By Center for Market Education

KUALA LUMPUR, Malaysia--The government announced that it will introduce a moving ceiling price for food items in a bid to strengthen food security, as suggested by the Economic Action Council (EAC).

According to a statement, the ceiling price will be adjusted based on changes in the price of various inputs in the supply chain.

Furthermore, the Prime Minister added that the country is looking to expand its agro-food ecosystem with supply chains led by government-linked companies (GLCs), government-linked investment companies (GLICs) and government agencies.

“This will lead Malaysia to become a Soviet-style country, – explained Dr Carmelo Ferlito, CEO of the Center for Market Education – where ‘prices’ are fixed by the government authority and production decisions taken by government agencies.

This demonstrates an abyssal ignorance of economic theory and history lessons: where these experiments were tried – Dr Ferlito added – famine prevailed, like in the Soviet Union (5.7 to 8.7 million deaths due to Stalin’s economic experiments just 1932-1933) and in Mao’s China (15 to 55 million deaths due to the Great Leap Forward)”.

The Center for Market Education is highly concerned about the decisions taken by the two past governments, which now want to address inflation with central planning after having created it with Lockdowns, monetary expansion and a reckless expansive fiscal policy.

The reasons why this new experiment in social engineering cannot work (it was often tried and only brought about death and starvation) are:

1. Prices are not determined by costs of production (which are also prices), but by the interaction of supply and demand in the market, which is by the interactions between millions of subjective evaluations; government-fixed prices are not prices at all, they are just arbitrary figures.

2. Prices are interconnected: consumption and production decisions are based on relative prices and profit expectations; if some of the prices are not determined by the market, they do not reflect the structure of demand and supply and therefore constitute a “bad signal”, leading to wrong production decisions; artificial prices will potentially bring to the market wrong products at wrong prices, compromising the entire economic system (failures, unemployment…) and not only the sectors were prices are fixed by the authority.

3. The State is not an entrepreneur: operating outside the market, government agencies base their production decisions on what bureaucrats think the system needs, rather than what actually the system needs (which spontaneously emerges in the market thanks to price-driven decisions); this means that the economic system will turn to be flooded with products that are not in demand (wasted resources), while there may be shortage of what the market asks for.

4. Real prices – corresponding to the structure of supply and demand – emerges in the market and not via costs. Production costs, in fact, are also prices and are determined by supply and demand in the markets for production factors; the entrepreneurial demand for them will be dictated by entrepreneurs’ expectations on consumer prices (expectations about profit); therefore, wrong consumer prices (fixed by the government) will create the chaos in the market for production factors and thus the production structure will turn into a sum of irrational decisions.

5. Real prices are the way entrepreneurs can judge the success of their decisions via economic calculation (profits and losses): without prices, performances cannot be evaluated and therefore the realm of chaos emerges.

“The Center for Market Education is highly concerned by the political pretense of being able ‘to fix’ the economy as it was an engine rather than a complex, organic and evolutionary system. Policy requires humbleness rather than arrogance, a humbleness dictated by the awareness about what the economy is: a complex and evolutionary network of human interrelationships. Disregarding this will bring the system to collapse on a false pretense of knowledge” – concluded Dr Ferlito.

The technical reasons why the EAC proposal cannot work are explained more in detail in the remaining parts of this document.

Technical Explanation

How prices are formed

A price is the good given by one person in an exchange. In developed economies, price is usually expressed in terms of the monetary unit. Money enables prices to be expressed in terms of a common denominator, and thus avoids the many inefficiencies of pure barter.

Having money prices for the factors of production—land, labor, and capital—enables businesses to compare the costs and benefits of different combinations of resources used to create goods and services.

This means they can estimate in advance which methods of production will be profitable and increase consumer welfare, and which ones will result in losses and waste.

The process of forecasting future prices to guide production is called economic calculation. The people who do the calculations are called entrepreneurs.

Entrepreneurs make decisions about how to use their own resources to produce goods and services. They constantly struggle with the uncertainty of the future, and they must use judgment to estimate how prices and markets will change in the future. Depending on how well they judge the future, entrepreneurs earn profits or suffer losses.

The pricing process always begins with value. Value is an estimation of the benefit that a good or service provides. It is a perception of how a thing will affect the welfare of its owner. Two implications are that value is individual and subjective.

Crucially, all exchanges involve two conflicting marginal values gradually moving toward a balance: the value of what is sold, and the value of what is bought.

Just as we consume until the cost of the marginal unit becomes too great, both parties in an exchange continue to trade until the value of their goods sold is slightly greater to them than the value of the goods they can receive. At this point, there is no reason to exchange further, as one or both parties would be worse off if they did so.

In this way the subjective costs and benefits of each person determine what and how much they are willing to exchange. And of course, these personal valuations also influence prices.

What about production costs? At each stage of production, the factors of production—land, labor, and capital—are used to create and modify goods and services.

Many if not most of the products exchanged in this way are not intended for direct consumption: they are simply links in a long chain of production that finally results in things with use value for consumers.

Until they reach that end stage, however, they are bought and sold by many different producers who desire them only for their exchange value. There are thus usually many costs involved in delivering consumer goods to their final users.

How do all these costs influence the pricing process? It is obvious that in order to stay in business, an entrepreneur must take in more income than she pays out. Revenue must exceed costs.

It might seem reasonable then to think that prices are determined by costs: if costs are high, entrepreneurs will charge high prices, and if costs are low, prices will be too.

Market supply is thus a result of cost, while demand is still determined by consumers’ valuations.

However, this view or value, cost, and price is incorrect. The reason lies in the idea of subjective value discussed earlier. Subjective value was stressed above because it plays a crucial role in the entire pricing process.

All aspects of price formation are ultimately determined by the subjective valuations of consumers, both in supply and in demand.

Prices for productive factors are ultimately driven by entrepreneurs’ expectations about consumer values, not by entrepreneurs’ own use values. Think of an entrepreneur buying wood to build houses.

If she expects that consumers will place a high value on the house and be willing to pay a large amount for it, she will be willing to pay more for the wood, and will bid the price up.

If, however, consumers are expected to place a low value on the house, the entrepreneur will not be willing to pay much for the wood (or other materials) because she has little chance of recovering her costs, and will likely search for more profitable uses for the lumber.

No matter where entrepreneurs are in the chain of production, they always expect to sell their products for more than they paid to produce them. And this expectation always depends ultimately on what the consumers will pay for the final product.

Consumers’ decisions to buy or not to buy determine the prices of consumer goods, and through these goods, the market prices of all the factors of production used to produce them.

We could say that the value of consumer goods is imputed to the land, labor, and capital used to produce them. These factors only have market value because of their ability to contribute to producing goods and services for consumption.

Prices signal important information

Prices summarize the terms of exchange on the market. The price system signals relevant information (including the subjective values and opportunity costs of others) that helps market participants plan.

Pricing enables millions of people to fit their plans in with those of others without the need for any central coordinating authority or any coercion. In doing so, the price mechanism helps us to realize mutual gains from exchange.

Market prices change quickly when underlying conditions change, leading people to adjust quickly.

When the price system is not permitted to function, incorrect signals are sent to both producers and consumers, potentially leading to shortages or oversupply and ultimately to a high degree of discoordination in the system.

Economic calculation

Economic calculation is the ability of economic actors to determine the expected value added of a potential use of a scarce resource. By comparing the expected value across potential alternatives, decision-makers are able to gauge which activities will have the highest value from the perspective of consumers.

Judging the expected value across alternatives requires market-determined prices, which capture the relative scarcity of resources while allowing for a common unit for comparison. Under a command economy, there could be no economic calculation because there would be no money prices (the EAC is in fact proposing to be the entity determining prices, which are thus not price at all).

With some of consumer prices determined by the government authority and not by the market, monetary prices for the factors of production, which arise through market trade and are exchange ratios that capture the opportunity cost of a resource, cannot emerge.  

By providing a common unit for comparison across goods and services, money prices allow people throughout the economy to judge the opportunity cost, or trade-off, of engaging in one course of action over another.

Without money prices for the means of production, rational economic calculation is not possible because there is no way for decision-makers to judge the expected value added of alternative courses of action.

Money prices emerge as the unintended outcome of the voluntary interaction of a multitude of individuals pursuing their separate and often conflicting plans in a market setting characterized by private ownership allowing for exchange.

The prices that emerge in the market convey general knowledge about the relative scarcities of particular goods, and thus serve as “aids to the human mind” for calculating how resources should be used.

In the absence of a market for the means of production, how would the Central Planning Board know which projects were economically feasible and which were not?

Abolishing prices—through the joint abolition of property rights and money—would result in economic chaos in contrast to the rational order promised by proponents of the socialist system.