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Thursday, March 3, 2011

Government Can’t Regulate Just One Side of the Market

The rest of the story.

I’ve spent the last week or so teaching price controls in my intro-to-economics class. One thing I tried to stress is that controls are often sold to the citizenry in a way that disguises what they really do.  I don’t mean just the obvious point that there are unintended consequences. I mean that such laws appear to regulate only the “bad guys” while protecting the innocent folks on the other side of the transactions.  In reality government can’t regulate just one side of the market: Regulations on sellers are necessarily regulations on buyers, and regulations on buyers are necessarily regulations on sellers.

Take a simple price ceiling, such as a maximum price for gasoline or maximum rent for Manhattan apartments.  People who support such laws think that somehow those who are selling or renting the good have the power to charge a higher price than what is perceived as fair or just, and that legislating a maximum below what would be charged must therefore protect consumers.  The traditional economic analysis rightly shows how this causes shortages and various other undesirable unintended consequences.

Buyers Limited Too

The point I want to make is that such laws also limit the behavior of buyers (or renters). In a genuinely free market, sellers who wish to maximize profits cannot charge any price they wish. They must be attentive to the intensity of consumer demand at various prices.  Ultimately the price of a given good is high because buyers find the product very valuable.  Price control says, “Sorry, buyers, you cannot express to sellers just how valuable you find this good, and therefore those of you who value it most highly will be unable to gain access to it.”  So rather than view price ceilings as laws to protect hapless buyers from ruthless sellers, we would be more accurate in seeing them as laws that prevent motivated buyers from outcompeting other buyers and communicating to ignorant sellers just how intensely they value the good.

We can make the same argument about price floors, or minimum-price laws such as farm price supports or the minimum wage.  Minimum-wage laws are normally couched in terms of protecting powerless sellers of labor against ruthless buyers, who have so much power, they can drive wages down to near-poverty levels.  Again, we know how the minimum wage causes all kinds of problems, most importantly high levels of unemployment among the least-skilled workers.  (In fact, many early proponents of the minimum wage recognized this, but saw it as a feature not a bug: It was a way to impoverish and eliminate the eugenically undesirable [pdf].)

However, like maximum-price laws, these laws really limit the other side of the market.  A minimum wage does not just prevent employers from “exploiting” workers at “too low” a wage; it also prevents workers from offering their services at wages they think will make them employable.  For lower-skilled workers, a minimum-wage law is effectively a minimum-productivity law that undermines their ability to outcompete other workers by offering to work for less when they can’t produce as much per hour as the minimum wage.  And this is precisely the feature of the law that higher-skilled workers like: It enables them to shut out competition from other workers.

Who Competes?

The key is to remember that market competition is not between buyers and sellers, but rather among buyers and among sellers.  As a result, all laws that limit prices necessarily limit the ability of both sides of the market to compete, regardless of how the law is framed or who its proponents say it will “limit.”  All price controls choke off market communication by preventing the competitive process on each side of transactions from telling the other side how much goods are valued.

The next time someone tells you that price controls or minimum-wage laws put the brakes on powerful firms that sell necessities at too high a price or buy labor at unfairly low wages, don’t believe it.  Those laws limit consumers and workers, especially lower skilled ones, at least as much as they limit powerful firms.

  • Steven Horwitz was the Distinguished Professor of Free Enterprise in the Department of Economics at Ball State University, where he was also Director of the Institute for the Study of Political Economy. He is the author of Austrian Economics: An Introduction.