Consider, for instance, the run-up of prices in early 2008, especially in gas and oil and food stuffs; additionally, prices on an average basket of goods purchased increased by nearly 4 percent in the United States and by 5.5 percent for the global economy. Such rates harken back to the 1970s. How could we assess a recommendation for mandatory
FIGURE 1.10
Inflation and Nixon's Price Controls
Wage and price controls as a means to combat inflation? Figure 1.10 traces a decade of inflation and reveals our experience with wage and price controls during the Nixon years. President Nixon’s opinion at the time was that the controls would benefit the economy.
As shown in Figure 1.10, Nixon’s controls (a choice made within his administration) were imposed in August 1971, when the inflation rate was 3.5 percent. The precontrol peak rate of inflation was 6 percent in early 1970 and was actually falling at the time controls were imposed. The rate of inflation continued to drift downward and remained around 3 percent throughout 1972; it started to rise in 1973, and by the time the controls were completely lifted in early 1974, the rate was 10 percent and rising.
On the face of it, controls did little to stop inflation. But what explains this dismal record? Were the controls themselves to blame, or were other factors responsible? Only a careful study of the period can identify the role of controls in the acceleration of inflation. A contrast between Nixon’s price controls and those imposed during the Korean War (which were not followed by a price explosion after controls were lifted) suggests two important things to look at: monetary and fiscal policies.
Price controls, moreover, disrupted the smooth functioning of the economic system. For example, to circumvent the Nixon controls, the U. S. lumber industry regularly exported lumber to Canada and then reimported it for sale at higher prices. (Refer to Economic Reasoning Proposition 4: institutions [rules] matter.) As fertilizers and chemical pesticides became more profitable to sell abroad than at home, agricultural production suffered for want of these essential inputs. (Recall Economic Reasoning Proposition 3: incentives matter.) These and many other similar disruptions to production decreased the growth rate of goods and services and, therefore, the inflation was worse than it otherwise would have been. We cannot explore this issue in depth here. Our point is simply that to evaluate policy proposals, we must inevitably turn to the historical record.1
The use of wage and price controls during World War II provides another example adding to our understanding of their effectiveness. One important lesson this episode teaches is the need to supplement quantitative studies with historical research. An economist cannot naively assume that price statistics always tell the truth. During the war, controls were evaded in numerous ways that were only partly reflected in the official numbers despite valiant efforts by the U. S. Bureau of Labor Statistics. One form of evasion was quality deterioration. Fat was added to hamburger, candy bars were made smaller and had inferior ingredients substituted, coarser fabrics were used in making clothes, maintenance on rental properties was reduced, and so on. Sometimes whole lines of low-markup, low-quality merchandise were eliminated, forcing even poor consumers to trade up to high-markup, high-quality lines or go without any new items. And, of course, black markets developed, similar to current ones in controlled substances, such as marijuana, have done. The job of the economic historian is to assess the overall effect of these activities.2
World History
