The Oldest Mistake in Economics

In 1964, Ted Heath deregulated the price of everyday items in shops by abolishing Resale Price Maintenance (RPM), under which producers could dictate the minimum price charged by stores. While RPM might have ensured that firms and individuals upstream could line their pockets, it was deeply damaging for many small businesses, preventing shops from competing by offering discounts. Consumers ultimately suffered as they faced higher prices when they did their weekly shop.

This all seems ludicrous today. What business is it of the State to essentially regulate the price of teabags and biscuits? Heath nevertheless faced a backlash and was mocked for his efforts, gaining the nickname ‘the Grocer’ from Private Eye. In many ways this backlash is understandable when one considers human history. Going all the way back to the Ancient Egyptians and Babylonians, rulers have attempted to control prices in order to both ‘protect’ producers, workers, and consumers.

While such measures are no doubt well-meaning, history is littered with examples of these controls producing more harm than good. Whether it’s Ancient Egypt, Diocletian’s Rome, the Reign of Terror in France, or post-war West Germany, price controls do not work and often make things far worse.

Prices are signals

This is because prices act as signals. They communicate changes in supply, demand, and relative scarcity and allow consumers and producers to respond appropriately. If prices increase, for example, then it is a signal to producers that demand is high and so they should expand production or enter the market. The end result is more of that product being available, the needs of consumers being met, and prices returning to normal. When governments attempt to control prices, they distort this signal and remove the incentive of producers to enter the market. It invariably leads to shortages.

Prices communicate scarcity. Distort the signal, and the shortages follow.

Unfortunately for the UK, successive governments and regulators have not learned this lesson.

The energy price cap

Let’s start with the energy market. Theresa May introduced the Energy Price Cap in order to protect households — especially those on the lowest incomes — from crippling fuel bills. While the desire to help the poor is a good one, it can hardly be seen as a success. It has also weakened competition. New entrants struggled with higher costs which they could not pass onto consumers in the form of higher prices. Twenty-nine suppliers failed between July 2021 and May 2022, causing chaos for households and imposing substantial costs on consumers.^[2] It has meant that energy firms have less money available to invest in their businesses and so are less efficient and productive. It has also clearly failed on its own terms. The Cap has not provided a shield to households and has required the government to step in with ‘Cost of Living’ payments to help them deal with spiralling costs.

Everyday essentials

Then there are everyday essentials. We don’t yet have price controls on food and other items set out by legislation, but effectively there are controls on prices. This was revealed during the Pandemic when there was high demand for products such as hand wash, toilet roll, and pasta. The normal market response would have been for prices to rise, cooling demand and encouraging increased production and new supply. Instead, the hapless Competition and Markets Authority issued warnings about ‘profiteering’ and ‘price gouging’.^[3] That hostility to higher prices blunted the price signal, although panic buying and supply-chain disruption were also major causes of the shortages.

The minimum wage

We also see something similar with wages. While the introduction of the minimum wage by Tony Blair proved far less damaging than feared by those on the Centre Right, it has still had an impact. It has continued to be raised and so has increased costs for businesses. The incidence ultimately falls on consumers in the form of higher prices and on workers who have fewer job opportunities or who miss out on performance-related bonuses or higher wages. Again, trying to protect workers by providing a minimum standard of living is a good thing, but if it is set at a level higher than the value they add for firms, then it is likely to have a negative impact and distort the labour market. It is not the only culprit, and the evidence does not establish a direct causal link, but sharp increases in minimum wage rates for younger workers have coincided with a surge in youth unemployment.

Burnham doubles down

It looks as though Andy Burnham’s government is set to double down on attempting to tackle the cost of living and tame inflation through price controls. On his first full day as Prime Minister, he announced the removal of VAT from household electricity bills from 1 October. On his second, the Government announced that participating single bus fares in England outside London would be capped at £2 throughout 2027, backed by £400 million of public funding.^[4] These are not conventional price controls — the first is a tax cut and the second a subsidised fare cap — but they reflect the same political instinct to treat the visible price rather than the underlying cost. A freeze on private rents had also reportedly been under consideration before Burnham entered Downing Street, although his Housing Secretary has since ruled out rent controls.

Fix supply, not the price

All of these policies might offer some temporary respite (or ‘breathing space’ in Mr Burnham’s parlance) but will do very little to tackle the underlying causes of the high cost of living and will ultimately just exacerbate it. Rather than tinkering and meddling with the economy, the country needs structural reform. Instead of targeting certain industries or subsidising demand, the government needs to look at the supply side. This will mean liberalising the planning system so that it is easier — and cheaper — to build more homes, offices, pubs, labs, data centres, and energy infrastructure. This will boost supply relative to demand and so lower costs for households and firms. It needs to slow down on the frantic rush towards Net Zero which has hiked energy prices, crippled firms, and made some industries unviable. Finally, it needs to reform the tax system so that it incentivises rather than punishes hard work and investment.

All of this will not only lower costs for households and firms, it will increase productivity. Given that this is the main driver of economic growth, real wages and living standards will increase as a result.

Andy Burnham needs to learn the lessons of history and from the folly of his predecessors. He should stop trying to meddle with the economy and instead get government out of the way so that the economy can grow.