Inflation vs. the Price Level, part 2

Can the government lower prices? Should it?

In yesterday’s post, I explained what became a crucial distinction in recent years when it comes to understanding the yawning gap between good data and bad vibes: the difference between inflation—the rate at which prices change—and the price level—what things actually cost. I showed that potato chip inflation has been zero recently, but they cost $2 more than pre-pandemic.

I then raised “a particularly timely and important question about the price-level question…in a capitalist economy, what can the government do to lower prices?”

Most economists would say “not much.” Many would say “don’t go there.” While sympathetic to both of those caveats—they both carry some important truths—I disagree.

First, let’s be very clear about the scope of what we’re discussing. Though they could do so by triggering a deep recession, no government or central bank (“Fed”) in their right mind would try to lower the overall price level, i.e., trigger an economy-wide deflation. Any benefits would be swamped by the costs of a deep downturn. You don’t burn down your house to get rid of the cockroaches.

Second, for most goods and services in a capitalist economy, price levels and changes provide important market signals that you don’t want to jam. You want prices signaling to actual and potential producers and workers (wage signals are just as important as price signals) where supply and demand are misaligned.

But what about when significant swaths of Americans can’t afford basic essentials, including child care, housing, health care, and higher education (as noted yesterday, Annie Lowrey has discussed this as an “affordability crisis”).

If anyone wants to fight about whether those are truly essential, go ahead, but as I’m convinced they are, I will not engage. If anyone wants to add to the list, go ahead, but be aware that we’re already capturing a large swath of the economy with the above list. Health care alone in this country accounts for 18% of GDP, close to twice that of most other countries (which makes it a poster child for this discussion of lowering prices). Housing investment (which isn’t the same as housing wealth) accounts for another 4% of GDP.

Okay, with that throat clearing completed, here are legit things governments can and should do to lower prices, or at least to slow the rate at which they grow. Deep dives are required in each case, so this is really just the framework to my disagreement that we should just leave prices alone.

Healthcare: Other countries control healthcare prices and generally take it out of the market.¹ That enables them to spend a lot less on it with better results. Paul Krugman points out this AM that Canadian life expectancy is 3.3 years longer than ours. They spend 12.4% of GDP on healthcare. Our gov’t of course spends profusely in health care—half of that 18% is public spending—but our public/private mix with little effort to control costs (I’m not including insurers’ harassments; that doesn’t control costs; it controls who pays) leads to excessive costs for treatment and drugs here relative to all other advanced economies. We made progress in the Biden administration both in terms of lowering costs for premiums in the Obamacare exchanges and using our Medicare bargaining clout to get lower drug prices (okay, I just elided over a huge and consequential difference here; premium subsidies make health coverage more affordable; they don’t lower its price; this is a key and germane distinction made by the Abundance movement ). But there is a lot more we could do to control the costs, expand the supply, and thereby the affordability of healthcare.

Competition: This is an increasingly important way in which gov’t action can lower prices. Various industries, including food production, health care, telecom, and retail behemoths have become concentrated to the point where they face too little competition. Sometimes that shows up as higher prices (food, health care telecom). Sometimes, and this was a key Lina Kahn insight, it shows up as worker exploitation (retail), dampening the labor price (the wage).

Housing and child care: I lump them together for a personal reason: these are the two biggest pieces of unfinished business in the Biden administration. We had good, robust plans to expand both, though here again the parenthetical distinction above is valid. In both cases, the market fails to provide adequate supplies such that even classical economists should view supply expansion in these areas as ways gov’t must internalize negative externalities (a fancy way of saying that undersupplied housing and child care spills over negatively to the rest of society).

Why does the market fail in both cases? Re child care, too many working-age people don’t earn enough to afford it, so they can’t go to work, or if they try to do so, they don’t have enough income left to get by (again, see Lowrey’s work on this). Re housing, the economics of building steers developers exclusively to build high-end housing. The return-on-investment to affordable housing doesn’t cover its costs and therefore supply must be subsidized and new places to build must be opened, which requires pushing back on land-use restrictions. Which is very hard to do.

Price controls: The economist Isabella Weber has long suggested that the gov’t should do more to directly control and lower costs. It’s anathema to most economists, largely due to don’t-jam-the-price-signal arguments, which, as noted above, are valid and important, particularly in areas where we want the private sector to add supply. But there are times and sectors—healthcare is a clear e.g.—where we should listen to her.

I could keep going (higher education is another market failure and another service, like health care, that shouldn’t even be so much in the market in the first place; we want our youth to go to college and then make it prohibitive for those that aren’t rich to do so), but you get the gist. There’s a lot gov’t can do to lower prices but it should act carefully. The bar should be high as to which sectors, goods, and services receive such interventions.

Before I close, I, of all people (lifetime full employment advocate), recognize that this conversation leaves out a huge part of the solution to higher costs, which is better pay. Inflation, and thereby the price level, almost always goes up, but in a fair economy, workers’ wages, and not just at the top of the wage scale but at the bottom and middle and every other percentile, go up faster.

There’s a lot that public policy can do to help ensure workers’ pay grows with productivity, much of which falls under the rubric of labor standards. But that’s a discussion for another day.

1. Fun fact: there’s a way in which we too take health care “out-of-the-market.” If you arrive sick at the emergency room, they have to treat you. If you arrive hungry at the grocery store, they don’t have to feed you.