Most understand the principles behind the law of supply and demand. Higher demand leads to higher a price, incentivising higher production; higher supply leads to a lower price, enticing higher consumption. Interference with the free price formation will lead to over-consumption and under-supply or vice versa. Not surprisingly, economists are generally opposed to such measures. When the free formation of market prices is interfered with, capital allocation gets distorted. Price ceilings will in the medium to long term divert resources from production of the price capped sector, leading to a sub-optimal order of production.
An extreme example of unintended consequences comes (unsurprisingly perhaps) from socialist Venezuela, where generous fuel subsidies make filling your tank virtually free. This leads to extreme over consumption, with massive traffic jams being a feature of Caracas until the economic meltdown put a halt to normal life over the last couple of years. It also has lead to large scale smuggling, costing the government an estimated $18bn annually. This extreme example of course only illustrates an amplification of the problems even more modest price controls entail. Despite this, political meddling with consumer prices is surprisingly common. According to the World Bank, 89% of developed countries interfere with the price of energy and 76% with the price of food items. Most western economies have established a price floor for labour in the form of minimum wages. Rent controls are popular in Europe and is making a comeback in many US states.
But price controls do not only come in the form of directly mandated minimum or maximum prices. Export bans, import levies, subsidies and taxes all distort consumer behaviour and the consequences can be devastating. Britain’s infamous Corn Laws, a set of tariffs and trade restrictions on imported food and grains, were set to protect British farmers from foreign competition but led to inflated food prices and significantly lowered living standards for millions of Brits in the mid 19th Century.
Unfortunately, once introduced price controls can be very hard to remove. The beneficiaries of such measures have strong incentives to lobby for their continuation and the political expediency that leads to their introduction similarly makes them politically difficult to repeal. Imagine the complications in repealing rent controls, with the inevitable accusations of doing the bidding of the reviled private landlords. It took a disaster to prompt the repeal of the Corn Laws, when the Irish Great Famine in 1845 led to a fall in food supplies that made the laws untenable.
It is not hard to see the political appeal of price controls. It offers a quick fix to a problem but does nothing to address the underlying issues while inevitably leading to unintended negative consequences. Minimum wages may provide many with a higher income but does nothing in itself to address lower productivity. At the same time, the least productive members of the work force will lose their jobs. Price caps on energy or rents will lead to underinvestment. Minimum prices for agricultural products may be a lifeline for some farmers but by allowing the most inefficient farmers to survive, the cost of food production is artificially inflated.
Price controls reduce the power of the consumer to influence the structure of production and places it in the hands of government officials and those who influence them: lobbyists, unions, special interests and crony capitalists. It doesn’t remove the economic problems of scarcity and capital allocation but replaces the economic competition for resources with the political. Distorted price signals confuse the market mechanism and leads to suboptimal capital allocation, reducing economic output and thereby living standards across the economy.