Compassion vs. Price-Gouging

In most cases where the the politicians debate about policy they can usually cite a bevy of economic experts, academic papers, and think-tank research to bolster their respective positions, but there are some issues where the experts pretty much all agree and the politicians don’t want to hear it.

One fun example is the tax plan NPR asked 5 economists to create that–though it reflects pretty unanimous economic consensus–is a political non-starter with either the Democrats or the Republicans. (Hint: removing the mortgage interest tax deduction doesn’t make anyone happy.)

Another example that’s like that is price gouging.  

As Wikipedia notes, laws against price gouging have been held constitutional in the US and are currently on the books in 34 states. What’s even more interesting, however, is that even when there are no laws against price gouging many retailers refuse to raise prices in the wake of a disaster no matter what happens to their supplies. As NPR reports, this is because there’s a widespread belief among ordinary people that price gouging is unfair, and since merchants will still need to sell to their customers after a disaster has passed, none of them will risk angering the public by raising prices.

In the aftermath of Hurricane Sandy, however, I’ve noticed that there’s been some real discussion about whether or not this anti-price gouging sentiment is actually helpful or hurting. Economist and blogger Greg Mankiw reported on some back-and-forth at his blog, for example, and the Bleeding Heart Libertarian blog had a really nice roundup of reasons why free markets should be allowed to function, even in the wake of a disaster.

The basic case for price gouging (or, as an economist would say, letting the market set the price) is an understanding of the role prices play in a market economy. You’d think that prices would be pretty fundamental to understanding markets, but it wasn’t until Friedrich Hayek‘s groundbreaking 1945 paper on The Use of Knowledge in Society that their role was really understood.

What Hayek said was pretty straight-forward: prices are a decentralized way for everyone involved in the economy to understand the relative value of different goods and services. In other words, if we allowed supply and demand to set price than in the wake of a disaster the price of gasoline (for example) might skyrocket to $10 or $15 per gallon, but this would signal to everyone in the economy that suddenly gasoline was very, very valuable. In addition to signaling the value, it would provide incentive for people to bring extra gasoline to the area.  Marketplace had an excellent story about how this plays out in real life:

Today, New Jersey’s attorney general sued seven gas stations and a hotel for price gouging in the wake of Hurricane Sandy. The defendants are accused of raising prices up to 59 percent. New Jersey has also issued 65 subpoenas. New York’s attorney general is investigating gouging as well, including gasoline sales offered on Craigslist.

In one Craigslist case, Steve Pulaski of Queens was traveling in Vermont with his father when Hurricane Sandy hit. Shortly after the storm, his mom called from home.

“She was waiting three hours on the gas line,” Pulaski says. “Me and my father, we got a couple 55 gallon barrels, we went to this local gas station and filled them up.”

Pulaski drove home, and listed the gasoline for sale on Craigslist.

“Within 10 minutes, I had more than 10 responses,” Pulaski says. “It was like a Sandy of phone calls.”

Each of his sales is negotiated. The average selling price: about $11 dollars a gallon.

“Politically, he’s part of the problem,” says oil analyst Steven Kopits at Douglas Westwood. “But in economics terms, he’s part of the solution. Obviously he’s bringing fuel to the area that simply wouldn’t exist if he hadn’t brought it down.”

It’s a simple question: would you rather be able to buy gasoline at $11/gallon or unable to buy it at $3.50/gallon?

Now you might be tempted to say that it would be better if people just donated the extra gasoline instead, but there are two problems with that. The first is that no matter how many people donate resources, you will have more resource if people also come in and sell it. The second is that donations are notoriously bad at matching the needs of the people they are trying to serve precisely because–without any price system in place–there’s no easy and free way to communicate accurately the needs of the people in trouble. This is why the charity group Underwearness exists, for example.  Lots of folks sent clothes after Hurricane Sandy, but very few people thought to send underwear. Charity groups are great, obviously, but without a price system in place they are largely flying blind.

The strongest argument against raising prices during a disaster is the idea of fairness. If you raise prices, then only the rich will afford to be able to buy necessities.  In the first place, however you have to balance the distribution with the total amount. If the price of gasoline goes up to $11/gallon the rich are going to buy less of it (no one wants to drive more than they have to when prices are that high) and that economizing will result in more gasolien for the poor to buy. $11/gallon is not going to bankrupt most poor people over the course of a couple of weeks, especially when in return for the economizing of gasoline you get a faster recovery.

When valuable resources are kept at artificially low prices, there is no incentive and no real signal to people to conserve, and so you’re much more likely to deal with shortages and these shortages will have no correlation to actual need. If ice costs a lot, for example, then a family who needs the ice to keep their insulin supply good is going to pay the money for it but a family who just wants the ice to cool their drinks probably will not. So yes, the family will have to pay more for ice, but part of what the higher price gets you is more availability of valuable resources to the people who need them most.

The Institute for Humane Studies discusses a lot of these issues (including the specific ice example) in this video:

Finally, however, the most important way to look at this question is to see how it has played out in the real world. This second video talks about how the free market has helped speed reconstruction efforts in Joplin, Missouri after the category EF-5 tornado struck in May, 2011.

The free market is certainly not the answer to every problem everywhere all the time, but there are certainly times where our intuition about what is best for people can lead us astray. The real problem with anti price gouging is not legal. In this case the law simply follows public opinion. If people are more educated, however, they will understand that “price gouging” is really just another name for free markets in hard circumstances, and can be the best way–along with charitable efforts–to ensure that people have access to the resource they need to survive and recover when disaster strikes.