The Online Library of Liberty

A project of Liberty Fund, Inc.

• Foreword
• Author’s Preface
• Interventionism
• Introduction
• 1.: The Problem
• 2.: Capitalism Or Market Economy
• 3.: The Socialist Economy
• 4.: The Capitalist State and the Socialist State
• 5.: The Interventionist State
• 6.: The Plea For Moral Reform
• I.: Interference By Restriction
• 1.: The Nature of Restrictive Measures
• 2.: Costs and Benefits of Restrictive Measures
• 3.: The Restrictive Measure As a Privilege
• 4.: Restrictive Measures As Expenditures
• II.: Interference By Price Control
• 1.: The Alternative: Statutory Law Versus Economic Law
• 2.: The Reaction of the Market
• 3.: Minimum Wages and Unemployment
• 4.: The Political Consequences of Unemployment
• III.: Inflation and Credit Expansion
• 1.: Inflation
• 2.: Credit Expansion
• 3.: Foreign Exchange Control
• 4.: The Flight of Capital and the Problem of “hot Money”
• IV.: Confiscation and Subsidies
• 1.: Confiscation
• 2.: The Procurement of Funds For Public Expenditure
• 3.: Unprofitable Public Works and Subsidies
• 4.: “altruistic” Entrepreneurship
• V.: Corporativism and Syndicalism
• 1.: Corporativism
• 2.: Syndicalism
• VI.: War Economy
• 1.: War and the Market Economy
• 2.: Total War and War Socialism
• 3.: Market Economy and National Defense
• VII.: The Economic, Social, and Political Consequences of Interventionism
• 1.: The Economic Consequences
• 2.: Parliamentary Government and Interventionism
• 3.: Freedom and the Economic System
• 4.: The Great Delusion
• 5.: The Source of Hitler’s Success
• VIII.: Conclusions
• Reading References

2.

The Reaction of the Market

Price control measures paralyze the working of the market. They destroy the market. They deprive the market economy of its steering power and render it unworkable.

The price structure of the market is characterized by its tendency to bring supply and demand into balance. If the authority attempts to fix a price different from the market price, this situation cannot prevail. In the case of maximum prices, there are potential buyers who cannot buy although they are ready to pay the price fixed by the authority, or even to pay a higher price. Or there are—in the case of minimum prices—potential sellers who cannot find buyers even though they are willing to sell at the price established by the authority, or even to sell at a lower price. The price is no longer the means of segregating those potential buyers and sellers who may buy or sell from those who may not. A different principle of selection has to come into operation. It may be that only those who come first or those who occupy a privileged position due to particular circumstances (personal connections, for instance) will actually buy or sell. But it may also be that the authority itself takes over the regulation of distribution. At any rate the market is no longer able to provide for the distribution of the available supply to the consumers. If chaotic conditions are to be avoided, and if neither chance nor force is to be relied upon to determine distribution, the authority has to undertake this task by some system of rationing.

But the market is not only engaged in the distribution of a given stock of ready consumption goods. Its foremost task consists in directing production. It directs the means of production to those uses which serve most urgent needs. If maximum prices are set below the ideal market price for certain consumers’ goods only, without at the same time regulating the prices of all complementary means of production as well, then those means of production which are not completely specialized will be used to a greater extent in the production of other consumption goods which are not hit by the price fixing. Production will thus be diverted from goods which are more urgently needed by the consumer but which are affected by the price fixing, and it will go into the production of other goods which from the standpoint of the consumer are less important but which are free from regulations. If it was the intention of the authorities to make the goods covered by the price fixing more easily available by its maximum prices, then its measure failed. Its production would either be restricted or would cease completely. A simultaneous price fixing for complementary goods would not have much of an effect either, unless all complementary goods are of such specialized character that they could be used only for the production of this one good. As labor does not have this highly specialized character we may omit it from our considerations. If the authority is not willing to accept the fact that the result of its measures to make a good cheaper is that the supply of such goods stops completely, then the authority cannot confine itself to such interventions as affect merely the prices of all goods and services necessary for such production. It has to go farther and prevent capital, labor, and entrepreneurial activity from leaving this line of production. It must fix the prices of all goods and services and of interest rates also. And it must issue specific orders stating what and how goods and services should be produced and at what prices and to whom they should be sold.

The isolated price control measure fails to accomplish the purpose in the operation of the market economy which its originators aim at; it is—from the standpoint of its originators—not only useless, but also contrary to purpose because it aggravates the “evil” which it is intended to alleviate. Before the price control was instituted the good was, in the opinion of the authority, too expensive; now, it disappears from the market. But, this effect was not intended by the authority which wanted only to make the good cheaper for the consumer. On the contrary, from its standpoint we have to regard the lack of the good, its unavailability, as the greater evil; the authority aimed at an increased supply, not at a diminution of supply. We may say, therefore, that the isolated price control measure defeats its own purpose, and that a system of economic policy which is based on such measures is contrary to purpose and futile.

If the authority is not willing to remedy the evils created by such isolated intervention, by cancelling the price control measure, then it has to follow up this first step with further measures. Further orders must be added to the initial order not to demand higher prices than those decreed—the order to sell the whole supply, instructions to whom to sell and in what quantities these sales are to be made, price control measures regarding complementary goods,1 wage rates and compulsory labor for workers, and interest rate control, and finally orders to produce and instructions about the choice of investment opportunities for the owners of the means of production. These regulations cannot be restricted to one or several branches of production only, but have to be expanded to cover all production. They must of necessity regulate the prices of all commodities, all wages, and the actions of all entrepreneurs, capitalists, landowners, and workers. But this means that the direction of all production and distribution is placed in the hands of the authority. The market economy, whether intended or not, has turned into a socialist economy.

There are only two situations in which price control measures may be used effectively in a narrowly confined sphere:

1. Price control measures lead to a restriction of production because they make it impossible for the marginal producer to produce without a loss. The nonspecialized productive factors are being transferred to other branches of production. The highly specialized productive factors, which under market prices were used to the extent permitted by opportunities for alternative uses of the nonspecialized complementary factors, will now be used to a smaller extent; a part of them will not be employed. But if the quantity of highly specialized factors is so limited that they are completely utilized under the rule of market prices for the products, then there is a certain field of latitude given for authoritarian orders which lower prices. The price fixing does not cause a restriction of production as long as it does not absorb completely the absolute rent of the marginal producers. An intervention which does not go beyond this limit does not decrease supply. But as it increases demand it creates maladjustments between supply and demand which lead to chaotic conditions unless the authority itself provides for the allocation of the products among prospective buyers.

As an example: The authority must establish maximum rents for apartments and for store space in central urban locations. If the authority does not go as far as to make agricultural utilization of the land appear preferable to the owners, this action will not decrease the supply of apartments and stores.2 But, at the prices fixed by the authority the demand will exceed the available facilities. How the authority distributes these limited facilities among those who are willing to pay the fixed rent is immaterial. No matter what the distribution, the result will be that a return is taken from the landowner and given to the tenants. The authority has taken wealth from some individuals and given it to others.

2. The second situation in which price control measures can be used with some degree of effectiveness is offered by the case of monopoly prices. The price control measure may succeed in the case of monopoly prices if it does not intend to lower the prices below the point at which the competitive price would be in the nonmonopolized, unhampered market. In the case of monopoly prices established by an international cartel of mercury producers, a world (or international) authority may successfully enforce price controls which will bring the price of mercury down to the point at which it would sell under competition among several producers. Of course, the same holds true in the case of institutional monopolies. If an intervention by the authorities has created the necessary conditions for monopoly prices, then a second decree may again destroy them. If by the grant of a patent right an inventor was placed in a position to demand monopoly prices then the authority may also take away the previously granted privilege by fixing a price for the patented article which would otherwise be possible only under competition. Thus, price fixing was effective in the time of the guilds which aimed at monopoly prices. Thus it may also be effective against cartels made possible by protective tariffs.

Authorities like to appraise the effects of their actions optimistically. If the price fixing has the effect that goods of inferior quality take the place of better quality merchandise, the authority is only too ready to disregard the difference in the quality and to persist in the illusion that its intervention has had the effect it desired. At times and temporarily a small but very dearly bought success may be achieved. The producers of goods hit by the price fixing may prefer to bear losses for a certain time rather than to run new risks; they may be afraid, for instance, that their plants will be looted by the incited masses without adequate protection of the government being available. In such instances the price control measure leads to the consumption of capital and thus indirectly and eventually to an impairment of supply of products.

Except for the two mentioned exceptions, price control measures are not the proper means for the authority to direct the market economy into the desired channels. The forces of the market prove stronger than the power of the authority. The authority has to face the alternatives, either to accept the law of the market as it stands, or to attempt to replace the market and the market economy by a system without the market, that is, by socialism.

[1. ]Direct fixing of prices for the material means of production which cannot be used in direct consumption may be omitted; if the prices are fixed for all consumers’ goods, and if interest and wage rates are fixed, and if all workers are forced to work, and all owners of the means of production are forced to produce, then the prices of material means of production are indirectly fixed as well.

[2. ]For the sake of simplification we disregard construction costs.