Price Gouging and Empathy
A Quaker Perspective
Whenever prices increase dramatically, as happened recently in the overnight jump in the price of gasoline when Hurricane Katrina hit, complaints of price gouging appear in the press, closely followed by thunderous denunciations from politicians. And then, a few days later, we see columns advising us that all of this is just the normal response of a free market.
Which is it? Immoral profiteering or normal market operations? To answer this question, we first need to understand how markets operate to bring supply and demand into balance. With this in mind, we can look at several non-market mechanisms for balancing supply and demand.
The Behavior of Markets
How do markets balance supply and demand? We are not asking how they should operate, but instead how they actually do operate in the real world.
In the case of independent retail gasoline stations, the price is set daily by the manager. When supply drops suddenly, as happened when Hurricane Katrina damaged a group of oil refineries, then there is an immediate imbalance between existing demand and the newly reduced supply.
Contrary to widespread public misconception, gas station managers do not simply mark up the price they charge by a fixed standard percentage above their wholesale price. They can and sometimes do set the price much lower than wholesale, for example to attempt to drive a nearby competitor out of business. These are called "price wars."
Conversely, they can and sometimes do set the price much higher than wholesale, for example to reduce the anticipated demand so that it matches their available supply. This latter circumstance is what happened throughout the country, and to a somewhat lesser extent throughout the entire world, when, in the wake of Hurricane Katrina, gas station managers were informed that they would be receiving substantially less gasoline in the coming weeks from their wholesale suppliers.
When supply restrictions like this occur, then managers raise prices immediately in order to choke off some of the demand. These sudden increases are inevitably labeled "profiteering" or "price gouging" in the press.
It is important to realize that raising prices in order to reduce demand works very well, from the point of view of the gasoline retailer. All customers, potential and actual, may be somewhat annoyed or dismayed by the higher prices, but the manager has avoided the situation in which those who arrive first buy up the entire supply and those who arrive later get nothing at all, no matter how needy or desperate they may be. By raising prices at the first indication of restricted supply, more customers will get at least some gasoline.
As an added benefit, of course, gas stations that increase their prices to reduce demand make higher profits, as long as supplies remain low. These very high profit margins attract new sources of supply, including some that may not have been worth pursuing under previous conditions, and as these new supplies gradually appear on the market, they force gas stations to reduce their prices.
Empirically, this is the way all free markets operate. This is Adam Smith's "invisible hand" at work, efficiently balancing demand with supply without the aid of any kind of central planning or control.
The simplest alternative to pure market operations is a system of price controls. When a government imposes lower prices than supplies justify, then some customers will not get their gasoline, no matter how much they need to refuel. To address this problem, governments will next institute rationing, so that everyone who needs gasoline gets at least something.
Price controls and rationing schemes lead almost immediately to the growth of "black" markets, where gasoline and ration cards are illegally bought and sold, but with much higher profit margins due to the very restricted supplies and the higher risks. Black markets provide ideal conditions for organized crime.
If rationing is continued for long enough, then the low profit margins received by producers act to inhibit the development of new sources of supply. Innovation and exploration cease, and the entire system stagnates. Governments typically address this new problem with government-sponsored innovation and exploration, paid for by taxpayers.
In the end, the driving public pays with taxes what they saved by rationing, leaving them no better off than if they had never instituted rationing (or perhaps worse, due to corruption and bureaucratic overhead). The entire artificial and highly inefficient structure eventually collapses when its indirect costs are finally recognized by the public.
I noted earlier that raising prices in order to reduce demand works very well, when seen from the point of view of the gasoline retailer. Does it also work well from the point of view of the customer? This is where the ethical issues become visible.
When supplies are tight, who should receive gasoline? In the free-market solution, each customer compares the posted price to his or her need for gasoline and disposable assets, including cash and lines of credit. The customer buys only when the usefulness of a tank of gasoline appears to exceed the usefulness of goods that will have to be foregone by spending the money to buy the gas.
From the point of view of a low-income customer, it seems painfully clear that a shortage causes the market system to discriminate against poor people to an even greater extent than it ordinarily does. The poorer one is, the more serious are the immediate consequences of sharp increases in price.
Thus where the economist sees the operation of an efficient and self-correcting price mechanism which stimulates innovation and enriches all of society, the poor see a cruel system, deliberately designed to further impoverish the poor in their hour of greatest need, while enriching only the already-wealthy producers, distributors, and retailers. Each group, as a rule, fails to appreciate the other's point of view.
An Extreme Case
The most extreme case may be instructive. As a thought experiment, let us consider a purely hypothetical situation in which gasoline has suddenly become extremely expensive, as could happen when an entire city is under an immediate evacuation order to avoid a lethal threat that has already destroyed most existing supplies of gasoline.
In this case, a very poor car owner may find himself literally out of the market, unable to buy what he needs to escape death.
It is at this dramatic point that ethical problems appear in their clearest form, both for individual vendors of gasoline and for society as a whole. This is the domain in which compassion comes into direct conflict with the blind ethos of the open market.
For an individual vendor of gasoline, the ethics are straightforward: this is when charity will do the most good, will even save lives. This is the time to abandon, if only temporarily, the conventional pricing mechanism in the interest of saving lives. From a purely economic standpoint, one hopes that in this situation the warm feelings that come from saving lives by giving gasoline to the desperate may, in the mind of the gasoline vendor, easily outweigh the usefulness of the income from the sale of a few additional gallons of gasoline at the prevailing market price.
In the real world, far away from abstract theories of ethics and economics, real people from time to time do face real dilemmas of just this sort. We see a variety of creative solutions: Some gas station managers may institute informal rationing, limiting each customer to the bare minimum of gasoline needed to get out of town. Others may reserve a quantity for those in dire need, and sell at market prices otherwise. Still others may not mark up their products at all, preferring instead to sell at the customary price until the supply is gone. Finally, some owners may not be able to face the dilemma at all; they will simply close down their gas stations and flee from both the emergency and the moral conundrum.
The Role of Society
For society as a whole, the shape of the moral dilemma is not so clear; in fact it is hotly controversial. It is a fact that there is no broad consensus on the responsibilities of society to its poor and desperate. Every prescription for what society "should" do for its poor arises out of the unique point of view and capacity for empathy of the person making the statement.
As Jack Powelson has described in his book, A History of Wealth and Poverty: Why Some Nations are Rich and Many Poor, the past half-millennium has seen political power in the West gradually diffused to lower and lower layers of society. Powers that were once thought to be the God-given right of monarchs have been parceled out and diffused, grudgingly and under duress, to the people and institutions of society. The wealthy societies of today appear to be those that began this process the earliest and pursued it to its greatest extent. Democracy (in the political arena) and free markets (in the commercial arena) represent the ultimate culmination of this process of power diffusion.
This sounds all very fine, but things become interesting when, as frequently happens, democracy and free markets conflict with each other. For example, a democratic legislature may vote to override the pricing mechanism of a free market during times of emergency. Even though the result is likely to be yet another dismal cycle of rationing, black markets, and corruption, it is still the democratically expressed will of the people.
Is this the way it "should" be? Or is this an unwarranted intrusion of political power into the orderly conduct of markets? Libertarians and free-market fundamentalists argue in favor of the latter. I insist that economic theory must remain descriptive of real human behavior, and not become a source of normative prescriptions for how we, and society as a whole, should behave.
I say that if the people want price controls, then that is what they must have. Economic theory is at its best when it is used to point out the consequences of political decisions well in advance, so that healthy decisions can be made by a well-informed electorate. On the other hand, economics is at its very worst when it is used to prescribe the actual decisions, usurping the right of the people to decide for themselves.
The Role of Spiritual Insight
Charity derives from three sources: tax incentives, moral strictures, and compassion for the afflicted. I have little use or interest in the first two of these, but compassion and empathy in all of its manifestations interests me greatly. It is the wellspring of the purest forms of charity, and touches upon deep psychological and spiritual issues in human relations.
In his writings, Gandhi took pains to speak to each level of spiritual development. He recognized that each of us acts according to our own level, that there is no single rule or standard that applies to all. The light of empathy is easily dimmed in the heart of a child, by violence, or cruelty, or severely conditional love. I believe that this has a profound and lasting effect on all future economic decisions, as the growing child learns to weigh financial gain against what he is able to see and feel of the pain of others. These are simple facts: some can empathize more than others, and those who empathize the best become our saints and prophets.
When faced with a choice between profit or compassion, we must make our own unique decisions as best we can, using whatever capacity for empathy and spiritual connection that we may possess. Let us not judge each other harshly for our decisions, according to dry rules of morality or economic theory. It is a question not of our moral or ideological correctness, but of how much light we each can bring in times of darkness. This I do most firmly believe.
Sincerely your friend,
Note: Please send comments on this or any TQE, at any time. Selected comments will be appended to the appropriate letter as they are received. Please indicate in the subject line the number of the Letter to which you refer!
Thank you, Loren, for so thoughtfully defining the issues, and especially for setting forth so well your own perspective on free markets and the poor. You have artfully corralled all of us gas station owners free marketers and bleeding hearts sorted out the variables, and dropped us into a well reasoned structure for decision-making.
Norval Reece, Newtown (PA) Friends Meeting.
Not sure if this belongs in your article, but what happened in Atlanta is interesting. Friday morning, several stations set their prices high ($5-6). Maybe they were profiteering, but lets assume they were trying to limit demand. Instead of limiting demand, it caused a panic, which increased demand. People were leaving in the middle of work to fill up their tank (even if it was already 3/4 full). This all happened before the hurricane hit, before there was any shortage. But with everyone topping off their tanks, a shortage was created.
An anonymous reader from The Motley Fool.
I like it since it in yet another way attempts to remind us:
Would that we can learn this and also understand that we are part of this globe, dependant on it, and affecting/affected by it... a web dew drenched and fragile which once broken cannot be rebuilt.
Another anonymous reader from The Motley Fool.
Balderdash. In the USA, people buy enough gasoline to fill their tanks, and then move on. These free-market apologetics may be useful for discussions about theoretical or large systems, but here in metropolitan New Jersey, none of my neighbors have an extra tank-trailer in the back yard for hoarding a gasoline supply when a crisis looms. People buy gas when they need gas. And few of my neighbors bought a half-tank of gas, hoping the prices would drop; they paid for the full tank, and went on.
Economists frequently wax poetic over the free market. When I see those words, I equate them with the mess that "de-regulation" has become:
I have no use for the "free market" argument. The "free market" may eventually return to something that approaches ethical behavior, but the time frame is too long, and in the meantime, wealth coagulates among the few, and generations are oppressed and, sometimes, killed. The "free market" supported human slavery in this country for decades.
Jim Brittain, North Brunswick, NJ.
Reply: Apparently I did not make my central point clearly enough: free market theory works best as a description of how people behave when left alone. Every democratic government has the right to modify or replace market mechanisms if the people so choose. Loren
Loren, I take it you call yourself a Libertarian? Just a response to your comments when you look at many of the people in this country that can do something, at this point, there are far too few Gandhis. Greed has taken over our country at an unbelievable level (e.g., Tom DeLay, Bill Frist, etc). When you have a government that is contemplating reducing so-called entitlement benefits to keep the deficit down so that Katrina victims can be helped instead of getting us out of a war that is eating us alive and reducing the tax cuts moral outrage must speak up! Why should the poor pay for the poor? Jesus was not a free market economist he spoke of helping those in need.
Reply: No, I am certainly not a libertarian (though I am a card-carrying member of the ACLU, a civil libertarian organization). I agree that Gandhi was not a free market economist, and neither was Jesus.
Personally, I favor strong government assistance for the mentally ill, the mentally retarded, and poor families facing catastrophic illness and major disability and that list covers a very large majority of today's American poor. In poor countries the dynamics are different, and I have different recommendations. If my description of how markets work offends you, please try to keep in mind that this is an empirical question of fact, not a normative prescription for how people should behave. Loren.
1. A nice exposition of how the market works: I would much rather be at a gas station with gas I cannot afford, than at a gas station without gas. However, the fact that reduced supply means that price has to rise if gas is to be available, does not mean that the station owner should necessarily reap the windfall profits. Whatever happened to taxes? Yes, of course raising gas taxes would cause political outrage, but TQE is where we expect to find a reasoned explanation as why such outrage is irrational? Real, but irrational.
2. "These very high profit margins attract new sources of supply, including some that may not have been worth pursuing under previous conditions." Loren! Loren! An increased supply of petrol is a "good thing"? Your letter was ideally poised to explain that Global Heating is a result of "market failure" for fossil fuels in general, and petrol in particular. Perhaps you could return to this question later? (This market failure also argues strongly for a carbon tax; and regulation. What do economists recommend when a "market solution" is likely to lead to the end of civilization as we know it?)
Will Candler, Annapolis Friends Meeting.
Author's Reply: Concerning the first point, tax policy is a very blunt and slow-moving instrument. A tax that can react with the same speed as changes in supply and demand would have to be a very high-tech kind of tax, never before implemented. That's not to say it could not be done in selected markets, using electronic means. It's worth further thought.
Concerning the second point, I plan to approach this topic slowly and deliberately, over the course of many essays. Most economists avoid this idea (that there might be circumstances in which market solutions lead to catastrophe) as though it were radioactive. I have no such qualms, but I need to cover a lot of preparatory topics first. Loren
Publisher's Reply: Raising taxes might be the right thing to do, and yet politicians' incentive is to lower taxes in such a situation. The trouble with taxes is that they apply all over the market and reduce flexbility. It may be that some people will simply turns off their pumps, or others keep their prices constant, or others raise their prices, or others offer personal credit. In my humble opinion, God doesn't say the same thing to everyone. If you have ever heard someone speak in a meeting, and wondered what kind of drugs they're on, you were hearing a message not addressed at you.
Russ Nelson, St. Lawrence Valley (NY) Friends Meeting.
I would like to take the first part of your lesson here and put it up in our social room, in large 144-point type.
When the price of orange juice goes up in our market because a hurricane has destroyed thousands of acres of Florida citrus, the Friends I know tend to reassure others that the farmers have taken a hit so, yes, naturally prices have to go up. But when two hurricanes take out 25% of the country's refinery capacity, the sharp tongues come out and go flying right at those heartless energy barrens who have nothing better to do than conspire to boost gasoline prices at the first sign of disaster.
Thanks again for your clear presentation on market mechanisms.
Thanks also for your clear presentation on ethics. I do believe that our understanding of economics does not absolve us from the responsibility to be servants of Christ, treating others with compassion, whether we are social workers, bus drivers or gas station managers. The gospels and the epistles made a point of bringing that responsibility down to the level of the "least" of us. If all of us who call ourselves Christians in this country accepted more of that responsibility, our free markets would be more humane.
Rich Ailes, Middletown Monthly Meeting, Lime, PA.
Loren, an economist who does not appreciate the point of view of the poor is simply a bad economist. The poor person who does not appreciate the value of free markets is also a bad economist, but they have the virtue of not claiming to be an economist. A vendor who does not take into account the community need and ability to pay may find himself censured and boycotted. Businesses have been ruined for less.
It is clear to me, however, that even in times of desperation, a society must not break its promise to protect property rights. A society that steals from its people in one time of need will not find any resources available to steal or buy the next time. If economists do not stand up for good economics, who else will?
Russ Nelson, St. Lawrence Valley (NY) Friends Meeting.
Thank you for a precise set of examples. Price rises reflect a change in the balance of supply and demand, so any big change in either one means a big change in prices. The quicker prices balance, the quicker we reach an optimum. And of course, people DO price-gouge, such as well-connected, oligopolistic Fortune 500 defense contractors faced with escalating war spending.
I cannot readily separate "moral strictures" from "compassion," however. In Faith, I have found that charity and giving enact the Spirit within the giver, and these acts are generally good for the giver more than for the recipient. Such is tithing.
Christopher Viavant, Director, Utah Health Choice Network.
When supplies are reduced, is it the increased prices per se that persuade suppliers to increase supplies, or is it the increased margins ("windfall profits") that accompany those increased prices? If in fact it is the increased margins that persuade suppliers to increase supplies, wouldn't a law to control margins be, in effect, a law to "kill the goose that laid the golden eggs"?
Economists have pointed out the unintended (and, more importantly, the undesirable) consequences of price controls and price caps. Would government controls or caps on profits have similar, undesirable consequences?
I realize that increased fuel prices are very hard on people of limited means, but perhaps what is needed is a solution that is tailored to this specific problem, not a solution (controls or caps on prices or profits) that is doomed to make matters worse.
If the people want price controls, does their desire for price controls trump the rights of the owner of the property to sell his property for whatever price he desires? Is it moral for the majority to trample on the rights of the individual?
Jim Morse, Middlebury (VT) Meeting [Feb 2006].
Reply: With respect to your last question, I take the point of view that individuals and property owners have only those particular rights that have been granted to them by the people in their exercise of constitutional democracy. If the people choose in a free election to infringe on property rights by instituting price controls, then so be it. For me this is not a question of morality at all, it follows directly and powerfully from fact that in a democracy the people are sovereign, by definition. Loren
RSVP: Write to "tqe-comment" followed by "@quaker.org" to comment on this or any TQE Letter. Use as Subject the number of the Letter to which you refer. Permission to publish your comment is presumed unless you say otherwise. Please keep it short, preferably under 100 words. All published letters will be edited for spelling, grammar, clarity, and brevity. Please mention your home meeting, church, synagogue (or ...), and where you live.
To subscribe or unsubscribe, at no cost, visit our home page.
Each letter of The Quaker Economist is copyright by its author. However, you have permission to forward it to your friends (Quaker or no) as you wish and invite them to subscribe at no cost. Please mention The Quaker Economist as you do so, and tell your recipient how to find us on the web.
The Quaker Economist is not designed to persuade anyone of anything (although viewpoints are expressed). Its purpose is to stimulate discussions, both electronically and within Meetings.
PUBLISHER AND EDITORIAL BOARD
Publisher: Russ Nelson, St. Lawrence Valley (NY) Friends Meeting.
Members of the Editorial Board receive Letters several days in advance for their criticisms, but they do not necessarily endorse the contents of any of them.
Copyright © 2005 by Loren Cobb. All rights reserved. Permission is hereby granted for non-commercial reproduction.