As surely as flooding disasters like Hurricane Harvey are followed by health concerns and homelessness, they’re followed by calls to legalize price gouging.
This time around, the first such calls were heard while the waters were still rising all across the Houston area. They came from conservative economists Tim Worstall of Britain’s Adam Smith Institute, writing in Forbes, and Mark Perry of the American Enterprise Institute, whose piece appeared on the AEI website and at Newsweek. Both demonstrated the chief flaw of such analyses: They were based on irreproachable textbook economics, and showed no sensitivity whatsoever to how things work on the ground during a major catastrophe.
As I’ve observed before, the odd things about these defenses of price gouging is that they cross ideological boundaries — they’re often favored by conservatives and liberals alike. It’s unclear why this should be so, unless liberals relish the rare chance to show that they’re not opposed to the free market now and then. But the notion that the free market can somehow redress the extreme disruption of supply and demand that occurs during a disaster is exactly wrong.
We now need some method of rationing that limited and scarce supply. ... Rationing by price is always the efficient way of doing this.
When the market breaks down utterly, as in Houston, where huge swaths of the region will have little or no access for days at least to fresh water, auto fuel and electricity, almost nothing the free market can do will get supplies of these commodities to places that can’t be physically reached. Instead, the market will impose a level of price discrimination that could become life-threatening for people at the wrong end of the income stream. If one conceives an important function of government as ensuring that the market doesn’t unduly disadvantage some people compared to others, then times like this are precisely the moment it should step in — by putting a leash on profiteering on essential goods, for instance.
The problem with the free market is that it’s not really universally “free.” Not all participants come to the marketplace with equivalent standing. In a crisis, those disparities are magnified.
Let’s see how reality conflicts with the idealized pictures offered by Messrs. Worstall and Perry. When the municipal water supply is knocked out and people are dependent on bottled water, Worstall proposes: “We now need some method of rationing that limited and scarce supply over that increased demand. Rationing by price is always the efficient way of doing this.” He argues that raising the price will encourage suppliers to flood the market (so to speak) with bottled supply. … We want, for example, people to start trucking bottled water from Louisiana to Texas. More money to be made by doing so will encourage people to do so. And as that extra supply arrives, then prices will go down again as demand is met.” It’s as easy as that.
Notice Perry’s swift gloss over the “cruelty” of this regime, as if that’s irrelevant. Unfortunately, people at the wrong end of the cruelty continuum could end up dead.
As I’ve observed before, most such justifications of price gouging fail to take notice of the population that can’t pay the higher (gouged) prices under any circumstances. Let’s say, for instance, that the market allows a convenience store to jack up the price of a bottle of water to $7 from $1, as a resident reported to the Houston Chronicle. There’s no question that the bottle would remain on the shelf, and therefore putatively available for purchase, for longer than normal, or until someone came by with such a desperate need for water that he or she would swallow the price.
Where does that leave a low-income mother with, say, three children needing to be hydrated? She might need a couple of dozen bottles, for which the price has now risen to $168 from $24. Throw in that, with the electricity out, she might not even have access to cash at an ATM. She might very well value that water at $7 a bottle, in principle. But that won’t matter, because she can’t afford it. This is why the public typically views price gougers as creeps. Their action substitutes one market phenomenon for another that seems much less fair: Instead of a first-come-first-served advantage, it creates a most-money-best-served advantage.
It’s all very well to cite the textbook claim — as Perry actually did in response to my earlier column — that price gouging merely avoids “serious misallocation of resources.” The issue for government officials tasked with managing a disrupted market is who receives the newly allocated resources. In this example, it’s only those who have $168 to spend, presumably in cash.
Another factor commonly overlooked by defenders of price gouging is that natural disasters tend to be (1) short-term and (2) not amenable to rapid response by market forces. If there’s no physical way to get a new supply of bottled water into some part of Houston, then allowing unrestrained price increases won’t produce a larger supply. Retailers lucky enough to have a few cases in the back room when the crisis hits will reap a windfall. But who does that help, except the lucky retailers?
Another argument in favor of removing crisis-stage price controls is that they fail to accommodate the higher cost of getting a scarce commodity such as water or gasoline into the stricken market. That’s a fair point, but it’s also why price-gouging laws typically allow for price increases within a certain limited range, or allow higher prices where a higher transport or production cost can be documented. Perry and Worstall and other defenders of price gouging would eliminate all controls, especially in disasters.
The conventional defenses of free-market pricing tend to have a bloodlessness about them that underscores their irrelevance to real-world conditions. Last October, Harvard economics professor N. Gregory Mankiw spoke up for free-market pricing, using his quest for Broadway tickets to “Hamilton” as the exemplary case. He had paid scalpers $2,500 per seat and was “happy about it” because, you know, it was a hit show. Had ticket scalping laws been enforced, he wouldn’t have been able to see it when he wished.
As I observed then, however, Mankiw’s effort to generalize from his experience to every possible application of the market only proved the opposite point. “To be sure,” he wrote, “most people can’t easily afford paying so much for a few hours of entertainment. That is indeed lamentable.” The word “lamentable” was asked to carry a lot more weight in that sentence than it should. Substitute “paying so much for drinking water,” or “shelter,” or “life-saving medicine,” and the situation starts to look a lot worse than “lamentable,” doesn’t it? Anyone can survive missing out on “Hamilton.” Those other things, not so much.
Certainly there are situations where price controls are too rigid or even unnecessary. But when the task involves opening access to a market isolated from the outside world by natural disaster, the free market is powerless to help; its only ability is to direct scarce, life-giving resources exclusively to those who can pay.
The only force that can address the market is government, by making the cost of crucial commodities irrelevant by getting them into the market at its own cost. We’re talking about a case where nature herself has thrown the economics textbooks into the drink. It behooves academic economists like Worstall, Perry and Mankiw to keep something in mind, always: We’re not talking about tickets to a show.