Thursday, May 24, 2007

In Defense of Price Gouging

Yesterday the House of Representatives passed a bill outlawing gasoline “price gouging.” Violators would face penalties of fines as high as $150 million or prison terms of up to two years. Price gouging is defined as “taking unfair advantage” or charging “unconscionably excessive” prices for fuels. What is unfair advantage? How does one measure when a price is unconscionably excessive? There is no answer.

This is bad law. First, because it is non-objective. Because no objective definition of price gouging is provided in the law, a gas station owner or oil company can never know when it is breaking the law. There is no way to comply with a law when the crime cannot even be defined. More ominously, a non-objective law becomes a tool to terrorize in the hands of unscrupulous government officials. The businessman is told that he must obey the bureaucrat or face punishment, a punishment he cannot defend against because there are no objective standards. This is a tool of tyranny. Incidentally, this is also the nature of antitrust. Like this anti-gouging measure, antitrust law is completely non-objective.

The other reason why this law should not be passed is because it is anti-capitalist. It attacks the heart of the market economy, which is the price mechanism. Prices work to harmonize the interests of buyers and sellers when they are allowed to freely rise and fall. This type of law, to the extent it is enforced, will function as a price maximum. Price maximums, enforced by the state, have one predictable consequence, shortages. This is true in all eras and for all commodities. The pricing principle is an iron law of economics, as solidly and universally valid as the law of gravity. Violate it by imposing price controls and artificial shortages will develop. The principle that price controls cause shortages is an iron corollary of the iron law of prices.

Price controls cause shortages because of two reasons. First, suppliers provide less gasoline (or any other controlled commodity) because they cannot make money selling at the lower price. They cut production until they no longer lose money. Second, at the lower price, customers want more of the product. Combine these two effects – reduced supply and enhanced demand – and you have a shortage. Supply and demand are no longer in equilibrium.

America has already walked down the path of price controls, for energy and many other products and services. In energy, the long lines at gasoline stations in the 1970s were solely due to the price controls imposed on the oil industry. Only when price controls were lifted in the late 1970s/early 1980s did the lines vanish. Notice that there were no gasoline lines during either Iraqi invasion, despite serious reductions in Middle Eastern oil production during both wars. Gasoline prices rose, but there were no lines. Supply and demand were brought into equilibrium, both by increasing supply and tamping down demand until they met. In the 1980s, the first decade after oil prices were liberated, U.S. oil production rose, defying the doomsday predictions of the 1970s pessimists who thought the world would run out of oil by the end of the century. In nearly every year since the removal of price controls, proven global oil reserves have increased. When prices and profits were determined by the market, it paid to explore and drill for new oil.

The sad consequence of all attempts to squeeze the profit out of the oil companies, whether through price controls, windfall profits taxes or other means is less production of oil. Oil companies that cannot charge market prices or earn market profits will invest less in the entire oil infrastructure, from gas stations, to oil refineries, to drilling platforms.

We pay high prices for oil for several reasons, all of them a consequence of our government failing to enforce rights, or actively violating them. One is the banning of oil drilling on certain lands, such as the Alaskan tundra, or the oceans off of Florida and California. Another is a shortage of refineries caused by the effective banning of construction of new refineries through NIMBY (Not In My Back Yard) local politics, and environmental rules that make the construction of new industrial facilities prohibitively expensive. Another reason for high oil prices are all the prior episodes when price controls and windfall profit taxes were imposed. The memory of these events and knowledge that they might be re-imposed further discourages oil executives from building new infrastructure.

Looked at from a broad, historical perspective, high oil prices are the consequence of decades of appeasement in the Middle East. The U.S. government allowed the Iranians to confiscate American oil fields in Iran in the 1950s, and then the rest of the Arab governments followed suit in succeeding decades. Today, the U.S. government stands mute when Venezuela and Russia expropriate Western oil properties. On the other hand, the U.S. government did take action to bungle the War on Terrorism by incompetently conquering Iraq while leaving true enemies such as Iran and Saudi Arabia untouched. These actions and others, such as stoking the Palestine-Israel conflict, push oil prices higher by engendering worries that Middle Eastern turmoil will disrupt supply.

With the anti-gouging bill, the House of Representatives is grandstanding at our expense. In an effort to curry votes from ignorant voters, the House lays the groundwork for new gasoline shortages. Moreover, it diverts attention from the party responsible for high oil prices, themselves.


z said...

Where can one find a good history of this nationalization? Whenever I try to bring this up in polemical situations, the other side will say something to the effect of "the leases ran out". I don't know the history, and have been making the argument based on the fact of what I know of Soviet Russia, esp in AB's Capitalist Manifesto, and based on the fact that middeast culture produces almost no technology to this day, so how could it have been "theirs" back in the 50's except by the collectivist standard of rights. But, as far as the specific injustices involved, I'd like to get more info.

z said...

Also, I'd like to comment that I'd love to see John Stossel do an expose on hurricane evacuations and gas prices. It seems that free market forces in the surrounding area of the predicted landfall would force gasoline prices up, causing fewer people to purchase gas from that area, instead waiting until they got, say, 30 miles farther inland. I'd love to see a contrasting case of a hurricane evacuation under strict gouging prohibition, vs an explicitly free-market evac, where the governor says that there will be no prosecutions for any form of price-gouging. Undoubtedly, under the free-market evac, there would be fewer people and gas stations running out of gas. There would also be better preparation by station owners, who would be enticed by the higher profits to reopen sooner after the hurricane. I know after Wilma battered So. Fla, my dad said the gas-stations neglected to keep generators, and that was the reason they were all closed for so long.

Galileo Blogs said...


I don't have specific information on the confiscations in the 1950s. I am relying on statements about them made by Leonard Peikoff. I have also seen references to them in industry articles I have read over the years.

Of course, the Venezuelan and Russian expropriations are going on right now, visible to all. Oil production will suffer from the incompetence of these expropriators in running the fields, if for no other reason. For example, Mexican state-run oil production is declining severely. Venezuelan oil production has also declined under Chavez.

Speaking more broadly, ownership of land, minerals, and other resources belongs to the persons who first appropriate it for production. To the Arabs, oil was simply black goo that got stuck in their camels' toes until Western oil men identified its value. Properly, the oil men's right of ownership was established at that time. The same was true in this country when homesteaders appropriated land by cultivating it.

Western businessmen have a moral right to the Mideastern oil that they discovered and developed. That right probably was recognized by the laws of many of these countries, and then their own laws were violated when the expropriations occurred. However, I do not know for sure whether the expropriations had a veneer of legality or not. It really doesn't matter, since a pseudo-legality can paper over all sorts of government-sponsored crimes.

As for your point about "gouging" after hurricanes, you are on target. My parents live in South Florida, and gasoline was not readily available after the hurricanes for the reasons you cite. If the gas station owner could charge $10/gallon without facing punishment, I suspect portable generators would have been up and running within hours after the hurricane swept past. As it was, I heard that state anti-gouging rules were enforced, and gas station owners and others had tangible fear of governmental action. So, they "offered" gasoline at the prior price, except that the gas tanks were empty and they were nowhere to be seen.

There are all kinds of benefits from free market pricing in all types of situations, but in emergencies it is especially helpful. First, it encourages rapid and creatively undertaken re-supply, as your example of gasoline stations securing portable generators shows. Second, it causes people to conserve on precious gasoline, so that what little there is is available for those who truly need it. Supply and demand are brought into harmony, thereby enabling a return to normalcy to proceed that much faster.