Government Price-Fixing   1 comment

The art of economics consists in looking not merely at the immediate, but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group, but for all groups.

This is an ongoing series of posts on Henry Hazlitt’s Economics in One Lesson. You can access the Table of Contents here. Although written in 1946, it still touches on many of the issues we face in 2017, particularly the fallacies government economic programs are built upon.

 

Hazlitt had touched briefly on the effects of government efforts to fix commodities prices above free-market levels. Now he turned his attention to some of the results to hold commodities levels below their natural market levels.

Hazlitt admitted that this had been common during the War and asked his readers to just set the wartime economy aside and consider the wisdom of continuing this practice long after the war is over.

Consider, he asked, when the government tries to keep the price of a single commodity, or small group of commodities, below the price set by a free competitive market.

When the government tries to fix maximum prices for only a few items, it usually chooses certain basic necessities, on the ground that it is most essential that the poor be able to obtain these at a “reasonable” cost.

He chose bread, milk, and meat as examples, but we could just as easily use New York City apartment rentals.

Image result for image of government price fixing

The argument goes something like this — if we leave beef (milk, bread) to the mercies of the free market, the price will be pushed up by competitive bidding so that only the rich will get it. People will get beef not in proportion to their need, but only in proportion to their purchasing power. If we keep the price down, everyone will get his fair share.

Hazlitt noted how inconsistent this argument was because it relied on need rather than purchasing power. Why charge for beef (milk, bread) at all? Why not just give it away?

Schemes for maximum price-fixing usually begin as efforts to “keep the cost of living from rising.” Their sponsors unconsciously assume that there is something peculiarly “normal” or sacrosanct about the market price at the moment from which their control
starts. That starting price is regarded as “reasonable,” and any price above that as “unreasonable,” regardless of changes in the conditions of production or demand since that starting price was first established.

Image result for image of government price fixingWe must assume that the purchasing power in the hands of the public is greater than the supply of goods available, and that prices are being held down by the government below the levels to which a free market would put them. Now we cannot hold the price of any commodity below its market level without in time encountering two consequences. When something is cheaper, people are both tempted to buy, and can afford to buy, more
of it. The second consequence is reduction in the supply of that commodity. Because people buy more, the accumulated supply is more quickly taken from the shelves of merchants. Additionally, production of that commodity is discouraged. Profit margins are
reduced or wiped out. The marginal producers are driven out of business. Even the most efficient producers may be called upon to turn out their product at a loss, which happened during the War when slaughterhouses were required by the Office of Price Administration to slaughter and process meat for less than the cost of cattle on the hoof and the labor of slaughter and processing.

The consequence of fixing a maximum price for a particular commodity would be to bring about a shortage of that commodity, but this is the opposite of what the government regulators originally wanted to do. They wanted to keep those commodities in abundant supply, but when their policy limits the wages and profits of those who make these commodities, without also limiting the wages and profits of those who make other items, they discourage the production of the price-controlled necessities while they relatively stimulate the production of less essential goods. Some of these consequences in time become apparent to the regulators, who then adopt various other devices and controls in an attempt to avert the consequences of their price controls. Among these devices are rationing, cost-control, subsidies, and universal price-fixing.

Image result for image of government price fixingWhen it becomes obvious that a shortage of some commodity is developing as a result of a price fixed below the market, rich consumers are accused of taking “more than their fair share;” or, if it is a raw material that enters into manufacture, individual firms are accused of “hoarding” it. The government then adopts a set of rules concerning who shall have priority in buying that commodity, or to whom and in what quantities it shall be allocated, or how it shall be rationed. If a rationing system is adopted, it means that each consumer
can have only a certain maximum supply, no matter how much he is willing to pay for more.

If a rationing system is adopted, it means that the government adopts a double price system, or a dual currency system, in which each consumer must have a certain number of coupons or “points” in addition to a given amount of ordinary money. In other words, the government tries to do through rationing part of the job that a free market would have done through prices. The effect is only partial because rationing merely limits the demand without also stimulating the supply, as a higher price would have done.
The government might try to assure supply through extending its control over the costs of production of a commodity. To hold down the retail price of beef, for example, it may fix the wholesale price of beef, the slaughterhouse price of beef, the price of live cattle, the
price of feed, and the wages of farmhands. To hold down the delivered price of milk, it may try to fix the wages of milk-wagon drivers, the price of containers, the farm price of milk, the price of feedstuffs. To fix the price of bread, it may fix the wages in bakeries, the price of flour, the profits of millers, the price of wheat, and so on.

As the government extends this price-fixing backwards, the consequences that originall drove them to this course also extend backward. Assuming that it has the courage to fix these costs, and is able to enforce its decisions, then it creates shortages of the various factors—labor, feed stuffs, wheat, or whatever—that enter into the production of the final commodities. The government is driven to controls in ever-widening circles, and the final consequence will be the same as that of universal price-fixing.

Recognizing that the attempt to keep the price of milk or butter below the level of the market might cause a shortage because of lower wages or reduced profit margins on the production of milk, the government may attempt to compensate for this by paying a subsidy to the milk and butter producers. Of course, this really subsidizes the consumers. The producers are not getting more for their milk and butter than if they had been allowed to charge the free market price in the first place, but consumers are getting their milk and butter at below the free market price. Those with the most purchasing power will buy the most of it, so they are being subsidized more than those with less purchasing power. Tax collectors will, in effect, but subsidizing themselves in their role of consumers.

There is no such thing as a free lunch, so while price-fixing may often appear for a short period to be successful, it eventually leads to demand chronically in excess of supply. If we ration one commodity, and the public cannot get enough of it, though it still has excess purchasing power, it will turn to some substitute. The rationing of each commodity as it grows scarce, in other words, must put more and more pressure on the unrationed commodities that remain.

The natural consequence of a thoroughgoing overall price control which seeks to perpetuate a given historic price level, in brief, must ultimately be a completely regimented economy. Wages would have to be held down as rigidly as prices. Labor would have to be rationed as ruthlessly as raw materials. The end result would be that the government would not only tell each consumer precisely how much of each commodity he could have; it would tell each manufacturer precisely what quantity of each raw material he could have and what quantity of labor.

Of course, this leads to a black market that will meet the needs of the public by end-running the errors of the bureaucrats. This was common in Europe during and after World War 2. In some countries the black market kept growing at the expense of the
legally recognized fixed-price market until the former became, in effect, the market.

By nominally keeping the price ceilings, … the politicians in power tried to show that their hearts, if not their enforcement squads, were in the right place.

There were consequences to this as well. During the transition period, the large, long-established firms, with a heavy capital investment and a great dependence upon the retention of public goodwill, are forced to restrict or discontinue production. Their place is taken by fly-bynight concerns with little capital and little accumulated experience in
production. These new firms are inefficient compared with those they displace; they turn out inferior and dishonest goods at much higher production costs than the older concerns would have required for continuing to turn out their former goods. A premium is put on dishonesty. The new firms owe their very existence or growth to the fact that they are willing to violate the law; their customers conspire with them; and as a natural consequence demoralization spreads into all business practices.

What lies at the base of the whole effort to fix maximum prices?

There is a misunderstanding of what causes prices to rise. The real cause is either a scarcity of goods or a surplus of money. Legal price ceilings cannot cure either — they merely intensify the shortage of goods. Price-fixing, like all the other government controls Hazlitt looked at, are the result of thinking only of the interests of the consumers immediately concerned and forgetting the interests of the producers. It is the same problem as existed with tariffs and subsidies, just in reverse.

The political support for such policies springs from a similar confusion in the public mind. People do not want to pay more for milk, butter, shoes, furniture, rent, theater tickets, or diamonds. Whenever any of these items rises above its previous level the consumer
becomes indignant, and feels that he is being rooked. The only exception is the item he makes himself: here he understands and appreciates the reason for the rise. But he is always likely to regard his own business as in some way an exception. He can see the inequity in holding down the price of what he produces, but not of what he consumes. Just as every manufacturer wants a higher price for his particular product, so each worker wants a higher wage. Each can see as producer that price control is restricting production in his line, but they don’t see it applying to other products.

Each one of us …has a multiple economic personality. Each one of us is producer, taxpayer, consumer. The policies he advocates depend upon the particular aspect under which he thinks of himself at the moment. For he is sometimes Dr. Jekyll and sometimes Mr. Hyde. As a producer he wants inflation (thinking chiefly of his own services or product); as a consumer he wants price ceilings (thinking chiefly of what he has to pay for the products of others). As a consumer he may advocate or acquiesce in subsidies; as a taxpayer he will resent paying them. Each person is likely to think that he can so manage the political forces that he can benefit from the subsidy more than he loses from the tax, or benefit from a rise for his own product (while his raw material costs are legally held down) and at the same time benefit as a consumer from price control. But the overwhelming majority will be deceiving themselves. For not only must there be at least as much loss as gain from this political manipulation of prices; there must be a great deal more loss than gain, because price-fixing discourages and disrupts employment and production.

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Posted February 2, 2017 by aurorawatcherak in economics

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  1. Pingback: Introduction to “Economics in One Lesson” | aurorawatcherak

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