Price Gouging
Imagine that you are the leader of an isolated community. Perhaps it is one of the first European colonies in America, or an outpost on another planet months or years away from any potential assistance. The main consideration here is that if an emergency arises, it will take the better part of a year, at least, before you can get word out and receive any help. You are basically on your own.
Assume that you are sitting at your desk one morning when an aide comes in to tell you that the crop has been utterly destroyed. Blight. Insects. Frost. Some deranged citizen with a flame thrower, destroyed the crops. The cause does not matter. The effect is that your community is facing a severe food shortage.
I am not talking about a situation where there is a very temporary short-term need for a commodity. I am not talking about a case like one where an individual comes across somebody dying of thirst in the desert and sells him a bottle of water in exchange for the individual’s house and all of his assets. The seller in this case is unethical; we should all eagerly offer assistance to those who find themselves with this type of temporary need.
I am talking about a situation where a society faces a long-term, significant shortage of an extremely important commodity.
What do you do?
I would immediately put all remaining food under armed so that none of it gets wasted. I would then set up some type of system for rationing, as well as setting up groups to find alternative sources of food — hunting, fishing, collecting worms if I had to.
Let’s assume that you would do the same thing. You give the order. Immediately, one of the more popular members of the village raises his voice in protest. He says, “We harvested this food at a time of plenty. We have a right to consume it as if we were still in a time of plenty. Sure, it makes sense to ration the new food as it comes in — the food gathered during a time of famine. However, you have to leave the food we already harvested alone.”
My guess is that you would view this individual as insane. We have to start rationing all available food now, regardless of how common and how inexpensive that food was before the crops were destroyed. We need to immediately put into place a system that punishes those who are wasteful, and rewards those who come up with ways to help us through this crisis. Following this protester’s advice, continuing to consume all existing food as if there were no famine, and worrying about starvation only after that food runs out, would be catastrophic.
Unfortunately, whenever society faces a shortage, there is always an immediate protest that we should use up the scarce supplies already in store as if there were no shortage. When the price of oil goes up, they insist that the price sold at the pump should stay low until the station owner has used up his existing supplies. If he raises his price, he is condemned for it. Similarly, these people argue, the refinery should not be raising its price until it has used up the oil it has in store that it purchased at the lower price. Only gas made out of higher-priced oil should be sold at a higher price.
The effect of this is the same as saying, in the case of the threatening famine above, that the bakers and the millers should not charge more for bread or for flower until the existing stockpiles have been used up and the warehouse is empty.
A hurricane strikes New Orleans. Immediately, the price of gasoline goes up. This is the market’s way of doing exactly the same things that I would do, and that I think you would do, if we were leaders of a village facing the same type of crisis. We would immediately enact measures to reduce wasteful consumption and to save those scarce goods for the future.
The market, through higher prices, tells everybody, immediately, that they need to cut back on their consumption to prepare for the famine to come. It tells them also to start looking for substitutes — alternative supplies that they can use as the resource becomes scarce. It rewards those who react immediately and appropriately to news of the shortage, and punishes those who are wasteful.
Yet, immediately, a flock of charismatic villagers start to protest about “price gouging”. They immediately insist on price caps and on punishing those who take the socially responsible action of putting that resource under lock and key. They insist that they be allowed to continue to use that resource at their original rate of consumption in spite of the impending shortage, and that we not worry about the shortage until current supplies are used up. That is the effect of insisting that prices stay at their current level until the current supplies of those resources are exhausted, and there is none left to buy.
As you can see if you put yourself in the shoes of the village leader facing a famine, these policies are insane.
Managing Scarcity
When it comes to dealing with scarcity, markets are tremendously more efficient than political processes, particularly for a large and complex society.
A small village might be able to get away with rationing. For a larger community, setting up a bureaucracy for rationing and running it without corruption and political favoritism, and without promoting a black market, is impossible.
The instant — the very second — people learn that something has happened to threaten the availability of a commodity, the market responds to tell people to cut back on using that commodity and to start looking for substitutes. Within minutes to hours the mechanisms for rewarding those who reduce consumption and who find substitutes are in place.
The threatened shortage does not even have to be real yet. Anticipation of a possible future event is enough to start prices upward — telling people to be prepared in case the worst happens. News of the destruction of a major pipeline sends oil prices skyward almost immediately. Those higher prices, in turn, tell those who would consume that resource, “You need to start using less of this stuff, because there is going to be a lot less to go around shortly.”
Furthermore, it sends out the message to everybody to start looking for substitutes. It tells them to look for other ways to get what they were getting from this commodity. It would be like you, as the leader of the village, immediately offering an extra bounty to anybody who can bring back meat, fish, or anything edible — and taxing the villagers enough to pay these providers. As an added bonus, villagers are taxed in proportion to the amount they consume; those who consume the most, pay the most. It seems only fair.
The political process does not even begin to work until those in power recognize that there is a problem. Chances are, there will be one or two special interest groups who do not want any official action taken until they have milked the situation for all it is worth. These “skeptics” will have to be defeated in the political arena before any political body can respond to the crisis. Dealing with them will require compromise, which again will distort and weaken the political response.
In the economic arena, political connections and expensive lobbyists backed by marketing companies paid huge sums to muddy the waters and confuse the public have less effect. The process goes directly from threats of a shortage, to price, to the need to take action to reduce consumption and find0 substitutes. There are no lobbyists in the way, no votes to take, no compromises to reach. We go straight from evidence of a shortage to action.
This problems distinguishing political from economic solutions continue as the situation changes. Assume that a new substitute is discovered and demand for the original resource goes down. Governments must still recognize the change, convene, study the possible effects, write up a change in the law, get it passed, and signed, and give sufficient warning before the new regulations are executed.
The market responds much more quickly. The company announces its new breakthrough. Immediately, the fact that the future shortage is not going to be as severe as expected means that the price drops. The “fees” in the form of higher costs levied against those who consume large quantities of that resource are immediately repealed. The “subsidies” for those who switch to the new technology are already in place, in the form of savings. The price of the original commodity will probably stay high enough to encourage those who can more easily switch to the substitute to do so, making sure that the new technology is implemented.
There is no way that political processes can even come close to matching the speed that market forces possess in regulating the use of a commodity in response to changing news. This is why people living in market systems — capitalist systems — end up being far better off than those who live in systems that use central government planning. Market systems have larger percentages of their population taking the appropriate action in response to changing events faster and with less corruption than political processes will ever be able to allow.
Political Action
Those who call for a windfall profits tax, or for price caps, in the face of price hits prompted by fears of a shortage, are advocating a policy that will make things worse in the long run.
Price caps prevent the price from going up. Because the price does not go up, people do not have an incentive to cut back on their consumption, or to seek substitutes. They have no incentive to do anything but to continue to use the commodity at the same rates they have been. They have no reason to adopt any changes in their lifestyle. They have no reason to devote their energies to producing some alternative to the commodity that now faces an uncertain future.
Because they do not prepare for the shortage, it will hit sooner, and it will impose far greater suffering than it would have inflicted if the people, through the mechanism of price, had been inspired to take steps to prepare for the event.
Windfall profit taxes punish those who work to reduce the shortage. It would be the same as if, when the village you were running faced famine, you imposed an extra tax on the hunters and fishers. The only effect would be to make sure that you had fewer hunters and fishers bringing in less food, so that they can pay less tax. When threatened with a famine, we do not want to be punishing those who harvest food. We want to be rewarding them. We reward them by allowing them to keep their profits. Hopefully, this will give us more hunters and fishers, working longer hours, bringing in more food, and saving off starvation for the community.
Genuine Problems
There is one genuine concern to face as prices go up that argues against allowing the market to move along its own path.
Not all people can handle the higher prices equally. The more important the good or service is to the people on the lower rungs of the economic ladder, the more greater the suffering that price hikes are going to cause.
If you triple the price of food, the rich can continue to eat as much and as often as they want. Instead of cutting down on what they eat, they can sell a few shares of stock, or quit sending their pets in to the groomers for expensive shampoos and manicures.
The poor, on the other hand, have few other things to give up, and cannot afford to give up more than a small amount of their ration of food. If they have to make a choice, their other options are not pet grooming. They are things like shelter, clothing, medical care, and educational expenses.
If a person is selling water at a time of extreme drought, the market would prefer that he sell a bottle of water to the rich person who wants it for the purpose of giving his dog a shampoo, rather than give it to the mother who has a child dying of thirst but who does not have $100 to spend on water.
Poor people do not have an obligation to watch their children die while the rich shampoo their dogs. However, price caps are not the best way to deal with this problem. Price caps tell the whole society to act as if the shortage does not exist, and that is foolish. Price caps guarantee that the shortage will be that much worse. We need some way to make sure that the poor are not forced to reduce their ration of a scarce commodity to an extent that makes their lives unbearable, as long as there is enough to go around.
The best option may be to increase the price of the commodity even further — to quintuple the price rather than triple it. Then, use the extra money paid by those who can afford it, to supply that commodity to those who need it but cannot afford it.
This will not only help to ensure that people living in poverty can continue to get this vital resource. It will also provide even more incentive for others to cut back their consumption, look for substitutes, and increase production. The taxes on the commodity create yet higher prices that give society a stronger signal this is important stuff; and it is absolutely vital to take steps to alleviate this shortage.
If the product really is that important to peoples’ lives, the last thing that you want to do is to send out a signal through the entire society that says, “Hey, let’s pretend that the problem does not exist.” Price caps do exactly that.
At the same time, we cannot allow the increase in price to so seriously threaten the lives of the poor if there is enough of the commodity to go around. Even then, there is no reason for the poor to suffer a special or disproportionate burden.
Summary
As the leader of the village facing a food shortage, I hope that you realize the last thing you would want to do, when you are told that the crops have failed, is to do nothing. Worse still would be to threaten, with fines and imprisonment, those who take steps to prepare to deal with the shortage in a rational and socially beneficial manner. You do not want to punish those who have the power to alleviate the shortage by finding and selling the commodity that is suddenly extremely scarce. You would not want to institute policies that are functionally equivalent to price caps, because doing so would send all of the wrong messages and deliver more suffering than the village needs to face.
You would certainly want to help the poor. However, this cannot be done by keeping prices artificially low. It requires allowing the price to rise and giving the poor some other form of assistance to help them face the shortage.
I obtained useful feedback on an earlier draft of this article that I posted on the Internet Infidels