A thought experiment where every price in town is set by a committee

This is a thought experiment, and the town in it is made up. There is no Fairhaven, no Fair Prices Committee and no Chairwoman of anything. Every scene below is invented to follow one idea to its logical end, and nothing in it should be mistaken for a news report. The final section steps out of the satire and tells you which real events the invented ones resemble. Now, to the town.

Fairhaven is a lovely place. It has a main street, a hardware store and a diner where the pie is better than it has any right to be. One spring the voters notice that prices go up and down, and they find this unsettling. Prices, they say, are chaotic. Prices are set by greedy people. What the town needs is a body of kind, educated citizens to decide what things are really worth.

So the town creates the Fair Prices Committee. It has seven members, a charter and a very nice conference room. The mayor cuts a ribbon. The local paper runs a headline about "a new era of fairness," and I am told the cookies at the reception were excellent. Everything that follows is simply the cookies' fault, in the sense that cookies were the last thing anyone priced correctly.

The setup: what a price is for

Before we watch the committee work, let me define the thing it is trying to replace, because the whole experiment turns on it. A price is a number that carries information. When wheat is scarce, its price rises, and that tells farmers to grow more, bakers to waste less and families to buy a little less, all at once, without anyone giving an order. In 1945 the economist Friedrich Hayek wrote an essay, "The Use of Knowledge in Society," arguing that the knowledge needed to run an economy is scattered among millions of people, each knowing a little about local conditions, and that prices are the system that gathers it. No committee can hold that knowledge, because no one person has it.

Hold that thought. The committee does not know it yet.

Here is the experiment in numbered premises.

1. Prices carry information about scarcity and demand.
2. If a committee sets the price, the number stops carrying that information, because it no longer responds to scarcity.
3. When the price no longer responds, buyers and sellers keep responding to the real conditions in other ways: queues, shortages, quality changes, favors and hidden payments.
4. The committee must then regulate those other ways, which requires more rules, more staff and more forms.

Watch for each premise as we go.

Week one: bread

The committee's first meeting concerns bread. The committee sits with a calculator and the baker's cost sheet. Flour costs this much, the oven's electricity costs that much, the baker's labor is so many hours, add a modest profit and you get a Fair Price for a loaf. They set it. It is a reasonable price, honestly computed. The committee is pleased.

Then the wheat price in the wider market goes up, because of a poor harvest somewhere else. Flour now costs more than the baker's cost sheet said. The Fair Price for bread has not changed, because the committee meets on the first Tuesday of the month. The baker is now selling each loaf for less than it costs to make. A baker who loses money on each loaf has three options: bake fewer loaves, bake smaller loaves, or make a worse loaf. A fourth, to bake nothing and go find other work, is available to the baker who is tired of the whole business.

The baker bakes fewer loaves. By Wednesday morning the line outside the bakery goes around the block. The committee observes that the bread price is stable, as designed, and the line is unfortunate but not within its mandate. A member suggests that the line shows how much people value bread. Another member points out that this is exactly what a higher price would have shown, with the difference that a higher price would also have told someone to bake more.

Week three: rent

Having handled bread, the committee turns to rent. It is a harder question, because apartments differ. The committee, after a long discussion, adopts a formula: the Fair Rent is a fixed percentage over the building's cost, adjusted for age. A building with a leaky roof and a building with a view are, under the formula, within a few dollars of each other.

You can guess what happens. The owners of apartments find that the Fair Rent is below what the market would have paid, and that the repair budget is the first thing to go. Why fix the roof when the tenant will pay the same either way? And nobody builds a new apartment building in Fairhaven, because a builder who can only charge the Fair Rent cannot cover the cost of building. The town's housing stock begins to age.

Meanwhile a young couple arrives in Fairhaven for a new job and discovers that there are no apartments for rent. There are apartments, of course, but they are occupied by people who intend to keep them forever, as the rent is a bargain. The couple is offered a spot on the waiting list, and the waiting list has a longer waiting list for the waiting list. A man at the diner tells them that for a "finder's fee" in cash a friend of a friend might know of a vacancy. The committee has now accidentally created a market in apartment tips. It is not an efficient market, and it is not a fair one.

Week six: gasoline

Now the committee's big moment: gasoline. The price of gas moves with the world price of oil and with the season, and Fairhaven's voters are annoyed by the signs at the filling station. The committee freezes the Fair Price of gasoline at a level that seems modest.

Then the world price of oil rises, as it will. The station's wholesale cost is now above the pump price it is allowed to charge. The station owner, who is not a villain and who has a mortgage, orders less gasoline. The station runs out of fuel by Thursday afternoon, and a sign goes up reading "NO GAS," which in the new economy is a sign of a well-run committee.

The line at the pump is now two hours long. People circle the block to wait. They idle their engines in the line, burning gas to get gas, which is the sort of thing that would make a poet weep or an accountant develop a nervous twitch. The committee issues a guideline: cars with even-numbered license plates may buy gas on even-numbered days. This is a reasonable rule that nobody enjoys. A cousin in the next town over, where the price is not controlled, notes that gas is expensive but available. A few drivers make the trip. The committee notes with concern that gas is flowing out of Fairhaven and passes a rule that no one may carry fuel out of town. Everything is working beautifully, if you do not look at the line.

Month three: the shortage reports

By the third month, the committee faces a problem that it has not seen before. Things are scarce, and the committee is being asked to explain. It has an answer, and it is a good political answer: someone is hoarding. Surely, the committee reasons, the shortage of bread, apartments and gasoline is the work of bad actors who hold goods back to drive up prices. The chair announces a Shortage Task Force.

The Task Force needs staff. It hires an investigator, an analyst and a clerk. The staff needs a budget, and the budget needs a line in the town's taxes. The committee's own conference room is too small, so it takes the one next door. A newsletter, "The Fair Prices Bulletin," goes out each month with updates on the shortage and a recipe for stale bread pudding.

The Task Force now has data. It finds that the baker is baking fewer loaves than before, which it classifies as a decline in output. It finds that the station owner is ordering less gas, which it classifies as hoarding. The baker and the station owner each explain that the price makes the product a losing proposition. The committee takes this under advisement and, in a moment of generous compromise, raises the Fair Price of bread by a small amount, effective the first of the next month. It is still below the cost.

Month five: the black market

The Fairhaven black market does not call itself that. It calls itself "an arrangement." A person who wants bread that is not in the store learns that a woman three streets over bakes bread at home and sells it for a price that exists nowhere on the committee's price sheets. She is cheerful and her bread is excellent. A neighbor, who is tired of the line at the filling station, buys gas from a friend who has a few spare gallons and a firm sense of the price.

None of the people involved think of themselves as wrongdoers. They think of themselves as people who needed bread and gas. The committee, however, has a view, because the black-market prices are the prices that actually clear the market, and they are a standing embarrassment to the Fair Price schedule. The committee has to decide what to do about a market it has just invented. It forms an Enforcement Division.

There is something worth saying about the character of the people in an economy like this. When prices are set by law and goods are short, ordinary behavior becomes a legal risk, and ordinary people become suppliers of illicit bread. Honest people learn to bend rules. Dishonest people learn that the rules can be bought. The committee set out to make the town fairer and has instead made it a town in which getting a loaf of bread depends on whom you know.

Month eight: the committee's growing staff

By the time the town's first anniversary of Fair Prices rolls around, the committee has a staff of thirty. It has an Office of Bread, an Office of Housing, an Office of Fuel, an Office of Other Goods and an Office of Offices. The charter said seven members; no one remembers anyone amending it.

Here is a feature of the experiment that I find the most reliable of all. Every shortage is treated by the committee as a reason for more authority, since a shortage is evidence that the rules were not strict enough. More goods get price schedules. Shoes. Light bulbs. Haircuts. The more goods the committee prices, the more shortages it creates, the more staff it hires to investigate them. The committee is not a failure by its own lights. It is thriving. The number of people it employs has never been higher.

A visitor from the next town, the one with the unfixed prices, drives through Fairhaven on a Saturday. She notes that the diner's pie is still excellent but the menu has been shortened to three items, that the hardware store has a sign saying "ask inside" in place of a display, and that the main street has an unusual number of parked cars with people sitting in them, waiting for something. She buys a coffee and leaves, a little puzzled by how quiet the place has become.

Stepping out of the satire: the real episodes behind each joke

Fairhaven is invented. The pattern is not. Each of the scenes above echoes something that actually happened, and I will tell you which, so that you can check my work.

Diocletian, 301 AD. The Roman emperor Diocletian issued an Edict on Maximum Prices that set ceilings on well over a thousand products and wages across the empire, and the text prescribed the death penalty for profiteers. A Christian writer of the time, Lactantius, blamed the emperors for the inflation and reported bloodshed caused by the price tampering. Enforcement was patchy, and by the end of Diocletian's reign in 305 the edict was mostly ignored. It is one of the oldest recorded price-control experiments, and it ended the way our invented one is heading.

The 1970s gas lines. In August 1971 President Nixon announced a 90-day freeze on wages and prices, and controls of various kinds lasted for years afterward. In October 1973, during the Arab oil embargo, Americans met the long lines at gasoline stations, and a federal allocation system tried to direct fuel to where officials thought it was needed. The odd-even rationing, by license plate number, was real; some states adopted it. Price ceilings on domestic oil and on gasoline meant that the price did not rise to reflect scarcity, and the lines were the price paid in time. Gas lines returned in 1979. The economist's explanation is that the ceiling created the shortage; the fuller account, and the story of how the inflation of the era was made, is in The Great Inflation of the 1970s was a policy choice, not bad luck.

Venezuela. In 2003 Venezuela's government suspended foreign-currency trading and created a currency-control board, and in the years that followed it relied on price controls for basic goods. By the 2010s shortages of staples such as milk, flour and toilet paper had become common, and Venezuelans spent hours in lines to buy rationed food. I will not claim more than the broad outline, because the details are best taken from the sources, but the shape of the story, ceilings that made goods scarce and a black market that sold them dearer, matches the pattern of our invented town. For a wider comparison, see eight socialism myths tested against the countries that actually tried it and the paired cases in Two Germanys and two Koreas, the natural experiments that socialism lost.

And here is the counterexample the committee should have studied. In June 1948, in the western zones of occupied Germany, Ludwig Erhard announced the lifting of price and production controls on many goods just as the currency reform took effect on June 20, which fell on a Sunday. Goods that had been hoarded or hidden appeared in the shops. The story is told in Ludwig Erhard ended price controls on a Sunday and launched a miracle. The lesson is not that markets are magic. It is that prices are information and that the shelves fill when the signal is allowed to move.

Why the committee cannot win

I should state the best argument for the committee, because the voters of Fairhaven were not stupid. Prices do rise painfully, and some people cannot afford what they need. A committee of decent people looked at that hardship and wanted to do something. The impulse is humane, and I do not mock it. I mock the method.

Here is the answer in plain terms. If a good is scarce, then something will ration it. Either the price will do it, so that those who value the good most and can pay get it, or something else will: the length of a line, the favor of an official, the luck of a license plate. Price rationing is at least open, and it gives sellers a reason to produce more. Rationing by queue and by connection rewards the patient and the well-connected, and it gives sellers a reason to produce less. If you want to help people who cannot afford bread, you can give them money, and the price will still tell the baker what to do. That is a much better program than telling the baker to lose money. The constitutional point is related: the Founders distrusted concentrated discretionary power over ordinary life. Madison wrote in Federalist No. 47 that the accumulation of all powers in the same hands is the very definition of tyranny; a committee that sets every price in town is a small version of the thing he feared, and see Federalist 47 Defines Tyranny as All Powers Gathered Into the Same Hands.

Hayek's point stands: no committee can know what the whole town knows. That is not a matter of intelligence or good intentions. It is a matter of arithmetic. The town contains thousands of buyers and sellers making decisions each hour, with information the committee cannot collect and could not process if it did. The price is how the town talks to itself. The Fair Prices Committee did not make the town fairer. It put a hand over the town's mouth.

The case in brief

1. A price is a signal that carries information about scarcity, and a committee that fixes it cuts the signal.
2. A price ceiling below the market level creates shortages, because sellers produce less and buyers want more.
3. Shortages get rationed by queues, favors and black markets, and each is less fair than the price it replaced.
4. Each failure of price control becomes an argument for more control, so the committee and its staff grow while the shelves empty.
5. The record, from Diocletian's edict to the 1970s gas lines to Venezuela, matches the invented town, and the cure in Germany in 1948 was to let prices move.

What you can do: the next time a proposal promises to fix a price by law, ask the sponsor one question and write down the answer: who will produce the good at that price, and where is the evidence?