Will the Real Price Administrator Please Stand Up!
APRIL 01, 1966 by IRVING E. HOWARD
The Reverend Mr. Howard is assistant editor of Christian Economics and is working towards a doctoral degree in economics at New York University.
Americans saw a display of naked arbitrary power in the recent roll-back of aluminum, copper, and later, steel prices in response to government threats or "persuasion." It brought a warning comment in The Wall Street Journal (January 5, 1966): "The structural steel price increase announced in the past few days threatens to usher in a new era of informal but intensive Presidential price control."
Government intervention in the pricing process is not new in American history. In fact, it has a long pedigree in antitrust legislation, as recounted by former Federal Trade Commissioner, Lowell Mason:
As an administrator of two antitrust laws diametrically opposed to each other, it was not difficult for me to accuse everybody at a trade convention with being some kind of a lawbreaker. Either they were all charging everyone the same prices, indicating a violation of the Sherman Act, or they were not charging everyone the same price, a circumstance indicating a violation of the Robinson-Patman Act.
Yet the purpose of the Sherman Antitrust Act was to protect competition and keep the market free. While the Act was being debated in the Senate in 1890, Senator Hoar declared: "The great thing that this bill does, except affording a remedy, is to extend the common-law principles, which protected fair competition in trade in old times in England, to international and interstate commerce in the United States."
The legislators sincerely thought that they were enlarging freedom again in 1914 when they passed the Federal Trade Commission Act and the Clayton Act. The Federal Trade Commission became an investigative body of which Lowell Mason was an administrator. By forbidding discrimination in price between different purchasers of commodities, the Clayton Act introduced the contradiction to which Mr. Mason referred.
Cost-of-Production Theory of Pricing
In 1936, still bent on keeping the market free, the legislators passed the Robinson-Patman Act which, among other things, forbids price discrimination in the form of discounts, rebates, or advertising allowances greater than available to competitors. The drafters of this Act reasoned that prices are discriminatory if they are not matched by like differences in costs. This kind of thinking reaches back to Adam Smith, David Ricardo, and to the labor theory of value. Is economic value determined by the cost of labor involved in manufacture? Economists exploded this notion a century ago, and the gist of their rebuttal is found in a simple example: "Pearls are not valuable because men dive for them, but men dive for them because they are valuable." The price of a good — its economic value — is measured by the satisfaction the economic good brings to the consumer.
For example, what of a theater that charges a lower price for a matinee than for the evening performance? It is the same show. The costs of producing it are practically the same. Is the theater guilty of price discrimination by charging a lower price in the afternoon? If differences in cost are to be the criterion, they are. If the satisfaction of the consumer (demand) is the criterion, they are not. The Robinson-Patman Act foundered upon this misunderstanding of the nature of economic value.
Moreover, the history of antitrust legislation in America illustrates another principle emphasized by Dr. Ludwig von Mises — namely, that one government intervention inevitably leads to another, and that to another, until all freedom of movement is lost in a maze of government regulations.
Berle and Means
It was against such a background that Adolphe A. Berle and Gardner C. Means set forth their theory of "administered prices." Means’ book, Pricing Power and the Public Interest. A Study Based on Steel,’ contains the most complete statement of the theory.
By an "administered price" these economists mean a price set by administrative action, rather than one resulting from market forces, and held constant over a period of time. They contend that large corporations in oligopolistic markets (few sellers and many buyers) have sufficient control of the market to do this.
At first, Dr. Means thought he had found the cause of the Great Depression. Large corporations, he argued, held their prices firm and varied their production, laying off men, creating unemployment, and thus worsening the depression.
In 1939, Dr. Jules Backman published "Price Flexibility and Changes in Production"² in which he said: "Not so!" He concluded that he could find no clear-cut relationship between specific commodity prices and production changes.
In 1942, Professor Alfred C. Neal joined Dr. Jules Backman in rejecting Means’ thesis. In his study, Industrial Concentration and Price Flexibility, he commented:
… one must be excused for wondering why so much ink has been spilled in debating these issues when there has been so little theoretical presumption in favor of the conclusions under dispute. There is, perhaps, much truth in Du Brul’s remark that if Mr. Means’ thesis had not been useful as a tool of politics, it would have died an early death.3
Political value it has had! The Berle-Means theory resulted in the Kefauver Committee making a three-year study of steel, automobile, and drug prices beginning in 1957.
Out of the hearings of this Committee, Dr. Means drew much material for his book, Pricing Power and the Public Interest. In this book, published in 1962, Dr. Means reversed his earlier theory and argued that administered prices cause an inflation. In fact, he coined the phrase, "administered inflation," to describe the inflation in 1955-1958. Professor Gottfried Haberler has thoroughly discredited Dr. Means’ "administered inflation" in his book, Inflation — Its Causes and Cures,4 but the mere fact that "administered prices" were supposed to have caused a deflation, and then also to have caused an inflation, should have been enough to raise a suspicion regarding the inherent consistence of Means’ thesis.
Price and Wage Guideposts
However, the theory had political value, and politicians were soon to make the most of it. In 1962, the Economic Report to the President suggested wage and price guideposts as a ceiling for increases in wages and prices. In adopting this guidepost concept, the Council of Economic Advisers were tacitly admitting that they had accepted the theory that prices and wages are administered and are not the result of market forces. Consequently, the conclusion was soon reached that, since the prices of commodities manufactured by large corporations are determined by management rather than by the market, the government should control the pricing policy. Wages have remained strangely immune to the application of the guidepost standard.
The recent application of the guidepost to aluminum, copper, and steel prices has ignored the fact that the philosophy behind the guidepost concept, the business-administered price theory, has never been proved. In fact, evidence has been accumulating that the relative inflexibility of the prices under discussion has been the result of inflexible wage rates which have been administered by national labor unions, and also stems from other inflexibilities introduced into the economy by government fixed rates, such as freight rates, public utility rates, postal rates, interest rates to say nothing of agricultural support prices and a host of other government controlled prices. These are "administered prices" indeed!
The so-called "administered prices" of private industry are very sensitive to foreign competition. Both steel and automobile prices, favorite whipping boys of the Kefauver Committee, have been driven down by foreign competition since this debate started. Moreover, metals all face competition from substitute materials. While prices in large corporations cannot be determined by an auction like securities on the stock exchange, nevertheless, management cannot disregard all the different kinds of competition its product must face when setting its asking prices.
There is much more to competition than Berle and Means and their followers are willing to admit. Not only is there competition between firms within an industry, and companies within a family, such as the General Motors family, but there is competition between very different industries. There is also competition from all kinds of substitutes. There is nonprice competition in quality and services. In short, the real world is much more competitive than it is painted by some economists.
The Magical "3.2"
Not only is the "administered price" theory open to question, but the guidepost itself is of doubtful value as a measure of prices. The guidepost is the ratio between total output and total man-hour input. It was devised by economists interested in national economic growth as a rough measure of productivity. Politicians have applied it to prices and wages.
In 1965, the government arrived at 3.2 per cent as its guidepost. Some statisticians thought it should be 3.4 per cent and others chose another percentage, but is any percentage trustworthy as a measure of prices and wages?
Total output and total man-hour input are only rough estimates and are not precise enough to determine the specific price of anything. Moreover, at best, the guidepost ratio is a five-year moving average! How many individuals or companies are average? The price and wage increases of some should be above and others below that five year average!
Nevertheless, the guidepost ratio was the yardstick the government used in its recent assault upon aluminum, copper, and steel. A price resulting from such dictation, is an "administered price." The guideposts are supposed to be "voluntary" standards, but as Mr. George Champion, chairman of the Chase Manhattan Bank, has observed, "Always in the background is the threat that failure to comply voluntarily with the guidelines would bring measures applied, for the most part, without debate in Congress or legal appeal in the courts."
The Limits of Tolerance
The most disappointing aspect of this new development between government and business has been the sheeplike acceptance of government domination by the business community.
"This is no time to be timid of tone or fearful of economic reprisal," Mr. Champion warned. "If we have men afraid of standing up to the government, then we have the strongest indictment of `big government’ that could ever be imagined. When that happens, economic freedom in our country will be dead."
The Berle-Means thesis that large corporations fix inflexible prices has been exploded by competent economists. Nevertheless, bureaucrats have used the theory to justify government administered prices. Now we see where the "administered price" theorists were going! Now the real price administrator has stood up and has been recognized!