Price Ceilings Harm the Poor; R. Ream

Likewise in the science of economRoger Ream Is Director of Seminars of The Founda tion for Economic Education. 682 ics, one must be cautious when ob serving the effects of economic in terventions. What seems obvious can be misleading. Take for example price controls. The politically deter mined ceiling price transmits faulty signals not only to consumers, pro ducers and entrepreneurs, and re source owners, but also to pseudo economists and most casual observ ers. As a result, the latter group reaches inaccurate conclusions con cerning the effect of the price con trol. It appears that a control which dictates a ceiling price for a product keeps the price down (below what it would be in an unhampered mar ket). However, this is an incomplete observation. A recent illustration of the actual effect of price ceilings is the control of oil. To most observers, it was ob vious that if the ceiling were re moved on the price of oil, the price PRICE CEILINGS HARM THE POOR 683 would rise. It was indisputable, they claimed, that if the price were no longer kept artificially low, it would increase. A so-called windfall profits tax was passed to remedy the injus tices that would occur when the price rose. To question the assumption that removal of the ceiling on the price of oil would cause it to rise was to in vite ridicule. It was so obvious that prices would rise and oil companies would reap windfall profits. To sug gest otherwise would put one in the position of Copernicus or Galileo, who likewise questioned the un questionable and faced banishment for doing so.

However, as experience has shown, the primary effect of the controls was to diminish the amount sup plied. They caused shortages and discouraged competition. Explora tion and production were curtailed, so that eventually the effect of the price ceiling was actually to hold the price of oil above its unhampered market level. Soon after President Reagan decontrolled the price of oil (removed the ceiling), the price be gan to come down. When the control was removed, production increased, additional supplies were brought to the market, and competitive forces led to lower prices. Things did not happen as it seemed obvious they would. The so-called experts were wrong. This was because the con trolled price was not, in effect, just a ceiling on the price, but a ceiling on the quantity supplied. It was a dis incentive to producers. The control held down the supply, not just the price. Remarkably, the ceiling was removed and the price fell.

The UnseenConsequences Despite overwhelming economic knowledge that price controls (in this discussion, .ceilings on prices) dis courage suppliers, thus causing shortages and therefore eventually pushing prices above their free mar ket levels, the clamor for controls never subsides. A plea on behalf of the poor is perhaps the loudest ex cuse for ignoring economic wisdom and imposing controls. This emo tional appeal to the plight of the poor often blinds individuals from seeing things as they really are, rather than as they seem. Controls lead to a less efficient employment of scarce resources, and this hurts the poor the most. It is those on the bottom of the economic ladder who have the greatest stake in efforts to create the most opportunities, goods, and services from limited resources. The effect of price controls will be shortages and eventually prices higher than they would be in an un hampered market; effects precisely contrary to the stated objectives of their supporters.

An area where well-intentioned but misguided individuals have done great harm to the very groups they claim to represent is the housing 684 THE FREEMAN November sector. In this instance, a type of price control particularly harmful to the poor has reared its destructive head. It is euphemistically called rent control, but in plain language it is control of people. Local governments intrude into the voluntary negotia tions between two consenting adults, a tenant and a landlord, and dictate the terms of their contractual agree ment. It is a denial of freedom of choice to both tenants and land lords. It is an attempt to transfer wealth from landlords to tenants, but it is doomed to failure as land lords eventually allow their build ings to deteriorate or abandon them completely. The actual effects of rent control are generally unseen. The pseudo economists and many casual observ ers fail to comprehend the long term effects of rent control. Similar to the case of price controls on oil, a ceiling on rents discourages present and po tential suppliers of rental units; consequently fewer units are made available. In an unhampered mar ket, when the quantity supplied is diminished (possibly due to a natu ral disaster, for instance), other things being equal, price will tend to rise. This rise in price tends to discourage the least urgent de mands, thus moving the market to ward market-clearing levels.

However, controls cause the quantity supplied to decrease, but prevent price from alleviating the situation. The market is grossly dis torted. The artificial drop in supply is not offset by a corresponding fall in the quantity demanded~a short age exists. Furthermore, other things are not equal, increasing birth rates, rising divorce rates, and a vast number of governmentally-induced factors cause demand to increase. This exacerbates the disequilibrium in the marketplace, causing the housing shortage to be considerably worse. Controls Cause Shortages The neglected, or unseen, aspect of the situation is the realization that the removal of ceilings on rent leads, in short order, to lower, not higher rents. Rent controls have the same effect as controls on oil-they stimulate demand and discourage supply, thus causing shortages (re member the gas lines) and eventu ally prices higher than would pre vail in an unhampered market. If rent controls were repealed the sup ply of rental units would increase almost immediately. Soon, the forces of competition would cause rents to move toward market-clearing levels where supply and demand are in close approximation.

At first glance, it is difficult to ac cept the fact that in an otherwise unhampered market, the removal of price ceilings tends to cause prices to fall. Where there are no barriers to entry, entrepreneurs seek to sat1981 PRICE CEILINGS HARM THE POOR 685 isfy consumer demand. Unfortu nately, many barriers to entry exist in the energy sector, the housing sector, and throughout the U.S. economy. These barriers decrease supplies. The oil and gas industry is replete with regulations and taxes which hamper the exploration, pro duction, and distribution of energy products. Zoning regulations and re strictive building codes artificially limit the supply of housing and therefore cause higher rents and housing prices. Throughout the economy governments at all levels have erected barriers that inhibit productive activity, add to costs, and therefore reduce the supply of eco nomic goods. Furthermore, government poli cies artificially increase demand for some items. Of course, controlling the price at less than a free market level causes an increase in demand.

Transfer payments enhance the purchasing power of some at the ex pense of others. When welfare pro grams are financed by inflation of the currency, an increase in demand is created virtually out of thin air. Those who get the new money first are able to purchase the limited sup ply of the controlled product. Since the price is controlled and therefore cannot be bid up, those first in line are able to buyout the product be fore others. Government artificially increases the demand for goods and services both intentionally and indirectly through its tax structure and regu latory policies. For example, the de mand for oil and gas is increased with emission controls on automo biles and by the regulation of truck ing which causes less efficient trans portation of goods. Government programs which offer guaranteed or low interest housing loans increase the demand for housing. Because of the tremendous gov ernmentally-induced influences on supply and demand, as well as the constantly changing values of con sumers, it is essential that prices re main free to accomplish smoothly their functions of transmitting knowledge of changes and coordi nating economic activity.

This is not a geocentric universe, even though it appears to be. Like wise, ceilings on prices do not help the poor. It is simplistic and wishful thinking to believe they are a solu tion to the problems of poverty. That is, it confuses what appears to be true or what one wishes to be true, with what actually is true. Price controls cause shortages and when there is less to go around it isn't the powerful or the well-to-do who will suffer most. With unfettered prices and an open market, economic effi ciency will be maximized and con sumers, the poor included, will be well served. , David Osterfeld the Politics of Economic Stagnation ALTHOUGH being gradually under mined throughout much of the twentieth century, the traditional international economic order-free trade and migration, private prop erty, the international division of labor-has recently been subjected to its most serious attack since Lenin's Imperialism appeared in 1917. This time the attack has come not from Marxists trying to ratio nalize the failure of Marx's predic tions about the economic self-de struction of capitalism, but from the "third world," or "less-developed countries" (LDCs), trying to explain their continuing poverty in the face of economic advancement by the Dr. Osterfeld Is Assistant Professor of Political Sci ence, St. Joseph's College, Rensselaer, Indiana.