Wednesday, December 11, 2013

John Kenneth Galbraith on Price Controls

This fascinating passage from John Kenneth Galbraith’s A Theory of Price Control (1952) gives us a crucial insight into Galbraith’s prices controls when he worked as deputy head of the Office of Price Administration (OPA) from 1941 to 1943 during World War II:
The next major respect in which the imperfect market assists the price-fixer arises from the tendency for prices to be inflexible and also, in some measure, institutionalized, in such markets. Where the seller has control over his prices—and ex hypothesi he has some measure of control in every imperfect market—he may for any one of a number of reasons seek to minimize the frequency of price changes. In some instances, market control, the entente between sellers itself, can be maintained only if prices are stable; the understanding may not be sufficiently complete or durable to survive too many ups-and-downs. In other cases, customers, or the Department of Justice, may have become accustomed to stable prices and may be aroused by change. Changes in prices also may be costly either in money or administrative convenience. Accordingly, profit maximization in an imperfect market may require that prices be kept constant over substantial periods; the price changes that would be required by any attempt to keep profits at a maximum at every point of time would reduce returns over a period of time.

The phenomenon of inflexible prices had been well-observed before the war, but so far as I am aware (and for good enough reasons) no one had observed that this inflexibility would facilitate wartime control. The contribution was considerable. Not only had buyers and sellers in markets characterized by rigid prices become accustomed to the level of the price, but they had also become familiar with the differentials, discounts, special deals, and all the other appurtenances of the price structure. It is much easier to continue and enforce such a settled and familiar structure than to check the upward surge of a more nearly competitive market. And in competitive markets, because differentials and discounts, like the level of prices itself, may change in day-to-day bargaining, no price schedule is as likely to conform neatly to a past structure. So, precisely at the time when sellers or market operators in such markets lose the prospect of higher prices or speculative gains, they must alter their business to conform to rules laid down in some not very engaging government prose.

For such sellers, compared with those who have been selling at infrequently changing prices, the discomforts of price control are great. The Office of Price Administration controlled the prices of all steel mill products with far less man power and trouble than was required for a far smaller dollar volume of steel scrap. Handlers of farm products complained with especial bitterness of OPA regulations, perhaps partly because it is their nature to complain, but partly because, as participants in competitive markets, their difficulties were greater. I am tempted to frame a theorem that is all too evident in this discussion: it is relatively easy to fix prices that are already fixed.

Infrequent changes in prices may best serve the long-run earnings position of a firm or industry. There is also a strong element of convention in price-making, which works on the side of infrequent change, and which does not directly serve the goal of maximum return. Traditionally (or in textbooks, at least), custom or convention has been considered an exceptional or off-type factor in price-making. The experience of modern wartime price control, I believe, would indicate its more general importance. It, too, helped the price-fixer.

The stronghold of conventional or customary pricing is in distributors’ margins, particularly in retail selling. For a large proportion of all retailers and a rather smaller proportion of all retail trade, the price charged for the service is a strictly conventional markup or ‘mark-on.’ Sometimes this is the markup suggested by the supplier; sometimes it is conventional with the store or trade for that particular class of merchandise. In either case, price control was invoked in markets in which participants had ceased to look upon price-setting as one of the exploitive or profit-making decisions on which the revenues of the business depended.”
(Galbraith 1952: 15–17).
The significance of this passage is clearly that price control was relatively easy in many US markets precisely because these were markets that already had private sector price administration: that is, relatively inflexible mark-up prices that are relatively easy to calculate and infrequently changed, and, when changed, are done so because of changes in total average unit costs or the level of the profit mark-up.

In these markets, prices are not conveying information about supply and demand or performing some Hayekian informational and allocative role (Dunn 2011: 131).

When US bureaucrats like Galbraith found so much of the US economy under private price administration, as he says above, their controls were much easier to calculate and implement.

Conventional economic arguments against price control do not work in these sectors, because these sectors simply do not have the price taking behaviour required in neoclassical theory in the first place.

In his later price control theory, Galbraith argued that effective price control should be limited to the mainly oligopolistic mark-up pricing sector (Dunn 2011: 131), which is a large part of any modern capitalist economy and an important source of inflation, the worst form being wage–price spirals.

Colander, David. 1984. “Galbraith and the Theory of Price Control,” Journal of Post Keynesian Economics 7.1: 30–42.

Dunn, Stephen P. 2011. The Economics of John Kenneth Galbraith: Introduction, Persuasion, and Rehabilitation. Cambridge University Press, Cambridge and New York.

Galbraith, John Kenneth. 1952. A Theory of Price Control. Harvard University Press, Cambridge, Mass.


  1. Hmm... I read Galbraith's book when I was a lot younger, It had a big impact on me. As did The New Industrial State. But I came away from it thinking: "there is no such thing as a theory of price now, at least in any 'neat' economic manner". I still think that to a very large extent. Prices are totally institutional. That is why I'm trying to put together some sort of framework to discuss them. In this regard, this post ties what I'm doing to Galbraith (his son complimented me on it, btw!):

  2. Is this guy for real? I mean he isn't talking about economics but about a bureaucrat's wishful thinking.

    1. Yes, Anthony Lima, I suppose the reasonably successful price control that America -- and indeed some other Western nations -- did in WWII was just a "bureaucrat's wishful thinking." Presumably you think it never happened.

      Your comment is idiotic and you deserve to be told so.

    2. Hand flying over head! Totally missing the point. I don't question that price controls happen. I question someone that thinks a firms price setting is how the market works.
      It's how firms work when it's impractical to auction every item they sell.

    3. "I question someone that thinks a firms price setting is how the market works.

      It's how firms work when it's impractical to auction every item they sell."

      You contradict yourself.

      On the one hand you imply that price administration by firms does not even happen ("I question someone that thinks a firms price setting is how the market works.")

      But then you immediately say it does happen ("It's how firms work when it's impractical to auction every item they sell.").

  3. Oh, you are right. A firm does decide what price they want to offer an item for on the market. Then all they have to do is administer prices for the factors so that they make a profit. So the entire economy is based on valuing factors and tacking on a profit.

  4. "So the entire economy is based on valuing factors and tacking on a profit."

    Galbraith never claimed that the "the ***entire economy*** is based on valuing factors and tacking on a profit".

    He said that an *important and large* part of the economy has markets where the administered prices are set by total average unit costs plus profit markup.

    That is correct. The empirical research from 70 years shows every first world major capitalist economy is.

    E.g., Shim and Sudit (1995: 37) and Govindarajan and Anthony (1986) found that from the 1980s to the 1990s full cost pricing accounted for roughly 70% to 85% of US industrial prices: