The devastation wrought by Hurricane Katrina has shocked the nation, but so has the response to that devastation. Anger is surging over the behavior of governmental relief agencies, local law enforcement, the underclass of New Orleans, the National Guard, and the profiteers who are capitalizing on human misery. Regardless of how we feel about the former groups, the assault on profiteering is misguided and counterproductive. The crisis would be shorter and less painful if we accepted without complaint what goes by the epithet of “price gouging.”
There is no doubt that gasoline supplies have been severely constrained by the hurricane. About 12 percent of the nation’s refining capacity has been damaged and the pipelines that deliver fuel from the Gulf Coast are still mostly offline. Oil companies are carefully rationing what they have and are uncertain when the flow of gasoline from refineries might return to normal. Meanwhile, panic is driving up demand as motorists line up for gasoline out of fear that it might be a lot more expensive -- or perhaps not even available -- tomorrow. Some communities are literally seeing the pumps run dry.
So, how should we ration our limited pool of gasoline? In a free market, scarce goods are typically rationed by price. People who value gasoline most are willing to pay higher prices than those who value it less. The former get the gasoline -- the latter to some extent go without. Allocating resources to those who value them most is one very important reason why our economy outperforms economies where resources are allocated by political action.
Some find this terribly unfair. The poor motorist may value the gasoline as much as the rich motorist, but his willingness to pay is constrained by his inability to pay. And even when he does pay, the economic pain caused by those high prices is far beyond anything inflicted on the rich. Accordingly, price controls are offered as a means to cushion the blow on the poor and to ensure a more equitable distribution of fuel.
Price controls, however, come at a cost. Lower prices result in more demand for fuel than do higher prices. That’s why the first thing we notice about price controls is that they lead to shortages. Price to the left of the intersection of the supply-and-demand curve and you are guaranteed to vaporize whatever you are attempting to keep inexpensive. It happened in 1973 when President Nixon imposed price controls on oil -- gasoline lines were the result. It happened in 2000/2001 when California Governor Gray Davis refused to lift retail price controls on electricity -- blackouts soon followed. Empty shelves are the defining feature of markets where price controls are in place. It’s a law of economic gravity.
Many American politicians seem to vaguely understand this, so instead of ordering price controls, they criminalize excessively high prices (leaving ambiguous just exactly what qualifies as an “excessively high price”) or, alternatively, they inveigh upon the industry to voluntarily price gasoline below what the market would bear. But the effect is the same. The reason that gasoline is disappearing from service stations across the nation is because station owners aren’t gouging with sufficient gusto. Whether out of a misguided sense of kindness, concern about what politicians might think, fear of bad press, or the desire to keep customers happy, they are pricing below what the market would otherwise bear and, as a result, their inventory has disappeared.
Now, how are the poor been helped by service stations closing down for lack of fuel? Gas at $6 a gallon, after all, is better than gas unavailable at any price. Moreover, shortages are likely to disproportionately affect the poor since rich people can spend more money finding gasoline and securing alternative means of transportation.
Price controls are also inefficient when it comes to allocating fuel among competing users. Those who value gasoline only somewhat have as much chance of getting fuel as those who desperately need it. Whoever gets in line first gets the gas. Human well-being in the aggregate suffers as a result.
Moreover, price controls lengthen the shortages. Allowing prices to rise to whatever their natural level might be sets off an economic chain reaction that remedies the shortage quicker than any conceivable government plan to do likewise. That’s because $3 gasoline and moral exhortations from President Bush and Bill O’Reilly to conserve fuel will not produce the same degree of frugality that $6 gasoline would deliver. Likewise, pleas to the oil industry to “help thy fellow man” will not yield up as much gasoline as the promise of great profit were suppliers to get new fuel to the market.
Be that as it may, “profiteering” strikes most of us as unsavory. But it depends on the context. After all, were we serious about criminalizing price gouging, we would throw every member of the National Association of Realtors behind bars. Although the markup on housing is far more dramatic than the markup on gasoline, we don’t seem to mind. Why? Because most of us getting gouged on Sunday afternoon at the open houses hope one day to do likewise. Apparently, Americans approve of gouging as long as they’re the ones doing the deed.
Be that as it may, America is apparently due for a refresher course in Price Controls 101. Watch carefully.