Government Price Controls

In Praise of Price Gouging

There is not really such a thing as price gouging, as long as there are competitive markets. In competitive markets, any rise in price, even if labeled price gouging by consumers and politicians, is in fact the market price. During hurricanes and other natural disasters, shortages of goods often appear due to a lack of supplies (which itself is often due to government’s preventing the free movement of goods in the name of safety of those otherwise willing to transport goods). In such times, government imposes price-gouging laws. But in these cases, more than in most, what’s needed is for the price accurately to reflect the supply of goods relative to their demand; what’s needed is for prices to rise (so-called price gouging).

Consider a gas station convenience store along a relatively isolated highway after a hurricane. If the price of gas rose extremely high — to the market price — people would only take as much of the expensive gas as they felt they needed, leaving spare gas for others. But if the price is set artificially low, those that arrive first will fill their tanks “just to be safe.” The same applies for the goods inside the store. Those first on the scene would take, say, five boxes of cereal apiece at a price of, say, $5. But if, due to scarcity, the price of the cereal box instead rose to, say, $95, each customer would likely take only one box. And just because the price increases does not mean that only the rich could afford the cereal. Poorer people could afford the first $95 box they really needed more easily than the rich could afford a second, third, or fifth box they don’t really need. Government-imposed price ceilings cause goods to become unavailable, whereas supplies would otherwise be available at some price.

The Worldwide Food Shortage

The same concept applies to the recent food shortages many countries experienced. Government imposed price caps on food and gasoline (food is made and transported with the use of gasoline) resulted in a lack of supply of food in these countries. The cost of making the food had risen considerably — by way of high commodity prices — but food producers were not allowed to sell their product for a profit, since government limited their selling price. They therefore quit bringing food to market. People thus starved, fought each other for food, and engaged in riots.

Paul Krugman blamed the price of food on, among other things, new food demand from China, and diversion of farmland from growing food to growing biofuel crops. Krugman did not, however, mention that the underlying cause of food shortages must necessarily be the lack of a free market, since shortages could not exist in a free market. Under free markets, while prices of goods would likely rise at the onset of reduced supplies, the goods in question would always be available at some price — and the higher the price, the more the supply would increase to meet demand, which would then of course reduce the price. If we had free world markets, food would be exported from some countries, such as the U.S. and Europe, where food is plentiful, to countries where it is needed. This is because it would be profitable to ship goods to needy areas where selling prices were higher. Yes, the poor countries could afford higher prices because 1) they would be buying less at the higher prices, 2) they would curtail other consumption and 3) just because they are poor does not mean they have no purchasing power at all.

The fact that this was not happening can be a result only of government price controls (that prevented prices from rising in needy countries), trade restrictions, or some other government barrier which prevents people from getting what they need. The World Bank, at the time, had cited a list of 21 countries which had price controls on basic staples. We all remember the stories of people in Ethiopia starving in the 1980s, when 3 million people went hungry. What was unreported was that there were 60 million people in Ethiopia at the same time who were unaffected by famine. The moving of food from one part of the country, where it was plentiful, to the other part, affected by drought, was prevented by fighting between the government and rebel groups near the area of the drought. Economic incentives were prohibited by 1) the government’s forced withholding of food shipments (so that rebel soldiers would not have access to supplies), 2) price controls, 3) the prohibition of grain wholesaling in much of the country, and 4) by the prohibition of the private selling of farm produce or machinery (based on communist economic planning). A similar situation occurred in Zimbabwe in the early 2000s. Indian economist Amartya Sen won a Nobel Prize for demonstrating that most famines are caused not by lack of food but by governments’ ill-advised intrusions into the functioning of markets. The rising food prices, as we discussed in Chapter 3, could only come from government printing presses. Otherwise, prices could not rise dramatically unless the real supply of food was quickly disappearing.

To be clear: for various fundamental reasons related to production, supply, and demand, there was a lack of supply of some commodities available relative to the growing real demand for them. Still, this lack of supply was not the root cause either of the occurrence of shortages or of the extreme increase in world food prices (by over 80 percent in three years). Additionally, though many commodities such as wheat had been stagnant or in reduced production over the prior several years, other commodities had seen continued increases in production. And other food groups such as cereals, fruits, livestock, and fish/seafood products had seen mostly increased supply. Data from The Food and Agriculture Organization of the United Nations showed that both world agriculture production and food production per capita had risen since 1990, and stayed steady since 2000.¹²⁶ In comparison, commodities’ prices constantly rose between 2000 and 2008.

Any real “new demand” for food from China (the increased “demand” was actually only an increase in the printing of money by the Chinese central bank, putting more money in its citizens hands) would necessarily have resulted not only in the Chinese themselves producing more food to meet this demand, but in the rest of the world doing so as well. In fact, China had increased agricultural production per capita by 22 percent between 2000 and 2007. Can we really imagine that world food producers would not have spotted this demand and tried to make profits by satisfying it? They had, and had therefore been producing more food. The Chinese population is increasing by just over one-half of one percent per year. How, then, could the Chinese suddenly have a desire and need for 30 percent or so more food per year in recent years? Further: how could they pay for it, even if they had the want of more food? The answer: they didn’t have that much of an increased real demand, they simply paid 30 percent more for it with the additional paper currency their government printed. If there were as much of a new demand for food in China as Krugman claimed, given a constant amount of money in the economy, there would necessarily be a corresponding reduction in the demand and prices of other goods. Therefore, the Chinese may well be consuming more food, but this increased consumption would not be responsible for (absolute) higher prices or shortages. The higher prices were the manifestation of inflation created by the world government’s printing of money, and shortages arose from price controls imposed because of the inflation.

As for Krugman’s last argument — that farmland usable for food was being diverted to the growing of biofuel feedstock instead — this is a question mark. In a free market, if there were a shortage of food and if the (necessarily) associated high prices of food gave that market signal, land used for any other item — biofuel feedstock, car lots, movie theatres, houses, or whatever — would be converted to use for farming. If we experienced sustained food shortages in the United States, for example, this is what would happen. Indeed, agriculture used to represent 50 percent of GDP at the beginning of last century, but is now less than 1 percent. Land use has changed to meet changing demands. But if we needed food, we could and would build agriculture back up towards that 50 percent level. On a world-wide scale, as food prices rose, land would be turned to the more profitable growing of food instead of the less profitable growing of biofuel feedstock.

Only if government subsidies were high enough to obscure these market signals, or if government required energy companies to purchase feedstock (which this author is told is the case in the U.S.), could the agriculture production structure be deformed so that this market response would not take place. Similarly, if agricultural lands became difficult to develop due to government regulations to, e.g., protect current farmers, increased production could become difficult.

In sum, the real cause for the previously rising food prices was the printing of money by world governments: since they slowed the printing presses in the last couple of years, and since commodities prices fell as a result, food prices have stabilized and fallen. The real cause of actual food shortages was the prevention of profitable global trade in food by the ill-advised policies of governments of the very people who are starving. To the extent that any other causes proposed contributed to a reduced supply more than temporarily, this must be because governments prevented the market from working. To ignore these primary drivers of recent world food shortages is either willfully to dismiss economic logic, or to be unaware of it.

The Gasoline Crisis of the 1970s¹²⁷

A gasoline shortage occurred in the U.S. in the early 1970s due to price controls. When an Arab-led OPEC embargo raised the price of oil in the west, the U.S. government imposed price controls in the North Eastern United States. Whereas OPEC could not have otherwise harmed us, our politicians allowed them to do so. Had our government allowed prices to rise, oil would have flowed from other parts of the U.S. (and the world), to the North East. But since it was unprofitable to do so, this did not happen. The result was cars lined up for hours waiting to obtain some of the little gasoline that very few gas stations had.

We should not be bothered about a possible refusal by Arab or all OPEC countries to sell to the United States harming us — a concern often voiced by those who cry that we should not be oil-dependent. As prices rose in the United States, non-OPEC oil-producing countries, along with other countries that also purchase oil from OPEC and non-OPEC countries, would export oil to the U.S. because they could profit by doing so. Besides, even if there were no indirect means of obtaining OPEC oil, OPEC would not refuse to sell to us for long. For doing so would cut off much of their revenues and profits. They would be engaging in economic suicide.

In fact, an OPEC boycott would help us, and it would have done so in the 1970s had we not had price controls, and had the American oil industry been otherwise unregulated (i.e., free).¹²⁸ As world oil prices shot up, American oil companies would have made tremendous profits, and would have therefore been in a position to locate, develop and produce much more oil, as well as other forms of energy, such as shale. Additionally, oil-dependent Western Europe would have needed to turn to the U.S. for their oil. The U.S. would have established itself as a much larger oil producing country and exporter. The OPEC countries, on the other hand, would have been deprived of oil revenues, and the smarter countries of the group would have broken from the OPEC alliance so as to resume bringing income into their country. All of these actions would have served to bring oil prices back down, and probably to a point lower than where they previously were.

A Personal Example of Being Harmed by Price Controls

Permit me to offer a personal example of what it means to be harmed by price controls. Upon the death of a family member several years ago, we as beneficiaries hired an accountant to help settle the estate. Upon interviewing this particular accountant recommended by my deceased family member, we inquired as to his estimated charges. He gave a reasonable figure and we accepted. Had the estimate been higher, we would have instead employed another accountant whom we knew personally, and who had given a similar cost estimate. Ultimately, the bill we received from the accountant was about four or five times larger than he had estimated. Further, he could not account for the details of the charges; he could not explain what was done hour-by-hour, so as to account for the number of hours he charged. I proceeded to make a formal complaint and appeared before a judge to make my case. No matter that the accountant clearly seemed to have lied and cheated us (an accusation he never contested), I lost the case, because of the fact that the charges were within the official range, as a percentage of the total estate, accorded by state law.

What’s notable is that the state effectively gives the accountants and lawyers themselves the power to write the law, as it is only they, supposedly, who know the “appropriate” charges. The law is presented as a means of protecting the consumer from price gouging, but in fact sets a price floor for the transaction. Though the lawyers, in the laws they write, cite a maximum percentage to be charged, they also cite a minimum percentage — at a price which represents very nice profits for themselves. In a free market any price could be charged, but competition would dictate that it is kept low. Of course there could be cases where an accountant figures a client to be a sucker, and charges him or her way too much. But, such a case would be rare, and most other clients, unlike today, would be charged appropriately based on true costs. Secondly, even if overcharged, clients would have first had to agree willingly to the charges (or could legally contest them), which means the charges were to a large degree acceptable to them. Otherwise, they could have hired one of the many other accountants and lawyers who could perform the same service for less. But because of today’s regulations, my family members lost money to others who could legally swindle us (and the estate was not a large one).

Rent Controls

The government sometimes imposes a maximum rental price so that renters will not be overcharged. The result is a lack of housing and deteriorating quality of current housing. If rental prices are capped, owners cannot adjust revenues to their higher costs as inflation rises. Thus, new housing will not be built. Existing owners invest little in maintaining their units, because they are not rewarded for doing so since 1) they can’t raise rents, and 2) they do not have to compete with other housing units in order to attract renters — given that the scarcity of new apartments leads to more renters competing for the same quantity of housing as the population increases. Whenever something seems screwy, look for the existence of government intervention and regulation.

The results of such regulation can be easily seen in New York City, one of the few cities in the U.S. still under heavy rent control laws. New York is famous for a shortage of housing, with renters competing for old, out-of-date, run-down apartments. It is common for the superintendents of these buildings, who are in charge of letting the apartments, to take bribes of tens of thousands of dollars from renters competing for the housing that’s available (at low monthly rates). Naturally, the poor can’t compete.

Were rent control abolished, thousands of old buildings would be torn down and replaced with well-maintained high-rise apartments, due to the very high prices that would suddenly take effect. After the supply of apartments increased, however, there is no question that overall rental prices would fall.

Pay Day Loans

I have a socialist aunt who insisted several years ago that the poor should never be charged a higher interest rate than other people. She was referring to the pay day lending business. She didn’t understand that pay day lenders were helping the poor, not hurting them.

Pay day lenders lend to those to whom others deem an unacceptable risk. Borrowers typically have very bad credit, which means they have not always repaid the money they owe on time, if at all. Predictably, many who borrow through pay day lenders do not repay their loans. Thus, the lenders must charge high rates in order to cover the losses they incur from those who don’t repay. The rates they charge are certainly high, typically well over 100-200 percent on an annualized basis (they usually lend money for a matter of weeks, until the borrowers receive their next paycheck, which is then used to repay the loan).

If the borrowers could have obtained loans at a bank, they would have. But since they were high risk, and since they likely had no collateral, banks do not typically lend (unless forced to and/or subsidized by government programs, as they are to a large extent). Thus, pay day lenders make money available to borrowers who otherwise would have no immediate means to obtain needed cash.

To a large degree credit card lenders work the same way; high rates cover the losses they incur from those who do not pay. Were such lenders forced to loan at official interest rates through some type of “fair lending” laws (new laws in addition to the current ones that have already put lenders out of business or ones that force the taxpayer to subsidize loans), they would either go out of business, lend only to borrowers with exceptional credit, or require some type of collateral in order to extend credit. For those who don’t believe these logical explanations and feel that these lenders are still gouging consumers, let them open a business lending to consumers at lower rates and see if they could take market share away from the current “greedy” lenders. Obviously, if this were possible, people would already be doing such things. In fact they have, and they brought interest rates down to the current market rates, the rates which are deemed excessive.

A friend recently equated credit card companies to the IRS. In correcting his understanding, I explained that for it to be the same thing, he would have to be forced by the government to borrow from a single government-run monopoly lender at the high rates they dictate (in order for there to be lower rates, the lender would have to be subsidized the equivalent amount by extra income taxes). In reality, if my friend does not like his current lender he can shift to others, or, choose not to borrow at all. With the IRS, we can’t choose not to deal with them.