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Wage and Price Controls 28 Copyright the Fraser Institute www.fraserinstitute.org WAGE AND PRICE CO~TROLS: PANACEA FOR INFLATION OR PRESCRIPTION FOR DISASTER? Jack Carr Associate Professor of Econorrucs, University of Toronto Visiting Scholar, University of California at Los Angeles THE FRASER INSTITUTE 1976 Copyright the Fraser Institute www.fraserinstitute.org S-lOO-SL688-0 NHSI PiJtlJiJSiJJ sJl(2!J llv 'vpvuv:J Jl(2!Jtdo:J ;)lnmSUI 1;)SU1d ;)ql Aq 9L61"p;)qsnqnd lSlld Copyright the Fraser Institute www.fraserinstitute.org Contents PREFACE v THE AUTHOR vii WAGE AND'PRICE CONTROLS: PANACEA FOR INFLATION OR PRESCRIPTION FOR DISASTER? Jack Carr I. Introduction n. Causes of Inflation 2 What is inflation? 2 Absolute and relative prices, 3 Measuring inflation 4 Questions ,about the causes 4 L Cost or price-push theories of inflation 5 Wages the culprit? 6 Two flaws in the cost-push philosopher's stone 6 Monopoly power the problem? 7 Does greed explain inflation? 8 2. Sociological theories of inflation 9 1 .Phillips Curve theory of inflation 11 The trade-off 11 Fooling all the people all the time 12 Confronting the Phillips Curve 13 4. Expectations theory of inflation 14 5, Profiteering theor:y of inflation 15 iii Copyright the Fraser Institute www.fraserinstitute.org 6. Monetary theory of inflation 15 What the theory says 15 Too many dollars 16 Theory applied - four Canadian episodes 17 Global evidence 22 Why increase the money supply? 22 The crucial role of U.S. dollars 22 Imported inflation? 23 Biting the bullet 24 Once burnt 24 World-wide excess 25 7. Government expenditure theory of inflation 25 Labelling the theories 28 III. Inflation and Wage and Price Controls 28 An argument for controls 29 Reducing the cost 32 Create the illusion 32 Expectations 33 Fooling whom? 34 IV. What Price Wage and Price Controls? 34 The Canadian case 35 The matzo ball-fringe benefit syndrome 37 Round-trip rump roast 37 Shortages and queues 38 Rationing 40 Black markets 40 The role that prices play 42 Double-barrelled signals 43 Short-circuiting the mechanism 43 Breaking the thermometer 44 The German case 45 :/ V. Summary and Conclusihns 45 iv Copyright the Fraser Institute www.fraserinstitute.org Preface This Study by Professor J. Carr of the University of Toronto is the first in a series of six on the topic of wage and price controls that the Fraser Institute is publishing. The other studies will be published in the coming weeks and a compen­ dium of the studies will be released in book form late in February. Each of the studies in the series is designed to deal with a particular aspect of inflation or wage and price controls. The present study was designed to investigate the causes of inflation in general and the sources of Canada's present pre­ dicament in particular. The study comes to conclusions in that regard and presents a point of view - a refreshingly different economic study on that account alone. Wage and price controls suspend individual rights, im­ pose a system of law that, by design, does not treat equals equally, and impose arbitrary bureaucratic control over peo­ ple's lives. In view of these high 'fixed' costs, Professor Carr in the study has also attempted to ascertain the operational costs and benefits of wage and price controls. In other words, what side effects does the 'cure' produce other than its obvious effects on individual freedom of choice. The Fraser Institute is publishing this study in the in­ terest of encouraging careful public consideration of current anti-inflation policy. If Professor Carr's analysis is correct Canadians would do well to question the course currently being charted by their government. At the very least we should not be lulled into thinking that 'everything is under control'. We should be vigilant and we should be quick to ob­ ject if the monetary and fiscal restraint promised by the government is not forthcoming. January, 1976 M.A. Walker v Copyright the Fraser Institute www.fraserinstitute.org THE AUTHOR Jack Carr was born in Toronto in 1944 and was graduated from the University of Toronto in 1965 before taking his PhD. at the University of Chicago in 1971. In 1968 he joined the department of Political Economy in the University of Toronto and became Associate Professor in 1973. Professor Carr is also a Research Associate of the Institute for Policy Analysis at the University of Toronto. During the 1975-76 academic year he is a Visiting Scholar at the Department of Economics, University of California in Los Angeles. Professor Carr's publications include: The Money Supply and the Rate of Inflation, a study prepared for the Prices and Incomes Commission in 1972; Cents and Nonsense (Holt, Rinehart and Winston), a book of popular essays on eco­ nomic policy, and numerous contributions to scholarly jour­ nals. vii Copyright the Fraser Institute www.fraserinstitute.org Wage and Price Controls Panacea for Inflation or Prescription for Disaster? JACK CARR Associate Professor of Economics University of Toronto Visiting Scholar University of California at Los Angeles I. INTRODUCTION On October 13, 1975 Prime Minister Trudeau addressed the Canadian public on national radio and television and an­ nounced the imposition of a comprehensive scheme of man­ datory wage and price controls. The Prime Minister made it clear at that time that these controls were being imposed to attack the inflation problem in Canada. The use of wage and price controls by government to fight inflation is not a novel approach. The first recorded example of wage and price con­ trols dates back to 301 A.D. At that time, the Roman Em­ peror Diocletian put a price ceiling on over 900 commodities, 130 different grades of labour and on a large number of freight rates. l Canada in the Second World War placed ceil­ ings on a large number of prices and wages. 2 England and a number of European countries have imposed price and wage controls3 at various times in the 50's, 60's and 70'S.4 More re­ cently and closer to home the United States imposed wage and price controls starting August 1971 and ending April 1974. 5 In fact, the controls just adopted by Canada are very similar to Phase IV of the U.S. control system. 1 Copyright the Fraser Institute www.fraserinstitute.org The current Canadian controls limit wage increases, in general, to the 8 per cent to 12 per cent range and allow prices charged by firms to increase only when the firm's costs increase. Prices are allowed to go up only enough to enable firms to recover their increased costs. In this way the controls attempt to freeze in dollar amounts profit per unit of output of firms. This volume will attempt to analyze the economic effects of the wage and price controls currently being placed on Canadians. Will these controls achieve their goal and reduce inflation in Canada? What is the price of these con­ trols? Will these controls lead to shortages, inefficiencies in the operation of the Canadian economy, black markets, and perhaps even more controls? Before investigating these questions, there is one question that has to be looked at first. Since the controls are aimed at fighting inflation, before we can tell whether controls will succeed in their goal of reduced inflation, we have to understand what causes infla­ tion in the first place. Let us now examine this question. II. CAUSES OF INFLATION What is inflation? The word 'inflation' has acquired various meanings in recent years and as a consequence there is confusion over what economists mean when they talk about inflation. One hears about 'land price inflation', 'housing price inflation', 'food price inflation', 'oil price inflation' and so on. The traditional meaning of inflation6 and the meaning of inflation that will be used in this paper is that inflation represents a general in­ crease in the price of all goods and services. Economists refer to the price of all goods and services as the absolute price level. Hence inflation is the increase in the absolute price level. When oil prices or food prices increase at a faster rate than other prices this will not be referred to as 'oil price inflation' or 'food price inflation'. Instead, we will say the relative price of food or oil has increased. It is necessary to bear in mind the distinction between the absolute price level and relative prices. When economists talk about prices they do not always make it clear whether they are referring to the absolute price level or to relative prices. 2 Copyright the Fraser Institute www.fraserinstitute.org Absolute and relative prices This confusion between absolute and relative prices leads to confusion about the causes of inflation. The causes of rela­ tive price changes always lie in changes in the demand for, or supply of, the particular good~or service/in question. Oil prices have increased because the producer's have formed a cartel and have restricted the supply of oil. It is this phenomenon which is responsible for oil prices increasing relative to the price of other goods. Bad harvests in the re­ cent past have reduced the supply of agricultural com­ modities and caused the relative price of food to increase. These individual supply and demand factors are responsible for the fact that the price of one commodity has increased relative to the price of another commodity. They do not ex­ plain why the price of all commodities has been rising. Table 1 -Percentage Change in Consumer Price Index, Canada Percentage Change in Average Change Year Consumer Price Index' for Period 1960 1961 1.3}-.2 1962 1.6 1.4 1963 1.8 1964 1.9 1965 1966 3.62.9}- 1967 4.1 3.9 1968 4.1 1969 4.6 1970 1.5------ 1.5 1971 5.0 5.1 1-.___ _ 1972 7.9 1973 9.1 J 1974 12.4 July 197 4-July 1975 11.0 'The percentage change in the Consumer Price Index for any year is calculated as the percentage change between the Consumer Price Index of December of that year and the figure for December of the previous year.
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