Why price controls are bad

When a government controls the price of a good, it will enables customers to buy more of the item while his income remains the same. When the demanded quantity of a good exceeds the supply available. Thus the price control has created a shortage.

By Medecci Lineil

As I have argued in previous articles in this series, when one has thoroughly investigated what inflation and its causes and symptoms are, one would realise that the difficulties we face are caused by government actions that result in more money being circulated.

In this final article, we examine the fallacy that price controls can remedy inflation.

When price controls are enacted, the government feels free to inflate the money supply all the more rapidly in the erroneous belief that prices cannot rise by setting up Kedai Rakyat, Kedai Ikan and so on. This policy does not deal with inflation and it does not stop inflation.

Price controls destroy the market economy by creating shortages of goods and services. Price controls also combine with inflation to produce a worse set of consequences than inflation alone would bring about.

The price system of capitalism is very important in the market economy. The term “market economy” implies human activity, human interaction and an ordered system of social cooperation.

The price system unites all rational individuals, all markets from Perlis to Sabah to all over the world, all occupations from farming to the management of corporations, all production and all consumption in a harmonious relationship serving the wellbeing of those who participate in it. All of these are what price controls destroy.

In the free market system, it is virtually impossible for shortages to occur. If you want to watch a movie, but the cinema is fully booked, you can line up for your ticket at the next showing. This is not a shortage because the cinema operator is in a position to supply more showings than demanded by his present set of patrons.

When a government controls the price of a good, it does so in the belief that this enables customers to buy more of the item while his income remains the same. But there comes a point when the demanded quantity of a good exceeds the supply available. Thus the price control has created a shortage.

Last January, there was a news report about rural folk in Sarawak facing a sudden shortage of fuel and food items.

Chaotic situation

The report quoted a town councillor as saying: “Whatever supplies that are left now, they are being sold at very high prices. There are some distributors bringing in these goods from Miri and selling them to rural longhouses at very high prices.”

He spoke of rumours attributing the “chaotic situation” to problems with transportation.

The quantity supplied falls if a price control on a good makes its production and delivery unprofitable or even if the profit to be realised is less than normally expected. This is especially true when the supplier is a a marginal entrepreneur. He will either stop his business or operate at a smaller scale.

In the news report mentioned above, the Sarawak Domestic Trade, Cooperatives and Consumerism Director was quoted as saying: “We are encountering some problems in transporting the goods into rural Sarawak.

“What happened was that our ministry headquarters (in Putrajaya) had not yet informed us when the transportation subsidies would be continued. I was told that the problem could only be sorted out by the end of this month.

“So, for now, the prices of the goods in the rural areas are being determined solely by those who are transporting them on their own without the government subsidies.”

Whether he knew it or not, he was explaining the situation in terms of free market capitalism.

I was pleased when he confessed: “There is nothing much the ministry can do for now.” In other words, the government failed and the free marker prevailed.

Those people transporting the items without government subsidies were profit-seeking entrepreneurs in areas not affected by the shortages. In anticipation of profit, they redirected their supplies from unaffected areas toward places where the goods were most desperately needed.

Of course, the rural folk have to pay more for the items. But at least they could still buy them. If people cannot pay for something with their money, they will pay for it with their time, energy and free speech. As a result, we will read of more complaints from the people, hear more nonsense from politicians and see more money in circulation (i.e. inflation).

Hoarding

In July last year, we read of a diesel shortage in Sarawak. News reports said the problem was caused by hoarding.

One report quoted the president of the Pan-Malaysia Lorry Owners Association as saying: “The price gap between commercial and industrial diesel is getting wider all the time, which causes some parties to take advantage of the situation by selling or smuggling subsidised diesel.”

This showed that a price control had caused the commodity to be consumed too rapidly, thus reducing the supplies available for future use.

As we have seen, not just in Sarawak but everywhere in the world, buyers over consume when prices are artificially low. At the same time, buyers dispose of larger supplies more rapidly since the price control discourages them from covering storage cost.

Under this situation, the buying public eventually realises that supplies will run out. Demand then sky rockets as buyers scramble for supplies.

The huge supplies that sellers are encouraged to place in the market under a controlled price regime eventually become insufficient to depress the market price because the commodity is hoarded up by a public all too aware of the shortage to come.

Those who hoard or smuggle the commodity are not responsible for its shortage. They hoard because they anticipate the shortages caused by the price control. They smuggle the commodity across the border to where the prices are not controlled and are higher.

The shortage is due to the disruption of the free market by the government.

In a free market system, the absence of price controls plus the additional demand of the public would simply raise prices. At the higher prices, the rise in the quantity of goods demanded would be cut back. Prices would rise to whatever extent necessary to level down the quantity demanded until it us equal to the supply available.

Economic logic

Consumers must be willing to pay the necessary price for what they want. This is economic logic. Supporting a price control means threatening the market economy and indirectly supporting a measure that makes supply impossible.

In addition to the shortage issue, I also read with deep interest several news items about impending hikes in electricity and water tariffs, local council taxes, school bus fares, Astro subscriptions, the prices of cooking oil, petrol, flour, sugar and so on.

Most of these items are regulated by the government and monopolies. The prices are set at levels higher than would have prevailed in free market competition.

When inflation drives up the production costs of the monopolies, it will be politically difficult for the government to allow these prices to rise even higher. It would then either allow only minor increases or freeze the rates altogether. It will impose price controls and increase the quantity of money in circulation through subsidies.

The industries protected by government then become unprofitable.

Bailout

At the end of the day, the monopolies will either go bankrupt or require a government bailout. In most cases, they are not just bailed out, but also nationalised. Nationalisation means that the ownership of the firm changes from the private sector to the government. The bigger the government, the bigger the crisis.

There has been much talk of an impending bailout of Malaysia Airlines. We can learn a lesson from the repeated bailouts of Japan Airlines, which eventually succumbed to its US$25 billion debt and filed for bankruptcy a few years back.

A bailout of Malaysia Airlines will only accelerate inflation and push prices higher. There is no reason to believe that a government bureaucrat can value assets more correctly than entrepreneurs who risk their capitals.

To return to a sound economy, bad investments already made must be liquidated. The companies involved must be allowed to go bankrupt.

Nevertheless, the reality is that bailing out government protected industries has been a common practice for decades. This is nothing less than transferring wealth from taxpayers to those who make poor decisions.

Of course, the government would conduct a bailout in the name of national interest, and it would finance it largely by increasing the quantity of money.

The same principle—using inflation to address inflation—is used in meeting demands for government support in housing, welfare and so on.

Low savings

Consumers are in a difficult position to enlarge their spending for higher electricity and water tariffs, for example, without reducing their spending for other things. They are forced to spend more money to buy government regulated goods. Their savings thus become limited.

Low savings are very much caused by artificial low interest rates. And when cheap money floods the market and bid for scarce resources, prices rise and malinvestments occur.

Anticipating even higher prices in future, consumers spend more money for present consumption and reduce their savings for future consumption. Some consumers start living beyond their means and go bankrupt.

Other than the idea of market interest rates, in a free market system, where there is freedom of competition, where government does not stand in the way of men competing, the search for higher profits is always the cause of more supply and lower prices. Producers find ways to cut their costs of production and offer goods and services to cater to changing needs and wants.

Thus, unlike in the case of government protected monopolies, participants in a free market pursue profits by trying to reduce, not raise, prices. The lower prices make our money buy more things.

The problems facing a market economy, such as price controls, inflation and rising costs, are the inevitable consequences of government intervention—that is, the increase in the quantity of money—which makes our economy sicker.

It is absurd to blame an industry’s inefficiency on anything but government interference by inflation, price controls and a long and silly list of bureaucratic regulations, which create no incentive to be efficient. In the free market system, on the other hand, profit and loss incentives, open competition and free pricing are the crucial elements for achieving coordination.

Medecci Lineil is an Austrian Libertarian who lives in Kuching. He is a board member at the Institute for Leadership and Development Studies and former senior executive at the Institute for Democracy and Economic Affairs.

Free Malaysia Today