I am writing this blog whilst sitting in the dark as my dorms electricity has gone out. Hurricane Sandy is continuing to ravage the Northeast with battering winds, down pouring rains, and massive flooding. This scene is nothing new to Freehold, New Jersey, where a “supercell” storm this past summer prompted me to write this blog post on the Keynesian notion of disaster-area stimulus. Unfortunately, to no one’s surprise, The New York Times ran a story yesterday on the price tag of the storm and included the potential for this to act as economic stimulus. But the Freehold storm was an isolated, random event that served as an example while Hurricane Sandy is a monstrous behemoth truly wrecking the East coast. Natural disasters like hurricanes provide fascinating insight into the ability of markets to provide solutions compared to government.
Another unfortunate episode in the economic illiteracy of disaster economics takes shape in the calls for anti-price gouging legislation. Take for example this warning from North Carolina Attorney General Roy Cooper, “We’re warning price gougers don’t use a crisis as an excuse to make an unfair profit off of consumers.” It seems seem counterintuitive that higher prices help more people attain precious items such as water or food, but that is exactly the reality. If one wants to see more people able to have bottled water, fresh bread, canned goods, batteries, and flashlights, then they should have been pleading for stores to raise their prices before the hurricane. Mr. Cooper’s notion of unfair profits is really a huge help to local consumers trying to prep their homes with storm supplies.
In order to accurately evaluate the economics behind price gouging in an emergency, one must understand the price system in a free market. Prices are not just numbers with a fancy, modified S in front of them. Prices are amazing pieces of information. They are numbers which tell a story and provide information to the seller and the buyer. As Leonard Read’s outstanding essay “I, Pencil” shows, the price system does a wonderful job of advancing cooperation between people unaware of one another. Leonard Read was influenced by Hayek’s infamous essay “The Use of Knowledge in Society” and Adam Smith’s “invisible hand” aphorism (although Smith only used the term twice in his writings). Both men spoke about the ability of spontaneous forces in the market to organize society in a succient, efficient, peaceful way.
“I, Pencil” provides three clear themes. First, knowledge is dispersed all over the world. Second, people are self-interested. And, third, no one is in charge. This may sound like a recipe for total chaos, but results in a society which produces everything you see around us. In the absence of a mastermind central planner, prices dictate information and order arises from human action, not human design. Hayek says, “The marvel is that in a case like that of a scarcity of one raw material, without an order being issued, without more than perhaps a handful of people knowing the cause, tens of thousands of people whose identity could not be ascertained by months of investigation, are made to use the material or its products more sparingly; i.e., they move in the right direction.” It’s truly incredible.
George Mason professors Alex Tabarrok and Tyler Cowen, in their Modern Principles of Economics textbook, define prices as a signal wrapped in an incentive. How does this relate to the price of water before a hurricane? If stores are allowed to raise their prices, the consumer will get the signal that the item is more heavily demanded and thus buying more of it will cost more and limit others from purchasing it. Unfortunately, only economics nerds will think like this. Instead, people will see a higher price and choose to only purchase what is essential. Simply, a family only buys the necessary water they need when it is $10 per case instead of $5. In this situation, water becomes less scarce because less cases are being purchased. The price of water discourages people with water from buying it and then more people are able to purchase cases of water. When prices are allowed to fluctuate, they convey essential information. Overall, more people will have fresh drinking water and each family has helped another family without even attempting to.
This is the glory of the free market! Consumers coordinate with each other without even realizing it. How could an evil act such as price gouging ever be justified? Simply, because it allocates resources to more people. The capitalist saves resources by finding cheaper ways to do more with scarce resources and thus lowering the price for all. For example, a store has one hundred cases of water at a normal price of $5 and the price is maintained through the storm. The twenty-five families that get to the store first will purchase four cases each and they will have water. If the price is allowed to jump to $10 per case, those twenty-five families will purchase two cases of water only. Now fifty families will be able to purchase the water, merely because the price system sent important signals to the seller and buyer. From the seller’s perspective, if consumers are willing to spend a lot more per case they are incentivized to get water to their customers. This will only help more people get the necessary items they need.
When the government institutes a price restriction like in North Carolina, shortages are inevitable. The people who get to the store first will buy more water than needed because the price is still low. Less people will be able to have the water, bread, or batteries that they needed. When pictures of empty shelves surface, it is very evident prices were kept too low to too long. Again, the notion of fairness and good intentions hinders the markets ability to provide for the most, using the least. This NPR article is a refreshing juxtaposition to the mainstream position that price gouging during a storm hurts the consumer. Economist Steven Horowitz wrote a great report on the ability of private companies, such as Walmart, to provide and assist disaster-stricken areas shows the markets prestige once again. It must be said that, as it always is with markets, they are not perfect. The imperfect market is judged against the “perfect” government, never the imperfect government, or even the incompetent government. Life will always be imperfect because humans are imperfect and mother nature is unbelievably powerful. However, government always does less and costs more than markets do. Free markets achieve through liberty what government attempts to achieve through force. The market option may not be the perfect option, but it provides the best chance for human prosperity and this is no different in times of crises. The plea remains the same: if a business wants to help people in its area the best thing, it could do would be raise prices on essential items.