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Why gouging laws don't work

By GRAHAM BRINK
Published December 11, 2005

At first blush, laws against so-called "price gouging" sound beneficial.

Who would want victims of natural disasters to face price hikes on essential supplies and services?

Well . . . a lot of economists, that's who.

Allowing prices to rise after a natural disaster may not be politically popular, but to many economists it makes sense. The laws create shortages and delay recovery, they say.

It's not some ivory-tower, market-efficiency argument, either, said Russell Roberts, an economics professor at George Mason University. Price-gouging laws hurt the very people they are intended to help.

Roberts and his supporters don't suggest that everyone in a disaster zone be left to fend for himself. Help the poorest and hardest-hit families with charity and targeted government assistance, he said. But let prices rise naturally.

"This argument is about what helps people's lives the most after a disaster," Roberts said. "Price-gouging laws, while well intented, are a terrible mistake."

Florida law prohibits charging excessive prices for essential items - including gasoline, ice, water, lumber, generators and shelter - after an emergency declaration. Retailers, however, can increase prices to cover legitimate costs.

The state looks at whether there is a "gross disparity" between what a business charged during the state of emergency and the average price it charged in the preceding 30 days. Violators face civil fines, not criminal penalties.

During the 2005 hurricane season, price-gouging hotlines set up by the state received thousands of complaints.

Florida Attorney General Charlie Crist, whose office aggressively investigates claims of price gouging, says victims of disaster should not be further victimized by "profiteers."

"Price gouging is one of the most callous acts undertaken while a community is suffering," Crist stated after Hurricane Wilma. "No one should have the opportunity to so coldly exploit their neighbors."

But one person's callous exploitation is another's economic necessity.

After a disaster, scarcity arises from an increased demand for goods or a disruption of supply, or a combination of both.

A sharp rise in prices signals to consumers that they should adjust their consumption right away. When prices go up, people are less likely to buy more than they need. That spreads the product around to more people, Roberts said.

In other words, higher prices help ration scarce supplies, economists argue.

Take as an example a shop that has 1,000 bottles of water that normally sell for $1 each. If the store is forced by price-gouging laws to keep the price at $1, the first 10 or 20 people through the door could easily purchase every bottle.

If the store is allowed to raise the price to $5 or $10, buyers will be more likely to purchase only what they need.

The same example can be used for any products that are scarce after a disaster - gasoline, generators, chain saws, even hotel rooms. For instance, higher prices would encourage a family of five to pile into one room instead of getting a separate room for the kids. That frees up a room for someone else. The higher prices also ensure that most casual travelers will stay out of an area, freeing up more rooms for evacuees.

Economist Don Boudreaux calls it "economic triage."

"Higher prices inspire people whose needs aren't as pressing to forgo using scarce resources," he said.

Higher prices don't just help ration supplies. They encourage quick resupply, as well.

Speed is of the essence after a disaster. Supplies need to make it to the hardest-hit areas as soon as possible. If a roof is leaking, it needs to be repaired soon, before it causes further damage. The potential for windfall profits encourages everyone along a supply line to work quickly to deliver products and services to the areas most in need.

Laws against price gouging erode that incentive.

Say a enterprising man in Tennessee sees that a storm has ripped through Central Florida. He buys 50 generators for $400 each from his local hardware stores and drives them to the disaster scene in a semitrailer truck that he rented. He then attempts to sell them for $800. Under Florida law, he is a price gouger.

No one is forcing anyone to buy the expensive generators, say opponents of price-gouging laws. But people should be able to buy one if they want to. Price-gouging laws eliminate that option.

The Tennessee entrepreneur, and others like him, can't be expected to deliver supplies without a hefty financial incentive. Eliminating the incentive only exacerbates the shortage of generators, or other supplies. The same goes for services provided by contractors, carpenters, plumbers and roofers. They need to be enticed to leave their families in faraway places to come to a disaster zone.

In a free market, financial incentives are the most reliable, Roberts said.

"Some people will help out for purely altruistic reasons," Roberts said. "But the majority of people have multiple motivations for helping out. It would be bad policy to rely solely on people's good will."

The potential for windfall profits helps limit shortages after a disaster in other ways.

Extra profit encourages businesses to stay open, even as they deal with many of the same hardships as everyone else in the community. Profits are the reward for taking the risk of continued service.

Fixed prices also discourage businesses from setting aside supplies in anticipation of future disasters. At the beginning of hurricane season, a hardware store could set aside a storeroom for extra generators or chain saws. But without the prospect of a financial windfall, the owner would have no incentive to waste money and space to purchase, store and maintain those supplies, because it could be months or years between disasters.

For some service providers, just the threat of getting caught up in price-gouging laws keeps them from bidding on repair jobs, Roberts said. And as the state becomes hypervigilant over "price gouging" - a gas station in the Panhandle was fined for raising prices just 8.7 cents per gallon after Hurricane Dennis - then the situation will only get worse, Roberts said.

"Overall, the result is that we will be less prepared when disaster strikes," Roberts said.

Allowing prices to rise naturally may not be perfect. But to University of Chicago economics professor Gary Becker, the alternatives are worse.

"The main alternative to higher prices is rationing in some form of another, such as selling on a first-come, first-served basis, selling to persons willing to bribe the suppliers, and so forth," Becker, a Nobel laureate, wrote in a recent online article. "All these ways are inefficient, and discourage production instead of solving the problem of reduced availability of certain goods."

Corruption, cronyism and long lines can slow recovery, Boudreaux said. If the government artificially restrains prices, then people with political or personal connections benefit the most, he said.

First-come, first-served isn't the answer, either, he said. There are no guarantees that the people who need a supply or service most will be near the front of the line. The hardest hit often have less time to line up, he said. They are the ones scrambling to keep the roof from leaking or dealing with injured loved ones.

But what about those who cannot afford higher prices?

The poor are no more likely to benefit from an arbitrary system, Boudreaux said. Rationing using personal and political ties favors the wealthy, who are generally better connected.

"Price-gouging laws stand in the way of the quickest possible recovery," Boudreaux said. "We should not pile a political disaster on top of a natural one."

Graham Brink can be reached at 727 893-8406 or brink@sptimes.com

[Last modified December 9, 2005, 18:44:02]