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The High Cost of Price Controls
The High Cost of Price Controls
Nov 25, 2024 9:46 PM

  About forty years ago, Brazils elected president was incapacitated, and his vice-president took office. With a big mustache and painted hair “dark as a crow’s wing,” he looked the part of a populist Latin American politician out of the Comedy Central cast. Unfortunately, there were other less colorful but equally pathetic features of his time in office.

  In 1986, the country was in the middle of a period of particularly bad mismanagement. Due to the governments lack of credibility, it had a chronic fiscal deficit that was becoming increasingly difficult to finance with borrowing. That forced the government to rely on inflationary financing, and prices went through the roof.

  President José Sarney, stepping into the presidential role, had a great idea to fight the inflation his government was generating: establishing a general price control.

  With that policy, he could blame the “greed” of businesspeople for the rise in the price level and divert attention from the fact that inflation was actually a tax on nominal incomes and cash balances that served to fund his government.

  It is worth mentioning that the country was emerging at that time from a period of rupture in the constitutional order, and neither Congress nor the courts had the power to prevent such economic lunacy.

  There is a reason why the most peaceful and prosperous human societies are those that limit political leaders whims. Without those limits, persons in a position of power cannot be protected from themselves. They engage in irrational behavior, putting what they perceive to be in their interest above the well-being of the people.

  We call those limits the rule of law, in opposition to the rule of men, and they are embodied in constitutions and laws that check rulers powers.

  Some of these rules are very specific, such as those protecting the integrity of elections. Others are more general, like those guaranteeing citizens a sphere of autonomy, i.e., private property rights and freedom of contract.

  Understood in this broader sense, the rule of law encompasses all the legal institutions that support the extended social order we enjoy today in the most advanced nations.

  Think about the spontaneous order of the market and its marvels. Those marvels include everything from having freshly baked bread every morning for a pittance to the most recent technological innovations like Artificial Intelligence. It is worth remembering that these wonders do not happen in a vacuum; they are only possible because of the proper rules under which the societies that produce them were established.

  If those rules are infringed, bad things start to happen. In Brazil, in a matter of months, the obvious consequences of Sarney’s price control policy started to manifest themselves. When milk became unprofitable at the controlled price, producers started to sell their cows to slaughterhouses, and milk production plunged. Once the dairy farms were emptied of cattle, the price of meat would not allow the slaughterhouses to pay the cattle growers for their animals, so they stopped selling them and meat production also plunged.

  One of the most memorable TV images I have of those times is of some officers from the Brazilian equivalent of the FBI in helicopters trying to wrangle cattle being “hoarded” in open fields, amusing the tele-spectators as if they were clowns in a rodeo.

  The problems of discoordination caused in the economy were widespread. The governments inflationary financing and price controls disrupted all sorts of industries, with the meatpacking sector being just an example.

  The Brazilian experience is not some sort of obscure knowledge to which only a few are privy. Nor is the economics behind it rocket science. There is a book with the suggestive title of Forty Centuries of Wage and Price Controls: How Not to Fight Inflation, written to a lay readership, that would have enabled Sarney to read and understand the problems of such policies, had he made the effort.

  Even the most profound argument about the nature and function of the price system, Friedrich Hayek’s 1945 article on “The Use of Knowledge in Society,” is comprehensible by almost anyone with a high school education.

  Let us delve for a moment into Hayek’s argument.

  In an order of command, like an army, all members have a single goal. Therefore, following orders makes sense. Conversely, the spontaneous order of the market is one in which the individuals all have their own goals. They must, therefore, find a way to cooperate with one another despite having no one in charge.

  Prices allow market participants to generate information about the most rational way for them to cooperate.

  It seems like a minor miracle that everyone in a developed country can find the bread they want in the morning, as Russ Robertss poem It’s a Wonderful Loaf, presents. It happens because the price system provides all the information necessary for various economic agents to coordinate their actions.

  Prices help each individual determine subjective priorities, such as whether he or she prefers to pay a dollar fifty for the chocolate croissant instead of a dollar twenty for the plain one.

  In the same way, prices help economic agents coordinate their intersubjective preferences. If others are willing to pay a hundred dollars for a fashion-brand pair of pants, let them have it. Without the fashionable label, I would buy the same pair of pants for fifty dollars.

  Hayek’s view of the price system as a mechanism to convey information has many important assumptions and corollaries.

  One important assumption is that the knowledge that helps individuals make rational decisions in their interactions with others is subjective; it is knowledge of particular circumstances that are not reducible to statistic form.

  Another is that the knowledge that individuals apply in their economic activities is knowledge that even they did not possess before joining the market.

  Think about the baker who, until yesterday, was working with a reference for the price of flour that does not allow him to sell a plain croissant for less than one dollar and twenty, who realizes that today’s flour price would allow him to sell the same product for one dollar and, hopefully, get more consumers, income, and profits.

  As opposed to scientific knowledge, then, knowledge of particular circumstances is the kind that cannot be conveyed to a committee of bureaucrats, enabling them to make a better-educated decision on behalf of the community—a decision that would be more rational than allowing the individuals to freely interact. Prices allow market participants to generate information about the most rational way for them to cooperate.

  I am too cynical to think that the former Brazilian populist president actually did not know that his own fiscal and monetary policies caused the inflation, or that his attempt to impose price controls was not just a naked plot to divert popular attention to politically weak targets.

  Leaving my cynicism (and Public Choice teachings) aside, what should a sincere politician do when she observes that the standard of living of the majority of people is declining?

  Brazil was not, and it is not now, a laissez-faire capitalist country (if ever one existed). To some degree, every country has many privileges protecting some economic interests from competition.

  Think for a moment about the etymology of the word “privilege.” The evidence shows that in the long term, only the law can protect special interests from competition and perpetuate distortions that would not survive in a free market.

  In the same vein, our sincere politician would acknowledge that even in the face of unfair economic distortions, the maximum that private individuals and corporations can do is to change relative prices, not the overall price level.

  Under a regime in which the state has a monopoly of the money supply, changes in the price level can only happen by a political decision by the monopolist.

  Inflation, understood as an increase in the price level, is always and everywhere a monetary phenomenon with a fiscal cause. Distortions in the market, such as oligopolies and bottlenecks, are for all practical purposes the result of state legislation, regulation, or whatever means are used to enforce the policies.

  Price controls cannot solve the problems caused by lax monetary and fiscal policies.

  Worse, they interfere with the price signals necessary to coordinate the economic activities of hundreds of millions of people in big societies like Brazil. This reduces economic efficiency, productivity, and production, ultimately lowering the standard of living compared to what it could otherwise be.

  The Brazilian experience with price controls lasted less than a year and ended in disgrace, with Sarney’s administration totally discredited. That, however, was not the first time that something like that happened, and as the evidence of 4,000 years demonstrates, it won’t be the last.

  Any opinions expressed are the author’s and do not necessarily reflect those of Liberty Fund.

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