The world is mired in an economic crisis, people are wondering if capitalism still works, were a few short months away from the Atlantic hurricane season (and the fourth anniversary of Hurricane Katrina), and wildfires can be counted on to cut their yearly paths of destruction through parts of California. What do these have to do with one another? The pain from each can be reduced if we let the markets work, while political interference with price mechanisms only makes it worse. Further, we can stimulate the economy by eliminating regulations on prices.
In a study recently published in the Journal of Business Valuation and Economic Loss Analysis, I surveyed political rhetoric on price increases after Hurricane Katrina and synthesized research showing how this rhetorical environment actually leads to a slower recovery.
Economists who study Katrina have studied the recovery in terms of the concept of regime uncertainty, which exists when people are unsure of what to expect from their governing authorities. This is particularly evident in government policies regulating prices after natural disasters. Many places do not enforce rigid price controls in which they determine the exact price that people are allowed to charge for their wares. Instead, they enact murky and incomprehensible laws against price gouging.
Laws against price gouging create regime uncertainty because it is difficult for an entrepreneur or a firm to tell whether or not they are committing a crime. Some places have clear rules as to what constitutes prima facie evidence of price gouging, but these rules are not exclusive. In many places, price gouging is defined the way the Supreme Court once defined pornography: we cant tell you what it is, but we know it when we see it.
That is a great legal standard if the goal is to scare away investors. For encouraging economic growth and reducing the tragedy associated with natural disasters, however, it is ridiculous. At the margin, the uncertainty associated with exposure to potential prosecution for breaking vaguely defined laws will discourage potential entrepreneurs and investors. The net result will be less economic growth and lower supplies of essential goods when disasters do strike.
Laws against gouging often use vague terms like unconscionable and grossly excessive to describe prices that are illegally high, and they do not answer the important questions: According to whose conscience? Compared to what? And by what right does an observer exercise veto power over anothers use of his or her justly acquired property?
Consider, for example, the definition offered by the state of Florida. A price is unconscionably high when (t)he amount charged represents a gross disparity between the price of the commodity before and after an emergency and if the increase in the amount charged is not attributable to additional costs incurred. Further, it allows the state to prosecute for gouging if (t)he amount charged grossly exceeds the average price at which the same or similar commodity was readily obtainable in the trade area during the thirty days immediately prior to a declaration of a state of emergency without a corresponding increase in costs. This was also put forth as the clearest definition of gouging among state statutes by researchers in a report they prepared for Congress.
Turning post-disaster pricing into a political issue presumes that someone is in a position to pronounce a moral judgment on an impersonal process. Moreover, it assumes that the person knows, or can know, the morally correct price of a good or service. There is no such thing as a morally correct price. There are only those prices determined by the market process.
As F.A. Hayek once said, The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design. The destructive impact of price gouging restrictions enacted by state governments suggests that we have much work to do.