The push for price controls: good politics, bad economics

September 29, 2005|By MARIO VILLARREAL

WASHINGTON -- Tragedy and need frequently give weight to arguments for increased government intervention in the economy. Times of crisis - such as we are experiencing now in the aftermath of two hurricanes - inevitably result in a ratcheting up of government spending and additional regulatory controls. A case in point is the consideration, once again, of price-gouging laws.

Maryland Del. James W. Hubbard, a Prince George's County Democrat, is working on legislation that would grant Gov. Robert L. Ehrlich Jr. authority to impose price controls on certain key supplies, such as gas, during emergencies. He argues that while oil companies increase their profits, most of the consumers who he represents are suffering.

As often is the case, good politics also means bad economics.

When government uses its power to regulate prices, coercion replaces voluntary exchange and mangles the price system's two crucial functions: to allocate scarce resources and direct production.

When goods are scarce, they must be rationed. In a free economy, this is achieved through the price system, which allocates resources based on individual information and judgment. Price communicates the value of a scarce resource to sellers and buyers, who then decide how much to buy or sell. Price adjusts accordingly to keep production aligned with purchases - supply with demand.

Prices also direct production. If consumer demand increases, or gas becomes scarce, this puts pressure on prices to rise, offering gas sellers an opportunity for extra profits. The incentives are clear: Producers are motivated to maintain goods flowing while consumers are encouraged to use them more carefully.

This process also works the other way around: Declining demand means falling prices and less potential for extra profits. In this case, producers have an incentive to allocate their resources to a more profitable use, to provide a good or service that consumers want.

Therefore, in a free economy, it is not necessary for the government to tell anyone what to produce or buy. Prices do a fine job.

Price controls create only economic disorder. In the short run, consumers might benefit from an artificial low price. But since sellers cannot raise prices, and are also paying higher prices to buy their provisions, they let supply run out rather than restock. Results: lack of needed goods, long lines, and upset customers - and sellers.

What would happen if nothing were done? There would be no gas shortages, people would drive less, demand would decrease and gas prices would go down. If buyers believe they are being abused by some sellers, reputation concerns might limit price increases. Since sellers are interested in building long-term relationships with their customers, a decline in trust would threaten their long-term profits. There is no need for government intervention.

Naturally, the consumer reaction when prices go up in times of great need is one of despair and resentment, a situation that offers a political opportunity. As Mr. Hubbard eloquently argued, price-freezing laws protect victims of disasters against merchants who take advantage of others' adversities. The frustration of politicians is understandable, but it can also misguide their judgment.

Not even the most capable government can determine the "correct" price for any good.

Although it might have good intentions, a bureaucracy cannot possibly coordinate economic activity as well as the price system. The necessary information is scattered among thousands, even millions, of individuals. And even if it could be gathered, no one has the capacity to properly analyze it. The former Soviet Union's ministry of prices ran out of business precisely for this reason.

There are more-effective ways in which everybody, including politicians, can help those in need, such as donating to the Red Cross or the Salvation Army. Simply put, price controls do more harm than good.

Although Maryland's Senate Finance Committee vowed to investigate options for protecting consumers from price-gouging, Mr. Hubbard declared that he would not wait for the results of the analysis, since he has "very little trust in private-sector business."

He fails to grasp that it is the private sector that creates wealth while government just taxes it. At the very least, he should keep in mind that bad economics also means bad politics.

Mario Villarreal is a doctoral fellow at the American Enterprise Institute.

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