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Politicians Should Remember the Power of Prices

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Politicians Should Remember the Power of Prices

July 26, 2015

With the start of the presidential campaign season, Americans have another opportunity to demand more from our leaders. Candidates who appear to have forgotten need reminding: price controls never work. Instead, more basic reforms to our nation’s educational, legal, and regulatory systems are needed, to get our economy growing at its full potential again and to ensure that the fruits of our prosperity are shared more equitably.

Price movements provide valuable information to consumers and businesses and keep markets functioning smoothly. When the price of a good in scare supply rises, consumers get a signal to scale back on their purchases, and businesses receive a powerful incentive to ramp up production and end the shortage. Conversely, when the price of an oversupplied good falls, it induces consumers to buy up the surplus and also indicates that some firms in the industry need to scale back or shift to manufacturing other products, in order to avoid further inefficiency and waste.

Prices work well in theory, but even better in practice. American adults remember vividly from childhood what happens when politicians and regulators fight against market forces to prevent prices from adjusting to restore equilibrium. Price controls during the energy crisis of the early 1970s did not make it possible for American workers to buy gasoline more cheaply; instead, they made it more difficult and sometimes impossible to find gas at all. Rent controls during the same decade did not make it easier for New Yorkers to find safe and affordable housing; instead, they gave landlords perverse incentives to improperly maintain their buildings and or even burn them down to collect on insurance. It’s easy to recollect all the “good times” when a song from those days comes on the radio. But, in truth, the 1970s were a very tough period for most Americans, and policies directed at controlling market prices, however well intentioned, only made matters worse.

Price movements work in financial markets as well, to keep savings in line with investment and to ensure that the most promising entrepreneurial ideas receive finding first, ahead of less promising ones. Many observers are quick, these days, to associate any rise or fall in the stock market with irrationality – a sign that traders are ignoring large deviations of asset prices from their fundamental values. But if some or all stocks trade far above or below the present discounted value of their future dividend payments, after appropriate adjustment for risk, then it should be possible for traders to profit systematically by purchasing undervalued assets and selling overvalued ones. Little if any evidence exists to suggest that traders are ever able to do this. To the extent that the American financial system is no longer allocating capital efficiently, there must be some structural problems that run deeper than asset price volatility alone.

Why are public policies directed so frequently towards blocking movements in prices that would otherwise be beneficial to the economy? Consumers may favor price controls because they see short-term benefits of being able to make purchases at lower prices, before the effects of shortages become fully apparent. But politicians must like price controls even more, because they provide a cheap and easy way of sidestepping more difficult problems. Voting to raise minimum wages makes it possible for elected officials to show that they care about younger and less-skilled workers, without ever having to consider the deeply flawed education and drug enforcement policies that have ruined many American families and placed our children at a disadvantage in the first place. Supporting rent control is an easy way to show sympathy with workers who deserve but cannot find nice apartments in neighborhoods they like, but also makes it possible to avoid discussions about who is buying multi-million dollar properties in other parts of town and where some of that money comes from. Appealing to “asset price bubbles” makes it easy to explain daily movements in the stock market, but also allows policymakers to avoid questions as to what, if anything, they have done, in the years since 2008, to reduce public subsidies enjoyed by large financial institutions that take on excessive risks, keep profits for themselves, and dump their losses on the American taxpayer.

Each of these examples highlights very real problems that our country faces today. But each reveals, as well, that those who blame problems on the workings of the price system are at best attacking symptoms rather than true, underlying causes. No one should wish for a return to the dark days of the 1970s, by pushing for policies that prevent prices from adjusting to changing economic conditions. Instead, we should ask our elected officials to draft rules and regulations that are simple, fair, and maximize opportunities for all, and then let the market, not the political system, do the rest.

 

Peter Ireland is a professor of economics at Boston College and a member of the Shadow Open Market Committee.  

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