Banning "Gouging" from Our Vocabulary

Bravo for the Wall St. Journal's editorial today (subscription required) concerning gasoline price gouging. It's pretty gutsy, even for the flagship media outlet of capitalism, to praise a practice that carries so many negative associations, not just in the recent past, but throughout the history of this country. And yet, it's a useful reminder that we have chosen freely to live in a market economy, and price is the tool through which the market regulates the necessary balance between supply and demand.

The impulse behind the general condemnation of gouging is noble: no one should profit from the misfortune of his neighbors. The problem is that, no matter how heartfelt and compassionate the basis of this dictum may be, when it comes to the sale of a commodity like gasoline, it is unwise and counterproductive. Anti-gouging laws and prosecutions of those suspected of the practice send a signal to the market that the government is willing to restrain prices artificially at a time when supply is scarce, thus contributing to a mentality of hoarding and negating the feedback mechanism that reduces demand.

Think about this from the standpoint of competition, which is generally the test of how well a market is functioning. At latest count, there were roughly 170,000 service stations in the US, 90% or so of which are owned by individuals or small businesses, not by oil companies. Never a high margin activity, gasoline retailers must typically supplement with sales of convenience items with much higher margins, in order for a station to turn an acceptable profit for the owner. Despite frequent allegations of collusion and price-fixing, this is a highly competitive business. How many other stores post the prices of their products where you can see them while driving by? Any station pricing significantly higher than its neighbors would see its sales dry up in a day. By the same token, undercutting its neighbors' prices by a large increment would drive up sales, but at the expense of already skinny profits.

Of course, allegations of gouging are normally only raised in the context of unusual circumstances, such as in the aftermath of a disaster. Competition plays less of a role in situations like this, and it's easy to see how a station owner might be able to set prices very high and still expect to sell his product. In fact, in a disaster in which the means for producing and distributing petroleum products has been severely disrupted, that is precisely what he should do, to prevent all the product being sold quickly and then none being available at any price, until the next delivery, which might not come for days.

Why is running out so bad? Consider drivers who need to fill up on their way to work. If the most convenient station has no fuel, they will have to drive to the next one. If that station is out, too, many of these folks will just head to work and hope to fill up later, but some won't have enough gas to do that, and will be faced with the choice of driving around until they find a station that has fuel, or of missing work that day. The value of the time lost in this activity, and the work lost if they are unsuccessful, outweighs the incremental cost of filling up at a higher price. For work, you can substitute any other activity of social or economic importance, and the argument still applies. Runouts are bad for the economy and bad for society.

So far, in the case of Katrina, higher prices seem to have had their intended effect. As of yesterday's report from the Energy Information Agency of the Department of Energy, the average price of regular gasoline had risen to $3.06/gallon, with some regions as high as $3.29. By definition, that means that while some stations fall below these averages, others are above, and some well above. But as stressful as that has been for consumers, only a few stations have reported running out.

Returning to our compassionate impulses and public morality, doesn't it make more sense to put these into practice by finding ways to reduce the impact of market forces on those least able to bear them? A gas-tax rebate for low income consumers makes for better policy than interfering with the market's ability to balance supply and demand. I believe that most of our legislators and public officials, up to and including the President, understand this. After all, it's only the application of things you'd learn in the first week or two of any Economics course. Unfortunately, they find it more politically expedient to condemn gouging and promise hearings and prosecutions, rather than reminding the public that paying more for a scarce commodity is fully consistent with the principles on which this country was founded, even if it might be painful in practice.