Ryan Bourne is the Head of Public Policy at the Institute of Economic Affairs.
There’s one area where politicians of all major parties do really seem to be “all in this together” – their commitment to price controls.
This might seem surprising to a ConservativeHome audience. Surely, you might say, the Conservative party justifiably lampooned Labour’s proposed energy price freeze as dangerous interventionism which would diminish investment and have the unintended consequence of raising prices now. And you’d be right. Unfortunately, in a range of other areas similar analysis is not applied.
For since then the Conservatives have celebrated capping payday loan charges. Their manifesto is committed to freezing rail fares in real terms for five years. They support and want to increase the National Minimum Wage. As yet, they have expressed no desire to remove the cap from tuition fees. In principle then, even the Conservative party seems to have no problem with government regulation of prices. Labour go further. Last week’s manifesto saw them commit to energy and rail fare price freezes, as well as ‘second generation’ rent controls. They also want to lower regulated tuition fees too.
Sometimes economists are lamented for knowing the price of everything and the value of nothing. But as my colleague Philip Booth pointed out yesteday, perhaps that is preferable to politicians thinking they know what the price of everything should be.
In principle, the costs of price controls are well known. Prices are crucial indicators for how resources should be allocated. They provide information about the relative scarcity of different goods and services in different contexts. Entrepreneurs and businesses use prices and profit and loss as guides for adapting their plans and reallocating resources to new and more highly valued ventures – for innovating. Distorting this process invariably prevents mutually advantageous exchanges from taking place.
Sure, there are some ‘winners’ – those who secure the goods or services at artificially low prices or sell their goods or labour at artificially high prices. These are usually readily identifiable. But there are losers, too – those who suffer from shortages and underinvestment, those stuck in queues, and the businesses and industries plagued by political uncertainty. Perhaps most importantly, the replacement of market competition with political competition which dampens innovation (as we are seeing across a range of areas already). The latter can have disastrous long-term consequences.
Having correctly abandoned price and wage controls as a means of trying to combat inflation, though, price controls seem to be more back in vogue than at any time since the 1970s. While we laugh at Venezuela for running out of toilet paper, more and more our politicians seek to find reasons why in just this or that market, controlling prices is justified.
With this in mind, yesterday the IEA published a new book – ‘Flaws & Ceilings: Price Controls and the Damage They Cause’. As well as providing some theory and historical context on price controls, it examines seven policy areas where price controls are used or have been proposed: minimum wages, rent controls, energy price caps, rail fare regulation, interest caps, tuition fees and minimum pricing of alcohol. It analyses the case that has been made for them and highlights clearly the damaging consequences controls can have.
Take the minimum wage. Almost all parties seem to agree it hasn’t caused much in the way of reduced labour demand – which is not surprising, given it is set with this in mind. Yet for certain groups, it appears to be very damaging indeed. People got uneasy when Lord Freud highlighted how minimum wage laws can freeze out many people with disabilities and low skills from the labour market entirely, but it was true. A letter from Candice Baxter to the Daily Telegraph last year explained how the minimum wage prevented her daughter with Down’s Syndrome from finding employment.
Or look at how our youth unemployment rate performance relative to other countries has worsened since 1999. Or the rise of unpaid internships. Wage controls have consequences – and often now policymakers are dreaming up new solutions to the problems that they have caused. Politically, the ceding of the idea that workers are paid according to supply and demand for their work has now morphed into the ‘Living Wage’ concept – a social ambition – with an ever-escalating bidding war for higher minimum wages, with little thought to the labour market outsiders.
Rent controls, too, are back. Not the disastrous caps which contributed to the huge collapse in private rented accommodation and disrepair of properties of the past, but a supposed gentler ‘second generation’ kind. Labour want three-year secure tenancies with rents pegged within them to some local average or to inflation. But while no doubt these controls would provide more security for some from so-called economic eviction – i.e. rents being raised rapidly – it will do precisely nothing to improve affordability in anything other than the very short term, since rents will adjust between tenancies. In fact, it will make things worse for many (especially the highly mobile) with many landlords likely to respond through higher initial rents, and greater tenancy risk leading to a higher cost of capital and less investment in the sector. This will exacerbate the real problem – an under-supply of new property, primarily due to planning regulations.
In other areas, we’ve already seen some of the consequences of price controls. Fare regulation on the passenger rail network leads to severe overcrowding on some routes at certain times of day. The regulation creates cliff edges when saver fares become valid. The rail industry is unable to innovate and encourage smoothing of numbers. Linking rail fares to general inflation makes this worse during periods when industry costs are rising quickly, and imposes more of a burden on the taxpayer through regressive subsidies.
The payday loan cost cap of 0.8 per cent per day for fees and interest reduced the number of loans and the amount borrowed fell by 35 per cent between February and July 2014. Great, you might say. But let’s just wait and hear the stories of the most vulnerable and socially isolated, who can’t rely on families or social networks, having to borrow from illegal loan sharks and the market becoming oligopolistic as many of the smaller market participants are driven out.
In energy, Ed Miliband learnt the hard way that companies can respond to the threat of future price freezes by buying energy in forward markets so that, if energy prices subsequently fall, companies will not be able to pass on the benefits to consumers. This has led him to have to re-define a ‘freeze’ as not a freeze.
Of course, we know the reason why price controls are celebrated in the media as ‘politically wise’. They fulfil a need to ‘do something’ and appease an interest group. The winners are identifiable and the losers usually the broader body of taxpayers or the ‘outsiders’ to a market. The key take-home from this book, though, should be that the path we are on of price controls becoming normalised again is dangerous. Not only do price controls tend to result in a range of negative, unintended consequences, but these poor outcomes then encourage further politicisation of markets to the detriment of innovation, and ultimately consumers.