Why Price Gouging Is Good

When a natural disaster strikes, it is almost guaranteed that there will be yet another uproar about price gouging. Media pundits will take to the airwaves to virtue signal against people who would dare to exploit disaster victims. Government officials will use the crisis to score political points by portraying themselves as defenders of the common people against greedy capitalists. But how accurately does this reflect reality? Let us explore the nature of price gouging to see the economics of such a situation and explain the behavior of journalists and state agents.

Economic Forces

In order to intelligently approach the concept of price gouging, one must first define it. Price gouging is a sudden, sharp increase in prices that occurs in response to a disaster or other civil emergency. Though this defines the act well, it does not explain the mechanisms behind it. When a disaster approaches, there are certain goods that people wish to acquire in greater quantities than normal, such as clean drinking water, non-perishable foods, wooden boards for protecting windows, and so on. If supply is held constant, then this sudden increase in demand for such goods will produce a sudden increase in their prices.

If left unhindered by the state, this upward pressure on prices will produce important benefits. First, it serves as a signal to producers and distributors of those goods that more supply is needed. The producers and distributors thus learn where their goods are most urgently in demand, allowing them to engage in mutually beneficial transactions with disaster victims. This is how free markets are supposed to function in order to meet the needs of customers.

Second, price gouging encourages proactive preparations. A potential business model for a firm is to invest in equipment that allows it to operate when a disaster would otherwise force it to close, and use the proceeds from price gouging to amortize the cost of the equipment. This helps consumers by allowing them to purchase goods at higher prices rather than be left without essential items during a crisis.

Third, price gouging provides an important benefit by conserving the fixed amount of resources which are present before more deliveries can be made to the disaster area. The higher cost of scarce goods disincentivizes people from buying up supplies that other people need, thus helping to keep the items in stock. This keeps scarce resources from being wasted on marginal uses, directing them toward their most valued uses and the people who most need them instead.

Markets And Malice

Unfortunately, not every instance of price gouging is so benevolent. Business owners who seek to exploit vulnerable people in order to make money do exist. But engaging in such behavior in a free market produces a short-term gain followed by a long-term loss. In a pure capitalist environment, reputation is everything for a business. Whatever profits may come from gouging disaster victims in the present will be more than outweighed by the sales that one will lose in the future because of the damage that this does to one’s brand. After all, most people would view such behavior as adding insult to injury and vote against it with their wallets. Though it is impossible to accurately count sales that do not happen, to dismiss this effect as nonexistent is to commit the broken window fallacy.

Enter The State

Most people are economically illiterate, so they tend to focus on the malevolent type of price gouging and be unaware of the benevolent type. In a democratic state, this has predictable results. Politicians and other government agents will frown upon price gouging and seek to punish anyone who they believe to be engaging in it. But it can be difficult to distinguish the natural effects of demand spikes and limited supplies upon price from the efforts of greedy exploiters of disaster victims, especially for government officials who are too far removed from the disaster area to be intimately familiar with the economic dynamics there. Thus, all price gouging is suppressed by the state, and while this may protect a few people from exploitation, it causes more harm than good by disrupting the market signals which would have informed producers and distributors that their goods need to be sent to the disaster area. The end result is that scarce goods are depleted and not replaced, leading people to once more blame the market for failing them when the actual cause of their shortage was a government failure.

Suppression of price gouging has several deleterious effects. First, by placing price controls on goods, the state deprives entrepreneurs of the profit motive to bring additional supply to the disaster area. Without state inteference, people who live outside of the disaster area and are willing to travel there in order to bring supplies could charge enough for their goods to recover their travel costs and be compensated for the inconvenience of spending time in a disaster area, all while making enough profit to make such a venture more attractive than other economic opportunities. Price gouging laws remove such action, leaving only state agencies and altruistic private groups to provide aid. Note that like all government regulations, price gouging laws are subject to regulatory capture by the largest businesses.

Second, removing the incentive for proactive preparations makes untenable the business model for operating during a disaster described above. Third, removing the conservation effect of price gouging forces business owners to sell goods below their market-clearing price. This incentivizes hoarders to buy more than they need and scalpers to buy goods for resale. The existence of scalpers also makes desired goods more difficult to find, as resellers will be more difficult to locate than established stores. Thus, laws against price gouging do not eliminate the practice, but rather shift it from primary markets to secondary markets and cause a different set of people to profit. Taken together, these effects result in artificial scarcity that makes conditions in a disaster area even worse.

A Pair of Razors

Given the clear case in favor of price gouging, one may wonder why so many people in positions of political power rail against it. Reece’s razor suggests that we look for the most cynical explanation when attempting to determine a motive for state policy. No other possibility prioritizes the self-interest of politicians and their minions over the lives and properties of citizens quite like the idea that government officials want to suppress the natural response of markets in order to make government disaster relief agencies look effective and necessary, thus justifying their existence and expansion, so Reece’s razor selects it.

However, it is not in the rational self-interest of elected officials to increase the suffering of disaster victims who are capable of removing them from office in the next election. A better explanation is offered by Hanlon’s razor, which says that one should not attribute to malice what can be explained by stupidity. In this view, government officials are not trying to increase the harm done during a disaster; they simply know no better because they are just as economically illiterate as the electorate, if not more so. This razor is a better fit for the available logic and evidence.

Conclusion

It is clear that price gouging has an important economic role in ensuring that goods both go to those who need them most and remain available in times of emergency. Market prices are important signals that tell producers and distributors where their goods are most urgently needed. When the state interferes with this process by imposing price controls, it turns off the signal and incentives for market actors to send aid, encourages hoarding and scalping, and discourages conservation and farsightedness. These effects mean that laws against price gouging harm the very people that they are ostensibly supposed to help. Therefore, price gouging should not be punished by the state or demonized by the press.

Disasters and the Pax Romana Problem

Whenever disasters impact an area in modern times, governments play a large role in the cleanup and recovery efforts. People file claims with the state to recover their losses while simultaneously inflicting those losses upon taxpayers elsewhere in the nation. Building codes are enhanced, and because resources spent on one expense cannot be spent on another, the result is less resources available for communication, medical care, and transportation to warn people of disasters, get them away from danger, and treat any injuries or diseases that result. The usual pork barrel spending and high-profile boondoggles will rear their ugly heads among the disaster relief spending.

But there is an even more insidious problem at work here, which we may term the Pax Romana Problem. Students of history will be familiar with the time of relative peace and stability from the time of Augustus (r. 27 BCE-14 CE) until the time of Commodus (r. 177-192 CE). During this time, the economy, the arts, and agriculture flourished because the tribal battles that predated Roman conquests as well as the rebellions and riots that predated the Pax Romana were largely suppressed. But there was a dark side to this, particularly in parts of the empire which were much closer to the border than to Rome. With Roman forces in charge of law, order, and security, many peoples suffered losses in the ability to provide these services themselves. After all, societal organs tend to decay from disuse just as individual people do. When the Pax Romana ended, these peoples were without the stabilizing forces which they had come to rely upon and were out of practice in providing these services for themselves. The end result was that several of these peoples were raided and conquered by various barbarians and empires.

At first glance, this may not appear to have much to do with disaster relief. But there is a similarity between what happens when governments step in during disasters and what happens when a large empire takes over security for formerly independent smaller tribes. Before there was massive government intervention to help disaster victims, people had more of an incentive to plan ahead and be ready for potential disasters because they knew that if something were to happen, they would have to rely upon themselves and the people in their communities to survive and recover. Without the potential for government agents to step in, people were less likely to view disaster relief as someone else’s problem and thus more likely to donate to relief efforts. When one relies upon people one knows for support during hard times, defrauding people is disincentivized due to both the loss of reputation in the community as well as the potential for reprisals. Looting is also less of a problem when security is handled directly by private property owners without involving the state because they and their hired help are both more competent at and more concerned with solving local crime problems than distant bureaucrats and their minions. Of course, these conditions meant a stronger social fabric and less dependence on the state, so governments found it all too tempting to interfere.

Before there was significant government involvement in the insurance industry, insurers would either refuse to insure or charge exorbitant rates to cover properties which were at a continually high risk for being destroyed by floods, earthquakes, volcanoes, and other such periodic catastrophes. This was an important market signal that certain areas are not good places for humans to build permanent residences. Of course, some people ignored those signals and suffered the consequences of their stupidity, but this has better outcomes for everyone else than rewarding such stupidity with government handouts which incentivize people to stay in places where they are likely to suffer disasters.

Now that governments play an active role in disaster relief, all of the problems that one might reasonably expect are present. When politicians have a choice between doing what is best for the people and doing what helps their public image, they will almost invariably choose the latter. Because the state has a coercive monopoly, it cannot be fired or have its funding suspended by normal means, regardless of how terrible its performance is or how much it interferes with private efforts which are trying to help people. To the contrary, failure means that statists can claim that insufficient funding is the reason for failure. There is also the matter of vote-buying, in that the people have an incentive to elect politicians who will deliver them the most funds from the government treasury. Disaster relief is not as reliable a payout method as welfare programs, but it is still a means of legal plunder available to those who live in disaster-prone areas.

We can also see the typical one-size-fits-all policies rather than the more targeted solutions that a private effort would attempt. For example, following Hurricane Katrina in New Orleans, the Federal Emergency Management Agency announced a program to give away $2000 to every household that claimed to be affected by Katrina, regardless of size or need. Of course, this was subject to much waste, fraud, and abuse. Unlike private organizations who must rely upon voluntary donations, the state has no incentive to actually figure out how much help each household needs, so it overpays some and underpays others.

With government infrastructure management, people are encouraged to live in places which are at higher risk for disasters than would otherwise be economical to inhabit. To use the example of Katrina again, levees held back water from areas which have an elevation below sea level. Investigations into their failure showed cost-cutting during construction as well as poor maintenance. While there is no guarantee that a privately built and maintained system would have been successful, that which may or may not work is better than that which is known to fail. Then again, leaving infrastructure up to the private market could have meant that low-lying areas would have always been underwater and thus uninhabited, meaning that structures and lives would not have been at risk there because they would have been absent in the first place.

Government flood insurance programs also encourage people to take risks which would not make economic sense in a free market. What is incorrectly perceived as a market failure is actually a market success; the process of voluntary exchange and decentralized calculation produces the result that flood plains are inferior places to build a house or business. Rather than people rebuilding communities in unstable locations for the umpteenth time, a free market in flood insurance would cause low-lying areas to be abandoned and returned to a state of nature, as is proper. Perhaps in time, such places which are near coastlines and below sea level could fill in with sediment and become livable lands which do not require levees to keep water out of them.

Finally, government police and National Guard forces have largely displaced private security measures to prevent looting during disasters. Worse than that, they have actively engaged in attacks upon disaster victims who were trying to provide such defense for themselves, causing the very problem they should be trying to solve.

Fortunately, this perverse state of affairs will not last forever. Someday, the United States government will decline and fall, just like Rome and so many other empires throughout history. Just like the outer peoples of the Roman Empire after the Pax Romana ended, the American people will be left to fend for themselves in the absence of the federal government. The degree of government involvement in their lives will leave them weakened in the face of disasters which will not cease to afflict them when the state does. But a return to proper incentive structures will mean that in the long run, behaviors will be positively modified, the attitudes of the people will change to match those behaviors, and the community bonds which support a truly healthy society can be rebuilt.