More Harm than Good: The Impact of Government Price Controls

A paper presented to Professor Leon Cort by Luke Heller, Hassan Abualola, Morgan Bailey, Michael Harris, and John Longo in partial fulfillment of the requirements for Microeconomics (ECON 215) Wentworth Institute of Technology Fall 2009

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Given the volatile and often unpredictable nature of microeconomics, governments are

often tempted to manipulate the price and supply of goods in order to gain a stronger grip on the economy. While this might seem like a logical strategy on the surface, a closer look reveals that attempts to control prices are frequently met with dismal failure. Different types of price controls have been implemented in a variety of countries, yet to date they have not been successful in any economic situation. Government price controls, while intended to help struggling industries or less fortunate consumers, are not only ineffective, but inevitably result in an economic net loss for society. The strategy of enacting price controls is not new, as the United States frequently turned to them in the 1930s and 1940s. A prime example of this comes during the Great Depression, as the U.S. government began to take a major federal role in agriculture. Farmers were especially hard hit by the Great Depression, as prices received by farmers for goods plummeted nearly two-thirds from 1930 to 1933 (Tregarthen and Rittenberg 90). This stark decline in revenue made it impossible for farmers to keep up with mortgage payments, and by 1932 over half of all farm loans were in default (Tregarthen and Rittenberg 90). In response to this crisis, the government introduced price floors to bolster the revenue of struggling farms. A price floor is a government-imposed limit on how low a price can be charged for a product (Price Floors). In order for a price floor to be effective, it must be greater than the equilibrium price (Price Floors). With an elevated market price, farmers see an increased amount of revenue, encouraging them to sell more product than they would otherwise produce under equilibrium market conditions (Hubbard and O’Brien 109). Price floors played a major role in Depression-era federal economic policy.

Farm legislation passed during the Great Depression has been modified and expanded multiple times, frequently at the expense of consumers. Recent decades have seen the introduction of government programs that guarantee a minimum price for additional agricultural products. In each case, these programs have been accompanied surplus crops, which are bought up the government (Tregarthen and Rittenberg 90). This is in keeping with the typical consequences of price floors, as many consumers are unable to afford the higher, government - mandated price (Hubbard and O’Brien 109). Between taxpayer-funded expenditures on surpluses and higher prices, agricultural price floors have been a losing proposition for American consumers. Another notable example of a price floor is a Truman-era policy for potatoes. This price floor was heavily lobbied for by potato farmers, since it virtually guaranteed a consistently profitable crop (Sky-High). Farmers, however, were the only group to benefit from this policy. The government mandated price soon crippled demand for potatoes. The U.S. government became so desperate to discard its excess potatoes that it successfully lobbied the Canadian government to place an embargo on Canadian potatoes bound for the United States (Sky-High). Unfortunately, the United States appears to have failed to learn from its past errors, as it continues to employ impractical price floors for agricultural products. A more recent example involves additional price floors for New England milk producers (Bruce). Whether they are used for wheat, potatoes, or milk, price floors will almost certainly prove to be a highly inefficient and burdensome option. The United States is not alone in succumbing to the allure of price controls to prop up industries. In the European Union, price controls are used to artificially inflate the price of goods such as milk. Instead of using a price floor, the EU sets a production quota that limits the amount

of milk farmers can produce. This serves to drive up the price of milk by keeping its available supply on the market artificially low (Milky). Once again consumers bear the brunt of the economic consequences, as the low supply of milk drives up its price to the point where many consumers are unable to afford it (Milky). In fact, the EU’s European Commission will devote roughly 600 million Euros in 2009 alone on “export subsidies” and on purchasing “unwanted dairy goods” which will do nothing but “molder in cold storage” (Milky). Europe has a fairly established history of employing counterproductive price controls. For example, price floors for butter in the 1980’s proved disastrous, as large numbers of consumers were unable to buy butter at such a high price. Not surprisingly, this development created staggering dairy surpluses referred to as “butter mountains” (Milky). This dismal track record of performance appears to have finally been acknowledged by European decision-makers, as the last few years have seen EU governments slowly begin to remove milk production quotas. Predictably, this has prompted European dairy farmers to stage bombastic protests all over Europe decrying milk quota repeals. According to the Economist, these farmers argue that even minor erosions of price ceilings have flooded the market with cheap milk that hurts farmer revenue (Milky). In September 2009, French farmers reacted to plans to ease milk quotas by launching a milk strike, as farmers nationwide refused to put their product on the market (Clarke). Some farmers resorted to even more dramatic methods, as 300 farmers recently protested the government’s quota plans by holding a large scale milk spraying demonstration (Clarke). By resorting to such ferocious tactics, European farmers appear to be either oblivious or indifferent to the damage the product quotas do to the overall economy. With such furious opposition coming from dairy producers, European leaders will find it difficult to fully break away from quotas in the near future.

In addition to price floors and quotas, price ceilings are used by governments to control the cost of goods. Simply put, price ceilings limit the amount producers can charge for a particular good (Price Ceilings). These mandated prices are set far below the natural market equilibrium price (Price Ceilings). As with price floors and quotas, price ceilings are implemented with the best of intentions, as they are geared towards making products more affordable for consumers (He). While price controls are successful in increasing demand, they also have a negative impact on supply, as producers are forced to reduce output in response to diminished revenue (He). As a result, price ceilings almost always lead to shortages and black markets (Price Ceilings). A notable example of modern price ceilings is in Venezuela, where they have become a staple of the economic policy of President Hugo Chavez (Millard and Gallegos). The Chavez government installed price ceilings soon after taking power in 1998. Over a decade into his presidency, it is blatantly apparent that the Chavez’s strategy has clearly backfired, as food shortages in Venezuela are a common occurrence. Instead of making common products more affordable for poor and working-class consumers, goods such as beef, chicken, and milk are now in short supply (Romero). Rather than revamping his economic strategy, Chavez has instead strongly insinuated that several companies are deliberately keeping food off the market. The Venezuelan president has even singled out specific companies, such as Empresas Polar, as being under a cloud of suspicion for hoarding products (Millman). Chavez’s threats have occasionally boiled over into aggressive government action, as shown by raids on two Coca-Cola plants owned by a Mexican beverage firm in 2003. The government again resorted to such tactics in February 2009, when it sent army troops to seize rice mills owned by the country’s largest food producer, Group Polar (Daniel). In line with his

previous rhetoric, Chavez claimed that Group Polar had disrupted the supply chain by “refusing to produce rice at prices set by the government” (Daniel). Perhaps most alarmingly, the Chavez government has resorted to using harsh penalties to enforce its policies, threatening to “jail grocery store owners and nationalize their businesses if they violate the country’s expanding price controls” (Romero). By continuing to punish and scapegoat businesses, the government only serves to reinforce the notion that it is oblivious to the impact its decisions have on the country’s private sector. The Venezuelan government’s rigid adherence to its failing policies puts many businesses in an impossible situation. The plight of businessmen like Ismael Cardenas is a story that has become an all too common occurrence in Venezuela. According to the Wall Street Journal, Cardenas is shutting down his milk-importing business since he “can no longer make a profit selling imported powdered milk under government-imposed price controls” (Millard and Gallegos). Cardenas describes his situation bluntly; “The controls have been very harsh. The numbers don't work out to import milk and sell it here” (Millard and Gallegos). Government price controls have been so damaging to the industry that food companies have watched helplessly as their profits have virtually vanished (Millard and Gallegos). Facing massive operating losses, many sellers “are skirting the rules or have stopped selling certain goods altogether rather than sell them at a loss”, adding fuel to the fire of the country’s “thriving black market” (Millard and Gallegos). Severe shortages have increased to the point that consumers have even resorted to theft to get daily meals, sometimes on an alarming scale. Two government food warehouses were thoroughly looted and pillaged by hungry mobs in February 2008, ironically located in Chavez’s hometown of Sabaneta (Millman). Between constant shortages of basic foods, floundering

businesses, emerging black markets, and additional social unrest, it becomes apparent that Venezuelan price controls have brought far more turmoil than economic relief. Given that all available evidence proves that price controls are not only ineffective, but also counterproductive, it may appear puzzling as to the lack of public disapproval against their continued use. A closer inspection of the environments where price controls are in effect, however, reveals the thought process of the effected populations. In the United States voters erroneously believe that the bulk of government farm aid is targeted towards individual farmers and farms with few workers (Lehe). Because of this, 77 percent of voters support subsidies for small farms (Lehe). Given this statistic, it is not difficult to imagine respondents likewise supporting price floors to benefit small scale farmers. Most voters appear to be unaware that large corporate farms are increasing dominating agricultural markets, and thus inordinately benefit from any government intervention (Study). Since 65 percent of respondents oppose subsidies to large farms, it is logical to assume that price floors that assist mostly corporate farms would be equally unpopular. Once this is taken into account, it can be safely said that voter ignorance regarding the true characteristics of U.S. farming keeps opposition to price floors to a minimum. In Venezuela, it is fairly easy to understand why such measures may sound appealing to lower and middle class consumers, as they are aimed at reducing the highest inflation rate in Latin America (Millard and Gallegos). Obviously, poorer consumers are more vulnerable to sharp increases in price that the wealthy, and price controls offer a seemingly quick and logical solution. This economic reality was confirmed in 2003, when high prices prompted Venezuelans to stage a general “two-month nationwide strike” (Millard and Gallegos). Not surprisingly, the price controls introduced soon afterward by the Chavez government were “warmly received” by

most of the Venezuelan public (Millard and Gallegos). Despite the damage he has inflicted on the Venezuelan economy, Chavez’s price ceilings are still “highly popular among Venezuela’s poor and working classes” (Romero). In Europe, government quotas on milk were likewise implemented due to external pressures on European governments. Unlike in Venezuela, however, European governments face a massive outcry from producers of dairy products, as evidenced by the antics of protesting French farmers. These protests are not limited to a few malcontents, and are theatrical enough to intimidate both politicians and voters alike. Anger amongst milk suppliers has reached a boiling point across much of the continent, prompting rioting from farmers in France (Milky). In Belgium, farmers staged a massive publicity stunt by using several hundred tractors to shutdown city traffic (Milky). Major news outlets have eagerly fanned the flames of farmer discontent, running articles with such inflammatory titles as “Europe deaf to farmer’s cries” (Milky). Facing a bombardment of criticism and calls for action, it is no wonder that European politicians buckle to pressure from such powerful voices. Private citizens would likewise be very hesitant to take on such a vitriolic lobby, and may even be swayed by sympathetic press coverage to side with farmers. Governments employ price controls in good faith, often to appease angry consumers and producers. Despite this, price controls have a track record of not only frequently failing to aid their intended beneficiaries, but of causing noticeable economic inefficiency. This is a belief that was proven true with US potato surpluses in the 1940’s, and continues to be reaffirmed today in the form of empty shelves in Venezuelan markets and the quantities of unsold European milk in cold storage. The inevitable damage inflicted by price controls on a given economy far outweighs any positive impact they may have, concrete evidence that the fallacy of government

price manipulation is a lesson that has withstood the test of time. With repeated failures on a worldwide scale, the history of price controls serves as a cautionary tale for all governments in the both the present and future.

Annotated Bibliography Clarke, Phillip. “Milk Crisis Biting Hard for British Ex-Pat” Farmer’s Weekly; (25 Sept. 2009), Academic Search Premier. EBSCOhost. Wentworth Institute of Technology Alumni Library Boston, MA 15 Nov. 2009. This article focuses on the reaction of French farmers to government efforts to repeal quotas on milk. The viewpoint of the dairy farmers is the main focus of this report, as it is stresses that many farmers are struggling to adjust to lower prices following the removal of production quotas. As a result, the reader is given a look into the mindset of dairy producers and the rationale behind their forceful protests.

Daniel, Frank Jack. “Chavez Orders Army to Seize Venezuelan Rice Mills.” Reuters 28 Feb 2009. 12 Nov. 2009

Frank Jack Daniel’s Reuter’s piece deals with the continued fallout from the Chavez government’s use of price ceilings to curb inflation. This article provides an excellent example of Chavez’s typical response to shortages caused by price ceilings, as it notes that the Venezuelan president faults food producers for the consequences of his economic policies. In this case, Chavez has taken his rhetoric one step further and has assumed control of several rice mills using army troops.

Hubbard, R. Glenn and Anthony Patrick O’Brien. Microeconomics. Upper Saddle River, New Jersey; Pearson Prentice Hall 2008 While Glenn R. Hubbard and Anthony Patrick O’Brien textbook covers a large variety of economic topics, is does provide brief yet concise and informative descriptions of price floors. Also discussed are the consequences of such measures, as Hubbard and O’Brien point out that price floors directly lead to massive quantities of surplus goods. While Microeconomics does not delve especially deep into the topic of price floors, it does provide a basic and easily understandable description of their characteristics, making it an excellent source for readers new to the subject.

Lehe, Lewis. “Down On The Farm: How Agriculture Subsidies Are Hurting Taxpayers, The Environment, And The World Economy” Pitt Political Review 22 Feb. 2009. 20 Nov. 2009 The lack of public outrage over price floors for U.S. farms is credibly explained in this article. In his article, Lewis Lehe notes that the American public’s perceptions regarding the nature of U.S. farming are outdated and at odds with reality. Lewis also supplies polling data that strongly suggests that if voters were fully informed about current farming practices, price floors for farms would be overwhelmingly unpopular.

“Milky mess.” Economist 392.8643 (8 Aug 2008): 48 Academic Search Premier. EBSCOhost. Wentworth Institute of Technology Alumni Library Boston, MA. 26 Sept. 2009 < http://search.ebscohost.com> This Economist article focuses on the dairy industry in Europe, particularly protests held by dairy farmers over raw milk prices. The article states that the protesters want production ceilings on milk to not only be preserved, but also strengthened. The article astutely points out that market forces, and not a lack of regulation, are to blame for low milk prices. Perhaps most interestingly, this article refers to the disastrous results of past attempts at price regulation, helping to bolster its already sound analysis.

Millman, Joel. “Chavez Tasks Food Producers Amid Shortage” Wall Street Journal (19 Feb 2008) A11 Academic Search Premier. EBSCOhost. Wentworth Institute of Technology Alumni Library Boston, MA. 26 Sept. 2009 < http://search.ebscohost.com>

The focus of Joel Millman’s article is the tension between Venezuelan president Hugo Chavez and the country’s foreign-owned food producers. The government has insinuated that these producers may be hoarding food, and has directly accused them of supporting anti-Chavez elements within Venezuela. While this article is not quite as descriptive as Peter Millard and Raul Gallegos’s article regarding the causes of Venezuelan food shortages and the agriculture industry’s reaction to them, it does succinctly mention why these measures were used and their impact on food companies. In addition, Millman is able to provide readers with a look into the

Venezuelan leader’s mindset, suggesting that Chavez government is in denial about the consequences of its policies and is simply using major food producers as a convenient scapegoat.

Millard, Peter and Raul Gallegos. "Politics & Economics: Price Caps Ail Venezuelan Economy; Moves to Curb Inflation Hurt Profits for Some Businesses, Spur Shortages, Black Market. " Wall Street Journal (15 Feb. 2006) A6 ProQuest. Wentworth Institute of Technology Alumni Library Boston, MA. 26 Sept. 2009

This article focuses on the fallout from the price caps imposed on the Venezuelan economy imposed by president Hugo Chavez. Chavez implemented price ceilings on various agricultural goods in an attempt to curb inflation. The controls have had a devastating impact on Venezuelan farmers and retailers, with greatly diminished profits forcing many to discontinue the sale of certain goods. Frequent shortages have forced many firms to ignore government regulations, and have directly lead to the creation of a strong black market. This article is an especially trustworthy and valuable source, since it provides actual quotes from suppliers and an abundance of economic facts to justify its conclusions, and further serves to support the thesis for our paper.

Merline, John W. “What you need to know about price controls.” Consumers’ Research Magazine

(March 1993): 16 Academic Search Premier. EBSCOhost. Wentworth Institute of Technology Alumni Library Boston, MA. 26 Sept. 2009 < http://search.ebscohost.com> John Merline’s article about price controls is wonderfully detailed source, as it comments on price controls in a wide variety of areas, such as gas, agriculture, and water subsidies. The article supports its claims with several supporting sources, including multiple prominent private organizations, the U.S. Department of Agriculture, and a U.S. congressman. This comprehensive research lends a great deal of credence to the Merline’s view that price controls are a proven failure, and that further price controls should be avoided.

Mohl, Bruce. "Official clears way for milk price-setting" Boston Globe (21 Mar. 1997) C19

ProQuest. Wentworth Institute of Technology Alumni Library Boston, MA. 25 Sep. 2009. This article discusses the push to create a price floor for New England dairy farmers in 1997. Though brief, the article does quote then US Agriculture Secretary Dan Glickman, who articulates the reasoning of many price control proponents by claiming that a price floor will benefit struggling farmers. The article’s most crucial piece of information, however, involves the opinions of market analysts, who warn about the steep costs of such a proposal. While the article may strike an overall neutral tone, the inclusion of critical analysis from knowledgeable market observers is likely to influence the opinion of the reader against the price floor.

“Price Ceilings” economic.fundamentalfinance. 13 Nov. 2009 http://economics.fundamentalfinance.com/micro_price-floor.php Price Ceilings is a source best suited for readers looking for a basic definition of price ceilings. A graph is included in this article, which better allows readers to comprehend the consequences price ceilings have on supply and demand. This source also uses hypothetical real-world examples to further illustrate its central points.

“Price Floors” economic.fundamentalfinance. 13 Nov. 2009 http://economics.fundamentalfinance.com/micro_price-floor.php As with “Price Ceilings”, the “Price Floors” description from economic.fundimentalfinance.com is brief, concise, and easy to understand. “Price Floors” details in a clear fashion how price floors impact supply and demand, and what courses of action governments can take to address the resultant surpluses. This description also includes a graph, making it even more useful to readers who are not familiar with the basic concepts of mircoeconomics.

Romero, Simon. “Chavez Threatens to Jail Price Control Violators.” The New York Times 17

Feb. 2007. 12 Nov. 2009 Simon Romero’s New York Times article is another fine example of Hugo Chavez’s delusional and reckless response to the shortcomings of Venezuelan price controls. The article vividly describes a situation that features the typical consequences of price floors, such as empty store shelves and burgeoning black markets. Romero also highlights the dilemma facing grocery store owners nationwide, as they risk devastating fines for not abiding counterproductive and onerous regulations.

“Sky-High Price Props Mean Farm Control.” Saturday Evening Post; (1 Jan 1949), Academic Search Premier. EBSCOhost. Wentworth Institute of Technology Alumni Library Boston, MA. 27 Sept. 2009 < http://search.ebscohost.com>

The price of potatoes is the central focus of this source, as it argues against a plan to enact stricter price controls on behalf of potato farmers. The Saturday Evening Post correctly observes that the move would likely result in fixed prices and rigid controls, thus aggravating the problem of surplus potatoes in the country. In addition, the article highlights the increase in the number of farm organizations that favor flexible price supports over a stronger price proposal, referred to as the 90-per-cent-of-parity plan. The only sensible choice, the article contends, would be to reject such stringent price controls.

“Study Shows Ag Market Concentration Increasing.” National Farmers Union 16 Apr. 2007. 21 Nov. 2009 This press release from the National Farmers Union sheds light on the current state of farming in the United States. Specifically, this source focuses on large firms garnering increasingly large shares in various fields of agriculture. By highlighting this trend, this study informs its readers about the stranglehold that large firms have on U.S. food production. A astute reader could also conclude that these firms would by extension receive the lion’s share of government farm aid.

Tregarthen, Timothy D. and Libby Rittenberg. “Macroeconomics” MacMillian. 1999. Google Books. Google Database < http://books.google.com> 14 Nov. 2009 Timothy Tregarthen and Libby Rittenburg’s “Macroeconomics” textbook provides invaluable information regarding the economic conditions that prompted the U.S. government to first introduce price floors for farms. Additionally, this source also contains a brief but insightful explanation regarding the unintended surpluses created by price floors. Given that this source is a textbook, its information only focuses on basic economic issues. However, the facts it presents are certainly relevant with regards to microeconomics, and are written in an clear and comprehensible manner.