Ignoring the Price of Our Mistakes

The labor market continued to show strong growth in November, though somewhat slower than in recent months. For all the current turmoil in the stock market, the strength of job and wage growth combined suggest growth in disposable incomes sufficient to ensure consumption growth remains steady, providing the economy a welcome stabilizing force.

We all love a good sale, right? Getting a good deal on a car, a vacation, or just 25% off on a new pair of shoes. We understand prices because we like them lower and grumble when they rise.

We understand prices in our daily lives, but somewhere along the way many of us forgot how prices play a vital role in our economy. Recalling this lesson from Econ 101 would go a long way toward solving many national, state, and local policy failures.

One would be hard-pressed to find a single federal economic policy failure that doesn’t have at its very roots a disdain for the proper role of prices in guiding economic decision-making. At the top of the list has to be the large and growing budget deficit.

Absent constraints, apparently all Americans will opt for more spending on something or other, and collectively this choice generally means more spending on nearly everything. Normally, the tax burden would represent the price of that spending, the constraint forcing tough budget decisions. Fundamentally, federal budget deficits persist because voters want – and politicians have given them – a 20% discount on federal spending.

Where government provides a service, the obvious inclination is to undercharge, and it does. Why is the federal highway program in financial straits? Because Americans want their roads – and governments usually want to build more roads – but Americans don’t want to pay the price.

While little recognized, the U.S. government is today the world’s largest insurance company, insuring everything from homes at obvious flood risk to bank deposits and private pensions. Not to mention the government’s central role in providing social insurance through Medicare and Social Security.

And which of these programs don’t involve beneficiaries paying some kind of price, whether premiums or taxes? None. And how many of these programs are in financial trouble? All.

The story is the same time and again. Constituents want their services at 80 cents on the dollar. We all love a sale, and politicians oblige them.

The federal government is in good company mucking up prices. Consider California’s long-running water crisis. Question: Is California’s water crisis the result of a serious and long-running drought? If you answered in the affirmative, then you (and apparently everyone in California state government) just failed Economics 101.

California’s water troubles wherever and whenever they arise are due to one simple policy mistake: California and its various political subdivisions refuse to charge a market clearing price for a scarce resource.

Imagine what would happen if California allowed the price mechanism to equate supply and demand as happens with nearly every other good or service in our economy.

First, the shortages of recent years, while still unpleasant, would have raised little controversy and less government meddling. More rain, less rain disputes over who gets the water would evaporate … excuse the pun. Second, the price would be much higher almost all of the time.

So, third, the long-hoped for measures dramatically improving water conservation would arise naturally and state-wide. A central feature of California politics for decades, water would disappear from the debate because there would be nothing left to decide. Just as there is nothing to decide regarding the price of tomatoes.

Of course, higher water prices would be a burden for the poor, and no doubt the agricultural interests would complain they can’t compete without heavily subsidized water prices. If Californians decide these complaints have merit, the solution is simple enough: cut a check. Increase income support payments for the poor and watch the big agriculture interests cash their welfare checks. These would be small prices to pay for ending simply and permanently California’s recurring water crises.

The subway system in our nation’s capital was once consistently clean, reliable, and safe. Today, riders can’t count on it to be any of those. While mismanagement and bloated payrolls are partly to blame, this is Washington after all, the real answer is underfunding.

Why is Washington’s subway underfunded? Because the powers that be insist on letting the users buy their tickets at a discount – all their users all the time. Instead, they drone on about finding a “dedicated revenue source,” a euphemism for finding some way to soak those who don’t use the system to subsidize those who do. So far, no suckers have volunteered to be the soakee.

Prices matter. And when government gets involved the tendency is to offer constituents a permanent sale price. Government involvement is often appropriate, but the sale rarely is. Thus, we all end up paying the price.

About the authors

J.D. Foster

Dr. J.D. Foster is the former senior vice president, Economic Policy Division, and former chief economist at the U.S. Chamber of Commerce. He explores and explains developments in the U.S. and global economies.