Economists for Price Controls?
In the saga over California’s electricity woes, the real heavyweights have jumped into the fray, says the New York Times, and they think that California needs price controls, thank you. According to the Times, ten "of the nation’s leading authorities on regulation" have signed a letter to President Bush, demanding that the administration immediately cap wholesale electricity prices.
This list seems to be formidable and authoritative. One signee is Alfred Kahn, the Cornell University economist who oversaw airline deregulation during the Carter administration. Others signees include Severin Borenstein of the University of California at Berkeley and Paul Jaskow of the Massachusetts Institute of Technology. When combined with the recent pro-price-control Business Week column by Laura D’Andrea Tyson, who served as Bill Clinton’s chief economic adviser, it would seem that the experts believe price caps will work in the Golden State.
Their argument goes like this: In a state of perfect competition, price controls are indeed harmful, since they cause shortages. However, electricity is produced by firms that operate in an arena of imperfect competition, which means that producers have "market power." These firms have the ability to "manipulate" supplies, or withhold electricity, at key times in order to drive up prices.
Price controls, the economists declare, would stop this unethical behavior, since there would be no reason to withhold electricity from the market because these power producers could not drive prices to astronomical levels. Under an "enlightened" price-control regime, producers would sell all the power that California needs at the regulated price. Of course, the "Gang of Ten" also warn that regulated prices need to be set high enough so as not to "discourage investors from building new power plants," and that the controls need to be temporary.
Despite the pedigrees of the Gang of Ten, their points are easily refuted. First, they assume that marginal costs in producing electricity are equal across all producers—something that is demonstrably untrue. The current California crises has brought a number of older, high-cost plants on line that ordinarily would only be pressed into service in peak-load conditions. The higher the market price for electricity, the more incentive electricity producers have to fire up the old plants, and price caps would almost surely make it uneconomical to use them.
Second, as William Tucker recently pointed out in The Wall Street Journal, some aluminum plants in the Northwest have scaled back on producing aluminum and have simply sold their electricity allotments to California, as they can make more money at the present time selling electricity. A new price-control regime would surely mean that these plants would go back to producing aluminum, with California losing that supply.
Third, their argument assumes that the laws of supply and demand only work in a hypothetical arena of "perfect competition," and not in markets where producers have some control over their output and pricing. This makes no sense whatsoever. In any market, whether it be inhabited by thousands of tiny firms or a relatively small number of large producers, prices for the final products sold to consumers result from market forces, as was pointed out by economists such as Murray Rothbard, Ludwig von Mises, and F.A. Hayek. Consumers still have a choice, believe it or not. For example, Californians have already said that they prefer rolling blackouts to higher electricity prices. (The environmental movement that dominates California politics has achieved the ultimate triumph: People are now camping out in their own homes.)
Fourth, the signees know that price controls are easy to implement and extremely difficult to remove. For example, New York’s infamous rent controls were installed as a temporary "emergency" measure during World War II. They remain more than fifty years later.
The price controls that strangled oil production during the 1970s had their beginnings as part of a ninety-day price freeze ordered by President Richard Nixon in August 1971. Those controls would last for a decade, until removed by President Ronald Reagan.
That these "prominent" economists would construct transparently faulty arguments says more about much of the economics profession than it does about laws of economics. Many of the signees, along with others in the profession who have demanded price controls, have served in various capacities under Democratic administrations. To put it another way, these folks are basically political operatives who cloak their partisan agenda in academic garb.
That they hail from the most elite institutions of higher learning carries no special dispensation. Places like Harvard, Yale, and Cornell long ago became thoroughly politicized, left-wing institutions. Besides, the efficacy of any argument comes, not from the prominence of its expositor, but rather from its truthfulness. The Gang of Ten has concocted a faulty argument, something that cannot be salvaged by elite academic pedigrees.