What goes wrong when the government interferes with prices

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Prices are a fact of life, and so is complaining about them. You probably prefer lower prices on just about everything, but especially when buying a house or paying for college, and you wish for higher prices when it comes time to sell that house or negotiate your salary. Complaints aside, prices are the key to widespread prosperity.

Prices contain vital information: They show us how scarce resources are. They indicate what consumers want. Entrepreneurs and innovators rely on them to decide what to make and how to make it. But not all prices are meaningful. Too often, governments interfere. In an attempt to protect consumers, politicians mandate lower prices. Other times, governments push prices up to benefit certain industries. These efforts might be well intentioned, but they distort the information that prices convey and tend to make us poorer.

Why are prices so important, and what happens when policy makers forget this lesson?

The economy looks chaotic. Every day, millions of people independently make billions of decisions. From cups of coffee to new cars, consumers are making countless purchases; innovators are busy developing new products; and entrepreneurs are investing in new equipment, processes, and buildings. Somehow, though, the result isn’t chaos: it’s widespread prosperity.

This order is a consequence of prices and competition. Price signals help create order where chaos seems more likely. Higher prices encourage consumers to conserve or to buy other products. Likewise, prices show innovators where they should commit their time and effort. They help entrepreneurs decide where they should invest their money.

But prices are effective only when they reflect actual economic conditions. They should rise and fall as consumer preferences change or when inputs become more or less scarce. When prices don’t reflect these changes, the result will be shortages or excess.

In the case of shortages, the cost to make more of the good is less than its value to society, yet no one has the incentive to produce more. Conversely, an excess supply means resources are wasted on goods that cost more to make than their value to society. Whether it is a shortage or an excess, the outcome is that society gets less of what it wants.

The COVID pandemic serves as a tragic example of the consequences of government price mandates. As demand rose for masks, personal protective equipment, and toilet paper, prices should have risen too. But that is not what happened. Anti-price-gouging laws prevented prices from rising. With the prices remaining largely fixed, businesses had little incentive to increase production and consumers bought more than they needed. Dangerous shortages followed. Hoarders bought up supplies, while doctors and nurses couldn’t get masks.

Government-mandated price controls are a problem not just during pandemics. In nearly every part of our economy—from housing to health care—there are regulations that prevent prices from adjusting as economic conditions change. These rules distort the signals prices send and result in less prosperity.

What about housing?

Governments often enact policies to push housing prices upward. At other times, they create policies to keep housing costs from rising. And occasionally they support policies that aim to raise and lower housing costs simultaneously.

Rent control is a classic example of a government-engendered price distortion. No one likes to pay more for rent, so politicians often resort to laws that simply prevent rents from rising. Advocates of these rules argue that landlords do little to deserve higher rent payments. In the San Francisco Bay Area, for example, landlords have been able to increase rents because of a booming job market. Why, rent control supporters ask, should these landlords collect higher rents when they just happened to buy a property at the right time?

Rent-control laws, however, distort incentives for renters and landlords. Those who don’t value the space have little reason to move to smaller accommodations, while would-be renters who need more space, such as families with children, can’t find adequate living room. The large family who needs more space would be willing to pay more, but rent-control laws mean there is no way for them to outbid those who don’t value the extra space.

Landlords have little incentive to maintain and invest in their properties. With rent so low, they can easily find renters, so why would they make any improvements? Other landlords may choose to stop renting. They turn their properties into condos or other types of units that are not subject to rent-control laws. Developers and prospective landlords meanwhile have no incentive to build additional rental units. Thus, rent-controls laws lead to housing shortages and reduce the quality of existing units.

Surprisingly, many places with rent control also have rules in place that lead to increased housing prices. The people who benefit from these rules are current homeowners who see their home values rise. The artificially high prices, however, hurt families who can’t find housing or have to pay higher rents. Moreover, because restrictive land-use policies discourage workers from moving to areas with plentiful job opportunities, workers remain in jobs where they are less productive. This, of course, hurts these workers, but it also harms the entire economy.

Conclusion

In the twenty-first century, fewer people are living in poverty and more needs are being met. Remarkably, this progress has come with little central planning. Most economic decisions are left in the hands of individuals. Their choices are guided only by their own preferences and by market prices. As we have seen, when politicians interfere with prices, they obscure and distort the guideposts that are integral to prosperity and ultimately weaken the delicate economic order that benefits so many.


Excerpt Daniel Heil, Hover Institute