Friday, May 26, 2006
Chapter 18 from: J.J. Ray (Ed.) "Conservatism as Heresy". Sydney: A.N.Z. Book Co., 1974
Why Price Control Won't Work
By: PETER SAMUEL
Price controls are not the simple solution to inflation most people seem to envisage. There is one kind of evidence of this in South Australia which has had price controls in operation more or less continuously for thirty years. Prices in that State have risen by almost the same amount as everywhere else in Australia. To be a bit more precise, going back the twenty-four years of the consumer price index, prices have risen by 282 per cent in Adelaide compared with 297 per cent in all six State capitals.
Price control merely raises the very difficult question of what cost increases, especially wage cost increases, should firms be allowed to cover with price rises? The Chifley Labor Government is said to have been voted out of office quite largely because of its persistence with price control. At least, these controls and associated rationing were thought by many contemporary commentators to have ranked with the attempted nationalisation of the banks and the disruptive coal and transport strikes as issues contributing to the defeat of the Chifley Government.
For about two decades afterwards price controls were associated in the minds of the majority of the public with a whole host of undesirables such as government bureaucracy, blackmarketeering, shortages, ration cards, and queueing. But the early seventies seems to be seeing a swinging back of the pendulum of opinion in favour of controls, with the pollsters reporting around two-thirds of the electorate now wanting direct price regulation. Memories of the postwar years have faded.
The scope for squeezing business profits is smaller than most people realise. Take the estimates for the coming financial year which the Treasury has published in the budget papers. Wages and salaries are expected to rise by seventeen per cent or $3,800 million during the course of the year, of which about $1,200m would be extra pay to government employees and $2,600m extra pay for private sector employees. Total pre-tax company incomes in Australia last year was $3,663 million, and non-farm unincorporated enterprises (shops and other small businesses) $2,513 million. The pre-tax profits of the entire non-farm private sector were $6,176 million. At their present rate of growth, wage and salary increases accompanied by a prices freeze would entirely eliminate private sector profits within thirty months.
Only a government of the Allende brand which wished to drive the private sector into bankruptcy would contemplate such a policy. A somewhat less radical government might want to compress total profits by say, twenty per cent. Even this would create grave problems for many businesses, since rates of return vary considerably and ability to absorb cost increases through improved productivity differs greatly from firm to firm. But even such a step as aiming to reduce total profits by twenty per cent would provide only six months breathing space at current rates of wage increases. So price control inevitably takes any government back to the question of how to control wages. In a modern economy with many highly capitalised industries where the cost of strikes are enormous, strong unions are able to extort large percentage increases in wage rates from management, and the weaker unions are able to invoke the principle of 'comparative wage justice' to ensure that these flow through to the rest of the workforce.
Would all this be changed by a government which introduced price controls? The answer is: probably not. Because the union movement is very heavily manned by people who either want to radically reduce business profits or even to exploit price controls to destroy them altogether. And the general wage pace is always set by the most militant unions, since all the others feel a need to avoid dropping behind. If price controls are not to be an exercise in business-bashing then they have to be accompanied by wage restraints.
Then there is the sheer problem of controlling prices. A simple freeze of all prices is easy enough but it cannot last much more than three months, or at the most six months without starting to produce serious unemployment, bankruptcies and supply shortages in low return, low productivity-growth industries.
The experience of short prices freezes has been that they are generally complied with even if they are left voluntary. In Britain, the U.S.A. and New Zealand firms have generally been prepared to accept short price freezes to avoid public antagonism. But wherever freezes have been ended without longer term measures of control they have been followed by price explosions, restoring the rate of inflation very quickly to previous rates.
Longer term price controls are surrounded by fundamental problems. Business people have a great variety of means of avoiding the controls one way or another if they do not like them. Product quality can be reduced, service cut or options reduced. And if price restraint is pressed to any lengths, output may drop and shortages replace price increases as the manifestation of inflation.
Soon after price controls were introduced into the U.S.A., the union leader George Meany got the newspaper headlines by pointing out than a can of his favourite Matzo ball soup contained only three Matzo balls after price control compared with four before. 'The case of the missing Matzo ball' quickly came to characterise the problem of producer resistance to controls.
And once resistance to price control takes the form of reduced output and shortages begin to appear, the consumer loses all bargaining strength, and gets in a very weak position. Buying becomes more time consuming, sellers can adopt contemptuous 'take it or leave it' attitudes and choice is reduced. Inflation is not being eliminated, it merely takes a new form.
In some large areas of spending price control is simply impossible. For example, jobs done on tender such as housebuilding and personal services from such people as doctors, hairdressers, motor mechanics and television repairmen. Governments can lay down elaborate lists of services with price tags attached but it will always be up to the service dispenser to specify what services he has performed. A pound of flour is a pound of flour but what is a short surgery consultation or a general mechanical checking of your car?
The pointlessness of general price control leads those who want business to bear the burden of anti-inflation measures to attack profits. Wartime controls and some of those imposed recently in Western countries have focused on profits because of the difficulty of controlling hundreds of thousands of prices of changing and often unmeasurable goods and services.
Limits on profits encourage businesses to increase their costs, either in reality or in accounting terms. In small businesses anyway costs and profits are very difficult to disentangle. The tax men already encourage small businessmen to become expert at padding the costs of their business and with price controllers also in the act, they will be even more active in the general use of the business car, the business telephone and purchasing items of household use through the business.
As for the companies, limits on profits are a heaven-sent excuse for management to exploit shareholders, through taking more in salaries and expenses. The incentive to greater efficiency whether by investment, by better management or use of new technology is largely destroyed by profit controls.
Heinz Arndt, economics professor at the Australian National University, said in a paper to the recent Perth ANZAAS congress: 'What is at stake, to put it bluntly, is the free market economy . . . the most promising and popular remedy is worse than the disease.'
The single positive aspect of attempts to institute price controls might be the educative effect of a competently run prices body in highlighting the real choices which the community faces --in publicising the hard fact that profits do not constitute a vast reservoir of wealth which wage earners can costlessly tap.
A major crunch will come in October when the Prices Tribunal reports on the BHP move for a 9.42 per cent price rise. The public hearings of this vitally important case are over, and the tribunal staff are beginning work on the report. It is already clear that they are torn between economic and political considerations. Unless the tribunal staff can find some major errors in BHP's accounting, it seems as though they will have to conclude that the steel company's proposed price rise is fully justified, so overwhelmingly strong is the case it presents on its figures. Australia's biggest company has realised that its future depends heavily on the outcome and has put enormous effort into the strategy and tactics of its appearance before the tribunal. It should win its case.
But the tribunal is acutely aware of the politics of its existence, and may feel the need to compromise economic rationality in its first big show case. Government ministers are expecting a compromise judgment that a four or five per cent increase in steel prices is justified, and probably this would go down best with a general public which sees negotiation and compromise as the best way of settling such disputes. The future of the tribunal will be politically easier if it takes the middle course and establishes itself as a kind of arbitration body rather than as a coldly logical economic agency.
But if the tribunal is to establish itself as a soft rather illogical conflict resolver then it will not be playing any educative role. The views of one member of the tribunal, Dr Allan Fels, are well known because he was speaking about prices justification as an academic before its establishment. In a paper to the Economics Society in February he said some things which Labor politicians find most unpalatable: 'To make a significant impact on inflation, any prices policy needs to be complemented by an incomes policy.' And on the role of the tribunal: 'It is not the task of the tribunal to lower the share of profits as a whole permanently: if anyone's, this is the task of the government using tax policy. The tribunal's task at the most is to lower excessive profits in particular cases.' But that was an economist member of the tribunal speaking and it remains to be seen what the others think its role is.
We now know, of course, that the tribunal chose the path of political expediency rather than that of economic rationality. ( J.J.R. )
This chapter originally appeared as an article in "The Bulletin", 22 September 1973, p. 27.