Why Kamala Harris’s price proposals could be damaging for the US economy

Whether she is outlining her economic policies in a rally or answering questions in a CNN interview, Kamala Harris complains that grocery prices are wrong and she will stamp down on the injustices created.

It is good politics. In a YouGov poll last week, 60 per cent of US respondents supported the US vice-president’s plan to cap increases in grocery prices with only 27 per cent against. This is more popular than tariffs.

It is true, as my colleague Martin Sandbu has written, that Harris is unclear about her exact policy, but the Democratic presidential nominee clearly wants the public to believe that grocery prices are wrong and that she will lower them. The following sounds awfully like price controls to me.

Prices in particular for groceries are still too high. The American people know it. I know it. Which is why my agenda includes what we need to do to bring down the price of groceries. For example, dealing with an issue like price gouging.”

Since the topic of such controls tends to get supporters and detractors into a froth, I’m going to outline some obvious economic analysis on the topic I hope the majority of people can agree upon. Then we can look at what a Harris victory would imply.

Price controls are bad

It is important to restate the standard economic finding. Price controls are bad in the majority of markets and circumstances. Even proponents of occasional controls do not think they are a policy for all seasons. In next week’s Economics Show with Soumaya Keynes, for example, Isabella Weber agrees with me that in normal times they have no place and her discourse about sellers’ inflation (often referred to as “greedflation”) is an exception rather than a rule, at least in the past.

The full horror story of price controls — whether on groceries, rents or other goods and services — is set out comprehensively and simply in The War on Prices, edited by Ryan Bourne. The effects of a cap can be summarised as destroying valuable price signals, creating shortages and queues, reducing quality, hindering innovation, generating inequality between those benefiting and those not, and (for rent controls) locking people into homes, preventing them moving.

Alan Beattie outlined the beneficial effects of price signals in global agriculture (upstream groceries) last week.

Let me repeat. Price controls are bad.

History is also not kind to them as a way of helping restrain increases in the cost of living. For a near contemporary view of president Richard Nixon’s early 1970s price controls, Alan Blinder and William Newton found that they did restrain increases, but this mostly unravelled when the limits were dismantled in 1974. Controls in the UK were no more successful.

It’s fair to present the following chart with the period of widespread price control highlighted and allow readers to draw their own conclusions.

The evidence from theory and practice that price controls are bad does not mean all examples of unconstrained pricing cannot go wrong.

The sale of Oasis concert tickets in the UK over the weekend was an example where price signals were doing their thing in matching supply and demand but at the same time having all the downsides of queueing normally expected of a controlled price.

There are some general exceptions

Almost every economic rule comes with some exceptions. Here, the most notable and widespread are in wages and pharmaceutical prices. Both of these have been found to be governed by significant market power, undermining the price-setting process.

Low wages used to be considered simply a market price, demonstrating the low value of “unskilled” work. But empirical economic research, starting in the 1990s and led by David Card, showed that the expected relationships of raising minimum wages did not apply. Employment did not fall in New Jersey fast-food restaurants that were on the border of Pennsylvania when New Jersey’s minimum wage was raised. Card won a share of the Nobel Prize in 2021 for this body of work.

The finding that employers of low-wage workers might have market power has encouraged many countries to raise minimum wages significantly since the 1990s and without many downsides, although it has undoubtedly raised relative prices.

Take the UK, for example, which has raised minimum wages significantly since they were introduced in 1999. Unlike the $7.25 federal minimum, the chart below shows that the UK one definitively raises wages of the lowest paid. As the minimum wage has gone up, employment has not been noticeably affected and wage inequality has fallen a lot.

Minimum wages can have some unhelpful effects, of course, such as the elimination of pay premiums for unsocial hours. If you want to read how this affected a single company, I would recommend this legal judgment in the past month on a pay discrimination case for the retailer Next.

The second general exception is in drug prices. Again market power is the culprit where some companies raise prices way beyond what is reasonable and necessary to provide incentives to invent new drugs.

Competition policies would normally be the first port of call for government when companies are abusing a dominant position, but it can sometimes be simpler just to regulate the price. The Biden administration has done this with Medicare for insulin. The UK’s NHS and government negotiate drug prices on behalf of about 70mn people. This is not price control as such, but balancing one powerful supplier with an equally powerful purchaser, which has much the same effect.

There are some rare temporary exceptions

Weber’s concept of sellers’ inflation is an offshoot of much economic cost-push thinking. A shock disturbs prices, giving companies market power they do not normally have and this inflation becomes amplified and embedded as workers seek to defend their real wages.

Weber advocates governments taking early action to stop price rises and entering the conflict stages of inflation — through holding buffer stocks, price controls or subsidies. She praises Europe’s 2022 energy price intervention which limited the peak of inflation after wholesale natural gas prices rose 10-fold.

While Weber thinks these policies might be needed quite often in a future world of supply shocks, trade tensions and global warming, more mainstream economists disagree. But they do not disagree that price controls can be helpful.

For example, the IMF’s chief economist, Pierre-Olivier Gourinchas, highlighted last year how Europe’s energy subsidies probably lowered inflation and kept it closer to target by reducing headline inflation and limiting subsequent wage claims. It worked because there was significant slack in the Eurozone, he said. His chart is below. Note that the actions did not prevent inflation and only mitigated the effects a little.

The difference here among economists is not that the mainstream thinks it is impossible that Weber’s sellers’ inflation can happen; it is that they think the conditions are rare and the effects of price controls in these rare instances are pretty small.

An even more limited application is anti-price gouging laws. These exist in most US states, including red-blooded ones such as Texas, and are implemented generally after a natural disaster, aimed at stopping excessive profiteering by a few lucky suppliers who have stocks.

Just as in the European energy crisis, the price signal still applies, encouraging both new supply and a drop in demand, but the state imposes limits on the extent of price rises. While it is reasonable to have an argument about the effectiveness of these laws, they are, almost by definition, extremely limited in scope and not used in normal times.

Come on down, the price is wrong

Economists are happy for there to be competition investigations to ensure companies cannot exploit a position of market dominance.

The difficulty with Harris’s position on grocery pricing is that where Federal price-control regulations would be used sparingly, they cannot be very effective. Were the powers used extensively, they would be undesirable.

What I’ve been reading and watching

• In a sign of what might be to come in the US if Donald Trump wins the race to the White House, Brazil’s President Luiz Inácio Lula da Silva has chosen a political ally and former deputy finance minister to head its central bank. Lula has railed against Brazil’s 10.5 per cent interest rate

• Russia’s central bank has warned that its overheating economy will slow sharply next year

• Danger money. The Libyan central bank governor, Sadiq al-Kabir, and his staff have been forced to flee his divided country after threats from armed militia, leading to the shutdown of most of the country’s oil production

• My column on the Bank of England’s coming decision on quantitative tightening provocatively suggested it was more important than the coming Budget

A chart that matters

In a must-read speech last week, Isabel Schnabel, an executive board member of the European Central Bank, said Eurozone inflation was on track to hit the ECB’s forecasts. But there was a sting in the tail. She put up a version of the chart below to show that the predictive power of ECB inflation forecasts become steadily worse the longer the forecasting horizon. They are pretty accurate one quarter ahead, but at two-year horizons, the forecasts are essentially useless.

Her conclusion was that you need to look closely at scenarios of what might go wrong. Very sensible. All three of her scenarios were of inflation proving higher than the central forecast, which was quite revelatory of her stance.

That said, the charts are marvellous. They came from Christian Conrad and Zeno Enders of Heidelberg university, using more than 20 years of data. Be a little careful in interpreting the 45 degree line in these charts, however, as the FT’s graphics software cannot produce an accurate line and I had to hack it as best I could.