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.

Why Did WWII Lift America Out of Depression?

Although I would add some caveats and a few more significant reasons, none other than the libertarian Robert Higgs (more or less) hits the nail on the head:

“Notwithstanding the initial availability of much unemployed labor and capital, the mobilization became a classic case of guns displacing both butter and churns. So why, apart from historians and economists misled by inappropriate and inaccurate statistical constructs, did people—evidently almost everyone—think that prosperity had returned during the war?

The question has several answers. First, everybody with a desire to work was working. After more than 10 years of persistently high unemployment and the associated insecurities (even for those who were working), full employment relieved a lot of anxieties. Although economic well-being deteriorated after 1941, civilians were probably better off on the average during the war than they had been during the 1930s. Second, the national solidarity of the war effort, though decaying after the initial upsurge of December 7, 1941, helped to sustain the spirits of many who otherwise would have been angry about the shortages and other inconveniences. For some people the wartime experience was exhilarating even though, like many adventures, it entailed hardships. Third, some individuals (for instance, many of the black migrants form the rural South who found employment in northern and western industry) were better off, although the average person was not. Wartime reduction of the variance in personal income—and hence in personal consumption—along with rationing and price controls, meant that many people at the bottom of the consumption distribution could improve their absolute position despite a reduction of the mean. Fourth, even if people could not buy many of the things they wanted at the time, they were earning unprecedented amounts of money. Perhaps money illusion, fostered by price controls, made the earnings look bigger than they really were. In any event, people were building up bank accounts and bond holdings; while actually living worse than before, they were feeling wealthier. Which brings us to what may be the most important factor of all: the performance of the war economy, despite its command-and-control character, broke the back of the pessimistic expectations almost everybody had come to hold during the seemingly endless Depression. In the long decade of the 1930s, especially its latter half, many people had come to believe that the economic machine was irreparably broken. The frenetic activity of war production—never mind that it was just a lot of guns and ammunition—dispelled the hopelessness. People began to think: if we can produce all these planes, ships, and bombs, we can also turn out prodigious quantities of cars and refrigerators.”
Robert Higgs. 1992. “Wartime Prosperity? A Reassessment of the U.S. Economy in the 1940s,” Independent Institute, March 1
http://www.independent.org/newsroom/article.asp?id=138

First, the command economy put an end to unemployment, and not only that but many discouraged workers (or the “hidden unemployed”) were brought back into the labour force. We can see the reduction in unemployment in the graph below (in which the estimates are those of Darby (1976: 8), whose better method for calculating the figures is explained here).

The sheer absurdity of asserting that “no economic good” of any kind came out of the war is refuted by this point alone. Many people no longer had to experience the grinding poverty of unemployment, and obtained work on the home front when the war started. And they obviously chose that work over being unemployed.

For anyone who subscribes to a subjective theory of value, it is obvious that many individuals must have obtained subjective value (or an “economic good”) from the newly created civilian employment they received during the war, even if nobody would seriously doubt that the hours in many of these jobs were long and the work difficult.

Secondly, the war allowed the accumulation of savings and money income. The point overlooked by Higgs is that this also allowed both business and consumers to finally complete the process of deleveraging and paying down private debt to a low level. That is a fundamental point: the debt deflationary drag on the US economy was eliminated during the war, as we can see in this graph (in the “private debt” line).

Thirdly, the war fundamentally shifted business expectations from being highly pessimistic to a strong optimism that emerged after the conflict ended.

With the end of the war, when expectations had become optimistic, there was a private investment and consumption boom, which was in part fuelled by the drawing down of savings earned in the war. That outcome is a Keynesian story.


BIBLIOGRAPHY
Darby, M. R. 1976. “Three-and-a-Half Million U.S. Employees Have Been Mislaid: Or, an Explanation of Unemployment, 1934–1941,” Journal of Political Economy 84.1: 1–16.

Higgs, Robert. 1992. “Wartime Prosperity? A Reassessment of the U.S. Economy in the 1940s,” Independent Institute, March 1
http://www.independent.org/newsroom/article.asp?id=138

Higgs, Robert. 1992. “Wartime Prosperity? A Reassessment of the U.S. Economy in the 1940s,” The Journal of Economic History 52.1: 41–60.

The Success of America’s Command Economy in WWII

Here is an astute author on America’s command economy during the Second World War:

“In 1940 and 1941 the economy was recovering smartly from the Depression, but in the latter year the recovery was becoming ambiguous, as substantial resources were diverted to war production. From 1942 to 1944 war production increased rapidly. Although there is no defensible way to place a value on the outpouring of munitions, its physical dimensions are awesome. From mid-1940 to mid-1945 munitions makers produced 86,338 tanks; 297,000 airplanes; 17,400,000 rifles, carbines, and sidearms; 315,000 pieces of field artillery and mortars; 4,200,000 tons of artillery shells; 41,400,000,000 rounds of small arms ammunition; 64,500 landing vessels; 6,500 other navy ships; 5,400 cargo ships and transports; and vast amounts of other munitions. Despite countless administrative mistakes, frustrations, and turf battles, the command economy worked. But, as always, a command economy can be said to work only in the sense that it turns out what the authorities demand. The U.S. economy did so in quantities sufficient to overwhelm enemy forces.” (Higgs 1992).

That is correct.

But who is the author of this passage? Some “statist”?

It is none other than the libertarian Robert Higgs, who is cited ad nauseam by other libertarians, but I doubt whether many bother to cite this passage. (As an aside, I have a sneaking admiration for Higgs for reasons which I will perhaps explain in another post.)

Now once it is understood that command economies were mostly run on the basis of “planners’ sovereignty” and not “consumer sovereignty,” the debate about whether command economies “work” either in a theoretical and empirical sense becomes much more interesting than the tired and grossly exaggerated themes of Mises’s Socialist Calculation Debate.

Some command economies failed. Others have succeeded. The former communist states like the Soviet Union did not operate their economies on the principle of “consumer sovereignty.” These were command economies with production decisions by planners. If one assumes that the output of the command economy is planned by administrators by their own designs, then one will have to measure the success of their planning by whether the output produced did actually match their plans.

The Western command economies during WWII in America, Canada, the UK, Australia and New Zealand were very successful indeed: they more or less produced what was planned and won the war for Western democratic civilisation.

BIBLIOGRAPHY
Higgs, Robert. 1992. “Wartime Prosperity? A Reassessment of the U.S. Economy in the 1940s,” Independent Institute, March 1
http://www.independent.org/newsroom/article.asp?id=138

The Broken Window Fallacy and WWII

The problems with the libertarian use of the broken window fallacy and WWII are illustrated well by these videos.






The problem with invoking the broken window fallacy in reference to WWII is this: it implies that all military actions and wartime production was literally done only and solely for the purpose of creating jobs and producing something. That is, the war had no purpose in itself and was like the random destruction of a hooligan smashing windows motivated by the belief that his vandalism is justified just because people will be paid for fixing the broken windows.

The libertarians invoking the broken window fallacy here are guilty of the truly bizarre inability to accept that

(1) US war spending was done in order to defeat Nazi, Italian, and Japanese fascism, and defend the democratic world from tyranny, and

(2) that war spending did indeed have the concomitant consequence that US income, employment and output increased, even if it was obviously not the type occurring in peacetime.

These facts do not entail that any Keynesian economist advocates war or natural disaster as a way of stimulating the economy.

The absurd assumption of the libertarian critics is that the wartime economy must have been simply like a peacetime economy in all respects (something which I do not think any Keynesian has claimed), so that the discovery that it was not is then touted as some devastating argument against economic benefits that the US command economy did have. Amongst those benefits was that (1) private sector income was increased and this allowed a substantial reduction in the level of private sector debt (which had been a major drag on the economy since 1929), and (2) the accumulation of both personal and corporate savings during war that could be drawn down after the war ended.

Moreover, the assertion that all war employment did not contribute to private sector growth is unconvincing. First, there is the scientific and technological advancement that occurred via employment, spending and R&D related to the war, such as jet propulsion, new aeronautic technologies, radar technology, nuclear technology, surgical innovations, and so on. These technologies provided lucrative to private sector businesses and still are.

Secondly, many industries were created or strongly developed in new ways in the war years, and proved to be just as important after the war ended, such as the aeronautics, motor vehicle, pharmaceuticals and antibiotics industry. Many of capital goods created in the war years were also useful after the war ended, directly or with some adaptation.

The argument that wage and price controls distorted real GDP figures, while true, has little force given that (1) much of the production in the war was not for the private sector, but the government sector, and (2) that the private sector itself practices massive administration of prices even in peacetime, yet that does not stop people from buying what they want and shunning what they do not want.