I am opposed to the imposition of wage/price controls. As we saw in the early 1970s, they are a terrible idea. Nonetheless, there is an argument for wage/price controls. But it’s not the argument that most of its supporters or opponents might assume.
Wage/price controls cannot stop inflation, which is caused by monetary policy. What wage/price controls might be able to do is prevent high unemployment. The real purpose of wage/price controls is to boost employment, not to reduce inflation.
Suppose you believe (as I do) that nominal wages are sticky in the short run. In that case, a monetary policy that sharply and unexpectedly reduces inflation may lead to a temporary period of high unemployment, until wages adjust to the lower level of nominal spending. In that policy environment, controls on wages might, and I emphasize might, be able to prevent the tight money policy from causing high unemployment.
Notice that I mentioned wage controls, not price controls. The dirty little secret of wage/price controls is that the government’s actual objective is to control wage growth, and the price controls are a fig leaf added to make the policy seem more “fair”, thus making it more politically feasible. The UK government was more honest than most, calling them “incomes policies”.
So why don’t wage/price controls work in the real world? Because they only work if you assume a competent and well-intentioned government, and if you had a competent and well-intentioned government then you never would have had the high persistent inflation in the first place.
Thus in 1971, the corrupt Nixon administration tried to juice the economy with expansionary monetary and fiscal policy in order to get re-elected in 1972, and then simultaneously imposed wage/price controls to delay the adverse effects of this stimulus until after the election.
If you have a credible 2% inflation target, then there is absolutely no benefit to wage/price controls. If you don’t have a credible monetary policy, then wage/price controls won’t solve your problem.
READER COMMENTS
Stéphane Couvreur
May 3 2022 at 4:55am
Regarding the carbon tax at 23:20, I am not surprised that a government official speaks of this instrument as her preferred option to reduce carbon emissions. What I find more surprising is the lack of reaction of economists, who could argue that cap-and-trade is preferable. There can be a reasonable debate about this claim, of course, but I believe cap-and-trade to be preferable because:
1) it doesn’t have the word “tax” in the title and generates no revenue for the governement (provided that the quotas are allocated for free),
2) as a consequence of 1), there is no need to redistribute the receipts from the carbon tax as is standard with a Pigouvian tax,
3)
Jon Leonard
May 6 2022 at 5:36pm
A key difference between a carbon tax and a cap-and-trade system is how they handle errors in forecasting. That is, under a tax system it is easier for individual businesses to adjust if the overall target was chosen incorrectly. Under a cap-and-trade regime, the total amount of pollution is pre-determined; this either pollutes more than necessary if the cap is “too high”, or stifles the economy more than necessary if the cap is “too low”. As in many cases in economics, the central plan can be suboptimal.
Stéphane Couvreur
May 3 2022 at 5:08am
(Oops!)
3) as a consequence of 2), there are fewer opportunities of rent-seeking and buying constituencies with the said tax receipts.
I have seen no economist making those points. Nordhaus prefers the tax because, as he writes in an endnote, quotas are more susceptible to cause corruption in developing countries. Sumner considers “foolish” the idea of allocating the quotas for free in a cap-and-trade system (I don’t understand why, cf. opportunity cost). Harford considers that a tax or a cap-and-trade are almost equivalent and points to Weitzman’s 1974 “Prices vs quantities” article. Levitt fears that firms would be better at distorting politically the allocation procedure in a cap-and-trade system than with a tax.
Do you have an opinion on the subject, David?
Best regards,
Stéphane
David Henderson
May 3 2022 at 7:03pm
Stephane,
I have two opinions.
First, either the tax or the cap and trade opens things to rent seeking. Your point #3 applies, but you didn’t mention the extensive fight that would go on as various firms, individuals, and governments pushed for more than their pro-rata share of permits. It’s hard for me to judge which is worse.
Second, your point about not getting revenue for the government is a good one. They’re likely to waste a lot of it. In my ideal world, which I think is highly unlikely, given the political system, the revenue would go to reducing the federal debt or reducing the most distorting taxes, dollar for dollar. Those are likely to be taxes on capital. But the political pressure would be strongly against that and in favor of giving each person and household a check. So the chance to either pay down the debt or reduce distorting taxes would be wasted.
A bigger point, in my view, is that there’s not much justification at this point for either. Remember that the goal is to “solve” global warming, not to reduce carbon usage per se. Reducing carbon usage is one way to do so, but there’s virtually no evidence that it’s the least-cost way. I think that some form of geo-engineering is likely to be substantially less costly.
Stéphane Couvreur
May 4 2022 at 1:07am
Thanks a lot for this long and thoughtful response.
A quick reaction:
Your third and bigger point is entirely right. No system solves for the optimal trade-off between reduction and adaptation. I will keep this in mind.
As for the first point, as long as there is some emission reduction, I believe cap-and-trade offers fewer opportunities for rent-seeking. Here’s why:
– it can be organized to be a one-time thing, so the rent-seeking contest occurs only once, initially, whereas the fight for the carbon tax receipts can go on forever;
– there is not much in it for bureaucrats, whose task would be to monitor emissions and not to regulate or collect a tax, so there’s a chance they will be more impartial.
Going back to your third point, I agree that cap-and-trade is far from “perfect” in any meaning of the word. Most economist I’ve heard criticizing it had a very different argument: “The price of tradable permits turns out to be too volatile to encourage firms to invest in carbon reduction technology”, they say (sic).
Your answer is implicitly that adaptation is better than reduction. This makes a lot more sense. It was also David Friedman’s answer.
Stéphane
David Henderson
May 5 2022 at 10:41pm
You’re welcome.
Good point about one-time.