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.


BIBLIOGRAPHY
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.

John Kenneth Galbraith on Administered Prices

John Kenneth Galbraith’s The New Industrial State (1985) is a classic book, and rightly so. It is not just that Galbraith provided an insightful (old) Institutionalist perspective on economics (with a nice dose of heterodox Keynesianism), but he was also a wordsmith.

I summarise Galbraith’s analysis of prices here. One must remember that some of Galbraith’s observations were written with respect to the US economy of the 1970s.

Galbraith notes the many US markets are oligopolistic and prices set by businesses based on costs with relatively inflexible prices (Galbraith 1985: 188).

Galbraith argues that

“Once established, industrial prices tend to remain fixed for considerable periods of time. None supposes that prices of basic steel, aluminum, automobiles, machinery, chemicals, petroleum products, containers or like products of the planning system will be sensitive to the changes in cost or demand which cause constant price readjustments for commodities, such as lesser agricultural products, where producers are still subject to control by the market. This stability of prices, in face of changing costs and demand, is a further indication, it may be noted, that in the short run the mature corporation pursues goals other than profit maximization.

Stable prices reflect, in part, the need for security against price competition.” (Galbraith 1985: 202).

Today we tend to call these “administered prices,” and how they are not confined to market oligopolies. Of course, Galbraith himself also knew that major changes in costs (above all, wages and energy) do have an important role in driving changes in administered prices (Galbraith 1985: 203).

Crucially, Galbraith himself stressed the importance of this idea for his work:

“[The New Industrial State] is built on the notion not of monopoly prices but broadly speaking of administered prices. It is administration which provides the certainty which the modern, very large technocratic organization requires. I have gone on from administration of prices to the management of the other economic parameters including that of consumer demand.” (J. K. Galbraith, Letter to Gardiner C. Means, August 19, 1970, as quoted in Lee 1998: 68, n. 2).

Galbraith famously called the industrial and corporate structure of America a “planning system,” because of the widespread existence of anti-market planning by these institutions, of which “price control”/administered prices was a fundamental element.

The first benefit of administered prices to a firm is stability of profit, and a minimum profit level (Galbraith 1985: 200). Truly flexible prices or price wars are shunned by many businesses as a grave threat to stability of profit.

The second benefit of administered prices is that they are a private sector method of reducing uncertainty. A truly flexible price system as dictated by the dynamics of supply and demand curve, as in neoclassical theory, introduces a high level of uncertainty into business life. But businesses don’t like this much. And administered prices provide a degree of predictability in the future planning of business production, estimation of profit level, and even costs (since one firm’s administered prices are another’s costs of production) (Galbraith 1985: 202).

Thirdly, relatively stable profits also allow stable capital investment, often important for productivity growth. On this point, Galbraith notes that government price regulation of certain agricultural commodities (as, for example, price floors) in advanced nations, far from being some “unnatural” practice, mimics the behaviour of private fixprice corporations, by providing stable income to farmers and allowing increased capital investments with new technology and strong improvements in productivity and greater output (Galbraith 1985: 199, n. 1).

In place of attempts to stimulate demand by cutting prices (which, we might note, evidence suggests do not always work anyway), fixprice businesses have developed other methods for increasing demand: advertising (Galbraith 1985: 208). This is a complex process, and for many businesses involves market research, creating a base of loyal customers and brand recognition (Galbraith 1985: 214).

If sales slip, in place of price cutting, generally a different strategy is employed:

“When a firm is enjoying patronage by its existing customers and recruiting new ones, the existing sales strategy, broadly defined, will usually be considered satisfactory. The firm will not quarrel with success. If sales are stationary or slipping, a change in selling methods, advertising strategy, product design or even in the product itself is called for. Testing and experiment are possible. Sooner or later, a new formula that wins a suitable response is obtained.

This brings a countering action by the firms that are then failing to make gains. This process of action and response, which belongs to the field of knowledge known as game theory, leads to a rough equilibrium between the participating firms. Each may win for a time or lose for a time but the game is played within a narrow range of such gain or loss.” (Galbraith 1985: 215).

In short, in place of price competition is another form of inducement of demand: business “demand management” by advertising, promotion, and product redesign.


Further Reading
“Early Literature on Administered Pricing,” May 8, 2013.

“Gardiner Means on Administered Prices,” June 20, 2013.

“Lachmann on Hicks on Fixprices,” May 13, 2013.

“Lachmann and Post Keynesianism on Prices,” August 1, 2012.

“Mises versus Lachmann on Equilibrium Prices,” December 17, 2012.

“Caldwell on Lachmann on Equilibrium Prices,” November 6, 2012.

“Kaldor on Economics without Equilibrium,” March 9, 2013.


BIBLIOGRAPHY
Galbraith, J. K. 1985. The New Industrial State (4th edn.). Houghton Mifflin, Boston.

Lee, Frederic S. 1998. Post Keynesian Price Theory. Cambridge University Press, Cambridge and New York.