Who’s taking advantage of whom?

Controlling prices during natural disasters can do more harm than good.

Derek Olson

Recent attention has been drawn to the shortage of gasoline in areas hit by Hurricane Sandy. Victims are facing long lines, or worse, they’re turned away because the pumps have run dry. Directly connected to this issue are the anti-price-gouging laws that have taken effect. Price gouging is a pejorative term for when firms or individuals raise prices during a disaster. These laws, which make price gouging illegal, are often supported across the political spectrum for reasons of ethics and consumer protection. However, a closer examination shows they are neither ethical nor protecting consumers.

Under normal market circumstances, a shortage of a good would cause the price to rise. When laws prevent this, there is an allocation problem. Those who can purchase gasoline are no longer those who are willing to pay for it. In this case, they are the ones who beat everyone else to the pump or those who can sacrifice a few hours to wait in line. Allocation is determined on a first come, first served basis, and the rest are left with nothing.

In economic terms this creates deadweight loss. Also called a loss of efficiency, it exacerbates the time it takes to recover from the disaster. The time wasted by standing in line could be put to other productive economic activity such as repairing the neighborhood or returning to work.

What would happen if the price rose? Consumers would be careful about conserving the scarce resource. They may decide to make ends meet with half a tank or make a full tank last twice as long. If the price is too low, consumers don’t have an incentive to conserve the resource before it runs out for everyone else. Moreover, this effect causes compounding of the problem. By the time the consumer reaches the front of the line, he is likely to stock up on gasoline so he doesn’t have to return to the long line. The resource becomes further depleted for those at the back of the line. The price restriction causes consumers to exacerbate a social problem, while a price increase makes consumers unconsciously more helpful to each other.

Perhaps even more important is the supply side effect. Suppose that a natural disaster destroyed a city’s bridge across which the tanker trucks drive. Now, the gas stations must pay more to transport fuel by some other means. However, if they cannot charge a higher price, they cannot afford a more expensive supply route. Instead, they decide not to sell any gasoline at all, leaving the entire city without it.

If prices were allowed to rise in the time of tragedy, suppliers would pay more money to transport more gasoline into the city, helping to alleviate the shortage. In the long run, suppliers might even build excess capacity to prepare for such an event.

Only two groups of people benefit from anti-price-gouging laws. First are those individuals who happen to fill up at the pump before supplies run dry for everyone else. There’s no guarantee that these keen individuals who act swiftly are low-income individuals who can’t afford a price increase. In reality, it’s probably more likely that affluent individuals have the resources necessary to react swiftly.

The other group to benefit is the politicians who get to mask their impotence in combatting Mother Nature and boast sympathy for the victims. Many people believe the government should protect the consumer. In this case, we must protect the consumer from the government.

In order to support this policy, one must successfully argue three points. First, that an essentially random allotment, awarding gasoline on a first come, first served basis and leaving the rest with nothing is fair. Furthermore, it is ethical to actively encourage those randomly awarded to over-consume, which further exacerbates the shortage that everyone else is suffering.

Second, if one can somehow construe the random allocation as more fair than the alternative, one must further justify it by arguing that this fairness is more important than the deadweight loss of efficiency in the market. Even those who are lucky to benefit from a lower price suffer because deadweight loss slows productivity and delays the recovery for everyone.

Third, if one can argue those two points, one must believe that this is the case for all natural disasters, and thus, the permanent policy that applies to all state-declared natural disasters is appropriate.

All three of these arguments fail by themselves. When stacked on top of each other, it is truly befuddling that anti-price-gouging laws are as common as they are.

If the government knows what the optimal price of gasoline is, why stop there? Why doesn’t it tell all businesses what prices are fair?

These laws represent how sympathy for the sake of ethics can suspend the people’s belief in free markets. In the absence of market failures, there is no justification for government intervention. The competitive free market is the most ethical solution. In no other way have so many people coordinated activity voluntarily.

Politicians usually back these laws with language that they are preventing businesses from taking advantage of victims. The people need to know who is really taking advantage of them.