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Thursday, May 24, 2007

Essel on Neo-Soviet "Economics"

In this Soviet propaganda poster, the slogan claims that the
huge demand for Soviet-made shoes is a hallmark of their quality.
In fact, of course, it was merely demonstration that there were
no alternatives and the regime was totally unable to match
demand with production even given the goods' infamously poor quality.

What Goes Around Comes Around

by Dave Essel

“I had one fundamental question about economics:
Why do some places prosper and thrive while others just suck?”

– P. J. O’Rourke
Kommmersant in an article headlined "The Return of the State Prices Committee," reports on Russian plans to reintroduce pricing structures set by the state:
“The Economic Policy Committee of the State Duma for the first time in 15 years is drafting a law on principles for the administrative regulation of prices within the country’s economy entitled On Pricing Policy in the Russian Federation. Although the proposed law has already drawn a fierce protest from Herman Gref, the Minister of Economic Development and Trade, United Russia MPs propose to put the law before the State Duma by December 2007. The aim is to enshrine in law principles by which price restrictions can be imposed administratively in individual markets even absent state monopolies.”
So the Russian State Duma can think of nothing better that the reintroduction of the USSR’s Gosplan and its pricing committee which managed the Soviet Union’s economy into the ground? Bravissimo! I begin to wonder if the Soviet Union did in fact manage to create the genetically modified Homo Sovieticus it so wanted.

The poor Duma certainly can’t be online. Or perhaps the real government of Russia has deliberately denied them a connection – an ignorant Duma will create less noise, even if it doesn’t have any real power anyway. Because simply Googling the words “price controls” leads one in 0.11 seconds to reams of information on economics that describe the result of price controls. Interestingly, this search for completely neutral words does not produce any results which have anything to say in favour of price controls.

Here is an excerpt from Economics in One Lesson by Henry Hazlitt (1894 -1993, journalist, literary critic, economist, philosopher 1894-1993)
Chapter XVII, “Government Price-Fixing” we cannot hold the price of any commodity below its market level without in time bringing about two consequences.

The first is to increase the demand for that commodity. Because the commodity is cheaper, people are both tempted to buy, and can afford to buy, more of it.

The second consequence is to reduce the supply of that commodity. Because people buy more, the accumulated supply is more quickly taken from the shelves of merchants. But in addition to this, production of that commodity is discouraged. Profit margins are reduced or wiped out. The marginal producers are driven out of business. Even the most efficient producers may be called upon to turn out their product at a loss. This happened in World War II when slaughter houses were required by the Office of Price Administration to slaughter and process meat for less than the cost to them of cattle on the hoof and the labor of slaughter and processing.

If we did nothing else, therefore, the consequence of fixing a maximum price for a particular commodity would be to bring about a shortage of that commodity. ...
Or we can refer to Murray N. Rothbard (1926-1995, made major contributions to economics, history, political philosophy, and legal theory):
Bad and discredited ideas, it seems, never die. Neither do they fade away. Instead, they keep turning up, like bad pennies or Godzilla in the old Japanese movies.

Price controls, that is, the fixing of prices below the market level, have been tried since ancient Rome; in the French Revolution, in its notorious “Law of the Maximum” that was responsible for most of the victims of the guillotine; in the Soviet Union, ruthlessly trying to suppress black markets. In every age, in every culture, price controls have never worked. They have always been a disaster.

Why did Chiang-kai-Shek “lose” China? The main reason is never mentioned. Because he engaged in runaway inflation, and then tried to suppress the results through price controls. To enforce them, he wound up shooting merchants in the public squares of Shanghai to make an example of them. He thereby lost his last shreds of support to the insurgent Communist forces. A similar fate awaited the South Vietnamese regime, which began shooting merchants in the public squares of Saigon to enforce its price decrees.

Price controls didn’t work in World War I, when they began as “selective”; they didn’t work in World War II, when they were comprehensive and the Office of Price Administration tried to enforce them with hundreds of thousands of enforcers. They didn’t work when President Nixon imposed a wage-price freeze and variants of such a freeze from the summer of 1971 until the spring of 1973 or when President Carter tried to enforce a more selective version.
And for a proper historical round-up and sad evidence that very few people ever wish to learn from the lessons of history:
Four Thousand Years of Price Control

by Thomas DiLorenzo (born 1954, American economics professor at Loyola College in Maryland)

The case against price controls is not merely an academic exercise, restricted to economics textbooks. There is a four-thousand-year historical record of economic catastrophe after catastrophe caused by price controls. This record is partly documented in an excellent book entitled Forty Centuries of Wage and Price Controls by Robert Schuettinger and Eamon Butler, first published in 1979.

The authors begin by quoting Jean-Philippe Levy, author of The Economic Life of the Ancient World,as noting that in Egypt during the Third Century B.C. “there was a real omnipresence of the state” in regulating grain production and distribution. “All prices were fixed by fiat at all levels.” This “control took on frightening proportions. There was a whole army of inspectors.”

Egyptian farmers became so infuriated with the price control inspectors that many of them simply left their farms. By the end of the century the “Egyptian economy collapsed as did her political stability.”

In Babylon some 4,000 years ago the Code of Hammurabi was a maze of price control regulations. “If a man hire a field-labourer, he shall give him eight gur of corn per annum”; “If a man hire a herdsman, he shall give him six gur of corn per annum”; “If a man hire a sixty-ton boat, he shall give a sixth part of a shekel of silver per diem for her hire.” And on and on and on. Such laws “smothered economic progress in the empire for many centuries,” as the historical record describes. Once these laws were laid down “there was a remarkable change in the fortunes of the people.”

Ancient Greece also imposed price controls on grain and established “an army of grain inspectors appointed for the purpose of setting the price of grain at a level the Athenian government thought to be just.” Greek price controls inevitably led to grain shortages, but ancient entrepreneurs saved thousands from starvation by evading these unjust laws. Despite the imposition of the death penalty for evading Greek price control laws, the laws “were almost impossible to enforce.” The shortages created by the price control laws created black market profit opportunities, to the great benefit of the public.

In 284 A.D. the Roman emperor Diocletian created inflation by placing too much money in circulation, and then “fixed the maximum prices at which beef, grain, eggs, clothing and other articles could be sold, and prescribed the penalty of death for anyone who disposed of his wares at a higher figure.” The results, as Schuettinger and Butler explain, quoting an ancient historian, were that “the people brought provisions no more to markets, since they could not get a reasonable price for them and this increased the dearth so much, that at last after many had died by it, the law itself was set aside.”

Moving closer to modern times, George Washington’s revolutionary army nearly starved to death in the field thanks to price controls on food that were imposed by Pennsylvania and other colonial governments. Pennsylvania specifically imposed price controls on “those commodities needed for use by the army,” creating disastrous shortages of everything needed by the army. The Continental Congress wisely adopted an anti-price-control resolution on June 4, 1778 that read: “Whereas it hath been found by experience that limitations upon the prices of commodities are not only ineffectual for the purpose proposed, but likewise productive of very evil consequences--resolved, that it be recommended to the several states to repeal or suspend all laws limiting, regulating or restraining the Price of any Article.” And, write Schuettinger and Butler, “By the fall of 1778 the army was fairly well provided for as a direct result of this change in policy.”

French politicians repeated the same mistakes after their revolution, putting into place the “Law of the Maximum” in 1793, which first imposed price controls on grain, and then on a long list of other items. Predictably, “in some [French] towns, the people were so badly fed that they were collapsing in the streets from lack of nourishment.” A delegation from various provinces wrote to the government in Paris that before the new price control law, “our markets were supplied, but as soon as we fixed the price of wheat and rye we saw no more of those grains. The other kinds not subject to the maximum were the only ones brought in.” The French government was forced to abolish its evil price control law after it had literally killed thousands. When Robespierre was being carried through the streets of Paris on the way to his execution the crowds shouted, “There goes the dirty Maximum!” If only this were a lesson learned by contemporary politicians.

At the end of World War II American central planners were even more totalitarian when it came to economic policy than were the former Nazis. During the post-war occupation of Germany, American “planners” rather liked the Nazi economic controls, including price controls, that were in fact preventing economic recovery. The notorious Nazi Hermann Goering even lectured the American war correspondent Henry Taylor about it! As recounted by Schuettinger and Butler, Goering said:

“Your America is doing many things in the economic field which we found out caused us so much trouble. You are trying to control peoples’ wages and prices — peoples’ work. If you do that you must control peoples’ lives. And no country can do that part way. I tried and it failed. Nor can any country do it all the way either. I tried that too and it failed. You are no better planners than we. I should think your economists would read what happened here.

Price controls were finally ended in Germany by Economic Minister Ludwig Erhard in 1948, on a Sunday, when the American occupation authorities would be out of their offices and unable to stop him. This spawned the “German economic miracle.”

Price controls were the cause of the “energy crisis” of the 1970s and of the California energy crisis of the 1990s (only the wholesale price of electricity was deregulated there; controls were placed on retail prices). For more than four thousand years, dictators, despots, and politicians of all stripes have viewed price controls as the ultimate “something for nothing” promise to the public. [my emphasis]

With the wave of a hand, or the flash of a legislative pen, they promise to make everything cheaper. And for more than four thousand years the results have been exactly the same: shortages, sometimes of catastrophic consequence; deterioration of product quality; the proliferation of black markets on which prices are actually higher and bribery is rampant; destruction of a nation’s productive capacity in the industries where prices are controlled; gross distortions of markets; the creation of oppressive and tyrannical price control bureaucracies; and a dangerous concentration of political power in the hands of the price controllers.
The trouble with subsidies and state-controlled prices is that the distortions they introduce have a domino effect, the consequences of which are impossible to predict and often go much further than anyone intended or expected.

Now maybe the members of the Duma are irreconcilable Russophiles and have an ingrained dislike of looking at foreign sources of knowledge. However, they must have a collective memory of the Soviet Union and what Gosplan did to their then country. My favourite example, which I frequently use in conversation with Russians about economic matters, is the rhetorical question “How would one set about destroying a country’s aviation industry with a single price control?”. The answer: “Have Gosplan price fuel at 10 kopecks a litre”.

When engineers set about designing something, they first draw up design parameters for all aspects of the design, balancing technical requirements of the final product against available technology, industrial capabilities, availability of raw materials, consumable requirements and so on. Naturally, a prioritisation is also effected. With fuel at 10 kopecks a litre and to all intents and purposes free in unlimited quantities to the military, when it came to designing aircraft civilian or military, fuel consumption of the future engines came way down on the list. Thus competent engineers came to design an incompetent product, and Russian aircraft were very fuel hungry compared to their Western counterparts. Compound this with a totally crazy manufacturing scheme of airframes made in Uzbekistan and engines in Russia, possible because underpriced fuel made transport costs immaterial and and it was thought a good idea to bind the USSR’s disparate republics in a web of interdependencies [ organisational planning that added to the nightmare of the collapse of the USSR].

And so Russia has no civil aviation industry to speak of; the national flag carrier operates foreign aircraft on all its major foreign (prestige) routes; and the new aircraft it says it is buying for its fleethas a French Snecma power plant .

The Soviet Union’s economic management was as risible as its behaviour in other spheres was horrible. But economics bite back and the proof of the pudding is in the eating. It happened then and it will happen again: wait for the bite. So there’s no point in the Duma thinking that a new Russian school of economics, different from horrid Western economics invented by horrid foreigners (perhaps specially to spite Russia), will solve all the country’s problems.

Another quote from Hazlitt makes the best close I can think of:
The whole of economics can be reduced to a single lesson, and that lesson can be reduced to a single sentence. The art of economics consists in looking not merely at the immediate but the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.
What a shame that the Great Russian uniqueness complex means that all this is p*ssing into the wind as far that country is concerned (an ignored minority excepted). For my part, I feel at touch of shameful pleasure as I anticipate that usual Western response “We told you so!”

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