Economic Nonsense: 2. Some prices should be legally capped

Prices do more than tell us how much we have to pay for things; they also convey important information that motivates people to act.  When prices rise for things in short supply, they tempt producers to bring more supply onto the market, alleviating the shortage.  Prices motivate people to put investment into particular sectors of the market, raising future supply there. Governments since that of Hammurabi over 4,000 years ago have at times sought to fix prices, often in response to political pressures: the Adam Smith Institute's Director, Dr. Eamonn Butler, examined the history of this kind of price fixing in Forty Centuries of Wage and Price Controls.  When prices are fixed, however, their role as conveyors of information is lost, and their ability to motivate people to act is compromised.

If energy prices, for example, were fixed, it would make energy less attractive as an investment, reducing the future supply of it and perhaps leading to blackouts.

Fixing the price of rents is popular with current tenants, but it will limit the future supply of rental property.  Rents set artificially below market rates leads to poor maintenance as landlords no longer have the same incentive to maintain and renovate properties.  Fixed rents attract fewer people to rent out property, and encourage landlords to take properties off the rental market.  The Swedish economist, Assar Lindbeck, famously said  "next to bombing, rent control seems in many cases to be the most efficient technique so far known for destroying cities."  It could be argued that it is more effective, since bombing takes out demand as well as supply.

The market has many self-correcting mechanisms that price controls prevent coming into play.  The high prices caused by shortages tell more producers to enter the market; the low prices caused by gluts lead them to direct their resources elsewhere.  This activity depends on the flow of information that prices generate, a flow that is stopped when prices are fixed by law.

Farmers are milking it through state subsidies

Milk is now cheaper than bottled water in some UK supermarkets. So of course there is much wailing that our dairy industry is in terminal trouble and needs subsidy and protection from foreign imports. Wrong. One reason why milk is so cheap right now is that supermarkets are using it as a loss leader. They hope that while customers are buying cheap milk, they might be tempted by less cheap other stuff. They are not actually paying farmers any less.

The dairy industry is indeed in a sorry state, but not because of the lack of state support. Rather, the problem is too much of it. When you protect industries from foreign competition through tariffs (as EU countries like the UK do), and then go on to subsidise them, you kill off competition, both international and domestic. Subsidies and protections allow production to carry on in old, outdated, inefficient, expensive ways. The result is higher prices, lower quality and less choice for customers.

Cold, rainy Britain is not a good place to raise cattle. It's fine in the summer, but in the winter the cattle have to be brought into shelters and given heat, silage and hay, all of which adds to the cost. So other, warmer countries, inevitably have the competitive edge on us.

Dairy producers can compensate for this a bit by creating much larger farms, which can be sited in the sunnier parts of the country, and where large-scale winter housing can be run much more efficiently than countless small-farm cattle sheds. In large, modern facilities, new technology can be employed, such as dry bedding, using other farm by-products for feed, recycling heat, and recapturing methane. And while we are on the subject of greenhouse gases, how much more energy-efficient is it to collect milk from one 8,000-cow farm than from 100 with 80 cows?

But planning policy, that great UK obstacle to progress, is making it hard to build such facilities – a plan for one in Lincolnshire has recently been scrapped. And the existence of subsidies makes it less urgent for inefficient dairy farmers to leave the business, and for more efficient ones to replace them.

Some people argue that we should subsidise UK agriculture to cut down on 'food miles'. Tosh. 80% of food-related emissions are from production, only 4% from transport. So it is 20 times more important to make efficiencies in production. That means super-farms here, or importing products from countries where the climate is more suitable. We do that with wine, why not with other agricultural products? And in any case, domestic production is an environmental nightmare, what with the fertilisers, pesticides and heating that have to be used. DEFRA figured that the carbon footprint of Spanish-grown tomatoes is probably smaller than that of UK tomatoes grown under glass. Remember too that food is transported, efficiently, in bulk. Most 'food miles' are getting small quantities of the stuff from the supermarket to your fridge, which is not going to change even if it is grown locally.

If we scrapped the subsidies and protections, the market could do its stuff, weeding out inefficient production and diverting investment into something better. That would be good for the industry, good for customers in terms of lower prices, good for taxpayers in terms of lower taxes, and good for the planet.

So how does this work then?

It would appear that someone, somewhere, is confused. It could be us that is confused but we're a bit, umm, confused about that. For the claim is that if retailers are providing a subsidy to the consumption of milk then this could devastate the milk producing industry. Which is confusing:

The price of milk has fallen to just 22p a pint thanks to a fierce war between supermarkets. Farmers have warned the UK dairy industry faces extinction if retailers continue to drive down the price – now at its lowest level in seven years. Asda, Aldi, Lidl and Iceland are selling four pints of milk for just 89p, while Tesco, Sainsbury’s and Waitrose are not far behind at £1. Pint for pint, milk is now cheaper than mineral water in most supermarkets. Retailers insist they are funding the cost of the price reduction from their own profits, rather than paying farmers less. Many supermarkets have guaranteed the price farms receive will stay above the cost of production. But farmers say the price war is also devaluing milk as a product at a time when they are under unprecedented pressure.

It doesn't get any less confusing on consideration, does it? The retail price of milk is lower, given the supermarket subsidy to it, leading to higher consumption, while the producer price is "guaranteed" to be above production costs. And this is going to devastate the industry? We don't think it is us getting confused here. Of course, the real background to this is that, as has been happening for the past couple of centuries as farming techniques improve, milk has been getting cheaper and cheaper to produce. And as has been happening over that time the higher cost producers have been pushed out of the market by the lower cost ones. This is, after all, the universe's way of telling you to go do something else, when the price of what you produce is lower than the cost of producing it. That's what is devastating farming, we're in general becoming more efficient at it. And the supermarkets are, through their subsidy, restricting this process which is the very opposite of devastation, isn't it?

Isn't the Venezuelan economy doing well?

The Venezuelan economy is at the top of the world. For something, at least:

The South American oil giant's economy shrank 2.3pc in the third quarter, after contracting 4.8pc in the first quarter and 4.9pc in the second, the central bank said.

The inflation rate, a figure the government had not released since August, came in at 4.7pc for November and 63.6pc for the year - among the highest in the world.

As we've mentioned around here before there's nothing wrong at all with the idea that you'd like to change an uneven income distribution. It may or may not be desirable, may or may not be practicable, but the basic desire for a little less extremity in the gap between rich and poor is not a dishonourable goal. It's just that there are sensible and non-sensible ways of going about this.

President Nicolas Maduro's leftist government has introduced mandatory price cuts and rent controls in a bid to rein in the increases but has not managed to get the inflationary spiral under control.

Inflation has been aggravated by severe shortages of basic goods.

Well, yes, it would be. Because price fixing is the wrong way to go about doing it. The problem that all too many of the simpler sorts of socialists have is that prices are not just what people must pay for something, they're also information to those producing things. So, if we price fix because we want the poor to have, say, toilet paper, we then find that the information going to those producing toilet paper is corrupted.

If we set prices above the market clearing price then forests will be razed to provide enough paper to overwhelm the very nation. If prices are set below that market clearing price, as they have been, then there will be shortages of this most basic accoutrement of a civilised bathroom experience. As there have been. And if we set prices at the market clearing price (ignoring that we can't actually calculate that without using the market itself to do so) then what the heck are we doing anyway?

Further, deliberately lowering prices by fiat will reduce production. Thus increasing the price of what is produced on that black market that will inevitably develop and this increasing inflation.

Price fixing just isn't the way to do it.

This is a lesson that our own socialists here in the rich world have learnt to some extent. They still get a bit confused over things like electricity, housing and health care, but at least for general consumables and comestibles they've got it. The way to enable the poor to enjoy more of these things is not to try to fix the price low but to simply give the poor some more money so they can buy at that market price. Which is what we do with tax credits and the like.

Whether we should be reducing inequality is a different matter: but if we are to then we should be doing it in a sensible manner. As Venezuela so obviously isn't.