Price Controls Create Man-Made Disasters

Daily Article by Art Carden Posted on 6/25/2008

In the wake of the recent flooding in Iowa, the state's attorney general has announced that Iowa's rules against price gouging are now in effect. These rules prohibit businesses from "substantially raising the prices for needed goods or services without justification" in the wake of a natural disaster.

According to a June 23 press release from the Iowa attorney general's office, the rule covers not only the time during which the disaster is declared but also a "'subsequent recovery period' up to six months." Missouri's attorney general is also encouraging Missourians to report "price gouging on necessary supplies like water, ice, storage units, and generators."

Enforcing these restrictions will have predictable effects: shortages of needed supplies, long lines, delayed repairs, and, perhaps, increased incivility. Like other forms of price control, price-gouging statutes will hurt precisely the people they are intended to help.

There are several channels through which this happens. First, price controls create shortages because they eliminate the market's way of telling people to conserve scarce resources. After a disaster like a flood, a hurricane, or a tornado, demand for some goods increases while the supply of some goods decreases. If prices are not allowed to adjust, people will want more "water, ice, storage units, and generators" than the market is prepared to supply at the controlled price. As Michael Munger, chairman of Duke University's political science department, has pointed out, this means that the effective price of a good for which the price has been controlled is infinite: beyond the amount that the market will supply at the controlled price, nothing can be done to call more goods into existence.

Instead of relying on prices, governments that institute price controls must rely instead on moral suasion. This will help in some cases, but it is unlikely to be as effective as a price increase. One might be tempted to respond that the government should be able to make up for the shortage, but the government's performance in similar cases, such as FEMA's ham-fisted response to Hurricane Katrina, provides us with grounds to be skeptical of this claim.

Restricting the price mechanism also means that recovery will be delayed. If prices are allowed to fluctuate freely, resources will be directed to where they are most desperately needed. Someone who wishes to build a new deck in San Antonio will have to think twice if lumber prices increase because people in Iowa are struggling to rebuild their houses. If lumber prices are not allowed to change, our deck-builder in San Antonio lacks the signal he needs to learn that the lumber he would otherwise use to build a deck might be better used rebuilding houses in Iowa.

In addition to these restrictions, many states also restrict who can participate in the market for home repair after a natural disaster. It is indeed true that some people are taken advantage of by the unscrupulous during a desperate hour, but restrictions on who can provide home-repair services and at what price after a natural disaster also keep many an honest business person out of the market. Some people are protected from predators and scammers, but as a result, many more are unable to secure the services they want at a low price.

This may also have an undesirable unintended consequence with respect to home safety. After Hurricane Katrina, I remember reading a short newspaper article about do-it-yourself roof repair because of the shortage of roofing services after the disaster. Should disaster strike I am by no means qualified to repair my own roof, foundation, walls, etc.; however, restrictions on who can and cannot supply these services in the market means that I might be faced with the choice of doing the job myself or leaving it undone. Anyone who has ever seen me swing a hammer knows that if I were to do the job myself it would be at best a marginal improvement over leaving the job undone. I am blessed with friends who are pretty good at that sort of thing, but I would guess that there are many others who are not so fortunate.

People's time is also valuable. A computer programmer who has to fix his own roof does so at the cost of time spent programming. The law of comparative advantage tells us that if he were able to devote his time to computer programming and use the income he earns to pay a professional to fix his roof, society will have more of both computer programming and roof repair. Restricting who can and cannot trade roofing services for money eliminates this option for many. The unintended consequence of restrictions on who can participate in the market is straightforward and ironic: restrictions aimed at ensuring access to high-quality repairs at low prices are more likely to mean low-quality repairs at high prices for many storm victims.

Price controls can also be bad for social fabric, though as far as I know this remains an untested proposition. Price controls mean that some businesses will close when they otherwise would have remained open after a disaster. The sight of a business closing up shop during a disaster victim's hour of need might breed ill will. In addition, long gas lines filled with disaster victims nursing frayed nerves can be fairly volatile environments. In a recent EconTalk podcast, Russ Roberts and Richard McKenzie discussed fistfights in long gas lines during the gas price controls of the early 1970s. Massive price increases create social tension (see the food riots that have erupted around the world, for example), but price controls also pit neighbor against neighbor for scarce resources.

Finally, enforcing price controls also requires resources. For the government, people who are engaged in identifying and prosecuting "price gougers" are necessarily diverted from maintaining law and order. For firms, the possibility of prosecution introduces additional uncertainties into their calculations and diverts them from their core business of delivering goods and services to the customer. Over the long run, this makes us poorer and therefore less well equipped to deal with future disasters.

Economic critiques of price controls are well worn. Nonetheless, these simple points bear repeating over and over again because price controls after natural disasters are so popular. The economic critique is more than an academic exercise or an attempt to apologize for the unscrupulous, as some critics maintain. Price controls have very real human costs. Some of these costs are quite apparent and some are harder to see. To the extent that they are attributable to price controls, though, they are avoidable.

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Art Carden is assistant professor of economics and business at Rhodes College, an adjunct fellow of the Independent Institute, and a visiting research fellow at the American Institute for Economic Research (until June 28). He was a summer research fellow at the Ludwig von Mises Institute in 2003, and his paper "Beliefs, Bias, and Regime Uncertainty After Hurricane Katrina" will be published in the International Journal of Social Economics. Send him mail. Comment on the blog.