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OPINION
Ross Gittins
Economics Editor
November 11, 2022 — 12.34pm
If you think economists say crazy things, you’re not alone. Speaking about
our soaring cost of living this week, Treasury Secretary Dr Steven Kennedy
told a Senate committee that “the solution to high prices is high prices”.
But then he said this didn’t apply to the prices of coal and gas.
How could anyone smart enough to get a PhD say such nonsense? He even
said – in a speech actually read out by one of his deputies – that this piece
of crazy-speak was something economists were “fond of saying”.
It’s true, they are. If they were children, we’d call it attention-seeking
behaviour. But when you unpick their little riddle, you learn a lot about why
economists are in love with markets and “market forces”, why they’re
always banging on about supply and demand, and why (as I’ve said once or
twice before) if economists wore T-shirts, what they’d say is “Prices make
the world go round”.
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11/11/22, 5:46 PM Treasury thinks the unthinkable: Yes, intervene in coal and gas markets
Dr Steven Kennedy: ‘The solution to high prices is high prices.’ PETER BRAIG
If the price of some item rises, this draws a response from the price
mechanism, which is driven by market forces – the interaction of supply on
one side and demand on the other.
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11/11/22, 5:46 PM Treasury thinks the unthinkable: Yes, intervene in coal and gas markets
The price rise sends a signal to buyers and a signal to sellers. The message
buyers get is: this stuff’s more expensive, so make sure you’re not wasting
any of it.
And see if you can find a substitute for it that’s almost as good but doesn’t
cost as much. If you’ve been buying the deluxe, big-brand version, try the
house brand.
On the other side, the message to sellers is: since people are paying more
for this stuff, produce more of it. “I’m not in this business, but maybe now
the price is higher, I should be.” If the price has risen because the firm’s
costs have risen, maybe we could find a way to cut those costs, not put our
price up and so pinch customers from our competitors.
See where this is going? If customers react to the higher price by buying
less, while sellers react by producing more, what’s likely to happen to the
price?
Saying the solution to high prices is high prices is a tricky way of saying
market forces will react to the price rise in a way that, after a while, brings it
back down again.
When demand and supply get out of balance, market forces adjust the price
up or down until demand and supply are back in balance. The price
mechanism has fixed the problem, returning the market to “equilibrium”.
This is the origin of the old economists’ motto: laissez-faire. Leave things
alone. Don’t interfere. Interfering with the mechanism will stop it working
properly and probably make things worse rather than better.
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11/11/22, 5:46 PM Treasury thinks the unthinkable: Yes, intervene in coal and gas markets
There’s a huge degree of truth to this simple analysis. At this moment there
are thousands of firms and millions of consumers reacting to price changes
in the way I’ve just described.
Kennedy admits that “there are many conditions that underpin” this do-
nothing policy, but “in most circumstances Treasury would support such an
approach”.
It assumes all buyers and all sellers know all they need to know about the
characteristics of the product and the prices at which it’s available. It
assumes competition in the market is fierce. And that’s just for openers.
However, Kennedy said, the circumstances of the price shocks caused by the
Ukraine war are “different and outside the frame” of Treasury’s usual
approach. Such shocks bring government intervention in the coal and gas
markets “into scope”. That is, just do it.
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11/11/22, 5:46 PM Treasury thinks the unthinkable: Yes, intervene in coal and gas markets
“The current gas and thermal coal price increases are leading to unusually
high prices and profits for some companies,” he said. “Prices and profits
well beyond the usual bounds of investment and profit cycles.
“The same price increases are leading to a reduction in the real incomes of
many people, with the most severely affected being lower-income working
households.
“The energy price increases are also significantly reducing the profits of
many [energy-using] businesses and raising questions about their viability.”
In summary, Kennedy said, the effects of the Ukraine war are leading to a
redistribution of income and wealth, and disrupting markets. “The
national-interest case for this redistribution is weak, and it is not likely to
lead to a more efficient allocation of resources in the longer term,” he said.
The government’s policy response to the problem could take many forms,
Kennedy said, but with inflation already so high, policymakers “need to be
mindful of not contributing further to inflation”.
This suggests that intervening to directly reduce coal and gas prices is more
likely to be the best way to go, he concluded.
Ross Gittins is the Economics Editor of The Sydney Morning Herald. Connect via
Twitter, Facebook or email.
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