I remember hearing a speech back in 1980 by former Treasury Secretary John Connally, who was then running for president. At the time, inflation was running at double digits and there were widespread calls for price controls to deal with it. Connally denounced this effort in the strongest possible terms, saying price controls never work and only make the problem worse.
Well, like the kid who said the emperor wasn't wearing any clothes, I had to ask the former treasury secretary why it was that he imposed price controls on the U.S. economy in 1971? It has been widely reported that among Richard Nixon's advisers, Connally was the strongest advocate of controls. He basically replied that while controls never work, there was this unique set of circumstances in August 1971, which never existed before and probably will never exist again, in which they could have worked.
I would have had a lot more respect for the guy if he had simply admitted that he was wrong. That is certainly the consensus view among economists. They believe that underlying inflationary forces can never be arrested through controls. All that happens is that prices catch-up after controls are ended, so that prices more or less end up in the same place eventually.
So widely accepted is this phenomenon that even the ultra-liberal New York Times accepts it. In an editorial on Dec. 29, 1997, it denounced plans for price controls on cable rates, saying, "When controls are lifted -- as eventually they must be -- prices promptly make up for all lost ground." This was clearly the case with Nixon's controls. Inflation fell from the 6 percent range before controls were imposed to the 3 percent range while controls were in place. But by 1973, as controls broke down, inflation accelerated, hitting more than 12 percent in 1974.
Controls break down in part because there are so many exceptions that must be made for the economy to function. Controls cannot be imposed on imports, for example, since foreigners are not subject to U.S. laws. This means that prices for critical materials, such as oil, can still rise despite controls, and that products using oil must also be allowed to rise. Exports must also be free of controls, lest foreigners simply buy up U.S. goods at controlled prices and resell them for market prices.
It makes no difference how diligently price controls are administered, they still break down. This has been the case throughout history, even when the death penalty applied to violations of them. A famous example survives from ancient Rome, when the Emperor Diocletian tried to do exactly that. And lest one believe that such extremism lies only in the distant past, in recent years both Iraq and Libya have imposed the death penalty for violating price controls.
Despite all this experience, the siren song of price controls still beckons the naive and self-serving. Even the Bush administration, which initially opposed controls on electricity prices in California, succumbed to political pressure and imposed them there. But even though the price caps 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 blackout policy to deal with temporary energy shortages. At least 10,000 businesses have requested exemptions from these blackouts, which means that they will have to be more severe on those that have to comply with them. 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 longer price caps remain in place, their problems will only increase. They will reduce the incentive to produce more energy and inevitably lead to litigation, as lawyers argue about whether controls were properly complied with. These effects will last long after controls are lifted. 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. And the litigation may go on forever, too. It wasn't until 1995 that Occidental Petroleum settled a case involving its alleged violation of federal oil price controls in 1979.
In return for a bit of temporary relief, California and the federal government have embarked down a slippery slope. These 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 on energy supply.
Chart data: Inflation
Year ---- Percent
1965 ---- 1.9
1966 ---- 3.5
1967 ---- 3.0
1968 ---- 4.7
1969 ---- 6.2
1970 ---- 5.6
1971 ---- 3.3
1972 ---- 3.4
1973 ---- 8.7
1974 ---- 12.3
1975 ---- 6.9
1976 ---- 4.9
1977 ---- 6.7
1978 ---- 9.0
1979 ---- 13.3
1980 ---- 12.5
Source: Bureau of Labor Statistics