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The Problem with Price Controls
Price controls don’t stop inflation. They will cause shortages. They are always a bad idea.
“Ugh, Price Controls”
I’ve spent the month of June working in Budapest, Hungary. My family and I took a week vacation in Italy – our first time to that wonderful country – and returned to Budapest for a final night or two.
On our drive back from Italy, we stopped in the countryside at a Shell station to buy gas. There were a few cars and it looked to be a quick stop.
As I pulled up, however, almost all the pumps had little bags on them. Everything was sold out except for 100 octane gas, but our hybrid rental takes 95 and we weren’t sure if the higher octane was a problem for hybrids or not.
I grumbled to my family, “ugh, price controls”.
Hungarian Price Controls
Inflation began rising in Hungary last year. For the past 20 years, Hungarian inflation has been around 5% on average although it hit near zero for the 2014-2016 period.
So we can forgive the Hungarian monetary authorities for also missing rising inflation, thinking its 2021 rate of around 5% was a return to normal and perhaps transitorily high due to a post-Covid bounce back. This is what everyone thought.
By Christmas last year it was clear that inflation was rising for real and the Hungarian government decided to take extra steps to limit the effect of higher food and fuel prices on its population. They soon announced price controls for the February to May period although this has since been extended.
When I first heard this - months ago - I grumbled to my family, “ugh, price controls… well, they’ll have shortages”. And, of course, that’s what happened.
But even policy makers learn. Knowing from experience that price controls mean shortages, the government got creative. The law placing caps on food items included a provision that if a store sold an item last year (before the price controls), then it would be legally obliged to sell it this year (during the price controls) whether it can afford to or not. Failure to sell food would lead to fines and persistent failure to sell could mean store closure for 6 months. Lovely…
…Back to the Gasoline Story
Anyway, relevant here is that gasoline was included in the price control law as it’s considered an essential item.
My family and I pulled out of the Shell, continuing down the highway looking for the next station, hoping it might be better. We also called the rental company to confirm that if we used 100 octane gas, our hybrid wouldn’t explode or burst into flames or something. They assured us it would be fine. More expensive but fine which did put our minds at ease.
We arrived at the next gas station run by MOL, the Hungarian national oil and gas company.
MOL has special privileges and a defined role in gas provision during the price control regime. For example, as far as I understand, MOL buys the gas and distributes it to the other gas companies.
Our hope, then, was that MOL would have gas. And it did.
Of course, as we pulled in, we could see the lines of cars running almost out onto the highway. See the picture below that I took from behind the steering wheel. I groaned to my family “ugh…price controls”. After about a 45 min wait we finally got 95 octane gas and were on our way again.
Picture: Somewhere mid-line at the MOL station, July 10, 2022.
It’s a General Problem
This is not a Hungarian story. This is a price control story. There are proposals in DC today to use price controls on prescription drugs, student loans, and range of other things.
The reason I’m writing about this now is because it is also unfortunately a popular policy idea during inflationary episodes. Prices are rising, politicians want to stop that (at least for their constituents) and so controlling prices by law always seems appealing.
So I want to comment early in the hopes that some people are listening and will help resist the inevitable temptation.
Prices and Markets
To understand why price controls inevitably lead to the same result, you have to understand just a little of what prices are and what their role is.
Prices balance supply and demand and thereby act as signals of information.
Imagine a new fruit stand at the side of the road. How much should the owner sell fruit for? First they make sure to sell the fruit for more than they bought it for. Then they might add a bit on top of that and open for business. For simplicity suppose they put out 10 apples (or pounds of apples or whatever you like) and try to sell them at $1.00 each.
If they sell all the apples by mid-morning, then clearly at $1.00 people were demanding more than 10 apples. This is useful information. Next, (a) they can try to sell more, say 15 apples, at $1.00 tomorrow (this is an increase in the supply of apples) and/or (b) they can raise the price.
Suppose they raise the price and add a few extra apples. If they run out again the following day, then they might bring even more apples and raise the price a little more.
They will keep this up until, on average, they sell all their apples every day. When this happens, they will have found what economists call “the market clearing price”. The market “clears” in the sense that all the supply gets bought up and that amount satisfies all the demand at that price.
If they try to raise the price higher, they’ll find that they have apples left over at the end of the day. They’ll usually keep them and sell them at a discount (i.e., cut prices) the following day.
The lesson here is that the price adjusts up and down until the amount supplied is the amount people want to buy at that price. As a result of this process, prices convey information about supply and demand conditions.
When price rises for something, this tells everyone interested that this good is valuable and relatively scarce. The effect of the higher price is to “call more goods to the market” – recall our fruit stand owners brought more apples the next day – and it also tells consumers to buy a little less, conserving the thing that is relatively more valuable.
When the price falls for something, this tells everyone the opposite. The good is a little less valuable, or relatively less scarce, and hence suppliers don’t need to bring as much to market and consumers can consume a little extra.
This works for a simple fruit stand and it works for modern complex products at giant mega-multinational companies. It works any where in the world at any point in time including throughout the entire span of human history.
Notice that the price moving around generates shortages and surpluses until the “right” price is found. That’s why whenever prices are capped so they can’t rise, there is a shortage. The price should rise and encourage additional supply and a little more restraint of demand, conserving the good. But it doesn’t. As a result, more is demanded at that price than is supplied and, without the higher price signal, no one has an incentive to bring more to market. The shortage will therefore persist.
Some Other Examples and The Unintended Consequences
When I first started studying economics in 1990, the hot topic was “transition economics” which was the study of how centrally-planned economies under Communist regimes could transition to market-based economies under democracies and the rule of law.
One of the first things a young American like myself had to learn is that when prices aren’t free to adjust, we still need a way to think about how the market functions and clears. And it turns out that one way is to consider the “true price” of something the total amount you have to pay plus the amount of time you must devote to obtaining it.
That is, for the consumer, the time spent waiting in line is part of the price you pay for something. But unlike other prices which you pay to someone, no one benefits from your wait. It’s just a loss. You stand it line for 30 minutes but that’s it. So, the official price is kept low by law but the true price rises. A longer line is a higher price. A shorter line, a lower price.
A second thing you have to learn is that, without prices to adjust officially, the door to discrimination and corruption is thrown wide open.
Consider living somewhere without market prices adjusting. There are shortages of popular items and surpluses of unpopular items. If you know the local shop owner, you can skip the line and also always be sure to get the good you want.
The result is eventually not just an innocent network of connections that you have to develop but also generally massive corruption where connected people – maybe the police or the local mayor’s family or whomever – get things easily while the rest of humanity suffers worse shortages and longer lines.
Additionally, racism, sexism and other forms of discrimination are free to run rampant. Maybe the shop owner allows friends and family to skip the line. Also, maybe they only let people of their same ethnic or religious background get ahead in line or always “mysteriously” run out completely before certain people can buy any food.
Under Soviet Communism where this sort of system was the norm, people developed other systems. First of all your family made connections with the right families to get the right supplies. Also, a system of barter emerged where you got stuff from personal connections that are valuable to others, then traded those things in order to get stuff more valuable to you.
And no matter what, you were always sure to have extra money or goods to bribe people to get things. You always needed to be ready to slip someone a little extra money under the table to be sure you get the goods or services you want. That usually extends to police, local administration, train conductors and so on. A whole network of corruption emerges. It’s quite amazing (and sad) actually.
In this way, people eventually manage even when prices aren’t allowed to adjust. And, again, this system works everywhere in the world at all times through history.
Take rent-controlled housing, for example. This is a popular policy in many countries, including the US. The rental price can’t rise, so suppliers only build apartments once – usually to get a subsidized up front amount of money – but they are certainly never going to spend extra to maintain the buildings or tend to customers. As a result the buildings quickly become dilapidated.
Additionally, by keeping the price low there are always more renters wanting apartments than there are apartments available so there’s always a shortage of housing. And in that environment the landlord is strongly encouraged to take bribes, side payments, or just exert their full discriminatory prejudices to only rent to “their kind of people” .
Where there are caps on medical payments, doctors discriminate and take bribes. And so on.
Find any country anywhere in the world today. If you hear of persistent shortages in something, look and you’ll eventually find price controls are causing it. I have yet to find a single exception. The story is always the same.
Why run on about this now? It’s been around for ever and is a pervasive problem in nearly all less-developed countries around the world where prices and people are often less free.
The reason is that I’m hearing talk about price controls as a way to fight inflation. I hear it in news discussions, on the street, from friends, from politicians and so on.
It has never stopped inflation. And if you put a price control in one spot it will cause a shortage there. If you pass a law to avoid the shortage there, it just pushes the shortage somewhere else in the system. It’s like placing large stones in a running river. The water just creates new pathways around the stones, but continues to flow downhill.
Hungary’s oil company, MOL, has been warning that the gas price caps shouldn’t last much longer. There will be bigger shortages soon and they are worried about building up reserves, especially given the war in Ukraine that continues to rage. Hopefully Hungary will lift their controls soon.
In the US there’s talk of imposing controls on a range of products, mostly medical and educational products at the moment. Wherever it happens, there will be a shortage. And if the control and shortage persists for very long, you’ll soon see corruption and other unintended consequences spring up.
With inflation hitting 9.1% now, the pressure to “do something” will only grow. Politicians will consider various price controls to “help” in this time of need. We’ll start to hear more about price controls as a solution to inflation from the talking heads on TV, in the news, etc.
Price controls never achieve the intended objectives. We’ll still have inflation and we’ll also get shortages and eventually more corruption and discrimination and all the social ills we generally loathe.
 Or over whatever time frame is relevant. Apples are probably still fresh for a few days, so they might aim to sell all their stock every few days. The basic point is the same.
 A shortage or surplus on any given day does reflect a pricing error – that is, there was a price that would have cleared the market perfectly – but it will go away quickly if prices can adjust. In our example, the fruit stand owners sell the apples at a discount the next day. But if you see a shortage that persists for a long time, it’s a price control causing it. I’ve never found an exception.
 It was a lesson for a young American like myself because Americans live in a relatively free country with relatively free, functioning markets. People from most other countries in the world experienced various price controls, shortages, and lines (or “queues” as they are often called elsewhere).
 Of course clever policy makers know this and often create additional requirements around things like rent-controls. For example the law might restrict the rental price and also mandate certain annual building maintenance or improvements or racial/ethnic/religious targets for renters. The result of course is that the developer then negotiates a subsidy or tax break from the state in return and so on. The fact that these are common “solutions” just confirms that everyone recognizes the problems with the price controls in the first place.