Government price caps are again in the news again. The U.S. government is in the process of imposing them on key drugs as authorized by the Inflation Reduction Act. Across the Atlantic, the British government suggests their use not just for energy but now also for food retail.
These are not new reactions to inflation and escalating costs. They are in line with the natural knee-jerk reaction of politicians to impose price controls as a mistaken cure for rising prices. For example, in the 1970s both British Prime Minister Edward Heath and U.S. President Richard Nixon experimented with price caps of one sort or another. These experiments sparked shortages and sparked inflation after the caps were lifted, severely harming the British and American economies.
Price caps have a long and sordid history, dating back to at least 301 A.D. when the Roman Emperor Diocletian imposed maximum prices on key products and services. Diocletian’s “Decree on Maximum Prices” failed miserably. It generated a massive shortage of all goods and was quickly lifted.
In short, price controls have never actually succeeded in combatting inflation. Instead, they have sown the seeds of dangerously anti-competitive markets and structural impediments to economic growth in the medium and long term. As economist Pierre Lemieux explains, price caps cause shortages, increasing the quantity demanded of a good while reducing its supply. As a result, sellers invest less in the production of the good, leading to an inefficient undersupply of the product in the future, to the detriment of consumers.
In the case of energy, where the United Kingdom regrettably still operates a price cap — one which has often acted as a price floor rather than a ceiling — maintaining price regulation will cause energy producers to exit markets and thereby lessen competition. This will drive up inefficiency, increasing the ultimate costs of energy production which the taxpayer eventually has to pay.
An energy price cap invariably harms the economy, yielding higher prices and lower production. The fact that a U.K. price cap is now being openly talked about in the context of food and supermarkets is very troubling.
As for U.S. drug price controls, these can be expected to deter innovation and the future supply of new drugs, denying innovative new life-saving medicines to patients. Specifically, the U.S. Chamber of Commerce recently reported that in light of the Department of Health and Human Services Department price control plans, research and development into important blood cancer and eye disease treatments is being dropped. Furthermore, important R&D in the fields of RNA and radioligands may also be discouraged.
More generally, the Congressional Budget Office points out that “proposed regulation of some drug prices would affect the sales volumes of existing drugs and, as a result, expected returns on R&D on future drugs; in turn, lower expected returns would result in fewer new drugs.”
In a similar vein, an Americans for Prosperity analysis finds that “drug price controls result in drug shortages, lower research and development spending by pharmaceutical companies, fewer drugs reaching the market, and longer wait times for drugs that do.”
Government price cap regimes are a textbook case of what we have called “anti-competitive market distortions.” These distortions lead to increased costs and more inefficiency and ultimately must be paid for by taxpayers. There is a reason that reliance on free markets — which enable human beings to meet each other’s needs in voluntary exchange — has been the most efficient and cost-effective way of uniting consumer demand with supply.
The cost of food is not high because of any type of market failure in the sector. It is especially high in the U.K. because of massive energy cost increases caused by a price cap for consumers in that sector and through a lack of sufficient generation of power.
High drug prices are a function of the very risky and massive R&D needed to produce new drugs. Only a small proportion of drug R&D projects actually result in new drugs being marketed.
The lesson is clear: Government price controls that ignore the diverse market factors that affect the pricing of different goods and services are a recipe for harmful market failure, not economic betterment.
Governments need to start addressing the real reasons for inflationary pressures. They could start by curbing the massive deficit spending and excessive money supply increases that lie at the heart of inflation. They should not apply infected band-aids in the form of price cap regulations that make the patient worse, not better. Let us hope that politicians and government officials pay heed to this economic reality and act accordingly.
Shanker Singham is an academic fellow with the Institute of Economic Affairs, CEO of Competere Ltd, and a former advisor to the United States Trade Representative and U.K. Trade Secretary. Alden Abbott is a senior research fellow with the Mercatus Center at George Mason University and a former general counsel with the Federal Trade Commission. They are co-authors of a new book, “Trade, Competition and Domestic Regulatory Policy.”