15A045 Reflections on Prices by Jim Davies, 7/23/2015    


Recently in the viewer-comment section of the PBS News Hour web site, I had the chance to introduce readers to the Austrian school of economics. I've never heard it mentioned on the News Hour, so presume that it was new to most.

Austrians have a distinguished history of scholarship spanning 150 years, and take the approach opposite to orthodox or "macro" economists so beloved of government people. The macro mandarins speak in terms of aggregates; how big is the GDP, what will be the effect of a change in money supply, how can an unemployment rate be lowered, etc. much as Captain Schettino saw his cruise liner; levers to be pulled, knobs to be twisted, buttons to be pushed, and helms to be swung to port or to starboard.

In contrast, Ludwig von Mises' magnum opus is called Human Action, because Austrians look first at how individuals behave in the marketplace. It's a "micro" approach to economics, which begins, rightly, with the choices made by free participants. He made frequent use of the term praxeology, meaning the study of what individuals purposefully do.

Von Mises' most famous prediction, based on this understanding, came in 1922 and held that the USSR was unsustainable. It took a long time before he was proven right (in 1990) because the country was propped up by repeated injections from Western governments, but eventually it imploded - for exactly the reason von Mises had given: the lack of freely moving prices, in its socialist system. Lacking that vital guidance, it ran aground.

Prices are priceless. They form continuously as a result of vast numbers of deals between people expressing their preferences for goods, services and money, and serve as signals to all players in the marketplace. If the price of a widget is found to be rising, it reflects increasing demand so widget makers rush to make more, so as to take advantage of the profit opportunity; and conversely if it falls, they slow down production so as not to waste resources or to cut losses. It's a constant, dynamic balance or ballet, price being the choreographer. Without price signals, nobody can know what to do. There may be a surplus of shoes, a shortage of vodka, and debates about which is worse.

So, Soviet planners had no idea what to make or in what numbers. It wasn't just that they took the arrogant step of directing production quotas and abolishing markets, it's rather that after doing so, they did not and could not have any idea of what quotas to set: they had to guess. Often, the guess was inspired by what similar products were fetching in the more-free West! Von Mises understood that, and so formed his prediction. Nobody else did.

Prices, or their absence, have a huge effect in our own society, much of which has been ruined by government intervention. Consider urban schools for example. The service offered is to pretend to give children twelve years of instruction in various fields of knowledge including reading, writing and math, so as to prepare them for adult life. They will be scanned for handguns every day on entering the premises, and may be strip-searched for drugs on the Principal's whim. No child will be expelled and discipline will not be imposed, so rather often, classroom instruction is impossible to deliver; the student will graduate hardly more literate than the day he entered kindergarten. What price would you offer for this service?

Obviously, nothing. There will be no deal - or certainly, not enough to make a K-12 institution viable in any such location. Therefore, there is no price signal at all. The whole idea of setting up such a school would, in a free market, be dropped. Yet government intervenes and forces the system to exist, and to be paid for collectively at gunpoint.

What price good medical care? - it's impossible to know, because almost nobody pays directly the price charged for what's provided. In the coming free market system, prices will rapidly adjust to show what kind of services are wanted and which, not. Today the trappings are all top-of-the-line, not just the equipment but even the furnishings of physician and hospital premises; the wastage is enormous. If you were a self-sustaining provider, dependent on revenues from patients, you would economize unless safety were a serious issue. There would be an active market in good used equipment. Cost management would be a priority; today it hardly matters, for "someone else will pay."

The price of labor is a strong indicator of what is wanted and where. If too few respond to a "Help Wanted" sign, the price (the offered wage) is raised until it attracts enough, as long as the employer calculates will still net him a profit. Or if a freshly-minted sociology graduate cannot find an offer to match her expectations, she must lower her price (salary requested) until one is. Or, perhaps, write off the cost of obtaining that degree and start over, in a new field of work where her skills are in demand. Price, always, signals the action needed, and immense hardship is caused when that price is mandated by law instead of negotiation, such as the minimum wage. That prohibits two people reaching agreement for low-price labor, and so hurts both. It's a major cause of the present 23% unemployment rate.

The price of money is critically important, for money is involved almost everywhere; and by its "price" I mean the cost of borrowing some, ie the interest rate. If it falls low, there is a signal to those considering adding capital equipment to their enterprise that now is a good time to do it. So businesses are extended for greater production, provided of course that the products are in healthy demand. Conversely if money available for loans has been largely used up, its price will rise and so signal against further expansion. Thus, in an unfettered market or ZGS, there will be an automatic "governor" on the engine of the economy. It grows not by fits and starts, but rationally and naturally.

When however the market is far from free, as today, that signal is distorted. For several years past the interest rate, or price of money, has been artificially depressed by the FedGov in the arrogant hope of causing prosperity by political fiat; they call it a "stimulus." As it happens, decision makers are getting wiser; they are recognizing that fraud for what it is, and are not buying it. Cheap money is being stored instead in the stock market, leading to artificially high prices there, which trigger a separate round of false signals and hence mainvestments. Confidence that solid investment in plant and equipment would yield added future profits is low, so even an almost zero cost of borrowing is a temptation being resisted. I think this has no precedent, and wonder how it will end.

Stock markets, too, can give false price signals when government intervenes. Right now the Chinese one is in steep decline, which is a signal to look for the reasons (I'd begin by finding out whether the massive, centrally-planned construction of empty cities suddenly stopped) but the government recently intervened by prohibiting for six months the sale of stock by anyone holding more than a 5% stake in any company. Outrageous! Now, it will be impossible for other stockholders to tell whether the managers think they can turn the company around, or not. Its stock price will give a wrong signal, courtesy of politicians. The ordinary investor will be the one most hurt.

Another way price movements make markets efficient comes from an attribute called price sensitivity. If it's possible to measure demand changes resulting from price changes, we have a parameter very useful for planning. Suppose a price doubles: if the demand falls by half, we have a price sensitivity of 1.0. If it falls only by one-tenth, the price sensitivity is said to be 0.1, which is very low.

That is particularly interesting in the illegal-drug business. The demand from regular users of these mood-enhancers has been surprisingly steady for over a century; about one person in twelve remains a regular buyer even though prices have risen a hundredfold. Their PS is therefore close to zero. Consequently when the price is brought down again close to that of aspirin, in the coming zero government society, demand is very unlikely to change much. This is an adequate reply to those who object to freedom on the spurious grounds that if all anti-drug laws were repealed everyone would get stoned out of its mind.

Everyone will certainly be out celebrating - but mainly, I expect, with champagne.

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