Over the last few years, the number of both man-made and natural disasters has seemingly increased significantly. Hurricane seasons have become more intense, with flooding and damage extending from the Gulf to the Northeast. Forest fires now plague the west coast almost year-round. Major security breaches have resulted in widespread shutdowns and even oil shortages. (Read more on how cybersecurity is a non-negotiable facet of business in this Bold story.) And of course, the pandemic essentially shut down the entire world. While the causes of these disasters are quite varied, they do have one thing in common. Each has been associated with the potential for price gouging, and each has triggered anti-price gouging laws. But whether this is an appropriate response to the situation is quite questionable.
The debate about how to handle price gouging is one that divide economists and politicians alike. In theory, it may seem at first that anti-price gouging laws are a good thing. They ensure essential goods are priced in an affordable range in times of disaster. They are also believed to prevent opportunists from taking advantage of others. But these assumptions are not necessarily true, and the negative impacts that these laws have are actually much more substantial. The disincentives they create affect disaster recovery in a bad way, limiting access to the very goods they try to protect. With this in mind, it’s worth taking a closer look at the effect price gouging legislation has overall.
“Higher prices encourage consumers to purchase what they actually need, leaving goods on the shelf for others. This discourages consumers from needlessly stockpiling goods.” – Daniel J. Smith, Director of the Political Economy Research Institute at MTSU, and Associate Professor of Economics, Jones College of Business
Anti-Price Gouging Laws and Hoarding
The pandemic had struck, and quarantines were beginning to go into effect. Everyone became suddenly obsessed with hand-washing, cleanliness, and mask-wearing as a result. In order to prepare for coronavirus, we rushed to the store for sterile wipes, hand-sanitizer, and of course, toilet paper. But when we arrived, many of us found the shelves empty. Others before us had already hoarded what supplies there were. Believe it or not, this is one of the downsides of anti-price gouging laws. Because price increases weren’t allowed, those who arrived first stockpiled all the essential goods.
Despite the fact that price gouging sounds bad at face value, it actually serves a very important purpose. When specific goods are in high demand, retailers increase the price as a mean to better ration a limited supply. In a disaster, however, anti-price gouging laws prevent this from occurring. Thus, rather than having the higher price deterring consumers from hoarding, the fixed lower price does just the opposite. As a result, fewer people actually gain access to these essential goods. In reality, price gouging (or increases) would encourage a more equitable distribution of these items.
“The statistic to focus on was not the price but, rather, the shortfall of supply relative to demand. Figuring out how best to eliminate that shortfall is the problem we need to confront.” – Michael A. Salinger, Former Director, Bureau of Economics, Federal Trade Commission
Price Gouging and Supplier Effects
Anti-price gouging laws affect consumer behavior, and they also influence supplier behavior as well. Consider a lumber yard that produces building materials. In the wake of a major tornado or hurricane, such supplies are in high demand. The building materials present in Home Depot and other retailers will sell out quickly, even in the absence of hoarding. In a normal situation, such demand would drive prices higher as supplies diminished. This would encourage the lumber yard to pay workers overtime, increase trucking and shipping lines, and boost production. But because price gouging isn’t permitted, the lumber yard has no incentive to do so. In fact, the extra costs, lower profit margins, and legal penalties actual deter such decisions.
Consider the same situation if price gouging behaviors were allowed. As building materials diminished, retailers would increase their prices of goods. Assuming consumers would be willing to pay these higher prices, suppliers would be encouraged to increase production. They would also preferentially supply regions where the supplies were most needed because they would be incentivized to do so. This actually works much better because building supply prices would only increase in the region affected by the disaster. Anti-price gouging laws prevent these normal market adjustments from occurring. And in turn, they actually contribute to the shortage of supplies in the areas with the most need.
“If prices are capped, there’s little incentive for businesses to hustle to increase supplies. It’s costly to find and transport extra products in hazardous conditions. If these extra costs eat up the profit associated with a fixed retail price, Adam Smith’s invisible hand won’t work; there’s no financial carrot.” – Rafi Mohammed, Founder of Culture of Profit
Letting the Market Take Care of Itself
Those who favor anti-price gouging laws generally fail to appreciate the negative effects they impose. Others who wish to prevent price gouging recognize these pitfalls and suggest additional measure to encourage fairness. Hybrid policies that invite both anti-price gouging laws as well as supplier subsidies represent one solution. But this does nothing to prevent hoarding and stockpiling. Though they may encourage suppliers to boost production, such solutions only address one aspect of the problem. Others believe purchase limits is the way to go alongside anti-price gouging laws. But here again, this too only focuses on one side of the issue. This approach would do nothing to boost needed supplies to a given region.
This leads us to the inevitable conclusion that anti-price gouging laws do little to promote fairness. Plus, they do nothing to alleviate an already bad situation where essential goods are needed in increased supply. Pricing strategies that let natural market forces and demand forecast price and supply based on demand remain the best approach. Not only will this better allocate and distribute resources. Such strategies will also address a critical need quickly so that markets can return to normalcy sooner. By definition, disasters are unwanted events, and price gouging is never something that’s going to be attractive. But it remains the best approach to solving the true needs that a disaster imposes. That’s why such pricing strategies are indeed good business practices from a political, economic, and even social perspective.