1/31/01 10:25 a.m.
Gray Davis, Meet Adam Smith
Economics and the California power crisis.

By John W. Danford, professor of political theory at Loyola University in Chicago & author of The Roots of Freedom.

just watched a new comedy show, The Newshour with Jim Lehrer. Margaret Warner hosted a discussion on the California power crisis, with the usual kind of talking heads. An earnest PR type spoke for the power-generating companies, and representing the other side was someone from a "consumer advocacy group." The PR flack was articulate and measured; the consumer advocate did his best to match her earnest tone. They agreed that the situation is terribly complicated.

No it isn't! Gov. Gray Davis (I saw him on another show) believes the problem has to do with the enormous "leverage" the power suppliers have with respect to the itsy-bitsy individual consumer. Many consumers, after all, are on fixed incomes. How this is different from the way any other good or service (computers, hamburgers, automobiles, life insurance) is supplied or purchased was not explained by the governor.

Now, markets are enormously complicated. But the principle is pretty simple. In fact, as lots of economists beginning with Adam Smith have observed, the whole point of free markets is that they can deal with complexity while allowing human beings to make their own decisions. Precisely because millions of decisions are made by millions of people pursuing their own aims in their particular circumstances, NO ONE can direct or decide, especially in advance, things such as the amount of power needed or the price at which it should or can be supplied. It's beyond the capacity of the human mind, even the capacity of the wisest and most benevolent agency, to direct such things. That's why free markets are so important. But they must be free. We just passed through a whole century which demonstrated the folly of central planning.

Every time politicos or administrative agencies — even courts — plunge bravely into a free market to help us (usually by regulating prices), the same thing happens, and it's something they didn't expect. Generally it's a shortage (or deterioration in the quality) of whatever it is that people want or need. Why is this so hard to learn? Prices are simply a signal. When they are high or going up, people respond to the signal by changing their behavior. Some change by purchasing less of whatever it is, others see a way to make a buck, and make an effort to supply more of it. Interfere with the price — the signaling mechanism — and what do you expect? California keeps the price of power low to benefit voters, er, consumers, and just can't believe what happens.

Someone should make a list of such price-interference follies, which are found in every age. "Just price" theory in the middle ages, rent control laws, the energy crisis of the 1970s, this goes on all over the world, again and again. My favorite example was the seasonal anguish of the city council in Galveston, Texas, which used to (still does?) try to regulate the price of plywood, which is used to board up windows when a hurricane threatens. The Galveston politicos passed laws to prevent "price gouging" in an emergency. Of course, the high prices caused by a run on plywood (in simpler times) induced entrepreneurs from distant places like Austin to fill their pickups with plywood and bring it down to the coast (to make a few bucks). Once the prices were safely kept down, of course, the entrepreneurs stayed home and lots of property owners just had to do without plywood. Thanks, city council. And the politicians are always surprised, or claim to be.

It must be an occupational disease of the political life to believe human beings can control or direct things, in the face of all the evidence. I used to think all politicians should be required to take a course in basic economics. But I have a son in college, taking economics, and I'm beginning to worry that at least some economics courses aren't getting this right. My son thinks that Alan Greenspan "controls" the economy, and sets interest rates (another kind of price). I tried to suggest that perhaps even the Federal Reserve Chairman's powers don't go quite that far. I think the problem is that the chattering classes in general, and that includes many academics, even economics professors, are strangers to humility. Maybe a history course on price-interference follies would help. More likely nothing will help.