Prices, supply and demand: on the government’s ambition to control the economy

Written by Dr Carmelo Ferlito, CEO of Center for Market Education

First published in Asia News Today on 06 February 2023

Unfortunately, as it happened too many times over the past few years, Malaysia has again to deals with ministers convinced that supply, demand and prices can efficiently be monitored, controlled and managed by the political authority. Such a pretence of knowledge has heavily harmed the Malaysian poultry industry, generating high prices and shortages for chicken and eggs.

It seems, however, that the new government is affected by the same pretence of knowledge, rooted in a misunderstanding about how markets work and prices emerge from the interaction between supply and demand, as showed by two recent ministerial statements.

First, the Farmers Organisation Authority and the Federal Agricultural Marketing Authority (Fama) have been instructed to take immediate measures to overcome a shortage of vegetables in the market. Agriculture and food security minister Mohamad Sabu said that, as a long-term measure, the ministry would be creating a system to get information in real-time on the vegetable supply situation in the country.

Second, Domestic Trade and Cost of Living Minister Datuk Seri Salahuddin Ayub said he has issued an order for all his officers to monitor prices of vegetables that are not listed as controlled items; in particular, he issued an order for enforcement officers to do a nationwide check to see which market and which traders are hiking up prices unnecessarily.

Let’s begin with this second point: hiking prices unnecessarily. Such a statement opens the door to the idea that there may be just and unjust prices, according to some social justice principle.

At this regard there is a long-lasting misunderstanding, which can be summarized with what Nobel laureate Friedrich A. von Hayek was writing in 1960: the market is not an economy.

What does this mean? Hayek described an economy as «an organization or an arrangement in which someone consciously uses means in the service of a uniform hierarchy of ends». On the contrary, the market order «does not serve a particular rank ordering of objectives, and indeed if, like any spontaneously created order, it cannot legitimately be said to have definite objectives, neither is it then possible to represent the value of its outcome as a sum of individual outputs».

Therefore, the market process is not the result of top-down decisions aiming at achieving previously ranked objectives; rather, as Adam Ferguson put it in the 18th century, it is the result of human action but not of human design. As such, its outcomes cannot be judged from the top down, comparing them with an ideal standard dictated by intellectuals or policymakers; and this for two reasons: 1) it would be questionable to have a limited group of individuals to dictate the ideal standards for an entire society; 2) those ideal standards could be achieved only by omniscient planners and only in case of pre-determined and never-changing information. Therefore, market outcomes can be fairly judged only by comparison with what would be achieved without market competition (a centrally-directed economy); then, the results of competition would appear pretty remarkable.

In fact, the idea that the market process does not serve a pre-ranked series of objectives does not mean that it does not produce a desirable order. «This order manifests […] by virtue of the fact that the expectations of particular transactions with other persons, upon which the plans of all the economy’s participants are based, are to a considerable extent realized» (Hayek), and such coordination happens through the learning process emerging from disappointed expectations (mistakes). But there is more: the market process also «provides that every product is produced by those who can produce it more cheaply […] and that goods are sold at prices that are lower than those at which anyone could offer the goods who does not offer them» (Hayek). This does not exclude the presence of large profits above costs, but that such costs are lower than those of the next best potential producer of the good.

Such a process of coordination, producing selling prices which may be “unjust” from the very personal view of a politician but are the best possible ones for each very temporary situation of knowledge of place and time, is made possible precisely by the price mechanism. In fact, in the process of market competition, prices guide production decisions, communicating relative scarcities: prices literally tell producers what to do. But, it has to be clear, they can only emerge as the spontaneous result of that competition, they do not exist as data available in advance.

And here we come to the issue of supply and demand that the government intends to monitor with sophisticated computers and IT applications. As again explained by Hayek, supply and demand are not data, but «rather outcomes of the constantly ongoing process of competition».

Computers and IT applications can capture events after they happened and nothing in the process of competition tells us that the future is going to behave like the past. Indeed, again, supply and demand are the outcome of a process, not data in an equation.

From such considerations, we can draw the following conclusions:

  • The government should not be worried about monitoring supply and demand; rather, it should leave markets unhampered. There should not be limitations to import and export; only in this way, supply can meet demand in the way which is the most convenient at any given moment. If, in example, import would be allowed only when data tell us that there is not enough domestic supply, too much time would be required for external supply to adapt to the new available information; instead, supply could be more constantly alert to market signals if there were no import/export barriers.
  • For such a process to work smoothly, prices need to be the result of the process of market competition, so to best exercise their communication function and more quickly allow the necessary adjustments; controlled prices would be wrong information sent to the market, resulting in wrong goods and wrong quantities being produced (shortages or oversupply).

Finally, do not expect markets to be perfect; in the end, who has the authority to define perfection? But you can expect markets to produce better outcomes than the available alternatives.