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Saturday, April 1, 2000

The Price of Resistance

Price Controls Always Create Shortages

Consider this remarkable sentence in the New York Times last winter: “Brandishing new data showing that the drug industry earns higher profits and pays lower taxes than most other industries, White House officials say drug companies may bring price controls on themselves if they continue to resist President Clinton’s plan to have Medicare provide pharmaceutical benefits.” This was said to be the “personal view” of Daniel N. Mendelson, associate director of President Clinton’s Office of Management and Budget. Yet Mendelson was speaking for the President.

What does it mean to say that the pharmaceutical companies “resist” President Clinton’s plan? If the companies have launched a guerrilla war against the government, the newspapers have missed the story. So I presume the resistance consists of speech, printed materials, and lobbying—all protected by the U.S. Constitution (not to mention the philosophy of natural rights) at last check.

The administration, then, is saying that if the companies continue peacefully to oppose its plan, they will lose their freedom to set the prices of their products. That’s a tough choice: the freedom to speak in defense of their freedom or the freedom to control their property. Unfortunately, the companies dropped their opposition. Where was the bellow of protest from the “civil libertarians”?

Ironically, the plan being resisted would bring price controls anyway. Under the proposed Medicare expansion, the federal government would become the buyer of the elderly’s prescription drugs. Anyone who thinks that wouldn’t give the government the power to set prices hasn’t thought about the matter. The feds may not control prices immediately, but when the inevitable price spiral sets in, as the elderly act as if the drugs are free (or cheap), price controls will be the next stage. That’s what happened with Medicare. At first the government did not set prices. The system operated on a cost-plus basis. But when prices soared, the government started a series of price-control schemes. It’s one reason that doctors are increasingly reluctant to see Medicare patients.

Economic theory and at least 4,000 years of experience with price ceilings lead to one inescapable conclusion: they create shortages. To understand this, we have to begin with the principle that prices in a market are not the result of businessmen’s kindness or callousness. While capitalists own their means of production in the moral-legal sense, economically speaking they hold them at the pleasure of consumers. Although business owners typically seek to maximize their revenues, and set prices accordingly, their decisions are subject to the preferences, needs, tastes, and whims of potential buyers, who are constantly being wooed by sellers of competing products. (See my article “Captain Consumer” in The Freeman, February 1999.)

Thus entrepreneurs are limited by the competitive process in what they can charge for their products. If the market price for a product is too low to enable an entrepreneur to bid the necessary scarce resources (labor, raw materials, and so on) away from other uses, that’s a signal that consumers want the resources devoted to other purposes. But if consumers are willing to pay a price that covers the entrepreneur’s expenses and yields an attractive profit, they are signaling that the project is worthwhile compared to alternatives. Profits are the rewards the entrepreneur reaps by noticing hitherto unattended-to consumer needs: the higher the profits, the bigger the previous oversight.

If the government imposes a maximum price on a product below what the market would set, producers will make less of it or none at all. Moreover, the quality will suffer, as producers minimize expenses beyond the point they would have minimized them in a free market. (Milton Friedman used to say that under price controls, there’s more air in the candy bars.) And entrepreneurs will be discouraged from looking for new profit opportunities in fields where prices are subject to government control. Businessmen will surely not be encouraged to take risks developing cutting-edge products like exotic medicines.

This is not “only a theory.” Anyone who lived through the energy shortages of the 1970s has firsthand experience of how a product can disappear when government refuses to let the market set prices.

Market for Medicine

The market for prescription medicines is intrinsically no different from other markets. Entrepreneurs strive for profits by making investments to develop products that consumers believe will satisfy a need. This is complicated by government prescription regulations—a paternalist intervention that should be abolished—but the economics are basically the same. (The President’s wish to crack down on Internet sales of medicine shows how technology can help us to ignore government dinosaurs.) There is another complication, however. The Food and Drug Administration’s bureaucratic demands greatly increase the cost of bringing drugs to market. Naturally, the companies try to recoup that investment. A genuine concern with the high price of medicine would begin with an examination of the FDA’s malign effect on the marketplace.

But, someone will say, people need medicine. Unlike food, clothing, and shelter? But even if medicine were unique, it would not change the fact that price ceilings make things less, not more, accessible. Motives notwithstanding, the laws of economics can’t be repealed.

It is particularly outrageous for the Clinton administration to hold the pharmaceutical industry’s high profits and low taxes against it. As noted, if profits are high, it is because the companies are constantly addressing urgent consumer needs and cutting costs. (I leave aside the issue of patents and the returns they make possible. Suffice it to say that the administration favors intellectual property rights in other contexts.) The industry’s taxes are lower than in other industries because the tax rules allow credits for research and for taxes paid to foreign governments. If the authorities think it is unfair that the industry pays less in taxes than other industries do, let them lower the taxes of the others. Taxes stifle production.

If the government is really concerned about the price of medical care, it should look to its own complex of policies that stimulate demand and reduce supply. Medicare is a prime culprit but not the only one. The tax-induced system of employer-based health insurance seriously distorts the medical marketplace by hiding prices from consumers. Licensure and control over medical schools restrict the supply of medical services.

We shouldn’t overlook the possibility that price controls on medicine may be intended to disrupt the pharmaceutical industry and offer the government new opportunities to intervene. Ever since the Clinton health plan was turned back, advocates of socialized medicine have pursued incremental socialization, knowing that the harm of each measure would provide grounds for the next increment.

  • Sheldon Richman is the former editor of The Freeman and a contributor to The Concise Encyclopedia of Economics. He is the author of Separating School and State: How to Liberate America's Families and thousands of articles.