Economic Thoughts, Part XV: Consequences of Price Controls

This posting is Part XV in a series of postings about economic thoughts.

The excerpts in this posting are taken from Thomas Sowell's book Basic Economics: A Citizens Guide to the Economy and addresses the many consequences of price controls - both ceilings and floors:

To understand the effects of price controls, it is necessary to understand how prices rise and fall in a free market. There is nothing esoteric about it, but it is important to be very clear about what happens. Prices rise because the amount demanded exceeds the amount supplied at existing prices. Prices fall because the amount supplied exceeds the amount demanded at existing prices. The first case is called a "shortage" and the second is called a "surplus" - but both depend on existing prices.

PRICE CEILINGS AND SHORTAGES

When there is a "shortage" of a product, there is not necessarily any less of it, either absolutely or relative to the number of consumers...

Demand Under Rent Control

Some people who would normally not be renting their own apartments...were enabled by the artificially low prices created by rent control to move out and into their own apartments. These artificially low prices also caused others to seek larger apartments than they would ordinarily be living in or to live alone when they would otherwise have to share...More tenants seeking both more apartments and larger apartments created a shortage, even though there was not any greater physical scarcity of housing relative to the population. When rent control ended, the housing shortage quickly disappeared. As rents rose in a free market, some childless couples living in four-bedroom apartments decided they could live in two-bedroom apartments. Some late teenagers decided that they could continue living with mom and dad a little longer, until their pay rose enough for them to afford their own apartments...The net result was that families looking for a place to stay found more places available...

In the normal course of events, people's demand for housing space changes over a lifetime...In this way, a society's total stock of housing is shared and circulated among people according to their individual demands at different stages of their lives.

The individuals themselves do not do this out of a sense of cooperation, but because of the prices - rents in this case - which confront them...

Given the crucial role of prices in this process, suppression of the process by rent control laws leaves elderly people with little incentive to vacate apartments that they would normally vacate...the chronic housing shortages which accompany rent control greatly increase the time and effort required to search for a new and smaller apartment, while reducing the financial reward for finding one. In short, rent control reduces the rate of housing turnover...

Supply Under Rent Control

Rent control has effects on supply as well as on demand...[fewer] new building[s] are built...

...fewer people are willing to rent to others after the rents are kept artificially low by law...

...landlords provide less maintenance and repair under rent control, since the housing shortage makes it unnecessary for them to maintain the appearance of their premises in order to attract tenants. Studies of rent control...have found rent-controlled housing to be deteriorated far more often than non-rent-controlled housing...

...a policy intended to make housing affordable for the poor has had the net effect of shifting resources toward housing affordable only by the affluent or the rich, since luxury housing is often exempt from rent control...this illustrates the crucial importance of making a distinction between intentions and consequences. Economic policies need to be analyzed in terms of the incentives they create, rather than the hopes that inspired them...

Even when rent control applies to apartment buildings where the landlord does not live, eventually the point may be reached where the whole building becomes sufficiently unprofitable that it is simply abandoned. In New York City, for example, many buildings buildings have been abandoned after their owners found it impossible to collect enough rent to cover the costs of services that they are legally required to provide, such as heat and hot water. Such owners have simply disappeared, in order to escape the legal consequences...

...It has been estimated that there are at least four times as many abandoned housing units in New York City as there are homeless people living on the streets there. Homelessness is not due to a physical scarcity of housing, but to a price-related shortage, which is painfully real nonetheless.

Such inefficiency in the allocation of resources means that people are sleeping outdoors on the pavement on cold winter nights - some dying of exposure - while the means of housing them already exist, but are not being used because of laws designed to make housing "affordable."...It also illustrates that the goal of a law - "affordable housing," in this case - is far less important than its actual consequences...

The Politics of Rent Control

Politically, rent control is often a big success, however many serious economic and social problems it creates. Politicians know that there are always more tenants than landlords and more people who do not understand economics than people who do...

Where rent control laws apply on a blanket basis to all housing in existence as of the time the law goes into effect, luxurious housing becomes low-rent housing...after the passage of time makes clear that no new housing is likely to be built unless it is exempted from rent control, such exemptions or relaxations of rent control for new housing mean that even new apartments that are very modest in size and quality may rent for far more than older, more spacious and more luxurious apartments that are still under rent control...

Ironically, cities with strong rent control laws...tend to end up with higher average rents than cities without rent control. Where such laws apply only to rents below some specified level, presumably to protect the poor, builders then have incentives to build only apartments luxurious enough to be above the rent-control level...Not surprisingly, homelessness tends to be greater in cities with rent control...

Scarcity Versus Shortage

...just as there can be a shortage without any greater physical scarcity, so there can be a greater physical scarcity without any shortage...

The usual function of prices in directing goods and resources to where they are most in demand no longer operates under price controls...

But price control prevents buyers and sellers from making mutually advantageous transactions on terms different from those specified in the law.

Black Markets

Bolder and less scrupulous buyers and sellers make mutually advantageous transactions outside the law. Price controls almost invariably produce black markets, where prices are not only higher than the legally permitted prices, but also higher than they would be in a free market, since the legal risks must also be compensated. While small-scale black markets may function in secrecy, large-scale black markets usually require bribes to officials to look the other way...

PRICE FLOORS AND SURPLUSES

...a price set above the free market level tends to cause more to be supplied than demanded, creating a surplus...it is often lost sight of in the swirl of more complex events and more politically popular beliefs.

One of the classic examples of a lower limit to prices imposed by government have been agricultural price-support programs. As often happens, a real but transient problem led to the establishment of enduring government programs, which long outlived the conditions that initially caused them to be created.

Among the many tragedies of the Great Depression of the 1930s was the fact that many farmers simply could not make enough money from the sale of their crops to pay their bills. The prices of farm products fell much more drastically than the prices of the things that farmers had to buy...the federal government sought to restore "parity" between agriculture and other sectors of the economy by intervening to keep farm prices from falling so sharply.

The intervention took various forms. One approach was to reduce by law the anount of various crops that could be grown and sold...Such arrangements continued for decades after the poverty of the Great Depression was replaced by the prosperity of the boom following World War II.

These indirect methods of keeping prices artificially high were only part of the story. The key factor in keeping farm prices artificially higher than they would have been under free market supply and demand was the government's willingness to buy up the surplus created by its control of prices...

Price control in the form of a "floor" under prices...produced [dramatic] surpluses...

During the Great Depression...agricultural price support programs led to vast amounts of food being deliberately destroyed at a time when malnutrition was a serious problem in the United States and hunger marches were taking place in cities across the country...

Still there was a food surplus. A surplus, like a shortage, is a price phenomenon. A surplus does not mean that there is some excess relative to the people. There was not "too much" food relative to the population during the Great Depression. The people simply did not have enough money to buy everything that was produced at the artifically high prices set by the government...

...The countries of the European Union spent $39 billion in direct subsidies in 2002, and their consumers spent twice as much in the inflated food prices created by these agricultural programs. Meanwhile, the surplus food was sold below cost on the world market, driving down prices that Third World farmers could get for their produce. In all these countries, not only the government but also the consumers are paying for agricultural price-support programs - the government directly in payments to farmers and storage companies, the consumers in inflated food prices. As of 2001, American consumers were paying $1.9 billion a year in artificially higher prices for products containing sugar and the government was paying $1.4 billion per month just to store the surplus sugar. Meanwhile, the New York Times reported that sugar producers were "big donors to both Republicans and Democrats" and that the costly sugar price support program had "bipartisan support."

In 2002, the U.S. Congress passed a farm subsidy bill that was estimated to cost the average American family more than $4,000 over the next decade in taxes and inflated food prices...In the nations of the European Union, the prices of lamb, butter, and sugar are all more than twice as high as their world market prices. As a writer for the Wall Street Journal put it, every cow in the European Union gets more subsidies per day than most Africans have to live on.

Although the original rationale for the American price-support programs was to save family farms, in practice more of the money went to big agricultural corporations...Most of the money from the 2002 bipartisan farm bill will likewise go to the wealthiest 10 percent of farmers - including David Rockefeller, Ted Turner, and a dozen companies on the Fortune 500 list...

What is crucial from the standpoint of understanding the role of prices in the economy is that persistent shortages are as much a result of keeping prices artificially high as persistent shortages are of keeping prices artificially low. Nor were losses simply the sums of money extracted from the taxpayers or the consumers for the benefit of agricultural corporations and farmers. These are internal transfers within a nation, which do not directly reduce the total wealth of the country. The real losses to the country as a whole come from the misallocation of scarce resources which have alternative uses...

...Poor people, who spend an especially high percentage of their income on food, are forced to pay far more than necessary to get the amount of food they receive, leaving them with less money for other things. Those on food stamps are able to buy less food with those stamps when food prices are artificially inflated. From a purely economic standpoint, it is working at cross purposes to subsidize farmers by forcing food prices up and then subsidize some consumers by bringing down their particular costs of food with subsidies...However, from a political standpoint, it makes perfect sense to gain the support of two different sets of voters...

Even when agricultural subsidies and price controls originated during hard times as a humanitarian measure, they have persisted long past those times because they developed an organized constituency which threatened to create political trouble if these subsidies and controls were removed or even reduced...

QUALITY DETERIORATION

One of the reasons for the political success of price controls is that part of their costs are concealed. Even the visible shortages do not tell the whole story. Quality deterioration...has been common with many other products and services whose prices have been kept artificially low by government fiat.

One of the fundamental problems of price control is defining just what it is whose price is being controlled...

...there is less incentive to maintain high quality when everything will sell anyway during a shortage...

The priorities which prices automatically cause individuals to consider are among the first casualties of price controls...

THE POLITICS OF PRICE CONTROLS

Simple as basic economic principles may be, their ramifications can be quite complex...However, even this basic level of economics is seldom understood by the public, which often demands political "solutions" that turn out to make matters worse...

...In an era of democratic politics,...actions would require either a public familiar with basic economics or political leaders willing to risk their careers to do what needed to be done. It is hard to know which is less likely.

Part XVI to follow...

For previous postings on Economic Thoughts, refer to:

Part I: What is Economics?
Part II: Myths About Markets
Part III: Why Policy Goals are Trumped by Incentives They Create & the Role of Knowledge in Economics
Part IV: The Abuse of Reason, Fallacies & Dangers of Centralized Planning, Prices & Knowledge, and Understanding Limitations
Part V: The Relationship Between Economic Freedom and Political Freedom
Part VI: More on the Relationship Between Economic Freedom and Political Freedom
Part VII: The Role of Government in a Free Society
Part VIII: The Unspoken, But Very Real, Incentives That Drive Governmental Actions
Part IX: More on the Coercive Role of Government
Part X: The Power of the Market
Part XI: Prices
Part XII: I, Pencil - A Story about the Free Market at Work
Part XIII: It is Individuals - Not the Society, Government or Market - Who Think & Act
Part XIV: On Equality