Romaric Godin: Price Controls – a Neglected Tool Against Inflation

This is a further article concerning Isabella Weber’s article concerning price controls.

Romaric Godin joined Mediapart in May 2017, where he writes about macroeconomics, particularly French macroeconomics.

This article was originally posted on Mediapart  (with paywall)

English version edited by BRAVE NEW EUROPE

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Photo: Frankie Fouganthin  licensed under the Creative Commons Attribution-Share Alike 4.0 International

An American economist, Isabella Weber, has reminded us of the effectiveness of price controls as a tool against inflation and for social stability. Despite the virulence of the response from orthodox economists, the proposal opens up interesting perspectives.

Inflation reached 5% in the euro area in December – the second highest rate in the history of monetary union after November. In France, prices rose by 2.8 per cent year-on-year.  In Kazakhstan, the revolt that has set the country ablaze is rooted in the increase in energy prices liberalised by the government. More than ever, the issue of inflation will be at the centre of the economic debate in 2022. The emergence of persistent and widespread price increases, a phenomenon that has been virtually unknown for four decades, is forcing us to think again about the question of prices, one of the thorniest in economic science. How to deal with this inflationary surge? What policies should be used to counteract the effect on “purchasing power”?

So far, the debate has often been reduced to a dialogue between those who see the emergence of inflation as a transitory phenomenon and those who see it as a real regime change. The former invoke the effects of the disruptions linked to the pandemic and consider that the general economic context remains disinflationary. To deal with this fever, limited one-off measures, such as the 100-euro bonus introduced by the French government, are considered sufficient. But overall, the prevailing idea is to do nothing, because any measure against inflation risks weighing on growth and destabilising the financial markets.

The problem is that in the meantime, during this “transition”, households, and particularly the most fragile, have to absorb the rise in prices. And this too can have negative effects on growth. On the other hand, those who see inflation as a more sustainable phenomenon point to tight labour markets and the end of the boom period of globalisation, during which prices were pulled down, but also to the effects of fiscal and monetary policies. For them, the solution is obvious: demand must be “broken” by raising interest rates and introducing fiscal austerity. This is how fiscal stability will return. And as time passes and inflation persists, the credibility of the first camp tends to diminish, making a future curb on demand more likely, in other words a new round of social repression.

This scenario is all the more possible as public debt is high everywhere, in the wake of the pandemic, and the inflationary argument can be used to pursue a policy aimed at making this debt ‘sustainable’. The risk is therefore that, as in the 1970s, the inflationary fever will gradually serve as a justification for a revival of projects to deconstruct the social state and workers’ protections. And already, the process seems to be underway. US Senator Joe Manchin has blocked the “Build Back Better” Social Security plan, citing its effect on inflation, while central banks seem to be gradually moving towards a tightening of their policies.

A top-down approach to the current debate

It is to avoid this gloomy prospect that Isabella Weber, an economist at the University of Massachussets-Amherst and author of a highly acclaimed book on price policy in China’s transition, has launched the idea of price controls. In an article in the Guardian on 27 December, she considers that this tool, hitherto neglected, could respond to the current reality. According to Isabella Weber, the current situation is more reminiscent of the aftermath of the Second World War, when bottlenecks and the maintenance of purchasing power drove up prices and corporate profits. Indeed, this is precisely what is happening now: the scarcity of certain resources is not preventing companies from posting historically high profits. “Then, as now, large companies with significant market power used supply problems as an opportunity to raise prices and make windfall profits,she notes. And, as then, these large companies were largely supported by the state during the pandemic, which allowed them to maintain their market power.

In the second chapter of her book, How China Escaped Shock Therapy (Routledge), Isabella Weber provides a comprehensive history of the price control debate in the aftermath of the Second World War. During the war, despite some initial resistance, President Roosevelt finally resorted to broad administrative price controls. But at the end of the war, his successor Harry Truman was faced with a dilemma. After the First World War, the advanced economies suffered a violent change, made worse by the Spanish flu epidemic of 1918-1919. In Germany, and to a lesser extent in France, inflation was allowed to accelerate until it led to serious crises: the hyperinflation of 1923 in Germany and the foreign exchange crisis of 1924 in France. In the United States and the United Kingdom, on the other hand, the decision was to curb prices by sudden monetary tightening and brutal austerity. The result was a severe recession in 1920. Both options therefore seemed to be harmful.

Hence the idea of a smooth transition by maintaining “strategic price controls”, developed by the Canadian economist Kenneth Galbraith, the strongman in Roosevelt’s Office of Price Administration. Galbraith was not alone. An opinion piece by 54 economists in favour of price controls was published in the New York Times on 9 April 1946. Among the signatories were some left-wing Keynesians such as Abba Lerner, the Marxist (very influenced by Keynes) Paul Sweezy, but also the future father of the synthesis between Keynesians and neoclassicists, Paul Samuelson, as well as economists unlikely to be favourable to socialism, such as Simon Kuznets or Irving Fisher.

The consensus was therefore very broad and was supported by public opinion. The economists stressed the need to control prices until the bottlenecks were resolved. However, in another analogy with our own time, the US Congress then prevented the introduction of a new price control law, despite Truman’s wishes. In July 1946, prices were suddenly liberalised, driving inflation up to over 10%, reaching 14.5% in 1947. While company margins rose by 21%, real wages fell by 8% in 1947. The previous year had seen a level of strikes three times higher than the very agitated period of the first years of the New Deal. At the end of 1948 the country went into a recession that lasted almost a year. Isabella Weber then contrasts this with the UK, where Clement Attlee’s Labour administration chose to maintain rationing and price controls. Price liberalisation there was gradual, taking into account the state of shortages and markets until the late 1960s. Inflation was more moderate, inequality more controlled and the social climate more peaceful than in the United States. According to the author, “the UK case illustrates that a more gradual transition policy leads to better results in terms of prices and social stability”.

A feasible and suitable instrument

The similarities between the two eras therefore encourages us to examine the question of strategic price control today. Rather than abruptly raising interest rates, reducing or abandoning social policies, or trying to curb inflation with bits and pieces such as the ‘inflation premium’ of the French government, which is de facto letting prices rise, states could cap the prices of energy and goods in short supply, or even resort to rationing, if necessary. These measures would only be lifted once tensions have subsided. As Isabella Weber summarises at the end of her paper: “We need a systematic view of strategic price controls as an instrument for a comprehensive policy response to macroeconomic challenges, instead of a supposed lack of alternative between ‘wait and see’ and austerity.” Two facts seem to argue in favour of such an option. First, current imbalances remain limited. The post-pandemic increase in demand is nothing like that of the post-war period. It remains moderate when compared with the level in 2019 even more so with the trend of 2019. In other words, there is no structural excess of demand that would require it to be “broken”. The main reasons for inflation are therefore the disruption of supply chains based on globalisation and ‘just-in-time’, and the ability of companies to transfer prices to consumers in real time. Price controls are a direct response to these difficulties: they break the runaway effect of financialised prices and save time.

Dipping into profits

This is what John Kenneth Galbraith meant by the term “strategic”: it is above all a matter of buying time to solve the problems that cause inflation. Rather than chasing price rises, we control them to adjust existing imbalances. In this case, it avoids breaking the weak economic momentum and preventing public investment, while addressing the inflationary issue that is weighing on the wallets of the most vulnerable. The second argument is obviously the level of profits. Fed with public money of ‘whatever it takes’ and, in the case of France, with various tax measures favourable to capital, companies are posting record profits.

Ultimately, there are two options for dealing with inflation. The first, which has been chosen for the time being, is to let companies adjust prices according to their accumulation needs. The rise in prices is therefore a transfer of money from households to corporate profits. Once real wages are eroded and savings from the pandemic are depleted, demand will collapse, leading to a recession. This is what happened in the US in 1948. Households are therefore adjusting twice: through the loss of purchasing power and through employment during the crisis. Since, moreover, aid to companies has become unavoidable in the event of a crisis, it can be said that this policy consists of giving full priority to capital.

The alternative, price controls, effects a reverse transfer. The increase in prices is, partially or entirely, taken over by the profits of the companies. Of course, in a capitalist regime, this can lead to difficulties, but the level of aid paid during the pandemic (and still today) and the high profitability of companies supported by neo-liberal reforms and lower taxes leave companies considerable room for manoeuvre in the event of price controls. In other words, as in the aftermath of the last war, this is a rather favourable time to impose an administrative price limit. Of course, this type of control presents technical challenges. But here again, it should be remembered that price controls were carried out, and proved effective, under technical and historical conditions that were much more complex than today. The so-called “maximum” law of 11 September 1793 set a maximum price for wheat, and on 39 consumer goods, which certainly generated a black market, but also made it possible to ensure supplies to large cities, even though France was in a state of civil and foreign war. This law also helped to break the price boom, which resumed once the maximum was abolished by the Thermidorians on 24 December 1794. Moreover, in accordance with the idea defended by Isabella Weber, this lifting of price controls immediately led to famine and social disorder, of which the insurrection of 12 germinal year III (1 April 1795), during which the Convention was invaded by a crowd shouting “bread and the 1793 Constitution”, was only the most visible part.

In short, the idea of strategic price control fits the present situation. It is a response to the challenge of high living costs for essential products, which affect the most vulnerable, and it is technically possible. Why then do governments refuse to mention such an option and look in vain for penny-wise and pound-foolish solutions to try to alleviate the social situation by maintaining ‘price freedom’?

The arguments of orthodoxy

Part of the answer lies in the very strong reactions of orthodox economists to Isabella Weber’s article. The most notable was that of Paul Krugman, an economist who is considered ‘progressive’ because of his opposition to austerity, but who is in fact a neoliberal Keynesian with a strong commitment to the main principles of orthodoxy. For him, while public spending may have a purpose, price controls and protectionism are unacceptable. His response on Twitter was so violent, with obvious sexism, that he deleted it himself. He had claimed that price controls were “genuinely stupid”, a haughty response rather typical of this kind of “expert”. In essence, the argument of these orthodox economists is based on their faith in the foundations of classical economics: preventing price adjustment through government intervention leads to shortages and black markets. In a post critical of Isabella Weber, economist columnist Noah Smith explains this with the help of elegant graphs, the basis of which remains highly questionable. Overall, setting an ‘artificial’ price equilibrium point does not satisfy either demand or supply. This would lead to adjustments at the margin, either through parallel markets where prices explode or through a recession. In the orthodox view, preventing the natural formation of prices is an attempt to prevent the rotation of the earth. But, as we have seen, this assumption has had its time. In 1946, the consensus was elsewhere. This reflects the fact that, despite the upheavals of the pandemic, the economic consensus remains neoliberal in essence, even among orthodox Keynesians. But in reality, these theoretical positions do not take into account the real conditions of production. This is precisely what the consensus of economists understood in 1946: market adjustment is not always the best solution. It can, in fact, lead to even more serious imbalances. This is the essence of the thesis defended by Isabella Weber in her book on China: by choosing not to abruptly lift price controls in the 1980s, the People’s Republic avoided the tragic fate of Russia in the 1990s, during which the good economists, who are now lecturing the country, all defended the ‘big bang’ on prices. The result is clear: the Russian and Chinese trajectories over the past 40 years show the harmful effects of price liberalisation and the reality of the benefits of neoclassical theory. Of course, the arguments on the other side are well known (and repeated, notably by Noah Smith): these are the cases of Argentina and Venezuela, where price controls did not prevent hyperinflation. Of course, price controls are not a magic bullet. In some contexts, notably that of a currency crisis in a “dollarised” economy that is heavily dependent on certain resources, it is not an effective defence. But attributing the Venezuelan situation to price controls alone makes no sense. As for Argentina, it was the liberalisation of the 1990s that led to the 2001 crisis, not the other way around. In general, the situation of the advanced economies today bears little resemblance to that of these two countries.

Overcoming the problem of inflation

It is interesting to note that, for these economists, price freezes would be more socially terrifying than austerity and higher interest rates. But the heart of the debate lies elsewhere: it is political. What the orthodox defend here is a social order, that of capital, which they consider ‘natural’. At the time of the abolition of the maximum, the Thermidorian Boissy d’Anglas summarised this policy as a “system of attack on property”. The social order was at stake. Behind their theoretical constructs, orthodox economists are the heirs of this thinking.

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