Thursday, October 16, 2014

A Tale Of Two Cities: Why Price Gouging Is Good

Today, Antwerp is the largest city in Belgium. In July of 1584 it was part of the Dutch Imperial States; it was also under siege by the Spanish. As with all such military operations, the besieged city eventually started running out of food. As food became more and more scarce, prices of food began to rise. The leaders of the city were outraged that people would charge their fellow man such unreasonable prices for such a basic need, so they enforced a strict price ceiling forbidding anyone from selling food at too high a price. This policy was successful in keeping food prices low – until they ran out of food. Antwerp surrendered on August 17, 1585.
While the price controls were not the sole reason that Antwerp fell, they certainly contributed as they ensured that the beleaguered city would be short on food. Prior to the seemingly humanitarian regulations, food prices got quite high. This signaled to those with food outside of Antwerp that they could make a sizeable profit by smuggling food into the city past the Spanish siege, and so they decided it was worth the risk. Smugglers braved the possibility of being captured or killed because the price was so high. When the price was made lower by law, they stopped smuggling. The low prices not only resulted in a decreased supply of food, they caused consumption to be higher than it should have been, given the situation. Had prices been allowed to rise such that the people of Antwerp could only afford a bare minimum, the high prices would have rationed the food supply and they would have stood a chance of outlasting the Spanish attempt to starve them out. With prices at their pre-siege levels, however, why not consume as you did prior to the siege? After all, if you don’t buy up a lot of food now, others will, leaving you without any in the near future. Since Antwerp’s controls on so-called price gouging led to city’s defeat, the policy was, to put it mildly, quite detrimental.

In Raleigh, North Carolina in 1996 a crowd of people cheered as two men were arrested. Their crime: selling ice to the people in the area who had lost power due to Hurricane Ira. To be more specific, they were arrested for selling ice at a price that the government deemed too high and, therefore, was deemed “price gouging”. As the police impounded the supply of ice and took the men away, one cannot help but wonder why people clapped. There is no arguing that these ice sellers were charging relatively high prices for their ice, and they were most likely motivated not by selfless benevolence but by greed. The interesting thing is, though, that it doesn’t matter; they were the only ones bringing ice to the people who needed it to keep their medications and food from spoiling.

The high price, which many people willingly paid before the endeavor was shut down, sent a signal to the surrounding areas that they should bring their ice into Raleigh. In a free market, that would have happened, but North Carolina decided to “protect” its citizens from exorbitantly high prices. The result: the price was irrelevant because there was nothing to buy. The shelves were empty. It didn’t matter how much you needed ice for your medications, there was none to be had. This fact leads to a second essential function of free prices which is especially important during disasters: rationing.

There were thousands of people who wanted ice, but some of their needs were greater than others. Since prices were not allowed to rise, however, the ice went to those who got to the store first, and was not available at any price to latecomer who may have needed it for an essential purpose. If prices had been allowed to rise, and if sellers from the surrounding areas had received the signal that Raleigh needed ice and they could enrich themselves by providing it, then distribution of the ice would have reflected the subjective valuation of that ice by different people. The person who wants to keep their ice cream cold may decide to let it melt rather than pay $20 for a bag of ice, meaning that there would still be ice available for the person behind them in line who had to keep their insulin cold.

The unreasonable practice of depriving citizens of essential resources in the name of protecting them is not confined to a peculiar North Carolina law or 16th century empires. Twenty-eight states and the District of Columbia currently have “price gouging” statutes on the books. These laws should be repealed so that price signals can coordinate the flow of resources to their most valued use, especially in times of crisis.

Another version of this article was published on Rightly Wired.

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