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11/13/92


TITLE WHY PRICE CONTROLS DON'T WORK

They Disrupt Markets, Cost Consumers Billions

First of two parts John Merline In Washington What do humid Cali-
fornia deserts, gasoline shortages, and free government cheese
have in common?


They are the indirect effect of federal attempts to adjust the
prices for water, fuel, and other commodities to please various
special interest groups, according to economists.  Some parts of
California's vast deserts are humid, for example, because of
federal water subsidies put in place to help farmers in arid cli-
mates.  The gas shortages were a result of fuel prices kept ar-
tificially low by government controls, and the free cheese by a
program to keep milk prices high through price supports.

And, although most economists and public officials recognize the
economic costs produced by these distortions, many price controls
still exist. Some fear more may be on the way.  The federal
government has been in the business of controlling prices -either
keeping them artificially high or low - for at least 60 years.
There are often strong political forces behind these efforts.
Altering the price of a product by law gives the appearance of
action on the part of legislators, analysts note.

Lifting or lowering prices also can be seen as an attempt to
achieve a fairer or more equitable outcome than the market pro-
vides, or to correct so-called market failures.  "The government
has been equally involved over the years in keeping some prices
up and others down," said Alan Reynolds, an economist at the Hud-
son Institute in Indianapolis, Ind.

"It really has to do with appealing to different constituencies,
primarily producers or consumers," he said.  Producers, Reynolds
notes, prefer high prices and shortages, while consumers prefer
low prices and surpluses.

Unfortunately for government officials attempting to appeal to
either of these demands, they inevitably clash with the laws of
economics.

Those laws say that artificially high prices - which encourage
supply but lower demand - create a surplus, while artificially
low prices - which discourage supply while encouraging demand -
create a shortage.

This has played havoc with past government attempts to tinker
with prices in various markets in order to achieve an economic
outcome not dictated by supply and demand.  Often justified as
benefiting a certain group, price controls have unanticipated
outcomes that, some believe, outweigh the gains.  Federal water
subsidies for California farmers give them little incentive to
use the product efficiently, a fact that grabbed much public at-
tention during the recent California drought when urban residents
were forced to strictly ration water use - even though they ac-
count for only about 10% of total water consumption.  Farmers in
that state pay about 1/100th the price urban residents pay for
water. According to some estimates, WHY PRICE CONTROLS DON'T WORK


farmers pick up only about 15% of the cost of delivering water to
their land.  "Farmers in California use very primitive irrigation
techniques because the water is so cheap," said an aide to outgo-
ing Rep. William Dannemeyer, R-Calif.  Many California farmers
use "flood irrigation techniques," often pouring enough water on
the ground so evaporation alone makes the air humid.  And, cou-
pled with the low cost, water is treated as a public commodity. A
farmer who economizes on his use is prevented from selling the
excess water to somebody else.

Recommendations On Water

"California's water problem is not one of supply, but one of poor
allocation," concluded a study by the Bay Area Economic Forum in
San Francisco, which found that a small reduction in water use by
farmers would have prevented the need for rationing by urban
residents.

Both the Forum and the Environmental Defense Fund have recommend-
ed a move to greater reliance on market prices for water to solve
these allocation problems.  "It's time to reduce subsidies and
free up market-driven allocation systems to a much greater extent
than has historically been the case," said David Yardas, a water
resource analyst at the EDF.

"If markets were allowed, water in California could be reallocat-
ed so that all . . . users would gain," said economist Richard
Stroup, a senior associate at the Political Economy Research
Center in Bozeman, Mont.

In the same fashion, the gas shortages of the 1970s were a direct
result of price controls on oil, not, as is commonly believed,
the Arab oil embargoes, according to energy experts.  They note,
for instance, that while the 1990 Iraqi invasion of Kuwait
resulted in a similar disruption of oil supplies, the U.S. did
not plunge into an energy crisis as it had previously, even
though the country was importing about the same amount of oil in
1990 as in the 1970s.  During the embargoes of 1970s, world ener-
gy supply was cut by between 3% and 6%. The invasion of Kuwait
led to a supply disruption of 5%.  "The difference between today
and early 1974 and mid-1979, when gasoline lines formed across
the nation, is the absence of oil price and allocation controls,"
said Robert Bradley, president of the Institute for Energy
Research in Houston.

Controls On Gas Prices

Price controls on gasoline prevented pump prices from rising high
enough to soften consumer demand for gasoline.  "Prices were
high, but they needed to be higher if for no other reason than to
get consumers to stop tank topping," said Bradley.  At the same
time, the price caps on gasoline discouraged domestic producers
from increasing production to fill in the supply gap.  In con-
trast, shortly after Kuwait was invaded, domestic prices in the
U.S. spiked, only to come down again in a few months as consumers
reduced consumption and domestic producers increased supply.
"There was a real jump in prices, but that was a good thing," ex-
plains Bradley.  "Consumers knew there was going to be plenty of
gasoline, they were just going to have to pay more for it," he
said.  Similarly, the natural gas shortages of the 1970s were a
direct result of price caps on natural gas supplies.  A report
from the Department of Energy found that because price caps "did
not keep pace with rising production costs, a serious supply-
demand imbalance eventually developed. This led ultimately to gas
shortages and curtailments of customer deliveries during the
1970s." In other markets as well, price controls produce sur-
pluses and shortages.

Agriculture. The federal government's 60-year-old program to sub-
sidize certain crops has led to massive surpluses. The program
sets a guaranteed price for wheat, cotton, rice, milk and other
commodities, giving farmers an incentive to overproduce these
products.  In response to surpluses, the federal government pays
farmers to keep land idle. Some 60 million acres of land -equal
to all the land in Ohio, Indiana and half of Illinois - is kept
idle.  The federal government also recently paid milk farmers to
kill dairy cows as a way to deal with the inevitable surpluses -
which were handed out as free government cheese - generated by
the milk price support program.  These price supports cost the
economy some $8 billion a year, according to Robert Hahn, a
resident scholar at the American Enterprise Institute in Washing-
ton, who published his findings in the Yale Journal on Regula-
tion.  Others, such as James Bovard, author of "The Farm Fiasco,"
put the price much higher. Bovard estimates that farm programs
cost roughly $20 billion in taxes and $10 billion in higher food
prices.
 Labor.-
 Economists are in general agreement that minimum wage laws in-
crease unemployment, although there is some disagreement about
the magnitude of the effect.  In essence, a minimum wage is a
price support for labor.

"When you put a floor on the price -the minimum price you can pay
labor -you tend to get surpluses of labor," said Ohio University
economist Richard Vedder.  "In other words, you get higher unem-
ployment," Vedder said.
 Rent Control. Studies have shown that cities with strict rent
control laws, which keep rental prices artificially low, tend to
have a shortage of housing space.  For example, vacancy rates in
cities with rent control - such as New York - are lower than va-
cancy rates in cities without such ordinances.  "New housing
starts have all but ceased in cities with strict rent control,"
according to William Tucker, author of "The Excluded Americans:
Homelessness and Housing Policy." Decontrolling prices in these
markets might bring about benefits to the economy and to consu-
mers of these products.

Indeed, in many other cases when the government deregulates
prices, the result is lower - not higher - prices, and a more ef-
ficient use of national resources.  For instance, despite fears
expressed at the time that decontrol of energy prices in the ear-
ly 1980s would cause them to fly up, real prices for energy fell
dramatically.  The inflation-adjusted price of gasoline is about
40% lower today than it was in 1980, even after increases in the
gas tax are included.  Prices for natural gas at the wellhead
have dropped 54% since prices were decontrolled.  Airline prices
fell sharply after industry regulations were lifted. Prior to
deregulation, the Civil Aeronautics Board determined both the
price an airline could charge and where it could fly.  Similarly,
trucking and railroad prices declined once businesses in these
industries were free to set prices and determine schedules and
destinations without applying to the federal government.  Some
estimates put the combined savings from airline, trucking and
railroad deregulation at $82 billion a year.

Economists largely attribute these price drops to efficiency
gains, as deregulated markets no longer had to go through cumber-
some regulatory procedures to set a price for their product.
Despite the obvious benefits of price decontrol, some economists
fear a return to greater reliance on federal tinkering with mark-
et prices.

Clinton's Plans


President-elect Clinton, for example, plans to enact what amounts
to price controls in health care and will attempt to discourage
sharp price increases for prescription drugs. He also plans to
index the federal minimum wage to inflation, effectively raising
the wage floor every year.

"People forget what price controls do, and eventually the govern-
ment will try to do it again," said Reynolds. "There's a certain
faddishness to quick fixes, and price controls seem like a quick
fix." Others, however, are more optimistic.  "In the short term,
it's going to be difficult to turn the clock back," said Jerry
Ellig, associate director of the Center for the Study of Market
Processes at George Mason University.

"We have a lot of people who now benefit from the deregulated en-
vironment," he said.  Still, even the optimists are cautious.
"The scary thing is how frequently people think they can get a
free lunch," Ellig said.

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