The Economic Fallacy of Price Controls

A renowned economist once said, “Even capital punishment could not make price control work in the days of Emperor Diocletian and the French Revolution” (Mises). Unfortunately, the monarchs, bureaucrats, and legislators of yesterday and those of today have yet to heed those words. As a couple of noted researchers also said, “Price controls are an ‘economic solution’ (Cox) used by well-meaning but ‘economically illiterate’ lawmakers (Van Doren, Peter and Jerry Taylor) to address specific economic problems (usually inflation).” They can either institute a maximum price (price ceiling) on a resource or good or a minimum price (price floor) with little or no regard to market forces. Penalties are enforced to discourage sellers from deviating outside whatever parameters are set.

However, not even good intentions can have a positive impact on what is basically bad economic policy, where the laws of supply and demand are ignored. Price ceilings often lead to shortages while price floors often lead to unnecessary surpluses (Gwartney et. al. 86).

Throughout history, many in positions of power have used price controls to influence economic activity and the results have often been disastrous. As mentioned previously, Diocletian’s own attempts to curb the rampant inflation which was devastating Rome at the time of his reign during the third century A.D., only hastened the economic deterioration of an already declining empire (Watkins). In the aftermath of the French Revolution, the government led by Robespierre instituted price controls (“Law of the Maximum”) on a variety of items (especially on food), which not surprisingly, led to widespread shortages and starvation (DiLorenzo).

Unfortunately, the United States has not been immune to the allure of price controls despite their dismal historical record. In a book review written by author Thomas J. DiLorenzo and published on the Ludwig Von Mises Institute website, he noted that at one point during the American Revolution, General George Washington’s army was in danger of starvation thanks to price controls instituted by “friendly” colonies such as Pennsylvania. These had the effect of causing severe shortages which were only alleviated after the Continental Congress recommended the repeal of these controls in June 1778 (DiLorenzo).

One could only hope that our dear legislators of today would take the time to thoroughly study the historical evidence before enacting policies that will hurt instead of help the economy. One suggestion would be to examine the impact of wage and price controls during the 1970s.

Professor William R. Park (University of North Carolina, Chapel Hill) recalled how it seemed like a good idea back in 1971, especially since it was popular with the general public and with a number of economists. President Nixon hoped to stem rising inflation (four percent in 1971) so on August 15th, he implemented temporary wage and price controls. Initially, this policy seemed to work as inflation took a dip in 1972 (helping Nixon win a major reelection landslide) and was still below four percent before Nixon’s second inauguration. Later in 1973, inflation went up again, and reached double-digits by the time wage and price controls were largely repealed, in April 1974. Nixon’s inflation-fighting strategy was deemed a “monumental failure” (Park).

Others have pointed out that the 1973 Oil Embargo and the sudden jump in gas prices helped fuel inflation and the recession that hit the United States, during that period. However, a 2003 article by Peter Van Doren and Jerry Taylor, which was published in the Cato Institute (Cato.org), blamed a significant, but not-so-obvious culprit: Nixon’s price controls. Back in 1971, oil companies responded by cutting back on imports (a price ceiling prevented them from passing on the higher cost of foreign oil) especially for use in gasoline products. As a result, the amount of gasoline in the U.S. market sharply declined leading to a significant reduction in the number of independent filling stations since the oil companies obviously gave preference to their own affiliates. Shortages then became a reality in parts of the country during the summer of 1973. The government responded by enacting the Emergency Petroleum Allocation Act in September, but this measure did absolutely nothing to increase the amount of available oil.

The short-lived “oil embargo” actually had minimal effect except to make an existing problem even more apparent. OPEC announced a five percent reduction in exports to the United States which was meaningless because supplies could have easily been replaced by non-OPEC oil. However, this inability to pass on higher prices to consumers and concerns over scarcity insured that much oil would be kept off the U.S. domestic market and the long lines at the gas pump continued until price controls on foreign oil were lifted (Van Doren, Peter and Jerry Taylor).

Unfortunately, these lessons seem to have been lost on some of the current generation of lawmakers. One recent example in the text (Microeconomics: Private and Public Choice) referred to the crisis that occurred after Hurricane Hugo struck South Carolina in 1989. The city of Charleston enacted a law against “price gouging” which insured that shortages would occur within the city area since prices could not be raised to meet actual demand. This also resulted in a misallocation of products as artificially low prices and scarcity combined to limit the availability of essential goods to those who were most productive and willing to pay higher prices, such as businesses (Gwartney et. al. 87).

Bad government policy is like that old Yoga Berra quote: ”It’s déjà vu all over again.” Nowadays, with skyrocketing fuel costs and food prices affecting the United States and other countries, some government officials are again taking a hard look at price controls as a possible panacea for staving off inflation and ignoring once again, what philosopher George Santayana referred to as the “mistakes of the past.” In recent years, countries such as Zimbabwe and Venezuela have instituted price controls only to experience the same disastrous consequences as others before them.

Why do people stubbornly cling to such a failed policy?  Author Laurence M. Vance links it to the often misunderstood concept of the “just price,” which he claims is the source of a “great deal of erroneous thought.” Vance cites the lack of biblical teaching regarding this principle, but instead sees the idea taking shape in ancient Babylonian laws and in the teachings of Greek philosophers such as Aristotle and Plato, who both took a dim view of merchants and commerce, in general. This may have formed the basis for the similar attitudes and views expressed by some prominent medieval thinkers-especially Thomas Aquinas (Vance). Unfortunately, these ideas would go on to influence many throughout the centuries and continue to this day.

It would take many years for us to finally reach Adam Smith, David Ricardo, Ludwig Von Mises, and a host of others, who together would clear up a lot of the confusion and misunderstanding that have muddled economic thinking since the early days of civilization. Ultimately, any worthy discussion of price controls has to be linked to an examination of this concept of a “just price” and who decides what that is. I hope policymakers would reflect on the following quotation,”If there is such a thing as a just price, then the extent to which it influences one’s pricing decisions should be a function of religion, ethics, and morality — not a function of law” (Vance).

Works Cited
Cox, Jim. “Price Controls.” The Concise Guide to Economics. 22 April 2005.
<
http://www.conciseguidetoeconomics.com/book/priceControls/>.

DiLorenzo, Thomas. “Four Thousand Years of Price Control.” Ludwig Von Mises Institute.  10 November 2005. 22 April 2008.<

http://www.mises.org/story/1962>.

Gwartney, James D., Richard L. Stroup, Russell S. Sobel, and David A. MacPherson. Microeconomics: Public and Public Choice. Mason: Thomson South-western, 2006.

Mises. Ludwig Von. “As quoted in Defense, Controls, and Inflation.” Ludwig Von Mises Institute, Auburn. 22 April 2008.< http://www.mises.org/quotes.aspx?action=subject&subject=Price+Control>.

Park, William R. “President Nixon Imposes Wage and Price Controls.” The Econ Review-online. <22 April 2008.http://www.econreview.com/events/wageprice1971b.htm>.

Vance, Laurence M. “The Myth of the Just Price.” Ludwig Von Mises Institute, Auburn. 31 March 2008. 22 April 2008.<

http://www.mises.net/story/2918>.

Van Doren, Peter and Jerry Taylor. “Time to Lay the 1973 Oil Embargo to Rest.” CATO Institute. 17 October 2003.
23 April 2008<

http://www.cato.org/pub_display.php?pub_id=3272>.

Watkins, Thayler. “Episodes of Hyperinflation: Rome.” Department of Economics, San Jose State University, San Jose. 22 April 2008.
<

http://www.sjsu.edu/faculty/watkins/ hyper.htm#ROMAN>.

5 comments to The Economic Fallacy of Price Controls

  • Thanks Emmanuel,

    It is understandable why politicians would promote economic manipulation. I am continually amazed, however, at how many intelligent, well educated people, including PhD economists, can ignore all of history and think they know better.

  • How refreshing to read a contribution by a new Citizen.Economist who deals in facts, rather then mere theory!

    No one yet has proven to the contrary that supply/demand is anything but simple economic fact.

    Everything else is simply one or another theory, subject to current vogue of idealogy

  • Dirk

    The experiences of the 70s, especially with New York housing, have relegated price controls to the same dungheap of history where lay the Divine Right of Kings, the Gold Standard, Lebensraum, and Communism.

    It is amazing how some economists keep returning to these principles, like a dog to its own vomit.

    I really hope the idea that economies should be constrained via monetary policy and interest rate manipulations will join these discredited ideas soon as a result of this latest crisis.

    But it will only happen when economic and financial scholars are brave enough to declare what the data has been saying for decades- the US Federal Reserve has been given the power to create economic and financial crisis (now on a global scale), and we, the people, must reign it in.

    Because monetary constraint and interest rate manipulation (even when tied to a gold standard) is another form of price control, isn’t it? Just because GDP growth goes over 4%, and prices of some goods go up 5-10% in a year, does that justify raising interest rates such that debt service (and the required increase in profits to maintain banking ratios) can create a 3X hit to business cash flows? This is like raising the price of all apartments 50% at the same time- but not allowing new apartments to be built. Then, we wonder why people aren’t/can’t borrow as much and economic activity crumbles.

    If you want to call this theory, OK, but there are plenty of facts supporting this- true?

  • Thanks Dan and Dr. Z!
    Hope you and everyone else are having a good holiday season! I initially wrote that post as a paper for microeconomics class last semester.
    Lately because of all my other school work, I’ve been largely playing the role of spectator on this site-and it’s been frustrating!

  • Raymond

    Emmanuel,

    Four thousand years of price controls never worked, that is your point. I also read Thomas DiLorenzo’s book How Capitalism Saved America. I bought two more copies and gave it to my two college aged children. Great book.

    Here is what’s curious—

    The interest rate is also a price, of borrowing money.

    Observe how mainstream economists, government and financial media discuss on which way interest rates should be manipulated to achieve their desired effect.

    Perhaps they actually believe they can do better than the market, despite four thousand years of history to the contrary.

    Isn’t that astonishing?

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