More on Price Controls

by Don Boudreaux on December 27, 2004

in Regulation

The killer tsunamis that yesterday ravaged Asia call to this economist’s mind discussions about price gouging. I don’t know the laws and legislation of Sri Lanka, Indonesia, and other countries whose citizens are now suffering so grievously, but I hope for the sake of these people that so-called price-gouging is not prohibited. (Hoping, alas, isn’t synonymous with predicting.)

To prevent the price of some staple good (say, lumber) from rising to its market level in the wake of a natural disaster is to camouflage the underlying reality. The underlying reality is that the disaster (1) appreciably reduced supplies of lumber available in the devastated area – both by destroying inventories of lumber and by destroying supply lines; and (2) appreciably increased the demand for lumber in these areas. In short, the underlying reality is that the value of lumber to people in these devastated areas is now significantly higher than it was just before the tidal waves hit.  These people need lumber more than they did before, and there’s less lumber immediately available.

This reality is unfortunate, but it is, well, real. Being real, it must be dealt with. It cannot be hollered, hoped, dreamed, prayed, or legislated away. And it means that the welfare of the people whose homes and businesses (not to mention love ones) were destroyed is much lower than it would have been had the tsunamis not hit.

In the aftermath of hurricane Isabel, which struck Virginia in 2003, I wrote this essay opposing restrictions on price hikes. Here’s the basic, familiar argument: if prices are allowed to rise to their market-clearing levels, these high(er) prices perform two important functions: (1) they encourage suppliers to supply more than they would supply at lower prices; and (2) they encourage people who want to use the now-much-scarcer goods and services to use them as judiciously as possible (what I call "economic triage.")

But I’ve learned that many people are unconvinced by this argument. "What about poor people?" the Unconvinced understandably ask. "The poor who can’t afford to pay market-clearing prices will be forced to do without."

Seems true. But I’m not so sure – at least, I’m not sure that the poor will fare worse when prices are not controlled by government than when prices are controlled.

If the price of lumber is currently below its market-clearing level, the quantity of lumber demanded at that price will exceed the quantity of lumber supplied at that price. With no controls on prices, this "excess demand" will cause price to rise. As price rises, some quantity of demand is choked off and the quantities supplied are increased. That is, the chief means of allocating available supplies among the demanders is the higher price.

But if regulation keeps price from rising, some method other than higher prices must be used to determine which of the many demanders of lumber get the relatively few supplies of lumber.

What are these other methods? They include principally queuing, black-market transactions, and use of political or commercial connections. They might include even violence.

An inevitable consequence of price caps, therefore, is to raise the value of the skills and other assets useful in carrying out these other methods of rationing – skills at queuing; skills at successfully conducting black-market exchanges; skills at manipulating personal and political connections.

Even if you’re concerned only with ‘the poor,’ therefore, the correct question is not "are the poor less able to pay higher prices than lower prices for staple goods?’ The answer to this question is all too obvious: yes.

The relevant question instead is "are the poor less able to pay higher market prices than they are able to pay to take advantage of the other methods of rationing that necessarily replace higher prices?"

The answer to this question isn’t at all obvious.

The poor might be better able than others to pay the cost of queuing – the time and aggravation of waiting in long lines. But not necessarily.

Even though no monetary cost is paid to wait in line, the poor might well be less able than others to be away from their families (in order to wait in a queue) following a disaster – say, because they have young children who must be watched, or because they must personally repair their plumbing and their roofs, unable to afford to hire repairmen even at normal rates.

But while the poor might conceivably be better able than the non-poor to afford to queue, it’s unlikely that the poor can outbid the non-poor for the assets that are necessary to compete in other ways for supplies of goods or services in short supply.

Are the poor likely to have a comparative advantage over the non-poor at creating and protecting black markets? Are the poor likely to have a comparative advantage over the non-poor at taking advantage of personal and political connections? Are the poor likely to have a comparative advantage at deploying violence as a means of acquiring goods?

Unlikely. Very unlikely.

If the poor would have even more difficultly paying for the assets, connections, and skills useful for acquiring price-controlled goods and services than they would have paying higher market prices for these goods and services, they will be better off without price controls.

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