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Most people may be unaware that they are competing when making purchases, and simply see themselves as deciding how much of various things to buy at whatever prices they find. But scarcity ensures that they are competing with others, even if they are conscious only of weighing their own purchasing decisions against the amount of money they have available. #52 | | |
One of the incidental benefits of competing and sharing through prices is that different people are not as likely to think of themselves as rivals, nor to develop the kinds of hostility that rivalry can breed. For example, much the same labor and construction material needed to build a Protestant church could be used to build a Catholic church. But, if a Protestant congregation is raising money to build a church for themselves, they are likely to be preoccupied with how much money they can raise and how much is needed for the kind of church they want. Construction prices may cause them to scale back some of their more elaborate plans, in order to fit within the limits of what they can afford. But they are unlikely to blame Catholics, even though the competition of Catholics for the same construction materials makes their prices higher than otherwise. #53 | | |
If, instead, the government were in the business of building churches and giving them to different religious groups, Protestants and Catholics would be explicit rivals for this largess and neither would have any financial incentive to cut back on their building plans to accommodate the other. Instead, each would have an incentive to make the case, as strongly as possible, for the full extent of their desires, to mobilize their followers politically to insist on getting what they want, and to resent any suggestion that they scale back their plans. The inherent scarcity of materials and labor would still limit what could be built, but that limit would now be imposed politically and would be seen by each as due to the rivalry of the other. #54 | | |
The Constitution of the United States of course prevents the American government from building churches for religious groups, no doubt in order to prevent just such political rivalries and the bitterness, and sometimes bloodshed, to which such rivalries have led in other countries and in other times. #55 | | |
The same economic principle, however, applies to groups that are not based on religion but on ethnicity, geographic regions, or age brackets. All are inherently competing for the same resources, simply because these resources are scarce. However, competing indirectly by having to keep your demands within the limits of your own pocketbook is very different from seeing your desires for government benefits thwarted directly by the rival claims of some other group. The self-rationing created by prices not only tends to mean less social and political friction but also more economic efficiency, since each individual knows his or her own preferences better than any third party can, and can therefore make incremental trade-offs that are more personally satisfying within the limits of the available resources. #56 | | |
Rationing through pricing also limits the amount of each individual’s claims on the output of others to what that individual’s own productivity has created for others, and thereby earned as income. What price controls, subsidies, or other substitutes for price allocation do is reduce the incentives for self-rationing. That is why people with minor ailments go to doctors when medical care is either free or heavily subsidized by the government, and why farmers receiving government-subsidized water from irrigation projects grow crops requiring huge amounts of water, which they would never grow if they had to pay the full costs of that water themselves. #57 | | |
Society as a whole always has to pay the full costs, regardless of what prices are or are not charged to individuals. When price controls make goods artificially cheaper, that allows greater self-indulgence by some, which means that less is left for others. Thus many apartments occupied by just one person under rent control means that others have trouble finding a place to stay, even when they are perfectly willing and able to pay the current rent. Moreover, since rationing must take place with or without prices, this means that some form of non-price rationing becomes a substitute. #58 | | |
Simply waiting until what you want becomes available has been a common form of non-price rationing. This can mean waiting in long lines at stores, as was common in the Soviet economy, or being put on a waiting list for surgery, as patients often are in countries where government-provided medical care is either free or heavily subsidized. #59 | | |
Luck and corruption are other substitutes for price rationing. Whoever happens to be in a store when a new shipment of some product in short supply arrives can get the first opportunity to buy it, while people who happen to learn about it much later can find the coveted product all gone by the time they get there. In other cases, personal or political favoritism or bribery takes the place of luck in gaining preferential access, or formal rationing systems may replace favoritism with some one-size-fits-all policy administered by government agencies. However it is done, the rationing that is done by prices in market economies cannot be gotten rid of by getting rid of prices or by the government’s lowering the level of prices. #60 | | |
Incremental Substitution #61 | | |
As important as it is to understand the role of substitutions, it is also important to keep in mind that the efficient allocation of resources requires that these substitutions be incremental, not total. For example, one may believe that health is more important than entertainment but, however reasonable that may sound as a general principle, no one really believes that having a twenty-year’s supply of Band-Aids in the closet is more important than having to give up all music in order to pay for it. A price-coordinated economy facilitates incremental substitution, but political decision-making tends toward categorical priorities—that is, declaring one thing absolutely more important than another and creating laws and policies accordingly. #62 | | |
When some political figure says that we need to “set national priorities” about one thing or another, what that amounts to is making A categorically more important than B. This is the opposite of incremental substitution, in which the value of each depends on how much of each we already have at the moment, and therefore on the changing amount of A that we are willing to give up in order to get more B. #63 | | |
This variation in the relative values of things can be so great as to convert something that is beneficial into something that is detrimental, or vice versa. For example, human beings cannot live without salt, fat and cholesterol, but most Americans get so much of all three that their lifespan is reduced. Conversely, despite the many problems caused by alcohol, from fatal automobile accidents to deaths from cirrhosis of the liver, studies show that very modest amounts of alcohol have health benefits that can be life-saving.{xi} Alcohol is not categorically good or bad. #64 | | |
Whenever there are two things which each have some value, one cannot be categorically more valuable than another. A diamond may be worth much more than a penny, but enough pennies will be worth more than any diamond. That is why incremental trade-offs tend to produce better results than categorical priorities. #65 | | |
There are chronic complaints about government red tape in countries around the world, but the creation of red tape is understandable in view of the incentives facing those who create government forms, rules, and requirements for innumerable activities that require official approval. Nothing is easier than thinking of additional requirements that might be useful in some way or other, at some time or other, and nothing is harder than remembering to ask the crucial incremental question: At what cost? #66 | | |
People who are spending their own money are confronted with those costs at every turn, but people who are spending the taxpayers’ money—or who are simply imposing uncounted costs on businesses, homeowners, and others—have no real incentives to even find out how much the additional costs are, much less to hold off on adding requirements when the incremental costs threaten to become larger than the incremental benefits to those on whom these costs are imposed by the government. Red tape grows as a result. #67 | | |
Any attempt to get rid of some of this red tape is likely to be countered by government officials, who can point out what useful purpose these requirements may serve in some circumstances. But they are unlikely even to pose the question whether the incremental benefit exceeds the incremental costs. There are no incentives for them to look at things that way. Nor are the media likely to. A New York Times article, for example, argued that there were few, if any, “useless” regulations{107}—as if that was the relevant criterion. But neither individuals nor businesses are willing or able to pay for everything that is not useless, when they are spending their own money. #68 | | |
No doubt there are reasons, or at least rationales, for the many government regulations imposed on businesses in Italy, for example, but the real question is whether their costs exceed their benefits: #69 | | |
Imagine you’re an ambitious Italian entrepreneur, trying to make a go of a new business. You know you will have to pay at least two-thirds of your employees’ social security costs. You also know you’re going to run into problems once you hire your 16th employee, since that will trigger provisions making it either impossible or very expensive to dismiss a staffer. #70 | | |
But there’s so much more. Once you hire employee 11, you must submit an annual self-assessment to the national authorities outlining every possible health and safety hazard to which your employees might be subject. These include stress that is work-related or caused by age, gender and racial differences. You must also note all precautionary and individual measures to prevent risks, procedures to carry them out, the names of employees in charge of safety, as well as the physician whose presence is required for the assessment. #71 | | |
. . . By the time your firm hires its 51st worker, 7% of the payroll must be handicapped in some way. . . Once you hire your 101st employee, you must submit a report every two years on the gender dynamics within the company. This must include a tabulation of the men and women employed in each production unit, their functions and level within the company, details of compensation and benefits, and dates and reasons for recruitments, promotions and transfers, as well as the estimated revenue impact.{108} #72 | | |
As of the time that this description of Italian labor laws appeared in the Wall Street Journal, the unemployment rate in Italy was 10 percent and the Italian economy was contracting, rather than growing.{109} #73 | | |
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Ideally, prices allow alternative users to compete for scarce resources in the marketplace. However, this competition is distorted to the extent that special taxes are put on some products or resources but not on others, or when some products or resources are subsidized by the government but others are not. #75 | | |
Prices charged to the consumers of such specially taxed or specially subsidized goods and services do not convey the real costs of producing them and therefore do not lead to the same trade-offs as if they did. Yet there is always a political temptation to subsidize “good” things and tax “bad” things. However, when neither good things nor bad things are good or bad categorically, this prevents our finding out just how good or how bad any of these things is by letting people choose freely, uninfluenced by politically changed prices. People who want special taxes or subsidies for particular things seem not to understand that what they are really asking for is for the prices to misstate the relative scarcities of things and the relative values that the users of these things put on them. #76 | | |
One of the factors in California’s recurring water crises, for example, is that California farmers’ use of water is subsidized heavily. Farmers in California’s Imperial Valley pay $15 for the same amount of water that costs $400 in Los Angeles.{110} The net result is that agriculture, which accounts for less than 2 percent of the state’s output, consumes 43 percent of its water.{111} California farmers grow crops requiring great amounts of water, such as rice and cotton, in a very dry climate, where such crops would never be grown if farmers had to pay the real costs of the water they use. Inspiring as it may be to some observers that California’s arid lands have been enabled to produce vast amounts of fruits and vegetables with the aid of subsidized water, those same fruits and vegetables could be produced more cheaply elsewhere with water supplied free of charge from the clouds. #77 | | |
The way to tell whether the California produce is worth what it costs to grow is to allow all those costs to be paid by California farmers who compete with farmers in other states that have higher rainfall levels. There is no need for government officials to decide arbitrarily—and categorically—whether it is a good thing or a bad thing for particular crops to be grown in California with water artificially supplied below cost from federal irrigation projects. Such questions can be decided incrementally, by those directly confronting the alternatives, through price competition in a free market. #78 | | |
California is, unfortunately, not unique in this respect. In fact, this is not a peculiarly American problem. Halfway around the world, the government of India provides “almost free electricity and water” to farmers, according to The Economist magazine, encouraging farmers to plant too much “water-guzzling rice,” with the result that water tables in the Punjab “are dropping fast.”{112} Making anything artificially cheap usually means that it will be wasted, whatever that thing might be and wherever it might be located. #79 | | |
From the standpoint of the allocation of resources, government should either not tax resources, goods, and services or else tax them all equally, so as to minimize the distortions of choices made by consumers and producers. For similar reasons, particular resources, goods, and services should not be subsidized, even if particular people are subsidized out of humanitarian concern over their being the victims of natural disasters, birth defects, or other misfortunes beyond their control. Giving poor people money would accomplish the same humanitarian purpose without the same distortion in the allocation of resources created by subsidizing or taxing different products differently. #80 | | |
However much economic efficiency would be promoted by letting resource prices be unchanged by taxes or subsidies, from a political standpoint politicians win votes by doing special favors for special interests or putting special taxes on whomever or whatever might be unpopular at the moment. The free market may work best when there is a level playing field, but politicians win more votes by tilting the playing field to favor particular groups. Often this process is rationalized politically in terms of a need to help the less fortunate but, once the power and the practice are established, they provide the means of subsidizing all sorts of groups who are not the least bit unfortunate. For example, the Wall Street Journal reported: #81 | | |
A chunk of the federal taxes and fees paid by airline passengers are awarded to small airports used mainly by private pilots and globe-trotting corporate executives.{113} #82 | | |
The Meaning of “Costs” #83 | | |
Sometimes the rationale for removing particular things from the process of weighing costs against benefits is expressed in some such question as: “How can you put a price on art?”—or education, health, music, etc. The fundamental fallacy underlying this question is the belief that prices are simply “put” on things. So long as art, education, health, music, and thousands of other things all require time, effort, and raw material, the costs of these inputs are inherent. These costs do not go away because a law prevents them from being conveyed through prices in the marketplace. Ultimately, to society as a whole, costs are the other things that could have been produced with the same resources. Money flows and price movements are symptoms of that fact—and suppressing those symptoms will not change the underlying fact. #84 | | |
One reason for the popularity of price controls is a confusion between prices and costs. For example, politicians who say that they will “bring down the cost of medical care” almost invariably mean that they will bring down the prices paid for medical care. The actual costs of medical care—the years of training for doctors, the resources used in building and equipping hospitals, the hundreds of millions of dollars for years of research to develop a single new medication—are unlikely to decline in the slightest. Nor are these things even likely to be addressed by politicians. What politicians mean by bringing down the cost of medical care is reducing the price of medicines and reducing the fees charged by doctors or hospitals. #85 | | |
Once the distinction between prices and costs is recognized, then it is not very surprising that price controls have the negative consequences that they do, because price ceilings mean a refusal to pay the full costs. Those who supply housing, food, medications or innumerable other goods and services are unlikely to keep on supplying them in the same quantities and qualities when they cannot recover the costs that such quantities and qualities require. This may not become apparent immediately, which is why price controls are often popular, but the consequences are lasting and often become worse over time. #86 | | |
Housing does not disappear immediately when there is rent control but it deteriorates over time without being replaced by sufficient new housing as it wears out. Existing medicines do not necessarily vanish under price controls but new medicines to deal with cancer, AIDS, Alzheimer’s and numerous other afflictions are unlikely to continue to be developed at the same pace when the money to pay for the costs and risks of creating new medications is just not there any more. But all this takes time to unfold, and memories may be too short for most people to connect the bad consequences they experience to the popular policies they supported some years back. #87 | | |
Despite how obvious all this might seem, there are never-ending streams of political schemes designed to escape the realities being conveyed by prices—whether through direct price controls or by making this or that “affordable” with subsidies or by having the government itself supply various goods and services free, as a “right.” There may be more ill-conceived economic policies based on treating prices as just nuisances to get around than on any other single fallacy. What all these schemes have in common is that they exempt some things from the process of weighing costs and benefits against one another{xii}—a process essential to maximizing the benefits from scarce resources which have alternative uses. #88 | | |
The most valuable economic role of prices is in conveying information about an underlying reality—while at the same time providing incentives to respond to that reality. Prices, in a sense, can summarize the end results of a complex reality in a simple number. For example, a photographer who wants to buy a telephoto lens may confront a choice between two lenses that produce images of equal quality and with the same magnification, but one of which admits twice as much light as the other. This second lens can take pictures in dimmer light, but there are optical problems created by a wider lens opening that admits more light. #89 | | |
While the photographer may be wholly unaware of these optical problems, their solution can require a more complex lens made of more expensive glass. What the photographer is made aware of is that the lens with the wider opening has a higher price. The only decision to be made by the photographer is whether the higher price is worth it for the particular kinds of pictures he takes. A landscape photographer who takes pictures outdoors on sunny days may find the higher-priced lens not worth the extra money, while a photographer who takes pictures indoors in museums that do not permit flashes to be used may have no choice but to pay more for the lens with the wider opening. #90 | | |
Because knowledge is one of the scarcest of all resources, prices play an important role in economizing on the amount of knowledge required for decision-making by any given individual or organization. The photographer needs no knowledge of the science of optics in order to make an efficient trade-off when choosing among lenses, while the lens designer who knows optics need have no knowledge of the rules of museums or the market for photographs taken in museums and in other places with limited amounts of light. #91 | | |
In a different economic system which does not rely on prices, but relies instead on a given official or a planning commission to make decisions about the use of scarce resources, a vast amount of knowledge of the various complex factors behind even a relatively simple decision like producing and using a camera lens would be required, in order to make an efficient use of scarce resources which have alternative uses. After all, glass is used not only in camera lenses but also in microscopes, telescopes, windows, mirrors and innumerable other things. To know how much glass should be allocated to the production of each of these many products would require more expertise in more complex subjects than any individual, or any manageable sized group, can be expected to master. #92 | | |
Although the twentieth century began with many individuals and groups looking forward to a time when price-coordinated economies would be replaced by centrally planned economies, the rise and fall of centrally planned economies took place over several decades. By the end of the twentieth century, even most socialist and communist governments around the world had returned to the use of prices to coordinate their economies. However attractive central planning may have seemed before it was tried, concrete experience led even its advocates to rely more and more on price-coordinated markets. An international study of free markets in 2012 found the world’s freest market to be in Hong Kong{114}—in a country with a communist government. #93 | | |
