This article is a part of a series of articles dedicated to questioning the use of classical economic theory during the Coronavirus crisis.
“It’s OK to make a profit. But there is a line.” Those were the words used by Ms. Healey, the attorney general of Massachusetts, in reaction to the spike in prices of products like hand sanitizer and face masks following the coronavirus outbreak.
Across the United States, state attorneys have been drowned in complaints of price gouging on everything from toilet paper to hand sanitizers. One store was selling hand sanitizer at $60 a bottle or toilet paper at $10 a roll. And if you were planning to buy a mask, you could find a set of 15 N95 face masks at $3,799 on Amazon. Regulations on price gouging are in place in 40 states in the US and some of them have since been reiterated and reinforced after people have decried the price increases.
The coronavirus outbreak is a good illustration of the conflict between economic theory and what society can accept in practice. The pandemic has created a negative supply shock as many manufacturers have been forced to halt production amid lockdowns, but this supply halt should not yet be visible in everyday life products. The shortage we experience at the moment is mainly due to consumers that rushed to the supermarket shelves to stock up on whatever they deemed necessities. In such a dire situation who is the most selfish? The owner who raises his prices because of increasing demand, or the consumer who hoards products that he doesn’t intend to use immediately?
Many economists think price hikes can actually benefit communities during a crisis. Spiking prices are simply the market mechanisms at work. To price-mechanism fundamentalists, any regulation could prevent an efficient allocation of resources and instead intensify shortages of some goods. Still, to the public, price hikes are often portrayed as reflecting the greedy behavior of owners. For example, two brothers Matt and Noah Colvin travelled across Tennessee and Kentucky and collected 17,700 hand-sanitizers to resell them for between $8 and $70 each on Amazon. The next day, the platform pulled their items and took strict measures to regulate the selling of certain items. Following the bad press, the two brothers finally decided to donate them.
On the other end of the spectrum are those who doubt the ability of the price-mechanism to allocate essential goods in a way that is acceptable to society. We hear politicians, concerned citizens, and some economists advocate for anti-price-gouging regulations, particularly if it prevents people from accessing vital goods. Higher prices in times of emergency have the most detrimental impact on poor individuals and families who are already the most vulnerable during crises. Joseph Stiglitz, recipient of the Nobel Prize in economics, said about relying on the price-mechanism during a crisis that “most of us would say that immoral, that we are at that point allocating the right to live by the price system.” From Stiglitz thought follows a rejection of the Invisible Hand. As he says “what is individual rational may not be beneficial for society. That is the fundamental issue in economics, that Adam Smith’s theorem is wrong.”
Milton Friedman, another Nobel Prize winning economist, would certainly disagree. Not famous for his morals, the free-market guru contended that price controls during emergencies remove the incentive for consumers to smoothen out their use of supplies and limit incentives for suppliers to sell goods where demand is highest. From the price-mechanism it follows that shortages result in higher prices. When a shortage occurs, demand generally rises beyond what supply can sustain, as people hoard goods in uncertainty of how long supermarket shelves will be empty and in fear that they will end up sitting with not a single stack of toilet paper if they wait too long. In the UK, the Coronavirus panic led to an increase of £1.9bn in groceries this month. In this context, anti-gouging regulation does little to help supply. Anti-gouging laws that keep prices low encourage overbuying, and they benefit the people who get to the store first, not the ones who need it the most. They also limit the incentive for companies to sell essential goods where they are most needed. Where demand is the highest, that is, in theory, the hardest hit areas, price increases the most, and firms allocate supplies there for higher profit. But there is a moral limit to the argument of efficient allocation; at a certain price some people cannot access vital goods anymore. In this sense, the income inequality is intensified as only the richest can still afford the goods. Anti-gouging laws are in this view more about morals than fixing the lack of supply. For the many economists that believe the dismal science shouldn’t be subject to morals, but an ‘objective’ take on reality, regulation is therefore unnecessary.
But if you feel like the price-mechanism fundamentalists’ rejection of morals, there remains an argument against price increases that is somewhat separated from morals. That is the companies’ incentive to maintain a positive social image. If a company wants to do business after the crisis, being remembered by consumers for wild price increases during the worst of times will frustrate the marketing team. Instead, firms ought to follow the many companies that are participating positively in the crisis. Companies in the coronavirus crisis are playing an important role to relieve the hospitals. The textile industry has been converted into the production of masks and protective clothing, while many car manufacturers are producing ventilators. In this sense, there might be monetary incentives in realizing that a turn from solely maximizing shareholder value, to – at least in times of crises – serving stakeholders, too.
At the moment, the media, politicians, and public opinion seem to turn against price-hikes of essential goods. Many view it as both companies’ and the government’s moral obligation to resolve the problems of supply. Whether you are Milton or morals these days, this, at least, speaks to our shared sense of community and solidarity.
Written by Bastien Rébéna. Edited by Jeppe Damberg. Illustration by Jimena Madrigal.
New Light On Price Gouging – AIER, American Institute for Economic Research
Price-gouging laws good politics but bad economics, Forbes
The Problem with Price Gouging Laws, Harvard Business Review