Should Price Gouging in the Aftermath of Catastrophes Be Punished?--Posner

Hurricane Katrina has produced a mass of interesting revelations. One is that more than half the states have laws forbidding "price gouging," often defined with unpardonable vagueness as charging "unconscionably" high prices. These laws are rarely enforced. But the sharp runup in gasoline prices as a result of Katrina (and also Hurricane Rita, which followed almost immediately), impeding imports of crude oil and causing a number of refineries in the path of the hurricanes to shut down temporarily, prompted a flurry of enforcement threats and even a few fines. It also prompted denunciation by politicians of greedy refiners and gasoline dealers, and proposals for federal legislation prohibiting "unconscionably excessive" gasoline price increases. What prompts such reactions besides sheer ignorance of basic economics (a failure of our educational system) and demagogic appeals by politicians to that ignorance is the fact that an unanticipated curtailment of supply is likely to produce abnormal profits. The curtailment reduces output, which results in an increase in price as consumers bid against each other for the reduced output. In addition, the reduction in output is likely to reduce the sellers' unit costs; the reason is that sellers normally sell in a region in which their costs are increasing--if they were decreasing, the sellers would have an incentive to expand output further. With both price rising and cost falling, profits are likely to zoom upward. (Some gas stations are reported to have seen their profits increase by 400 percent shortly after Hurricane Katrina struck.) In times of catastrophe, with consumers hurting, the spectacle of sellers benefiting from consumers' distress, while (it seems) deepening that distress by charging them high prices, is a source of profound resentment, and in a democratic society profound resentments trigger government intervention. Such intervention is nevertheless a profound mistake, and not only from some narrow "economic" perspective that disregards human suffering and distributive justice. If "price gouging" laws or even merely public opinion deters refiners and dealers from charging the high prices necessary to equilibrate demand and (reduced) supply, there will be shortages. Consumers will still be paying a higher price than before the shortage, but they will be paying the higher "price" in the cost of time spent waiting on line at gasoline stations, or (if they drive less because of the shortage) in the form of restricted mobility. And those who need the gasoline the most, not being able to express their need by outbidding other consumers for the limited supply, will suffer the most from the shortages. The only beneficiaries will be people with low costs of time and nonurgent demand. But here is an interesting wrinkle. Admiralty law and common law (both are systems of judge-made law, but they are classified separately by lawyers because they used to be administered by separate courts) alike forbid certain practices that might be described as "price gouging." Suppose a ship is sinking, and another ship comes along in time to save the cargo and passengers of the first. The second ship demands, as its price for saving the cargo and passengers of the first ship, that the owner of the ship give it the ship and two-thirds of the rescued cargo, and the captain of the first ship, on behalf of the owner, being desperate agrees. The contract would not be legally enforceable; under the admiralty doctrine of "salvage," the second ship would be entitled to a "fair" price for rescuing the first, but to no more. In a parallel case, also maritime but governed by common law rather than admiralty law (the Alaska Packers case, well known to law students), seamen on board a ship that was fishing for salmon in Alaska waters went on strike, demanding higher wages. The captain of the ship agreed because, the fishing season in these waters being very short, he could not have hired a replacement crew in time to make his quota. Again, however, the court refused to enforce the contract, in essence because it had been obtained under duress. These cases, it turns out, are subtly but critically different from the "price gouging" alleged in the wake of Katrina and Rita. The refiners and dealers who raised prices after the hurricanes disrupted gasoline refining had not created the situation that resulted in a reduction in supply. If they had, say by agreeing to increase price above the existing level, they would have been punishable for violating the antitrust laws. (There were some accusations of price fixing, but as far as I know they have not been substantiated.) Similarly, in the salvage case, the rescue ship is not being asked to ration a limited supply by raising price; there is no one else competing for the rescue service--there is just the one ship in distress. And in Alaska Packers, there was no labor shortage, which would have justified seamen in demanding higher wages; the seamen created the shortage by refusing to work. From an economic standpoint, their workers' cartel was symmetrical with my hypothetical refiners' or dealers' cartel. Both are examples of opportunistic behavior--behavior designed to take advantage of an unforeseen opportunity to charge a monopoly price by threatening to withhold output. The hurricane-induced scarcity of gasoline that pushed up prices was not an artificial scarcity, but a natural one. The price increases generated by a natural scarcity (or indeed any scarcity not created by the person or firm imposing the increase), while they may generate "windfall profits," are unavoidable in a way that price increases due to a shortage created by a cartel are not. A further exception to taking a hard line against responding to a natural scarcity by imposing price controls, some would argue, is the rare situation in which the consequence would be an intolerable gap between wealth and welfare. Suppose there is a highly limited supply of human growth hormone, so that if price is allowed to ration demand, all the hormone will be purchased by rich people who would want their sons and daughters of average height to be taller, and no hormone will be purchasable by poor people, or even people of average income, who have children who will be dwarfs unless they get the hormone; they simply are outbid by the rich. In such a case, there may well be a compelling moral argument for allocation of the limited supply on a basis other than price, presumably some utilitarian concept of welfare: aggregate happiness would be promoted by allocating the hormone on the basis of need rather than ability to pay. This was not a factor in the market's response to the incipient gasoline shortage caused by the hurricane. Not only are the duress and welfare objections to price allocation inapplicable to the run up in gasoline prices but higher prices for gasoline are a source of substantial external benefits (that is, benefits not conferred on the parties to the transaction, so that the parties do not have an incentive to consider them in deciding on the price and other terms of the contract). By reducing the amount of driving and (if the higher prices persist) a switch to more fuel-efficient cars, higher gasoline prices cause a reduction in the amount of carbon dioxide emitted into the atmosphere--a major cause of global warming--while also reducing more conventional forms of automobile air pollution. A reduction in driving also reduces traffic congestion, which imposes costs in the form of delay on all drivers in congested areas. Finally, a reduction in the amount of oil consumed in the United States would make the nation more secure by reducing the wealth and economic leverage of the vulnerable, unstable, or hostile nations, such as Saudi Arabia, Iran, and Venezuela, that control so much of the world’s oil supply. In short, the social benefits of gasoline "price gouging" appear to exceed the social costs by a large margin.

Comments

[Michelle]

What I don't understand is why price gouging during crucial times is necessarily a bad thing, or rather, that it's not 'normal economic action.' After all, the owners of the gas stations were risking their lives to provide people with gasoline. If there were strict price controls then few people would be able to find gasoline and for survival's sake, the gas stations would probably have been ransacked.

All too often, unfortunately contracts are signed under duress. A handsome salesman for example, visiting a lonely woman, can be said to have enacted an exchange while she was less able to make projections on why really she would need a set of dictionaries. Such things are not reported of course, but force and fraud leads many to do things that are not for their 'best interest.'

Also, I'm really interested in learning about your stance on the Great Depression. For some, like Joseph Kennedy, it was a boon, for most, it was a bust.(climbing on the bones of many) Is it even ethical to buy and sell stocks at all? Are some stocks too terrible even if they will bring one a profit?

[mike riikola]

Paul Gowder:

Your figures nicely prove what we should all intuitively know. Parallelism of the curves is to be expected, because (a) there is no real substitute for gas, and (b) it is scarce (i.e., not universally abundant, like salt or O2). Hence there is no need for "collusion" among the oil companies. They know an opportunity when they see it and behave in perfect parallelism.

[mike riikola]

Paul Gowder:

Your figures nicely prove what we should all intuitively know. Parallelism of the curves is to be expected, because (a) there is no real substitute for gas, and (b) it is scarce (i.e., not universally abundant, like salt or O2). Hence there is no need for "collusion" among the oil companies. They know an opportunity when they see it and behave in perfect parallelism.

[Winston]

This part had me confused:

The curtailment reduces output, which results in an increase in price as consumers bid against each other for the reduced output. In addition, the reduction in output is likely to reduce the sellers' unit costs; the reason is that sellers normally sell in a region in which their costs are increasing--if they were decreasing, the sellers would have an incentive to expand output further. With both price rising and cost falling, profits are likely to zoom upward.

Why do the sellers' unit costs go down? I would think that when supply decreases, the sellers' average costs will increase as it tries to increase supply through less efficient methods. Posner wrote that sellers usualy sell in a region in which their costs are increasing, but what happens after a natural disaster that changes this?

[Joe Merchant]

Ben,

The chaos is down at the ground level - where people actually live and work. Sure, overall US GDP is up and growing steadily - and a windfall for big oil is likely to benefit the US more than most other countries, except the major oil producers.

If all the economists care about is the view from 8 miles high, yeah, this is all roses, $26 billion didn't go down a black hole, it just got relocated - from the pockets of many into the pockets of few. If that redistribution of wealth pattern doesn't bother you, you should visit a country like Panama - see how the top 1% of wealthy there live, then check the lifestyle of the bottom 90% - it's not the model for a vibrant world economy.

[Corey]

"I would not advocate massive intervention in the oil market just because gas is $3/gallon. That's still the same price in real terms that Americans were paying 30 years ago."

What, you mean during the mid-70s energy crisis? The other problem is that the wage and wealth of the average American has dropped significantly over that same time. (A fact often obscured by citing GDP growth numbers that include the massive growth in wealth among the already rich since 1975)

"Is it the government's job to decide what a "good return" for a company is?"

YES. Recall the originalist rationale for chartering corporations in the first place. It was viewed as a quid pro quo privatization of services the government did not want to micro-manage. However, there is a public trust element, often reconceptualized in this day and age into a "shareholder trust" element.

"So what? a) That's not money down a black hole."

No, you are right, it will be great for the beachfront real estate industry and create several new toilet-cleaning jobs at the new summer cottage of the Exxon CEO. But it represents an extremely massive redistribution. $26 Billion dollars that was in the hands of American consumers, now under new management by the Board and CEO of Exxon. Maybe if we write them a nice letter they will spend it on developing new eco-friendly fuels that will destroy their business model instead of voting for dividends, stock buybacks, and profit sharing plans that net them each $100 million dollars in spending cash. Lets all watch the news and see what happens eh?

This whole thing is a textbook example of why the initial distribution of market power directly determines the end distribution of market benefits. The ironic thing about the price-gouging laws is that where they did get applied, it was against individual gas-station owners (that is, small-business owners who may or may not have been gouged themselves by their suppliers).

Exxon made Billions, and gets a insurance/gov't bailout of all the actual damage to its infrastructure.

The American populace paid Billions, regressively, and only managed to provoke a few statements from congress and some prosecutions of localized small-business scapegoats.

But as Posner points out and I agree, to a free-market economist, this result was efficient.

You folks who want to reduce oil consumption by raising prices on consumers... why are you unwilling to accomplish the same end with a top-down government limit on output? A price control is somehow evil because it disincents production and causes queues? But price-gouging is OK because it reduces consumption without causing queues? The result is the same! I say that you just don't want to have to look at the queues. Lines of working class people at the pumps would be unpleasant and remind us daily of real disparities in wealth. The other problem with queues is that even the well-off have to sit in them. But under Posner's way, the poor stay home, out of sight, and the middle class can still afford to come out and pay extra for gas. One could even say the price increase is worth it, because it keeps those unsightly poor from crowding the lines at the station and the supermarket.

Behold the sanitation tax.

[Corey]

The other point is, even if the Exxon managers spend their new $26B in a socially responsible way, what is your rationale for preferencing that over the socially responsible spending of the 300M American consumers who would otherwise have done so if they hadn't had to spend $26B extra on gas to get to work?

Ah, see, maybe you don't think the people will behave collectively in a socially responsible fashion? The Board of Exxon is more controllable, rational, and efficient at managing money?

So why not give ALL money to the Board of Exxon. If they are truly capable of acting in the best interest of the common good, we should empower them to do so no?

Oh, but that looks like fascism! I agree. So, the question becomes, at what point does profit maximization and wealth concentration cross the line and convert a system that was primarily democratic into one that is primarily fascist?

The question isn't, does Joe Sixpack get a job? Rather, did Joe Sixpack have enough resources to choose his job independently, or was he subject to re-assignment into an unwanted locale by the Board of Exxon.

[Sylvain Galineau]

Ah, see, maybe you don't think the people will behave collectively in a socially responsible fashion? The people collectively re-elected George W. Bush on one of the largest turnouts in recent memories; yet I have a feeling that this outcome was not entirely satisfactory to you. On what basis do you believe the same people are more likely to behave in a 'socially responsible' way - whatever that means - than the alternatives given the choice ? Would you actually trust them with that choice ? Or would you rather foist it upon them for their own good ?

Lines of working class people at the pumps would be unpleasant and remind us daily of real disparities in wealth.I am sure the 'working class people' across the nation would love nothing more than spend hours waiting in line for the education of Mr Posner and the public revelation of those embarrassing disparities of wealth; I am also sure that while these lines would be 'unpleasant' to Mr Posner, they would in fact be quite comfortable for, and appreciated by, those in them who are working class. If anything, they would certainly be quite an improvement over our present arrangements.

As for those problematic disparities, they would clearly be best dealt with by making us all equally broke so we have nothing else to do but wait in line for whatever little is available and affordable. I mean, we'd all be in line all day long but equal. That's got to count for something at the end of the day, right ?

I guess I should not joke around too much. Given how intimate with the desires and aspirations of the 'working class' you seem to be, one can only conclude you must be one of them.

Can I give you a hug ? Or do I have to get in line for that too ?

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