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In the October 2002 Freeman I elaborated on one of the central and most-important practical lessons of economics: price controls distort the flow of information that is necessary for markets to work well [2]. Whenever the government puts a ceiling on, say, the price of bottled water or mandates a minimum wage, it orders markets to lie about the underlying facts; it commands that false information about economic reality be spread to all who are affected by this reality and whose actions, in turn, affect this reality.
My column is below the fold.
As schoolchildren we learn of ancient kings who, when told of their armies’ defeats, angrily commanded that the messengers be put to death. Each of us recoils at the cruelty and pointlessness of such killings. We ask ourselves how anyone could be so foolish as to imagine that a messenger is in any way to blame for the reported misfortune. A messenger, after all, simply carries and conveys information. The facts he reports would be the same if he failed to report them, and these facts aren’t altered by his death.
While no modern political leader is known to have shot a postman delivering an unwelcome letter or to have ordered the death of an associate reporting a calamity, we moderns shouldn’t be so quick to applaud ourselves for having advanced beyond the mindlessness that led ancient rulers to blame messengers for unwelcome news.
We blame messengers relentlessly.
We blame messengers when we criticize competitive firms that raise prices. Every price change, whether downward or upward, happens because of some change in the market’s underlying conditions. Sellers who change their prices deliver to the rest of the world the message that some important market condition has changed–a change that we’d best be aware of so that we can adjust our plans and actions accordingly.
At the end of every Spring, for example, the price of a gallon of gasoline typically rises a few cents. The reason is that more of us jump into cars for long road trips. The demand for gasoline increases. This increase in demand for gasoline is an underlying fact of the market. It’s not created or conjured by oil companies. It is simply a fact that must be dealt with.
Oil is scarce; there’s not enough of it to satisfy all the demand there would be for it if its price were zero. The price charged for oil (and for each product made with oil) tells producers how much they should produce, and it tells consumers how much they should use. By regulating the quantity of oil supplied and demanded, prices ensure that producers supply enough oil to satisfy consumers’ demands without, at the same time, generating excess supplies.
The price of gasoline is a shorthand, easy-to-read summary–a report-of an extraordinarily vast array of relevant facts about the oil market: the amount of gasoline currently demanded by motorists; the amount of heating oil currently demanded by homeowners; the amount of available refining capacity; the size of known reserves; the experts’ best estimates of the size of future oil reserves; the expected costs of regulations and tort liability. These and many other fundamental facts of the oil market interact with each other and result, at each moment, in a market price for gasoline.
When any of these underlying facts of the market changes, the price of gasoline changes. When consumers start driving more, the resulting higher price of gasoline reflects consumers’ greater demand for gasoline. It is the message to all concerned that gasoline has become scarcer relative to demand.
In the 1970s the United States government didn’t quite kill the messenger (say, by destroying or nationalizing oil companies), but it did something almost as bad: it outlawed the message. By imposing price controls on oil, the government effectively declared, “We dislike the message of higher prices; therefore, we refuse to let it be heard. Silence!”
Of course, a chief benefit of information to those receiving it is that they can adjust their plans and actions to the facts described by that information. Even if it is unpleasant, acquiring and dealing with it is a must if things are to work out as well as they possibly can under the circumstances.
Facts Unchanged
Outlawing the message of higher oil prices did nothing to undo the facts that, but for the price cap, would have caused higher prices. Indeed, by silencing the message, government encouraged everyone to act as if the underlying facts of the market were different than they really were, thus making the facts increasingly worse.
By keeping the price artificially low–that is, by keeping the market’s message about the facts of the oil market deceitfully rosy–price controls told consumers to try to acquire more gasoline than was available. Simultaneously, these artificially low prices told producers not to expand production. The result was a series of severe shortages.
And as those of us who remember the 1970s recall, the results were long waits in long lines at gasoline stations, as well as great anxiety over the very real threat of being unable to fuel our automobiles.
A tragicomic irony here is that keeping the price of gasoline deceitfully low raised gasoline’s cost. Waiting in line, anxiety, and empty fuel tanks are very real and very high costs that consumers in a market suffering a shortage of gasoline must endure.
In 1981 Ronald Reagan stopped the foolish practice of muffling the message. By delivering honest information to consumers and producers, prices set by the market now prevent the problems that were so prominent during the 1970s.
All price controls silence truthful and useful messages. Rent control silences the message that the demand for rental housing is higher, and the supply lower, than the silencers wish. Minimum-wage regulations silence the message that many low-skilled workers would prefer to work at wage rates lower than the legislated minimum rather than be unemployed. Regulations limiting how far stock-price composites, such as the Dow Jones Industrial Average, may change during each trading day silence messages about the true state of the market for corporate equity.
Only those who believe that reality is a storybook–that you change reality merely by changing the words and symbols used to describe it–can believe that price controls improve matters. Such people are like the kings of old who killed messengers out of some primal notion that doing so might undo the unwelcome facts.
Of course, perhaps no king ever believed such foolishness. Perhaps messengers were killed simply because vindictive rulers vented their frustrations on convenient targets. And perhaps the same pointless vindictiveness is what motivates modern governments to institute price controls.
Regardless of the reasons governments impose price controls, to support them is akin to killing messengers. It is to believe that muting messages will somehow make reality better.