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II. INTERFERENCE BY PRICE CONTROL

1. The Alternative: Statutory Law Versus Economic Law

MEASURES OF PRICE CONTROL are directed at fixing prices, wages, and interest rates at amounts different from those prevailing in the unhampered market. The authority or the group expressly or tacitly entrusted by the authority with power to control prices fixes them as maximums or minimums. The police power is used to enforce these decrees.

    The aim underlying such interference with the price structure of the market is either to privilege the seller (in the case of minimum prices) or to privilege the buyer (in the case of maximum prices). The minimum price should make it possible for the seller to achieve better prices for the goods he is offering; the maximum price should enable the buyer to acquire the goods he desires at a lower price. It depends on political conditions just which group the authority will favor. At times maximum prices have been established, at times minimum prices; at times maximum wages, at times minimum wages. Only for interest rates have there been only maximums, never minimums. Political expediency has always demanded such a course.

    Out of the controversies over governmental regulation of prices, wages, and interest rates, the science of political economy developed. For hundreds and even for thousands of years the authorities have attempted to influence prices through the use of their power apparatus. They have imposed the heaviest penalties on those who refused to obey their orders. Innumerable lives have been lost in this struggle. In no other field has the police force displayed more eagerness to use its power, and in no other case has the vindictiveness of the authorities found more enthusiastic support by the masses. And still all these attempts failed of their objective. The explanation which this failure has found in the philosophical, theological, political, and historical literature precisely reflects the opinion of the authorities and of the masses. It was maintained that human beings were egoistical and bad by nature and that the authority had been too weak and too reluctant to use force; what were required were hard and ruthless rulers.

    Realization of the truth had its origin in the observations of the effects of such measures in a narrowly confined field of application. Among the price control measures, particular importance attaches to the attempts of the authority to impart to debased coins the same value as to coins of full metallic content, and to maintain a fixed exchange ratio between the precious metals gold and silver, and later between metallic money and depreciated paper money. The reasons which caused the failure of all such attempts were early realized and were formulated in the law named after Sir Thomas Gresham. From these early beginnings it was still a long way to the great discoveries of the Scottish and English philosophers of the eighteenth century, that the market followed certain laws which bound all market phenomena in a necessary relation.

    The discovery of the inevitable laws of the market and exchange was one of the great achievements of the human mind. It laid the cornerstone for the development of liberal sociology and gave rise to liberalism and thus brought with it our modern culture and economy. It paved the way for the great technological achievements of our time. It was at the same time the starting point of a systematic science of human action, that is, of economics.

    The pre-scientific mind distinguished between the good and the bad, the just and the unjust in human action. It believed that human behavior could be evaluated and judged by the established standards of a heteronomous moral law. It thought that human action was free in the sense of not being subject to the inherent laws of human behavior. Man should, it argued, act morally; if he acted differently God would punish him in the hereafter if not during his lifetime; man’s actions do not have any other consequences. Therefore, there need be no limit to what the authority might do as long as it did not come in conflict with a stronger power. The sovereign authority is free in the exercise of its power provided it does not exceed the boundaries of the territory in which it is sovereign; it can accomplish everything it desires. There are physical laws which it cannot change; but in the social sphere there are no limitations on what it may do.

    The science of political economy began with the realization that there is another limit for the sovereignty of those in power. The economist looks beyond the state and its power apparatus and discovers that human society is the outcome of human cooperation. He discovers that there prevail laws in the realm of social cooperation which the state is unable to modify. He recognizes that the process of the market, which is the result of these laws, determines prices and that the system of market prices provides the rationale of human cooperation. Prices no longer appear as the result of an arbitrary attitude of individuals dependent on their sense of justice but are recognized as the necessary and unequivocal product of the play of market forces. Each specific constellation of data produces a specific price structure as its necessary corollary. It is not possible to change these prices—the “natural” prices—without having previously changed the data. Every deviation from the “natural” price releases forces which tend to bring the price back to its “natural” position.

    This opinion is directly contrary to the belief that the authority can alter prices at will through its orders, interdictions, and penalties. If prices are determined by the structure of data, if they are the element in the process which effects social cooperation and which subordinates the activities of all individuals to the satisfaction of the wants of all members of the community, then an arbitrary change of prices, that is one independent of changes in the data, must necessarily create a disturbance in social cooperation. It is true that a strong and determined government can issue price orders and can cruelly revenge itself on those who fail to obey. But it will not achieve the aim it seeks through the price orders. Its intervention is but one of the data in the market which produces certain effects according to the inevitable laws of the market. It is extremely doubtful whether the government will be pleased with these effects and it is extremely doubtful whether the government will not consider them, when they appear, as even less desirable than the conditions it sought to change. At any rate these measures do not achieve what the authority wants to accomplish. Price interventions are, therefore, from the standpoint of the initiating authority not only ineffective and useless, but also contrary to purpose, harmful, and thus illogical.

    Anyone attempting to refute the logic of these conclusions denies the possibility of analysis in the field of economics. There would otherwise be no such thing as economics and everything that has been writ­ten on economic matters would be meaningless. If prices can be fixed by the authority without producing a reaction in the market which is contrary to the intentions of the authority, then it is futile to attempt an explanation of prices on the basis of market forces. The very essence of such an explanation of market forces lies in the assumption that each constellation of the market has a corresponding price structure and that forces operate in the market which tend to restore this—”natural”—structure of prices if it is disturbed.

    In their defense of price controls, the representatives of the Historical School of Political Economy, and nowadays the Institutionalists, reason quite logically from their viewpoint because they do not recognize economic theory. To them economics is merely an aggregate of authoritarian orders and measures. Illogical, however, is the argument of those who on the one hand study the problems of the market with the methods of theoretical analysis but on the other hand refuse to admit that price control measures necessarily produce results contrary to purpose.

    The only alternatives are statutory law or economic law. Prices are either arbitrarily determined by the individuals in the market and may, therefore, be channeled by orders of the authorities in any desired direction; or prices are determined by the market forces commonly called supply and demand and the intervention of the authority affects the market as but one of many factors. There is no compromise possible between these two viewpoints.

2. The Reaction of the Market

    Price control measures paralyze the working of the market. They destroy the market. They deprive the market economy of its steering power and render it unworkable.

    The price structure of the market is characterized by its tendency to bring supply and demand into balance. If the authority attempts to fix a price different from the market price, this situation cannot prevail. In the case of maximum prices, there are potential buyers who cannot buy although they are ready to pay the price fixed by the authority, or even to pay a higher price. Or there are—in the case of minimum prices—potential sellers who cannot find buyers even though they are willing to sell at the price established by the authority, or even to sell at a lower price. The price is no longer the means of segregating those potential buyers and sellers who may buy or sell from those who may not. A different principle of selection has to come into operation. It may be that only those who come first or those who occupy a privileged position due to particular circumstances (personal connections, for instance) will actually buy or sell. But it may also be that the authority itself takes over the regulation of distribution. At any rate the market is no longer able to provide for the distribution of the available supply to the consumers. If chaotic conditions are to be avoided, and if neither chance nor force is to be relied upon to determine distribution, the authority has to undertake this task by some system of rationing.

    But the market is not only engaged in the distribution of a given stock of ready consumption goods. Its foremost task consists in directing production. It directs the means of production to those uses which serve most urgent needs. If maximum prices are set below the ideal market price for certain consumers’ goods only, without at the same time regulating the prices of all complementary means of production as well, then those means of production which are not completely specialized will be used to a greater extent in the production of other consumption goods which are not hit by the price fixing. Production will thus be diverted from goods which are more urgently needed by the consumer but which are affected by the price fixing, and it will go into the production of other goods which from the standpoint of the consumer are less important but which are free from regulations. If it was the intention of the authorities to make the goods covered by the price fixing more easily available by its maximum prices, then its measure failed. Its production would either be restricted or would cease completely. A simultaneous price fixing for complementary goods would not have much of an effect either, unless all complementary goods are of such specialized character that they could be used only for the production of this one good. As labor does not have this highly specialized character we may omit it from our considerations. If the authority is not willing to accept the fact that the result of its measures to make a good cheaper is that the supply of such goods stops completely, then the authority cannot confine itself to such interventions as affect merely the prices of all goods and services necessary for such production. It has to go farther and prevent capital, labor, and entrepreneurial activity from leaving this line of production. It must fix the prices of all goods and services and of interest rates also. And it must issue specific orders stating what and how goods and services should be produced and at what prices and to whom they should be sold.

    The isolated price control measure fails to accomplish the purpose in the operation of the market economy which its originators aim at; it is—from the standpoint of its originators—not only useless, but also contrary to purpose because it aggravates the “evil” which it is intended to alleviate. Before the price control was instituted the good was, in the opinion of the authority, too expensive; now, it disappears from the market. But, this effect was not intended by the authority which wanted only to make the good cheaper for the consumer. On the contrary, from its standpoint we have to regard the lack of the good, its unavailability, as the greater evil; the authority aimed at an increased supply, not at a diminution of supply. We may say, therefore, that the isolated price control measure defeats its own purpose, and that a system of economic policy which is based on such measures is contrary to purpose and futile.

    If the authority is not willing to remedy the evils created by such isolated intervention, by cancelling the price control measure, then it has to follow up this first step with further measures. Further orders must be added to the initial order not to demand higher prices than those decreed—the order to sell the whole supply, instructions to whom to sell and in what quantities these sales are to be made, price control measures regarding complementary goods,[1] wage rates and compulsory labor for workers, and interest rate control, and finally orders to produce and instructions about the choice of investment opportunities for the owners of the means of production. These regulations cannot be restricted to one or several branches of production only, but have to be expanded to cover all production. They must of necessity regulate the prices of all commodities, all wages, and the actions of all entrepreneurs, capitalists, landowners, and workers. But this means that the direction of all production and distribution is placed in the hands of the authority. The market economy, whether intended or not, has turned into a socialist economy.

    There are only two situations in which price control measures may be used effectively in a narrowly confined sphere:

    1. Price control measures lead to a restriction of production because they make it impossible for the marginal producer to produce without a loss. The nonspecialized productive factors are being transferred to other branches of production. The highly specialized productive factors, which under market prices were used to the extent permitted by opportunities for alternative uses of the nonspecialized complementary factors, will now be used to a smaller extent; a part of them will not be employed. But if the quantity of highly specialized factors is so limited that they are completely utilized under the rule of market prices for the products, then there is a certain field of latitude given for authoritarian orders which lower prices. The price fixing does not cause a restriction of production as long as it does not absorb completely the absolute rent of the marginal producers. An intervention which does not go beyond this limit does not decrease supply. But as it increases demand it creates maladjustments between supply and demand which lead to chaotic conditions unless the authority itself provides for the allocation of the products among perspective buyers.

    As an example: The authority must establish maximum rents for apartments and for store space in central urban locations. If the authority does not go as far as to make agricultural utilization of the land appear preferable to the owners, this action will not decrease the supply of apartments and stores.[2] But, at the prices fixed by the authority the demand will exceed the available facilities. How the authority distributes these limited facilities among those who are willing to pay the fixed rent is immaterial. No matter what the distribution, the result will be that a return is taken from the landowner and given to the tenants. The authority has taken wealth from some individuals and given it to others.

    2. The second situation in which price control measures can be used with some degree of effectiveness is offered by the case of monopoly prices. The price control measure may succeed in the case of monopoly prices if it does not intend to lower the prices below the point at which the competitive price would be in the nonmonopolized, unhampered market. In the case of monopoly prices established by an international cartel of mercury producers, a world (or international) authority may successfully enforce price controls which will bring the price of mercury down to the point at which it would sell under competition among several producers. Of course, the same holds true in the case of institutional monopolies. If an intervention by the authorities has created the necessary conditions for monopoly prices, then a second decree may again destroy them. If by the grant of a patent right an inventor was placed in a position to demand monopoly prices then the authority may also take away the previously granted privilege by fixing a price for the patented article which would otherwise be possible only under competition. Thus, price fixing was effective in the time of the guilds which aimed at monopoly prices. Thus it may also be effective against cartels made possible by protective tariffs.

    Authorities like to appraise the effects of their actions optimistically. If the price fixing has the effect that goods of inferior quality take the place of better quality merchandise, the authority is only too ready to disregard the difference in the quality and to persist in the illusion that its intervention has had the effect it desired. At times and temporarily a small but very dearly bought success may be achieved. The producers of goods hit by the price fixing may prefer to bear losses for a certain time rather than to run new risks; they may be afraid, for instance, that their plants will be looted by the incited masses without adequate protection of the government being available. In such instances the price control measure leads to the consumption of capital and thus indirectly and eventually to an impairment of supply of products.

    Except for the two mentioned exceptions, price control measures are not the proper means for the authority to direct the market economy into the desired channels. The forces of the market prove stronger than the power of the authority. The authority has to face the alternatives, either to accept the law of the market as it stands, or to attempt to replace the market and the market economy by a system without the market, that is, by socialism.

3. Minimum Wages and Unemployment

    Of greatest practical importance among the measures of price-fixing policy are wage scales determined by trade union action. In some countries minimum-wage rates were established by direct government action. The governments of other countries interfere with wages indirectly only, by acquiescing in the application of active pressure by unions and their members against enterprises and those willing to work who do not abide by their wage orders. The authoritatively fixed wage rate tends to cause permanent unemployment of a considerable part of the labor force. Here again the government usually intervenes by granting unemployment relief.

    When we speak of wages we shall always mean real wages, not money wages. It is obvious that a change in the purchasing power of the monetary unit must be followed, sooner or later, by a change in the nominal money rate of wages.

    Economists were always fully aware that wages, too, were a market phenomenon and that there were forces operative in the market which, should wages depart from market wages, tend to bring wages back to the point conforming to market conditions. If wages fall below the point prescribed by the market, then the competition of entrepreneurs who seek workers will raise them again. If wages rise above the market level, part of the demand for labor will be eliminated and the pressure of those who become unemployed will make wages fall again. Even Karl Marx and the Marxists have always maintained that it is impossible for the trade unions to raise the wages of all workers permanently above the level established by market conditions. The advocates of unionism have never answered this argument. They have merely condemned economics as a “dismal science.”

    To deny that raising wages above the point prescribed by market conditions must necessarily lead to a reduction in the number of employed workers is tantamount to asserting that the size of the labor supply has no influence on wage rates. A few remarks will prove the fallacy of such assertions. Why are opera tenors so highly paid? Because the supply is very small. If the supply of opera tenors were as large as the supply of chauffeurs, their incomes would, given a corresponding demand, immediately sink to the level of chauffeur wages. What does the entrepreneur do if he requires especially skilled workers of whom only a limited number is available? He raises the wages he offers in order to induce workers to leave competing entrepreneurs and to attract those he seeks.

    As long as only one part of the labor force, mostly skilled workers, was unionized, the wage raise forced by the union did not lead to unemployment but caused wages for unskilled labor to fall. The skilled workers who lost their jobs in consequence of the wage policy of the trade unions entered the market for unskilled labor and thereby increased the supply. The corollary of higher wages for organized labor was lower wages for unorganized labor. But, as soon as labor in all lines of production becomes organized, the situation changes. Then, the workers who become unemployed in one industry can no longer find employment in other lines; they remain unemployed.

    The trade unions testify to the validity of this point of view when they try to prevent the influx of workers into their industry or into their country. When the trade unions refuse to admit new members or make their admission more difficult by high initiation fees, or when they fight immigration, they prove themselves convinced that a larger number of workers could only be employed if wages were lowered.

    Also by recommending credit expansion* as a means of reducing unemployment, the trade unions admit the soundness of the wage theory of the economists whom they otherwise dismiss as “orthodox.” Credit expansion reduces the value of the monetary unit and thus makes prices rise. If money wages remain stable or at least do not rise to the same extent as commodity prices, this means a reduction of real wages. Lower real wages make it possible to employ more workers.

Finally, we have to consider it a tribute to the “orthodox” wage theory that the trade unions impose upon themselves restrictions in their fixing of wage rates. The same methods by which trade unions force the entrepreneur to pay wages which are 10 percent above the rates which would prevail in the unhampered market might make it possible to bring about even considerably higher wages. Why, therefore, not ask for a wage increase of 50 percent, or 100 percent? The trade unions refrain from such a policy because they know that an even greater number of their members would lose their jobs.

    The economist considers wages a market phenomenon; he is of the opinion that at any given moment wages are determined by the prevailing data of the market supply of material means of production and of labor, and by the demand for consumers’ goods. If by an act of intervention wages are fixed at a point higher than the one given by market conditions, a part of the labor supply cannot be employed; unemployment rises. It is precisely the same situation as in the case of commodities. If the owners of commodities ask a price above the market they cannot sell their entire stock.

    If, however, as those who advocate wage fixing by unions or by government maintain, wages are not definitely determined by the market, the question arises, why should wages not e made to rise still higher? It is, of course, desirable to have the workers receive as large incomes as possible. What then deters the trade unions, if not the fear of larger unemployment?

    To this, the trade unions reply, we are not after high wages; all we want is “fair wages.” But what is “fair” in this case? If the raising of wages by intervention does not have effects which are injurious to labor’s interests, then it certainly is unfair not to go still further in raising wages. What prevents the trade unions and the government officials, who are entrusted with the arbitration of wage disputes, from raising the wages still more?

    In some countries it was demanded that wages be fixed in such a way as to confiscate all the income of entrepreneurs and capitalists, other than salary for managerial activity, and to distribute it to the wage earners. To achieve this, orders were issued prohibiting the dismissal of workers without special permission of the government. By this measure an increase in unemployment was prevented in the short run. But it caused other effects which in the long run were contrary to the interests of the workers. If entrepreneurs and capitalists do not receive profits and interest payments they will not starve or ask for charity; they will live on their capital. The consumption of capital, however, changes the ratio of capital to labor, lowers the marginal productivity of labor, and thus ultimately lowers wages. It is in the interest of the wage earners that capital should not be consumed.

    It should be emphasized that the preceding statements refer to one aspect only of trade union activity, namely their policy to raise wages above the rates which would prevail in the unhampered market. What other activities the trade unions are carrying on or might undertake has no bearing on the subject.

4. The Political Consequences of Unemployment

    Unemployment as a permanent phenomenon of considerable magnitude has become the foremost political problem of all democratic countries. That millions are permanently excluded from the productive process is a condition which cannot be tolerated for any length of time. The unemployed individual wants work. He wants to earn because he considers the opportunities which wages afford higher than the doubtful value of permanent leisure in poverty. He despairs because he is unable to find work. From among the unemployed, the adventurers and the aspiring dictators select their storm troopers.

    Public opinion regards the pressure of unemployment as a proof of the failure of the market economy. The public believes that capitalism has shown its inability to solve the problems of social cooperation. Unemployment appears as the inescapable result of the antinomies, the contradictions, of the capitalistic economy. Public opinion fails to realize that the real cause for the permanent and large unemployment is to be sought in the wage policy of the trade unions and in the assistance granted to such policy by the government. The voice of the economist does not reach the public.

    Laymen have always believed that technological progress deprived people of their livelihood. For this reason the guilds persecuted every inventor; for this reason craftsmen destroyed machines. Today the opponents of technological progress have the support of men who are commonly regarded as scientists. In books and articles it is asserted that technological unemployment is unavoidable—in the capitalistic system, at least. As a means to fight unemployment shorter working hours are recommended; as weekly wages are to remain stable or to be lowered less than proportionately, or even increased, this means inmost cases further wage rate raises and thus increased unemployment. Public works projects are recommended as a means to provide employment. But if the necessary funds are secured by issuing government bonds or by taxation, the situation remains unchanged. The funds used for the relief projects are withdrawn from other production, the increase of employment opportunities is counteracted by a decrease of employment opportunities in other branches of the economic system.

    Finally credit expansion and inflation are resorted to. But with rising prices and falling real wages the trade union demands for higher wages are gaining momentum. However, we have to note that devaluations and similar inflationary measures have, in some instances, been temporarily successful in alleviating the effects of union wage policy and in halting temporarily the growth of unemployment.

    Compared with the ineffectual handling of the unemployment problem by countries which customarily are called democratic, the policy of dictatorships appears extremely successful. Unemployment disappears if compulsory labor is introduced by inducting the unemployed into the army and other military units, into labor camps and similar compulsory service. The workers in these services must be satisfied with wages which are far below those of other workers. Gradually an approximation of wage rates is sought by raising the wages of the service workers and by lowering the wages of other workers. The political successes of the totalitarian countries are primarily based on the results which they achieved in the fight against service workers and by lowering the wages of other workers. The political successes of the totalitarian countries are primarily based on the results which they achieved in the fight against unemployment.


[1]Direct fixing of prices for the material means of production which cannot be used in direct consumption may be omitted; if the prices are fixed for all consumers’ goods, and if interest and wage rates are fixed, and if all workers are forced to work, and all owners of the means of production are forced to produce, then the prices of material means of production are indirectly fixed as well.

[2]For the sake of simplification we disregard construction costs.

*[See Chapter 111.—Editor]

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