by Ludwig von Mises
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The knowledge that the constellation of the market determines prices precisely, or at least within narrow limits, is relatively new. Some earlier writers may have had a dim notion of it, but only the Physiocrats and the classical economists elaborated a system of exchange and market relations. The science of catallactics thus replaced the indeterminism of theory, which explained prices from the demands of sellers, and saw no price limits other than their fairness.
He who believes the formation of prices to be arbitrary easily arrives at the demand that they should be fixed by external regulation. If the conscience of the seller is lacking, if without fear of the wrath of God he demands more than is “fair,” a worldly authority must intervene in order to help justice prevail. And minimum prices must be imposed for certain commodities and services over which buyers are believed, not quite logically, to have the power to force deviations from the just price. Government is called upon to create order because disorder and arbitrariness prevail.
The practical doctrine based on the knowledge of scientific economics and sociology—liberalism—rejects all intervention as superfluous, useless, and harmful. It is superfluous because built-in forces are at work that limit the arbitrariness of the exchanging parties. It is useless because the government objective of lower prices cannot be achieved by controls. And it is harmful because it deters production and consumption from those uses that, from the consumer’s viewpoint, are most important. At times liberalism has called government intervention impossible. Of course, government can issue orders that regulate prices and punish the violators. Therefore, it would have been more appropriate for liberalism not to call price controls impossible, but rather unsuitable, that is, running counter to the intentions of their advocates. The following discussion will demonstrate this unsuitability.
Liberalism was soon replaced by socialism, which seeks to replace private property in the means of production with public property. Socialism as such need not reject the price knowledge of science; it is conceivable that it could recognize its usefulness for an understanding of market phenomena in its own economic order. If it were to do that, it would have to conclude that government and other interference with prices is as superfluous, useless, and harmful as liberalism says it is. In fact, the doctrines of Marxism contain, besides quite incompatible principles and demands, the beginnings of this perception; this is clearly visible in the skepticism toward the belief that wage rates can be raised by labor-union tactics, and in the rejection of all methods Marx calls “bourgeois.” But in the world of Marxian reality etatism is dominant. In theory etatism is the doctrine of state omnipotence, and in practice, it is the government policy to manage all worldly matters through orders and prohibitions. The social ideal of etatism is a special kind of socialism, such as state socialism or, under certain conditions, military or religious socialism. On the surface the social ideal of etatism does not differ from the social order of capitalism. Etatism does not seek to overthrow the traditional legal order and formally convert all private property in production to public property. Only the largest enterprises in industry, mining, and transportation are to be nationalized. In agriculture, and in medium- and small-scale production, private property is to be preserved formally. But in substance all enterprises are to become government operations. Under this practice, the owners will keep their names and trademarks on the property and the right to an “appropriate” income or one “befitting their ranks.” Every business becomes an office and every occupation a civil service. There is no room for entrepreneurial independence in any of the varieties of state socialism. Prices are set by government, and government determines what is to be produced, how it is to be produced, and in what quantities. There is no speculation, no “extraordinary” profits, no losses. There is no innovation, except for that ordered by government. Government guides and supervises everything.
It is one of the peculiarities of etatist doctrine that it can envision man’s social life only in terms of its special socialistic ideal. The outer similarity between the “social state” it extols and the social order based on private property in production causes it to overlook the essential difference that separates them. To the etatist, any dissimilarity of the two social orders is merely a temporary irregularity and a punishable violation of government orders. The state has slackened the reins, which it must pull short again, and everything will be in the best of order. The fact that man’s social life is subject to certain conditions, to regularity like that of nature, is a concept that is alien to an etatist. To him, everything is power, which he views in a grossly materialistic light.
Although etatism did not succeed in supplanting the other socialistic ideals with its own ideal, it has defeated all other branches of socialism in practical policy. In spite of their diverging opinions and objectives all socialistic groups today seek to influence market prices through outside intervention and force.
The theory of price controls must investigate the effects of government interference with market prices in the private property order. It is not its task to analyze price controls in a socialistic order that preserves private property by form and outward appearance, and uses price controls to direct production and consumption. In this case the controls have only technical significance, and remain without influence on the nature of the issue. And they alone do not constitute the difference between the socialistic society that uses them and those socialistic societies that are organized along different lines.
The importance of the theory of price controls becomes evident in the contention that there is yet a third social order besides the private property order and one built on public property, an order that retains private property in the means of production, but is “regulated” through government intervention. The Socialists of the Chair and the Solidarists, together with a great many statesmen and powerful political parties, continue to hold to this belief. On the one hand, it plays a role in the interpretation of economic history during the Middle Ages, and on the other hand, it constitutes the theoretic foundation for modern interventionism.2. Price Controls
Sanctioning Controls. We may call those controls “sanctioning” that set prices so close to those the unhampered market would set that only insignificant consequences can ensue. Such controls merely pursue a limited task and do not achieve great economic objectives through interference with market forces. Government may simply accept the market prices and sanction them with its intervention. The case is similar when government imposes price ceilings that lie above the market prices, and minimum prices that lie below them. The case is slightly different when government imposes controls in order to force a monopolist to charge competitive prices instead of higher monopolistic prices. If government creates monopolies or limits the number of competitors, thereby promoting monopolistic agreements, it must, without question, resort to price controls if it does not want to force consumers to pay monopolistic prices. In none of these cases is the result of government intervention a deviation of price from that of the unhampered market.
The situation is somewhat different when a government regulation deprives a seller of the opportunity, under certain conditions, to demand and obtain a price that is higher than that he can normally obtain. If, for instance, government fixed rates for taxicabs, cabbies would be prevented from exploiting those cases in which passengers are willing to pay more than normal rates. The affluent tourist who, late at night and in bad weather, arrives at a strange railroad station, accompanied by small children and loaded with many pieces of luggage, will gladly pay a much higher fare to get to a remote hotel if he must compete with others for the few or perhaps only taxicab offering a ride. With extraordinary gains from exceptional opportunities, the cabbies would be able, when business is poor, to charge lower rates in order to increase the demand for their services. Government intervention thus eliminates the difference between the fare at times of great demand and those of weak demand, and establishes an average rate. Now, if government fixes rates that are even lower than this ideal average price, we have genuine price control, to which I shall return shortly.
The case is similar where government does not set prices directly, but forces the seller, such as a restaurateur, to post his prices. This, too, has the effect that the seller is prevented from exploiting extraordinary situations in which he could obtain a higher price from individual buyers. He must take account of this limitation; if he is prevented from charging more under favorable conditions, he will find it difficult to charge less under unfavorable conditions.
Other price controls are to prevent windfall profits that might be reaped under extraordinary conditions. If a city power company for any reason should be prevented from generating power for a few days, candle prices would soar, and merchants with candle supplies would reap extraordinary profits. Now government intervenes and sets a price ceiling for candles, at the same time forcing the sale of candles as long as the supply lasts. This has no permanent effect on the candle supply inasmuch as the power failure is quickly corrected. Only insofar as merchants and producers, having such failures in mind, calculate prices and candle inventory does government intervention have future consequences. If the merchants must anticipate that under similar conditions government will again intervene, the price charged under normal conditions will rise and the incentive for larger inventories will be reduced.
Genuine Controls. We may call those price controls “genuine” that set prices differing from those the unhampered market would set. If government seeks to fix a price higher than the market price, it usually resorts to minimum prices. If government seeks to fix a price lower than the market price it usually imposes price ceilings.
Let us first consider the ceiling, or maximum, price. The natural price that would emerge in an unhampered market corresponds to an equilibrium of all prices. At that point price and cost coincide. Now, if a government order necessitates a readjustment, if the sellers are forced to sell their goods at lower prices, the proceeds fall below costs. Therefore, the sellers will abstain from selling—except for merchandise that quickly spoils or otherwise loses in value—and hold on to their goods in the hope that the government regulation will soon be lifted. But the potential buyers will be unable to buy the desired goods. If possible, they now may buy some substitute they would not have otherwise bought. (It should also be noted that the prices of these substitute goods must rise on account of the greater demand.) But it was never the intention of government to bring about these effects. It wanted the buyers to enjoy the goods at lower prices, not to deprive them of the opportunity to buy the goods at all. Therefore, government tends to supplement the price ceiling with an order to sell all goods at this price as long as the supply lasts. At this point price controls encounter their greatest difficulty. The market interaction brings about a price at which demand and supply tend to coincide. The number of potential buyers willing to pay the market price is large enough for the whole market supply to be sold. If government lowers the price below that which the unhampered market would set, the same quantity of goods faces a greater number of potential buyers who are willing to pay the lower official price. Supply and demand no longer coincide; demand exceeds supply, and the market mechanism, which tends to bring supply and demand together through changes in price, no longer functions.
Mere coincidence now eliminates as many buyers as the given supply cannot accommodate. Perhaps those buyers who come first or have personal connections with the sellers will get the goods. The recent war with its many attempts at price controls provided examples of both. At the official price, goods could be bought either by a friend of the seller or by an early bird in the “polonaise.” But government cannot be content with this selection of buyers. It wants everyone to have the goods at lower prices, and would like to avoid situations in which people cannot get any goods for their money. Therefore, it must go beyond the order to sell; it must resort to rationing. The quantity of merchandise coming to the market is no longer left to the discretion of sellers and buyers. Government now distributes the available supply and gives everyone at the official price what he is entitled to under the ration regulation.
But government cannot even stop here. The intervention mentioned so far concerns only the available supply. When that is exhausted the empty inventories will not be replenished because production no longer covers its costs. If government wants to secure a supply for consumers it must pronounce an obligation to produce. If necessary, it must fix the prices of raw materials and semimanufactured products, and eventually also wage rates, and force businessmen and workers to produce and labor at these prices.
It can thus be readily seen that it is inconceivable to resort to price controls as an isolated intervention in the private property order. Government is unable to achieve the desired result, and therefore finds it necessary to proceed step by step from the isolated pricing order to comprehensive control over labor, the means of production, what is produced, how it is produced, and how it is distributed. Isolated intervention in the market operation merely disrupts the service to consumers, and forces them to seek substitutes for those items they deem most important; it thus fails to achieve the very result government meant to achieve. The history of war socialism has clearly illustrated this. Governments seeking to interfere with market operations found it necessary, step by step, to proceed from the original isolated price interference to complete socialization of production. Government would have had to proceed ever faster if its price regulations had been observed more faithfully, and if black markets had not circumvented the regulations. The fact that government did not take the final step, the nationalization of the whole apparatus of production, was due to the early end of the war, which brought an end to the war economy. He who observes a war economy is clearly aware of the phases mentioned above: at first price control, then forced sales, then rationing, then regulation of production and distribution, and, finally, attempts at central planning of all production and distribution.
Price controls have played an especially important role in the history of coin debasement and inflationary policy. Again and again, governments have tried to enforce old prices in spite of coin debasement and expansion of circulating money. They did so again in the most recent and greatest of all inflation periods, during the World War. On the very day printing presses were put into the service of government finance, rising prices were fought with criminal law. Let us assume that this at first succeeded. And let us disregard the fact that the supply of goods was reduced by the war, which affected the exchange ratio between economic goods and money. Let us further ignore increased demand for money due to delayed money delivery or clearing system limitations and other restrictions. We merely wish to analyze the consequences of a policy that aims at stabilizing prices while the quantity of money is enlarged. The expansion of money creates new demand that did not exist before, “new purchasing power,” as it is called. When the new buyers compete with those already in the market, and prices are not permitted to rise, only a part of demand can be satisfied. There are potential buyers who are willing to pay the price, but cannot find a supply. Government, which is circulating the newly created money, is seeking thereby to redirect commodities and services from previous uses to more desirable uses. It wants to buy them, not to commandeer them, which it certainly could do. Its intent is that money, only money, shall buy everything, and that potential buyers shall not be frustrated in their search for economic goods. After all, government itself wants to buy, it wants to use the market, not destroy it.
The official price is destroying the market on which commodities and services are exchanged for money. Wherever possible, the exchange continues in other ways. For instance, people resort to barter transactions, that is, to exchange without the interaction of money. Government, which is ill-prepared for such transactions because it owns no exchangeable goods, cannot approve of such a development. It is coming to the market with money only, and therefore is hoping that the purchasing power of the monetary unit is not further reduced by the money holders’ inability to get the goods they want with their money. As a buyer of commodities and services itself, government cannot adhere to the principle that the old prices must not be exceeded. In short, government as issuer of new money cannot escape the consequences described by the quantity theory.
If government imposes a price higher than that determined by the unhampered market, and prohibits the sale at lower prices (minimum prices), demand must decline. At the lower market price supply and demand coincide. At the official higher price demand tends to trail supply, and some goods brought to the market cannot find a buyer. As government imposed the minimum price in order to assure the sellers profitable sales, the result was unintended by government. Therefore, it must resort to other means, which again, step by step, must lead to complete government control over the means of production.
Especially significant are those minimum prices that set wage rates (minimum wages). Such rates may be set either directly by government or indirectly by promoting labor union policies that aim at establishing minimum wages. When, through strikes or threats of strikes, labor unions enforce a wage rate that is higher than that determined by the unhampered market, they can do so only with the assistance of government. The strike is made effective by denying the protection of the law and administration to workers willing to work. In fact, it is irrelevant for our analysis whether the apparatus of coercion imposing the controls is the “legitimate” state apparatus or a sanctioned apparatus with public power. If a minimum wage that exceeds the unhampered market rate is imposed on a particular industry, its costs of production are raised, the price of the final product must rise, and correspondingly, sales must decline. Workers lose their jobs, which depresses wages in other industries. Up to this point we may agree with the wage fund theory on the effects of nonmarket wage boosts. That which the workers in one industry are gaining is lost by the workers in other industries. In order to avoid such consequences, the imposition of minimum wages must be accompanied by the prohibition to dismiss workers. The prohibition in turn reduces the industry’s rate of return because unneeded workers must be paid, or they are used and paid in full production while their output is sold at a loss. Industrial activity then tends to decline. If this, too, is to be prevented, government must intervene again with new regulations.
If the minimum wage is not limited to a few industries, but is imposed on all industries of an isolated economy, or on the world economy, the rise in product prices caused by it cannot lead to a reduction in consumption.2 The higher wages raise the workers’ spending power. They can now buy the higher-priced products coming to the market. (To be sure, there may be shifting within the industries.) If entrepreneurs and capitalists do not want to consume their capital they must limit their consumption since their money income has not risen and they are unable to pay the higher prices. To the extent of this reduction in consumption, the general wage boost has given the workers a share of entrepreneurial profits and capital income. The workers’ real raise is visible in that prices do not rise by the full amount of the wage boost because of the entrepreneurs’ and capitalists’ cutback in consumption. That is, the rise in consumer prices is less than that of wages. But it is well known that even if all property income were divided among the workers, their individual incomes would rise very little, which should dispel any illusion about such a reduction in property income. But if we were to assume that the wage boost and rise in prices should allocate a large part, if not all, of the real income of entrepreneurs and capitalists to workers, we must bear in mind that the former want to live and will therefore consume their capital for lack of entrepreneurial income. Elimination of capital income through coercive wage boosts thus merely leads to capital consumption, and thereby to continuous reduction in national income. (By the way, every attempt at abolishing capital income must have the same consequence unless it is achieved through all-round nationalization of production and consumption.) If again government seeks to avoid these undesirable effects, no alternative is left, from the etatist point of view, but to seize control over the means of production from the owners.
Our discussion applies only to those price controls that endeavor to set prices differing from those of the unhampered market. If the controls should seek to undercut monopolistic prices, the consequences are quite different. Government then may effectively intervene anywhere in the range between the higher monopolistic price and the lower competitive price. Under certain conditions price controls may deprive a monopolist of specific monopolistic gains. Let us assume, for instance, that in an isolated economy a sugar cartel is holding sugar prices above those the unhampered market would set. Government could then impose a minimum price for sugar beets that is higher than the unhampered market price. But the effects of price controls could not develop as long as the intervention merely absorbs the specific monopoly gain of the sugar monopolist. Only when the beet price is set so high that sugar production becomes unprofitable even at the monopolistic price, forcing the sugar monopoly to raise prices and curtail production in line with shrinking demand, will the price control effects take place.
3. The Significance of the Theory of Price Control for the Theory of Social Organization
The most important theoretical knowledge gained from a basic analysis of the effects of price controls is this: the effect of intervention is the very opposite of what it was meant to achieve. If government is to avoid the undesirable consequences it cannot stop with just market interference. Step by step it must continue until it finally seizes control over production from the entrepreneurs and capitalists. It is unimportant, then, how it regulates the distribution of income, whether or not it grants a preferred income position to entrepreneurs and capitalists. It is important, however, that government cannot be satisfied with a single intervention, but is driven on to nationalize the means of production. This ultimate effect refutes the notion that there is a middle form of organization, the “regulated” economy, between the private property order and the public property order. In the former only the play of market forces can determine prices. If government prevents this play in any way, production loses its meaning and becomes chaotic. Finally, government must assume control in order to avoid the chaos it created.
Thus, we must agree with the classical liberals and some older socialists who believed it impossible in the private property order to eliminate the market influence on prices, and thereby on production and distribution, by decreeing prices that differ from market prices. For them it was no empty doctrinarism, but a profound recognition of social principles, when they emphasized the alternative: private property or public property, capitalism or socialism. Indeed, for a society based on division of labor there are only these two possibilities; middle forms of organization are conceivable only in the sense that some means of production may be publicly owned while others are owned privately. But wherever property is in private hands, government intervention cannot eliminate the market price without simultaneously abolishing the regulating principle of production.
1Handwörterbuch der Staatswissenschaften [Handbook of social sciences], 4th ed., vol. VI, 1923.
2We are ignoring the monetary forces’ exerting their influence on prices.
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