributed and decided through coordination among a large number of localised experts, and to have this information available to a central committee in a timely manner would be almost impossible. Problems would surely arise, the solutions to which would require even more intervention.
Consider, for instance, shortages that may arise due to imposition of price ceilings as producers no longer have the incentive to produce more quantities to meet demand. A central committee may now ration for fair allocation. This would require that it anticipate the fluctuating needs of a plethora of different individuals. This undermines the market process, which through the price mechanism, would have coordinated the actions of both producers and consumers in deciding what to produce and consume. Further intervention by a central committee to incentivise producers and consumers requires more planning. In some cases, the government may have to become the producer and distributor by setting up their own subsidiaries. Nationalisation of sectors that were privately owned or acquisition of a dominant stake in private companies, takes this one step further.
In India, sectors like steel, petroleum, chemicals and mining are dominated by PSUs. The lack of any penalty for inefficiency on part of a nationalised entity, unlike that which would be suffered by a private player, can be seen as a moral hazard problem. This often furthers or leaves unchecked inefficiencies in manufacturing.
Government involvement in operations of PSUs, especially in industries such as telecom, aviation and banking, has impacted their performance often at a cost to the consumers and the job market in which they participate. The large losses suffered by these entities, if nationalised on account of them being too big to fail, can be seen as additional tax for the tax paying consumers.
In the United States, on 15th August 1971, the Nixon Administration announced a wage & price freeze. This would prove over the course of several years a failed economic experiment leading to several shortages and an ensuing period of stagflation (high inflation coupled with slow economic growth and steadily high unemployment). Shortages and severe inflation on the removal of these price controls led to the need for further intervention, which simply stopped being effective upon being resisted by producers.
A second price freeze, coupled with the decision to take the dollar off the gold standard and other policies in the backdrop of the Yom Kippur war, was imposed. This led to the oil embargo of 1973 imposed by the OPEC on the USA, which led to huge shortages of gasoline and long lines at the pump. Ultimately, price controls and their effects discredited them in the eyes of the common people, but this ultimate realisation did not mitigate its lasting damage. This is a lesson that we should look upon especially when lured by the idealised argument of price controls.
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Post Disclaimer
The opinions expressed in this essay are those of the authors. They do not purport to reflect the opinions or views of CCS.
