The Problem With Price Controls
July 16, 2001
Economists believe underlying inflationary forces can never be arrested through price controls. For instance, after President Nixon imposed price controls in 1971, inflation fell from the 6 percent range to the 3 percent range. But by 1973, as controls broke down, inflation accelerated, hitting more than 12 percent in 1974 (see figure).
Controls break down in part because so many exceptions must be made for the economy to function. Although price caps on electricity in California are just a few weeks old, they are already breaking down.
One problem is that they encourage excessive energy use.
- If people can buy any commodity for less than the market price, then by definition they are going to use more of it.
- This problem is exacerbated by California's temporary blackouts: at least 10,000 businesses have requested exemptions from blackouts, which means those who must comply may be blacked out more often.
- Also, some businesses are encouraged to waste energy, so that when the state forces them to cut back on energy use, they will have power to spare.
The problems with price caps will only increase the longer they remain in place.
- They will reduce the incentive to produce more energy.
- California will forever be viewed as a riskier place to invest in power plants, meaning producers will have to get higher prices permanently to protect them against the risk of new controls.
- The price caps will lead to lengthy litigation over compliance -- in 1995, Occidental Petroleum settled a case involving its alleged violation of federal oil price controls in 1979.
Temporary controls are likely to last much longer than anyone imagines, because the threat of catch-up price increases will be politically intolerable. But the longer controls last, the more severe their impact.
Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, July 16, 2001.
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