Flaws and Ceilings: Price controls and the damage they cause

UK economy riddled with damaging price controls

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Summary:

  • Price controls damage markets by preventing the supply of products rising to meet demand. They can cause significant welfare losses, a deterioration in product quality, a reduction in investment and, in the long run, higher prices. Price controls also encourage black markets and illegal economic activity.
  • In the labour market, minimum wages can reduce employment. This is especially so among the most vulnerable groups. Minimum wages can also lengthen unemployment terms and create labour markets in which ‘lucky’ insiders gain at the expense of ‘unlucky’ outsiders.
  • Rent controls in the UK were disastrous in terms of their effect on the private rented sector. In the period of control, the private rented sector fell from three quarters to one tenth of the total housing stock. Since liberalisation, private renting has rebounded to around one sixth of all housing provision.
  • Although the form of rent control currently being proposed by politicians would not have the same devastating effects as the controls used in the 20th century, ‘second-generation’ rent controls would damage choice, reduce quality of accommodation, raise the costs of investment and hence could increase rents in the long run. Rent control is a typical example of the use of price control to suppress the symptoms of mistaken policies: fundamentally, the reason why the cost of housing is so high in the UK is because of highly restrictive land-use planning laws. No attempt to reduce rents by regulation can alleviate this problem.
  • The proposed freeze of energy prices comes after a number of years in which governments have been retreating from the policy of liberalisation which was very effective in reducing prices. Specifically, the energy regulator has reduced the number of tariffs that companies can offer and prevented some forms of discounting. One result has been higher profit margins for providers. In the short run, a pre-announced price freeze is likely to lead to higher prices as companies take action to raise the base level at which prices are frozen. In the long run, such interventions raise the cost of capital and are likely to reduce investment. We need to return, instead, to the policy of liberalisation that was so effective in creating competition and reducing prices.
  • Price controls currently cover large parts of the rail sector. These controls benefit some rail travellers, though taxpayers and other rail travellers bear the costs. It is mistakenly assumed that there is a monopoly in rail travel when rail is simply one small part of a vibrant market for transport services. Fare caps artificially encourage overcrowding at peak times and on particular lines and reduce the incentive to invest in the network. They also prevent product differentiation in transport such as the development of lowcost, short-haul trains with more basic seating facilities or luxury commuter coaches.
  • Until recently, UK financial products markets have been free of price controls for a number of decades. However, the government has recently brought in caps on the cost of shortterm consumer finance (payday loans). The government had previously rejected such price control for good reasons. The evidence from overseas suggests that restricting consumer credit can drive the market underground or lead vulnerable consumers to complete financial breakdown and thus make all credit and financial services difficult to access in the future.
  • The UK government is introducing controls on pensions charges. Again, this is happening after such controls were rejected and despite evidence that the market was working effectively. The government concedes that it is likely that price controls will inhibit new entry and competition in the industry. One government agency suggests that the price cap might become a ‘target’ for providers who might otherwise have priced their products lower than the cap. It is clear from the development of the charge capping agenda that the proposed regulation will be driven by political rather than economic considerations.
  • Controls on university fees are very common around the world. However, the systems of student finance that governments have introduced prevent the competitive process operating in higher education that would otherwise help ensure that many students received a much lower cost education. The caps on fees, combined with the way student finance is provided, prevents a differentiated market developing which would provide different types of courses at different fee levels appropriate for a highly diverse student body.
  • The Scottish government has passed legislation to implement a price floor in the market for alcohol. Such a measure remains under consideration in the rest of the UK. The health benefits of minimum pricing for alcohol are likely to be very small and the costs will be heavy and borne disproportionately by the low paid. It is likely that the main effect of minimum pricing will be that companies will move towards producing more expensive products and spending more on marketing. It is with good reason that the EU normally regards minimum price regulation as illegal.

The publication was featured in The Daily Telegraph

The Cato Institute's Regulation Magazine described this book as "an excellent choice as an ancillary text in grad school or even upper-level undergraduate classes in economics and public policy".

Read the press release here.

2015, Hobart Paperback 179

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