The Myth of Price Gouging and Houston's Best Hope

Taking a quick break from my regular Bastiat Commentary schedule to discuss a timely and widely misunderstood concept.

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There's no such thing as "price gouging." Still, the screens have been filled with either foolish or dishonest talking heads using the term as a way of creating controversy. Search for the term on Google, and the first thing that comes up is a loaded definition courtesy of Wikipedia:

Price gouging is a pejorative term referring to when a seller spikes the prices of goods, services or commodities to a level much higher than is considered reasonable or fair, and is considered exploitative, potentially to an unethical extent.

Anyone using the term or believing this definition knows so little about how pricing works and the role that it plays in the market, and are so unaware of their lack of knowledge, that it would be best for society as a whole if they were to never speak on an economic subject again.

The term is an attempt to lead an audience to believe that something nefarious has happened. Something out of the ordinary has, but nothing treacherous. Despite all the chaos that has occurred in the wake of Hurricane Harvey, one thing has continued to operate as efficiently as it always does: market pricing. And if Texas' Attorney General and Governor (those supposedly "free-market loving conservatives") have enough sense to get out of the way, it's the mechanism which will help Houston get back on its feet quickest.

The problem stems from a misunderstanding about what prices are. Most presume they are nothing more than what we pay to get something we need or want. If prices were that and nothing more, there would be little harm in government setting prices across the economy and not just in a disaster. But they serve a much more vital role.

Prices are the method of communication for economies. They transmit information from one end of the economy to another. For commerce, they serve the same role as language does for humans. Remove the ability to use language from humanity, and we are crippled. Do the same with prices in an economy, and the result is no less devastating.

The reason it's so critical that economies have a communication method is scarcity. There is never an unlimited amount of resources available. So the question is how these scarce resources should be used, transformed, and distributed. And not just in a single instance but over the course of days, years, and the life of humanity.

Prices are the mechanism that ensures that resources move in ways that provide the most value to society. The particular distribution that is the most valued changes every second. But the mechanism of pricing is able to both better discover what that most valued distribution is and move resources ever closer to it. Unless, of course, someone decides to set limitations upon what prices are allowed to do.

Prices send information to entrepreneurs about how things are valued. Entrepreneurs then use that information to direct resources to those places. We all affect the price signaling process as we choose what to buy and what not to. We play a part in decisions regarding how resources will be used based on the jobs and education we pursue or avoid. We all take on the role of entrepreneur to different extents. We react to pricing signals almost instinctually.

One of the best characteristics of prices is the speed at which they send their information. So when we see prices spike rapidly after an event such as a hurricane (or something less tragic like an athletic milestone driving the prices of autographed memorabilia higher), it's not prices that are behaving any differently. They signal to entrepreneurs that some real world element has changed.

Price changes tell entrepreneurs that particular resources are suddenly more highly valued in some locations. And because entrepreneurs know that the best way for them to acquire the things that they value, is to supply the most value to others, they immediately start shifting resources to those places.

In our daily lives, this process tends to occur slowly. But in unusual moments, the prices can change as suddenly as the event itself. Instead of decrying this as a tragedy upon a tragedy, we should welcome it. The quicker the prices change, the quicker the resources begin to move in the more valued direction. And as useful as something like charity can be in disruptive events, it will never be able to act with the swiftness and accuracy that a pricing signal permits.

There are three more points worth addressing regarding the myth of price gouging. The first is related to charity. In moments such as Hurricanes Katrina and Harvey, it may not always be possible to have a pricing signal to direct resources. Certainly, charities do the best they can to fill the gap. But it is worth considering, and the issue is a larger discussion than I feel at liberty to make in this article, whether it may have been possible to have more pricing signals involved in situations like the hurricanes I mentioned.

Whenever government takes action, pricing signals get distorted. This distortion means that resources aren't perpetually moving towards their most valued uses. In many cases, including disaster recovery, the government has removed pricing signals altogether. They tax the people and claim to be the primary if not only, plan for relief in these instances. The foolishness of this belief was exposed during Katrina. And because of that exposure, Houston's non-governmental rescue efforts were more well-prepared. Had Katrina not happened, it's easy to see how this tragedy would have been even worse. But it also strengthens the argument that preperation and response could have been even better if there wasn't a default reliance on the mythical safety net of government.

The second point expands on the first. Because governments distort price signaling, it's important to recognize that prices don't come close to reflecting more valued uses before an event. Nor will they during the event or after. The more government we have, the more distorted these prices become. The best way we can prepare for future events, survive them, and rebuild after, is to reduce the amount of government we have. Every step we take towards freer enterprise will save lives.

The third and final point involves perhaps the most self-evident and emotional of the critiques of allowing markets to direct the use of resources. Many who understand and agree with every point I've made to this point are still tentative and some recoil entirely from what I'm proposing because they are concerned that only the rich will get the resources needed. But there's two flaws with that perspective.

The first flaw is that it attempts to view the event in a vacuum. We must acknowledge that resources are used before the event and will continue to be used after. And people will value different uses of resources in those times. In free enterprise, which I would never argue that this country is a beacon of though it is better than most, the only way one can gain wealth is by providing value to others. Part of the reward for having provided that value is that they are better able to weather such a crisis.

If we arbitrarily remove that reward, or only allow them enough to handle their situation but take the rest, we remove a major incentive for people to try to provide the most value they can in society. Why continue to work to create value and wealth if you know that it will all be taken in the next crisis? We are all made poorer by such policies.

The second flaw is that it doesn't recognize the humanity of the wealthy. The rescue efforts would be severely hampered were it not for the generosity and compassion of the rich. In Houston, for instance, a signification rush of donations was sparked by J.J. Watt, a defensive lineman for the Houston Texans. He started a relief campaign with a goal of $200,000 and donated the first $100,000 himself. Within days the fund surpassed $10 million, including $1 million donations from various football owners, the NFL itself, and Walmart with The Ellen Show. The rich have shown that they are willing to help others. If they were allowed to keep more of their earnings, they might do even more.

We live in a world where scarcity exists. That means there will always be those in need. But the best to way to perpetually reduce that need is to let prices guide resources where they provide the most value. Even when the timeline gets shrunk and the media uses nonsensical terms like "price gouging."

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Photo by Ryan Johnson on Unsplash