We at FEE have been discussing recent inflationary trends since May of this year. Unfortunately, it took experts several months to even acknowledge it as a problem, but there’s no hiding now. With inflation breaking records in recent months, the higher prices Americans are feeling can no longer be ignored.
So, after ignoring inflation, saying it will just be “transitory,” and saying inflation is no big deal, many are being forced to address it. Unfortunately, some of the suggested remedies are even more disappointing than the initial denial.
One “solution” being put forward by the Biden Administration is that the government needs to enforce rules which keep markets from becoming monopolistic, known as “anti-trust” laws.
The logic goes something like this. Monopolies are able to charge higher prices, so stopping monopolies will stop prices from rising. If you don’t think too hard, this makes a superficial amount of sense. In reality, however, this is unlikely to work.
Lawrence Summers, an economist and former Treasury Secretary to Bill Clinton, equated the idea of using anti-trust to fight inflation with being “science denial.”
The emerging claim that antitrust can combat inflation reflects “science denial”. There are many areas like transitory inflation where serious economists differ. Antitrust as an anti-inflation strategy is not one of them.
— Lawrence H. Summers (@LHSummers) December 26, 2021
The explanation is clear. In any kind of science, either social sciences or natural sciences, it’s a truism that constants can’t explain changes. If something is identical to how it was yesterday, it can’t account for something else changing.
If a friend got rid of her whole wardrobe and replaced it with blue turtlenecks and blue jeans, and you asked her why she did this, a response of “I like blue” would be unsatisfactory. If your friend liked blue last year, liking blue can’t explain why she waited until today to change out her whole wardrobe. If your friend instead explains she started her own business and therefore she doesn’t have to conform to a corporate dress code, this makes more sense. One change led to another change.
Likewise, the existence of monopolies cannot explain rising prices. It’s true that industries consisting of monopolies will have higher prices, but if a business was a monopoly yesterday and today, there’s no reason why the business would be able to suddenly raise prices today. If the monopolists could raise prices today and make more profit, why didn’t they do so yesterday? Something else must have changed.
This line of reasoning is similar to Elizabeth Warren’s claim that inflation is caused by greedy businesses, a claim that doesn’t make sense, as FEE’s Brad Polumbo explains. If businesses raised prices today because they’re greedy, does this imply they weren’t greedy yesterday? Are they more greedy today than yesterday? Again, greed is a constant—companies are always trying to maximize their profits. This unchanging desire can’t explain changes.
At this point, a supporter of the administration’s plan could argue that perhaps industries are becoming more monopolistic. If that’s the case, then we would expect increasing prices. But, as Summers makes clear in his Twitter thread, there’s just no evidence to suggest that monopoly power has increased as inflation has risen.
In fact, it’s possible that new anti-trust regulations or increased enforcement standards could lead to higher prices. As governments increase the burden of meeting regulatory requirements, businesses that have more difficulty meeting these requirements may decide to either drop out of the market or not enter the market in the first place. When businesses choose not to enter or choose to leave a market, the supply is relatively smaller than it otherwise would be. And when supply falls, prices rise.
Lastly, anti-trust laws are problematic because they ignore the nature of how markets actually work. When experts try to identify monopoly, they compare the world to the ideal model of what economists call “perfect competition.” The problem with this standard is that the perfect competition model is a horrible benchmark for reality, because it is unrealistic.
The model assumes businesses offer completely identical goods, that everyone has complete knowledge of all things relevant to the market, and that there is perfectly free entry into the market. In his piece The Meaning of Competition, Nobel Prize-winning economist F. A. Hayek explains that these assumptions would lead us to believe that practices such as advertising, undercutting, and improving goods are all anti-competitive. Hayek concludes from this, “‘perfect’ competition means indeed the absence of all competitive activities.”
Anti-trust, by relying on an unrealistic picture of the economy, threatens to undermine the true dynamic competition businesses are engaged in. This threat to real competition means worse and more expensive products are sure to follow.
Price Controls, Again
Anti-trust enforcement isn’t the only bad idea being proposed to tackle inflation. A recent article in The Guardian by Professor Isabella Weber calls for the use of laws which prevent companies from raising prices, typically known as price controls.
The problem with price controls is they do nothing at all to alleviate the fact that goods and services are scarce. If prices are held artificially low, consumers have less incentive to consume less of a good and producers have less incentive to produce more of it.
As a result, the quantity demanded begins to exceed the quantity supplied. In other words, you get a shortage. Individuals then must compete for scarce resources in ways other than price competition. For example, people engage in competition by waiting.
As I highlighted in a past article, this exact situation played out in the mid 1970s when Richard Nixon imposed price controls on gasoline. The result of these policies was that massive lines formed at gas stations across the country. In FEE’s magazine called The Freeman, economist Milton Friedman showed how this failed policy response contrasted with Germany’s successful decision to let prices increase:
“Germany imposed no price controls on petroleum products … The price of petroleum products jumped some 20 or 30 per cent, but there were no long lines, no disorganization. The greedy consumers found it in their own interest to conserve oil in the most painless way. The greedy oil tycoons found it in their own interest to see to it that petroleum products were available for those able and willing to pay the price.”
The belief that price controls can be used to ease the burden inflation has placed on consumers is based on a confusion between prices and costs. While it’s true that price controls can lead to lower prices, this doesn’t imply that they will lead to lower costs.
If someone is willing to pay $4 for a gallon of gas, but a price control lowers the price to $2, this means consumers will pay a lower monetary cost. However, this same consumer will be willing to wait in line for a time equal to $2 in value (since they were originally willing to pay $4). In this case, the lower price hasn’t helped them. They have monetary costs of $2 and nonmonetary (waiting) costs of $2, for a total cost of $4. The buyer is no better off.
As George Selgin points out, this will likely make things worse in the long run. If prices increase due to, for example, an increase in demand, companies are able to make a higher profit, everything else held constant. This incentivizes companies to find ways to expand production. However, when prices are prevented from rising, this process is stymied:
Obviously controls don’t make the controlled items any less scarce. On the contrary: unlike higher prices, they discourage efforts to expand output. Anyone with even a meager knowledge of their history should know this. 7/n
— George Selgin (@GeorgeSelgin) December 29, 2021
Some Real Fixes
Despite the problems with the above two solutions, the government isn’t without options. But fixing inflation requires recognizing its sources. Like any good, when the supply of money is increased, the price (or purchasing power) of money falls relative to where it would have been without the supply increase.
The supply of money (measured by M2) has increased 39 percent since January 2020. With a money supply increase of this magnitude, it’s no wonder prices have begun to creep up. When the number of dollars increases and the amount of goods remains the same, more dollars chase the same goods leading to higher prices.
The Federal Reserve has begun to reluctantly cut monetary stimulus in what Dr. Weber describes as a “hawkish turn.” Weber laments this turn as she says it will be unable to fix supply chain problems, but this is beside the point. Unplugging the money printer doesn’t need to fix supply chains. By allowing a relatively lower supply of money to persist, the value of money will be higher (i.e. less inflation) with everything else held constant.
For supply chain problems, the government needs to look no further than avoiding the policies of the past. Policies which shut down business operations are sure to lead to a decline in the production of goods and services, which makes them more scarce (and more valuable) relative to money. To avoid supply chain issues, not shutting down supply chains is a good start.
The post Top Clinton Economist Labels Biden Administration's Proposal to Curb Inflation 'Science Denial’ was first published by the Foundation for Economic Education, and is republished here with permission. Please support their efforts.