Price Controls | Basic Economics by Thomas Sowell | Ch. 3
If you haven't read my first two chapter summaries for this book, here they are (Ch. 1 | Ch. 2). Like those previous posts, I'll be giving an overview, and then some thoughts and analyses based on the chapter. And so, without further ado, let's get into it!
This chapter begins to talk about price controls, which is what happens when a government begins to keep prices from varying freely with financial laws and policy. When prices rise due to demand being higher than supply (i.e. a shortage), sometimes government will step in to keep it from getting to high. On the other hand, if prices fall due to supply being higher than demand, the government often comes in and provides a minimum. These controls, while seemingly benevolent, can often have disastrous consequences for people.
Rent Control and Shortages
Let's look at apartment rent control. Rent controls are often enacted under the guise of preventing greedy landlords from taking advantage of and making otherwise well-to-do people homeless. But rent control doesn't mean that there are more apartments available, just that prices of the current ones are being kept artificially low. What often happens then is that more people who normally wouldn't rent an apartment do so, even when they don't need to. They then take up the space of those who actually do need it. After all, need comes at different times for different people (depending on age, family status, jobs, etc.). And thus, the people who were meant to benefit from rent control actually are hurt by it.
The examples given in the book include both Sweden and the United States after World War 2. Because of rent control, there was a massive housing shortage, even when the government began to sponsor and build houses. It was only when the rent controls were repealed that the housing shortage stopped. Additionally, due to the repeal, private businesses began developing lands, and they produced housing that the people wanted, leaving the government-built houses a vacant waste of tax-payers' dollars.
The above example also helps us understand how rent control reduces supply. While rent control tells potential residents that renting is cheap, what it's telling land developers is that the land which is under the law is unprofitable. Furthermore, landowners are also less inclined to maintain their properties, because rent control prevents them from benefiting from maintenance. Since populations typically increase, what happens then is that there is an ever-increasing demand, while the lack of development and maintenance holds or diminishes supply. As Sowell concludes,
In short, a policy intended to make housing affordable for the poor has had the net effect of shifting resources toward housing affordable only by the affluent or the rich, since luxury housing is often exempt from rent control.
In this way, almost all economists agree that price controls (e.g. rent controls) are a bad thing. The problem is politics. Rent control is often sold to the public as an effort to quell wealthy people so as to help the poor (who outnumber the rich, and thus get the law passed). But the landlords of rent controlled areas that poorer people own are not always rich, and have mortgages of their own or need to spend time maintaining these properties. Thus, these middle-income people are also hurt by rent control, since they must split their time, and often can't continue maintenance. This leads to worse and worse conditions for those who live in these rent controlled properties.
There are lots of other examples that Sowell gives, but I think the rent control one is a good enough example to understand why rent control is bad, and how extensive it is in influencing an economy, despite its good intentions.
Floors and Surpluses
We typically think surpluses are good. However, when an artificial floor is set on prices above market demand, these surpluses end up hurting the economy as well.
Price floors are used to artificially inflate low demand items. After all, if those items weren't in low demand, they'd have higher prices. What then ends up happening is that those low demand items go even lower in demand when price floors are put in. This is because customers are even less inclined to buy something they don't really want for an even higher price. This creates a massive surplus, which is must either be destroyed or stored, rotting away.
Given our global economy, what if we took that surplus and sold it elsewhere in the world? In those instances, the surplus must be sold at under the prices of what is normal in those other locales. This creates an imbalance, since the locals in that area can't compete with the prices being offered, and thus are driven out of a job.
The government, when setting price floors, often comes in and buys the additional surplus. While this may create some respite for producers, that surplus is still in low demand, and, especially when it's food, must eventually be destroyed (i.e. burned). Not only do those same producers not know what the actual demand for their product is, but the government goes into more and more debt, wasting more and more money.
This is what a government subsidy essentially is, and this is why it's a terrible idea.
Furthermore, it creates less incentives for producers to maintain a quality product. After all, if the government always is going to buy it at a higher price than the product is worth, why maintain quality? This has even happened in the medical arena, where physicians tend to spend less time with their patients when the government artificially controls the prices of medical and health care.
Like price control through ceilings, price control through floors are also easily sold politically, this time to producers. In fact, government-subsidized health care is a great example of both. On the one hand, poor people want low prices or even free healthcare. On the other, doctors, nurses, and all other people who work in the field (e.g. hospital staff, etc.) need to be paid. It's a conundrum that has resulted in poorer quality healthcare as well as not meeting the actual needs of those who are poor (since they get less and less coverage of what they actually need).
I love this quote from Sowell in this chapter (about rent control, but it can be easily applied throughout this chapter):
This illustrates the crucial importance of making a distinction between intentions and consequences. Economic policies need to be analyzed in terms of the incentives they create, rather than the hopes that inspired them.
In reading this chapter, it's really easy to see why everyone needs some sort of education in basic economics. When we don't understand how certain laws, even when they seem like good moral policies, actually create a worse situation than the one they're trying to address, we are less inclined to believe our politicians when they promise to fix our problems.
Let's look at the United States stimulus packages that have been given due to the COVID-19 as an example. In May, 15, 2020, the United States Congress passed the HEROES Act, a bill designed to relieve citizens who had been forced to stop working because of the global pandemic. The package gave $1,200 to each single person ($2,400 to married couples), as well as $500 for each additional dependent (i.e. children). The average monthly rent for an apartment in the United States is around $1463 in 2020.
Let's say there's a married couple with two kids (a pretty decent example, I think). They would receive $3,400 from this stimulus bill, which means that their package would help them afford their residency for about two months (not counting utility bills, groceries, insurance, etc.). This gives them up to July in terms of help. Because many cities and states are still on shutdown in the U.S. today, this couple now needs help from the government. Yet, even now, Congress has not been able to pass a bill two months after the deadline for this couple.
This is a simple illustration, and doesn't include a lot of other complications (including what children actually cost, the use of unemployment benefits, etc.), but I think it shows just how terrible government is at allocating resources, even today. Dependency on monopolized centralized authorities that have no incentive to help anyone is a sure path to a horrible life.
**Governance and the Future of Crypto
**I will probably do an entire post on this subject in the future. But, given the trajectory of blockchain, which has gone from the development of distributed ledgers to a foundation of exchanges (including decentralized exchanges) to decentralized financial products and services today, I think the next (very obvious) step for the space is governance.
Governance is something that has existed in all financial spaces at all times. In crypto and DeFi, it is the ability of people who have bought a coin to have a say in how the services which use that coin will function and change over time. The best example of this today is the Maker coin, from MakerDAO. Anyone who owns a Maker token is able to vote on governance proposals that have an effect on things like what can collateralize DAI and savings rates, as well as other things on MakerDAO's services.
New services like this (e.g. Compound, Kava, Aave, etc.) with their own governance tokens are popping up everywhere. While we are in the beginning days, I think it's pretty obvious this is where the market is headed into the future.
Without getting into it too much, I think it's important for people to really learn basic economic principles, especially if one is going to participate in the governance of these chains. Understanding how incentives work, and why certain policies may or may not work, will go a long way into helping you make sure your crypto investment is a beneficial one. Not only for yourself, but also for those who are going to use it for their own financial lives.