Price controls cannot fight inflation
Isabella Weber, professor of economics at UMass, consulted the pages of The Guardian advocate for price controls to fight inflation.
Today, economists are divided into two camps on the question of inflation: the Transitory team argues that one should not worry about inflation since it will soon disappear. The Stagflation team calls for budget cuts and an increase in interest rates. But there is a third option: the government could target specific prices that drive inflation instead of switching to austerity that risks a recession.
Making price control seem like the reasonable and above-the-fray option is utterly rhetorical. First of all, there aren’t really two camps on this issue among economists; there are too many to count. But let’s say there are only two, Team Transitory and Team Stagflation. Both of these positions are based on economic reasoning and have a chance to be right. Price control is set aside as the third way because it is certainly wrong.
Weber turns causality upside down from the start. She writes that “a critical factor that drives up prices remains largely overlooked: an explosion in profits.” It makes no sense to say that profits drive up prices in competitive markets. Profit is defined as income minus costs. For profits to increase, something has to change in terms of revenues and costs. The equilibrium price of a good does not in any way depend on profit.
What happened is the exact opposite of what Weber claims. The general increase in prices has resulted in increased profits, as higher prices mean more revenue for businesses. (Producers also face higher costs, as the producer price index has also increased significantly, but at least for now the increase in income has balanced this at the aggregate level. economy.)
The only way for companies to raise prices by increasing their profits would be to have pricing power, that is, to be monopolistic. Weber never provides evidence that companies have suddenly become monopolistic in recent months and have raised their prices enough to cause the price level to rise significantly. It would be quite strange if they had this power from the start and only chose to use it now, all at the same time.
Weber uses the following metaphor:
If your house is on fire, you wouldn’t want to wait for the fire to go out. You also don’t want to destroy the house by flooding it. A skillful firefighter extinguishes the fire where it burns to avoid contagion and save the house.
It doesn’t work in some ways. First, the price increase is not the fire. The fire is that there is an imbalance between supply and demand. A price increase is the fire alarm, so to speak, alerting everyone to this reality. You don’t put out a fire by turning off the fire alarm, and you don’t solve inflation with price controls.
Second, who is the “skillful firefighter” in real life? Who is the person or group of people with sufficient knowledge of the economy to know what prices should be controlled and what they should be fixed at? President? The Ministry of Commerce? Congress? The Faculty of Economics at UMass?
In essence, Weber is upset by some indicator of the problem, not the problem itself. Higher prices are an indicator of an imbalance between supply and demand, and they are used to coordinate behavior. They communicate, “Hey, there’s a need here! To people who could help solve the problem.
We’ve seen this happen in the supply chain industry, where record levels of private investment are pouring in. People are very upset with the high shipping costs, so there is a lot of money to be made in fixing the issues that are bothering them. . Companies see the high profits in the supply chain sector and want to be part of the action, increasing competition and spurring innovation. Competition and innovation mean undercutting, which will lead to lower prices that erode the current outsized profits.
Weber repeatedly says that she advocates “strategic” price control. What exactly is Weber’s strategy, she doesn’t say. What prices should be controlled and at what should they be set? It is unfair to expect her to lay out her entire plan in an editorial, but she does not provide any example of what her strategic price controls would be.
It makes a big deal out of the price controls imposed by the Roosevelt administration during World War II. She writes that during the war “the price increases were small, while the increase in production was almost beyond imagination.” She does not mention that there were ration books or that the increase in production was in the production of planes, tanks and bombs to wage the largest and most destructive war in the history of humanity.
Weber points out that “some of the most prominent American economists of the 20th century called for the continuation of price controls” after the war. What Weber misses is that they were wrong. Paul Samuelson, for example, wrote that the end of the war and the controlled economy would lead to “the greatest period of unemployment and industrial upheaval an economy has ever known.” Harry Truman ignored the doomsday prophets, got rid of price controls, cut government spending, and the post-war economic boom happened instead.
“Strategic price controls” (strategy to be determined) are not a tool to fight inflation. It is a retreading of ideas from the past that did not work before and will not work now because they are based on a fundamentally unhealthy economy. Isabella Weber doesn’t know what prices should be set, and neither does anyone else.