Tuesday, January 22, 2008

Economics: Government Price Fixing and the Consequences

This week all the chapter readings of Economics in One Lesson seemed to focus on various types of price fixing. One category is fixing the price artificially high, to protect the producer (usually a group with special clout because of political power or sometimes sentimental power, like the "for the children" appeal that never gets old in public education expenditure). The other category is when a price is fixed artificially low to protect or aid the consumer.

(Before I go on, Cindy's Mr Linky is here with the other contributions to the discussion -- so you can get a bigger picture than I can provide solo)

  • "Parity" pricing – returning to the pricing of another day and age, in this case for farm prices. It is artificially fixing the price at a former high (never a former low in this kind of case)
  • Saving the X Industry – a more general way of looking at parity pricing.
  • "Stabilizing" commodities to prevent surpluses and shortages
  • Government price-fixing in general
  • And one particular form of price-fixing to favor the consumer--- rent control.

Dana said that because we are in the middle of the book and the terminology and examples are probably getting more difficult to follow, we could pick one example to focus on. I will pick on the "price –fixing in general" because it is a sort of paradigm of the others, if I am understanding all this correctly.

Hazlitt says that most people don't understand that prices are a delicate and if unhindered, an accurate and reliable, response to supply and demand. (Remember that he wrote this book in the 40's so perhaps there is more understanding now, but perhaps not).

If there is more of something than is required, prices will go down because people already have plenty of it. Their money will be diverted to other areas where there is more need. This is probably why pins are so inexpensive. Most people only need X amounts of pins and so once they have enough they aren't tempted even by rock bottom prices. But if something is in demand, and there is not "enough" for the present moment, prices will go UP because people are competing to buy something that is relatively scarce. However, this situation is most often temporary because more producers will jump into the market where the returns are higher. If housing is scarce, you see more land developers; if there is more housing than people really need you see deflated prices and the entrepreneurs moving out of land development or focusing on something else.

So Hazlitt says that if you come in and FIX the prices artificially low, usually to help the more economically disadvantaged consumers, you end up making the problem worse. It works this way (and this is exactly what I am pretty sure happened during the 70's with gasoline prices) –

You fix the prices at a lower rate than the market would naturally provide. More people can buy more. So they do. But because the prices aren't really reimbursing the producer, and the prices are such that the consumer can expand demand, there is a scarcity as result. The entrepreneurs that would normally come in and increase the supply are staying in another industry which is more financially rewarding. The buyers are buying at a rate which is BY DEFINITION lower than the market can provide for. So there is only X amount of the commodity, when the market is asking for X plus Y amount. So there is still not enough – the people that are willing to get in line the longest, or have an "in" with the producers or the government, get what there is of the commodity. The government that has fixed the prices originally now often comes in to solve the problem by rationing, or by commanding the producers to produce more. The intervention escalates.

If this goes to its logical conclusion, you have a completely managed economy. It becomes a matter of top-down centralized planning, or else reactive – a matter of putting out fires by edict. If it doesn't go to its logical conclusion, then you have relative inequalities – one group is favored, but always at the expense of another. This is my understanding of what he is saying. Of course, there is way more that I have skimmed or not mentioned at all.

I suppose it might be possible to say that this simply redirects the market, in a good way. Instead of the richest people getting housing, those who got in line first get the housing. It is more equal. But this ignores the market "response" to an economic demand. Under free conditions, when there is a scarcity of something, people look for substitutes, or they economize on the luxury. In the meantime, the more daring producers jump into the market because the pay-offs are bigger. But under "directed" conditions, there is less incentive to economize, and very little incentive to get into the market, so the demand continues to exceed the supply,

This goes back to his original thesis statement. If you look at only what happens directly as a result of the government intervention, it might seem beneficial. But if you look at the bigger picture and the longterm results, you see that inevitably you are going to need more and more intervention to "fix" the problems that result from intervening in the first place.

You also see that inevitably, because the political arena has taken over the functions of the market arena, that the market battle becomes a political one. The rich or influential people will still control the market, but in a different way. They will use their economic clout to swing government interventions in their direction. What further happens is that these bureaucratic interventions are usually difficult to implement. You need a commission, a bunch of people paid to implement and enforce the intervention. These people are not exactly producers – they do not necessarily need to be efficient in order to keep their jobs. All too often, inefficiency is rewarded because the budget for their commission goes up in response to their inadequacy. I know it's unfair to keep mentioning the public school system, but there it is. The less effective it is, the more money has to be poured in.

You get monopolies and cartels…. Those who have power get more power, the "big boys" work together behind the scenes to make sure the inequalities remain.

When the government gets involved in economics, it is like the referee becoming a player. The government becomes a business gorilla, with unfair advantages.

OK, Hazlitt didn't say all that last part. His part of it stopped with the paragraph about the thesis statement. What follows is strictly me, and please take it as ponderings right now. If you see a problem with the logic, feel free to let me know.

I don't know the solution, because I'm no economist and no politician. Deo gratias. But as a citizen, I REALLY hate paying taxes for wasteful government programs that are not directly accountable to the market OR to voters. I really dislike all unnecessary and tyrannical interventions from above, so I'm not just talking about government here. If you've read Harry Potter, think Dolores Umbridge.

This goes back to subsidiarity -- a larger organization should not do for a smaller and more organic one what the latter can manage for itself. The larger organization does have an important role to play, but it does not accomplish that by stepping outside its role to micro-manage in other areas. Just for an example, I very much appreciate the help of the medical establishment in managing Aidan's medical care. This is not something I could do on my own. I can't do liver transplants. But they would be trespassing if they tried to set up parenting protocols for me outside of the medical sphere. I can do mothering, and I can do it better than I could if they were second-guessing or contravening me.

So, the way I understand it, the task of the "polis" is to keep the playing field level. The government doesn't do that by, in effect, jumping into the playing field itself, but by setting things up so it plays out fairly. How is this done? I am not sure, and this is not the focus of Hazlitt's book. His focus is to point out the problems that ensue when the government becomes a "player" – intervenes to favor one side at the expense, inevitably, of the other sides.

When the referee becomes a player (I am thinking games because last weekend was such a big football weekend for my teens who are Patriots and Packers fans, but the analogy is just an analogy), you get corruption, bribery, inefficiency on the part of the team that the referee is intervening for, and unfairness. And there is little recourse. That seems to be roughly analogous to what happens when the government intervenes, no matter how well-meaningly, in the market. Quis custodiet ipsos custodies? Who guards the guardians? Socrates brought that problem up centuries ago, and the democratic answer seems to be decentralization and separation of tasks – separation of powers --- not the reverse.


Dana said...

Our governmental policies are schizophrenic....

For example, in 1984 they (FTC) forced AT & T to break up. Now 25 years later, the baby Bells are consolidating again.

The referee keeps changing the rules, and as you say, he shouldnt be *in* the game in the first place!!

Chari said...

Woman.....you are so way over MY head........maybe it is from working a 12 hr shift today and driving for an hour in near blizzard conditions...that makes me too numb to follow you.......but, I doubt it. :)

I am thinking Matthew might dig your thoughts. :)

God bless you and yours!

Willa said...

Yes, I was digging some of that same blizzard off of our deck yesterday. : (

I bet Matthew would like Hazlitt's book. Also, if he hasn't already he should read Pope Leo's Rerum Novarum -- it is SO good and quite short. I just read it and wished I had read it years ago.

Dominion Family said...

I am way behind because my son and his wife were visiting but I love your analogy. I am enjoying reading all the comments and posts because I really did get lost in these chapters and I still have 2 to go this week. Your simple illustration of the referee in the game is clarifying.