DRI-311 for week of 11-04-12: Natural and Unnatural Disasters

An Access Advertising EconBrief:

Natural and Unnatural Disasters

A natural disaster can wreak havoc on the economy of a city or a region. But it remains to be seen whether this is worse than the unnatural disaster created by politicians grimly determined to cope with the resulting crisis.

Hurricane Sandy stuck the U.S. East Coast last weekend. Although only a Category 1 storm – hardly of vast magnitude by historic standards – Sandy nevertheless inflicted considerable death and destruction. Among her sundry devastations were the trashing of New York City harbor and the interruption of electric power for millions of local residents.

By interdicting shipments of gasoline into the port, Sandy left inhabitants of metropolitan New York City and New Jersey temporarily out of gas. By shutting off power, the storm left many gas stations unable to open for business even if they had gas to sell. On Friday, some two-thirds of New York City gas stations were closed. On Saturday, the proportion of closures still numbered one-third.

A triumvirate of elected officials – Gov. Andrew Cuomo of New York, Gov. Chris Christie of New Jersey and Mayor Michael Bloomberg of New York City – reacted in the inimitable way of politicians everywhere when faced with a career-defining, character-revealing problem.

They ran amok.

The Political Devastation: Gasoline Rationing

Gov. Chris Christie of New Jersey is a Republican. He is highly regarded in certain right-wing circles. Once that would have testified to his economic bona fides. His reaction to Sandy and the sudden spike in scarcity of gasoline, though, was more reminiscent of the Neanderthal left.

Gov. Christie imposed gasoline rationing. This is a time-honored reaction to a decrease in supply or increase in price of something popular or important. Honored by time, that is, but not by logic. Rationing is a political means of deciding which buyer’s desires get satisfied when there’s not enough of the good to satisfy everybody. And the reason why there’s not enough is that the good’s price is not allowed to rise high enough to call forth a sufficient quantity supplied.

After all, the Law of Supply is one-half of the Laws of Supply and Demand. It says that producers will wish to produce more of any good for sale at higher prices of that good than at lower prices – all other things equal. Superimpose this Law over the Law of Demand – which says that buyers will wish to buy more of any good at lower prices of that good than at relatively higher prices, all other things equal – and you have the makings of a market. Together, the two Laws combine to generate an equilibrium price – the price at which the quantity buyers wish to purchase equals the quantity producers wish to produce for sale. This is the price towards which a competitive market will tend to gravitate and the only price that could (in principle) persist indefinitely.

Competitive markets tend to equalize the amount people want to purchase and the amount producers want to produce and sell. They do this through fluctuations in price. If a drastic decline in supply occurs – perhaps through the intervention of a disaster like Hurricane Sandy – the immediate effect of this will be a shortage of the good at the previously prevailing equilibrium price. Suddenly buyers are no longer able to get the amount of the good they previously purchased at the former price. Their dissatisfaction will goad sellers to increase production and shipments to the market in order to enjoy a higher price and increase their profits.

Gradually, as price rises ever higher, two things happen. Producers supply more and more because they are making more and more profit. Buyers wish to buy less and less as price continues to rise. Consequently, the shortage gets smaller and smaller. Ultimately – bam! – the point is reached where the amount producers ship and sell equals what buyers wish to purchase. At that point, nobody has an incentive to change their behavior further. The fewer the political and logistical constraints exist, the shorter this adjustment process will be.

If the supply disruption caused by a natural disaster were sufficiently protracted in time – something like, say, the dislocations caused by the earthquake and follow-up tsunami in Japan in 2010 – the continuing availability of supranormal profits would attract entry by new firms into the industry. The increase in supply caused by this new entry would eventually lower price until all firms were earning merely a competitive rate of return.

But Hurricane Sandy is a short-run phenomenon whose supply disruptions will be handled entirely by existing firms. Recent declines in crude oil prices have reflected a brewing worldwide recession. These declines have translated into lower gasoline prices. Refineries have accordingly cut back on production in response to this cyclical decline in demand. The trick is to get them to increase production and stand the cost of shipping product to the East Coast to meet this sizable temporary need. That is the function of the price system – one is ideally equipped to handle.

There is no rationale for intercession by government into the process, either in the short run or the long run. The stated justification for government rationing is always the same. It is to prevent the price from rising “too high,” to prevent the good from becoming “unaffordable,” to preserve “equity” and “fairness,” to prevent sellers from “exploiting an emergency” to earn “windfall profits” or “obscene profits” or “profiteering” or “putting profits above people” or “earning profits off the backs of the disadvantaged victims.” None of the quoted phrases have any objective meaning or definition. All of them are emotive terms designed to evoke terror or pity or outrage in an observer without having to meet any analytical standard of proof. In short, they are the rhetorical currency of the politician.

In this case, Gov. Christie announced a formula for gasoline rationing. He announced it with the utmost gravity despite the fact that it was entirely whimsical. It was the “odd-even” formula. New Jersey motorists whose license plates ended in an odd number could legally acquire gasoline only on odd-numbered days of the week. Owners of plates ending in even numbers bought on even-numbered days.

Competitive markets allow price to move to the level necessary to equate the quantity supplied and the quantity demanded of the good in question. Rationing has the specific intent of preventing price from increasing to the level it would otherwise reach. Rationing deliberately strives to preserve the condition of shortage. Of course, it does so in the name of “fairness.” But then, what political atrocity isn’t committed under some noble-sounding pretext or another?

More Political Devastation: “Free” Gasoline

Not to be outdone by a neighboring politician, Gov. Andrew Cuomo of New York state elbowed his way into the act with an executive announcement of his own. No less august an agency than the Department of Defense – presumably taking a break from its successful prosecution of various wars or “wars” – was riding to the rescue. It would establish mobile fueling stations in New York City and Long Island, with gas supplied by the federal government.

“And the good news is,” the governor concluded triumphantly, “it’s going to be free.” What a triumph for the NannyState! State disaster relief provided free by the federal government herself! (Of course, there would be a 10-gallon limit on purchases – the Governor was countering Christie’s proposal with his own differentiated rationing product.)

Unfortunately, the best-laid economic plans of bureaucrats gang aft agley. In fact, they gang invariably agley. It apparently never occurred to these master planners to worry about what people would do at the prospect of “free” gasoline.

What they did at the Freeport Armory in Long Island was to line up, some 1,000 strong, waiting for the station to open. But when it did, they learned that it would be eight hours until the gasoline itself arrived. At another mobile station in Queens, would-be buyers formed a line that stretched for 20 blocks.

Needless to say, the public was not happy when it felt the strings on that “free gas” offer. One caption on a picture of the resulting turmoil read: “Tempers flared after people camped out all night, waiting for their turn at the pump…” Teacher and gasoline consumer Lauren Popkoff commented, “There’s just so many people getting very frustrated. People don’t know what to do.”

At length, the State Division of Military Affairs intervened with a plea that the public eschew the mobile stations until additional gasoline supplies arrive. Now the government had to order the public to avoid the special gas stations it had set up especially to relieve their “gasoline poverty.” It finally fell to the State Division of Military Affairs (!) to administer this fiasco, which lent just the right comic-opera touch to the proceedings.

There’s No Such Thing As A Free Lunch – Or Free Gasoline

Students often react reflexively to tales like this with responses such as, “Well, at least the people got their gas free.” Of course, this is arrant nonsense. We are so habituated to smoothly functioning markets that we see ourselves driving up to a pump, getting out, pumping gas and leaving – all within a short span of time. This is the implicit context within which we define our notion of “free gasoline.”

Significant time spent queuing – let alone marathon waits of eight hours or more – changes this picture completely. Now we must face the fact that the true economic price of gas also includes the opportunity cost of the time spent acquiring it. That is represented by the value of our time – either our labor time or our leisure time.

What is an hour of your time worth? Back east, eight dollars an hour is a low wage. Yet that means that the 10 gallons of “free gas” cost customers at the Freeport Armory in Long Island a minimum of $6.40 per gallon – and that’s just the price for a minimum-wage customer who was first in line. Customers who were last in line might easily have “paid” double that much. If they were people with decent jobs, paying $20-50 per hour – they might have paid six or seven times that much. It is odd that the egalitarian left wing, obsessed with the concept of discrimination, has never worried about the differential pricing effects of rationing. Perhaps the right wing should coin a slogan for these cases – something like “people, not politics” or “reason, not rationing.”

Go back to September 11, 2001. On that day, “runs” on gasoline stations were not uncommon. Quite a few motorists anticipated widespread dislocations and disruptions resulting from terrorism – at this point, the scale, scope and source of the attacks were unknown. Long lines formed at the pumps, which game a few enterprising station owners the brainstorm of charging ultra-high prices of $5 per gallon for “no-waiting” gasoline. Predictably, this gave rise to cries of discrimination and price-gouging. But these entrepreneurs were solving the problem and making us better off. They simply allowed the public to sort itself into those people with low-valued time – who waiting in line at Quik-Trip or at oil-company stations – and those with high-valued time – who paid $5 per gallon to avoid paying much more in lost time at work or lost leisure.

The contrast between these two types of response is instructive. Government takes arbitrary actions that are mandatory and coercive and take no account whatsoever of individual differences and preferences. They are designed purely to serve the interests of politicians and bureaucrats. The private market takes actions tailored to the interests of the different customer groups they serve. Those actions allow customers to maximize their own welfare by meeting their own needs and tailoring their actions to the differing prices and values they confront at each point in time. Entrepreneurs act this way not necessarily because they are noble and altruistic – they may or may not be – but because they have to serve their customers well in order to survive commercially and prosper.

Anti-Price Gouging Laws Gouge Consumers

It is easy to laugh at the comical antics of chief executives – mayors, governors and presidents. They are chosen more for their personalities and political instincts than for their analytical skills. But attorneys general and legislators are mostly lawyers who are supposedly trained analysts. They craft, pass and enforce complex legislation. These are people whose mental faculties are finely honed. Yet when they open their mouths on economics, they become blithering idiots.

Beginning immediately after 9/11, state legislatures began to pass anti-price-gouging bills, ostensibly designed to protect consumers against high prices in emergencies. In New Jersey, businesses were forbidden from raising prices more than 10% within 30 days of a declared emergency. In New YorkState, merchants could not charge “unconscionably excessive price[s]” for “vital and necessary” goods. As to what constitutes “unconscionably excessive,” the law remained mute.

And sure enough, no sooner has Sandy made landfall than the respective AGs went into their act. New Jersey Attorney General Jeffrey Chiesa: “Anyone violating the law will find the penalties they face far outweigh the profits of taking unfair advantage of their fellow New Jerseyans during a time of great need.” Just to make sure that people knew the government meant business, it had previously hit a gas station with a $50,000 fine for raising its price by 16% during Hurricane Irene.

This reminded economist Benjamin Powell of the famous directive of Roman emperor Diocletian in 301 A. D. The emperor instituted a maximum price for bread and threatened violators with death. Powell noted that the chief result of this was an absence of bread. And “much as the Roman threat of death couldn’t force producers to bring products to the market, neither can New Jersey’s excessive fines.”

The one thing Northeasterners want most is gasoline. Prosecuting producers who supply it will not encourage them in this pursuit. And a theoretical right to obtain unlimited free quantities of a good of which there is no supply is not worth a tinker’s dam to consumers.

And Then There Was Bloomberg

Hovering over the crisis like a Big Brother was Mayor Michael Bloomberg of New York City. It isn’t often that Mayor Bloomberg is upstaged in a public controversy, but in this case he was technically outranked by Gov. Cuomo. Still, he managed to get his rhetorical licks in. On Saturday, he announced that the gas shortages should be over “in a couple more days,” when the Port of New York City was reopened. But as recently as Wednesday, November 6, Huffington Post still carried accounts of the shortage. Offers to trade sex for gas were popping up on Craig’s List.

A reliable byproduct of any durable program of rationing is the appearance of black (illicit) markets. Technically, the motivation for black markets arises due to the condition of shortage. When price is not allowed to rise and eliminate the shortage, this creates a permanent condition in which the maximum price buyers are willing to pay exceeds the legal price suppliers currently receive at the shortage-constrained price. Buyers have an incentive to offer a higher-than-legal price to get more of the good; producers have an incentive to violate the law by supplying more to the market at prices above the legal level. Thus, the dance floor is prepared for the black-market tango.

Sex-for-gas is somewhat irregular, but by no means outré. After all, a cash transaction would be traceable, at least theoretically, but sexual barter is much more difficult to trace and prove.

Rationing By Price vs. Non-Price Rationing

Supply disruptions create a situation in which a limited quantity must be allocated among many buyers. Economics suggests that there is a good and a bad way to do that. The good way is to ration the demand of many buyers using price. The bad way is to ration demand by queue, by coupon or by some other non-price method.

Rationing by price has certain key advantages. Among these are: 1. the ability of price to rise is an inherent advantage to the supply of the commodity, since it gives producers an incentive to supply the good. And in cases like Sandy’s, that is exactly what exasperated consumers want most – they want the good in question. 2. A higher price gives buyers the incentive to conserve and allows each buyer to take his or her own particular circumstances into account. A poor consumer, for example, may nonetheless need to purchase a large amount of the good and may want to pay a high price to do it. 3. In order to maximize utility or satisfaction in an ordinary marketplace setting, a consumer equalizes his personal rate of tradeoff for the good to that offered by the market. That is to say, he buys the amount of any good that equates its marginal value or benefit to its marginal cost or price. All consumers face the same price for a good; all consumers equalize their personal rates of tradeoff to that offered by the market. Since two (or more) things that are equal to the same third thing are equal to each other, that means that marketplace exchange guided by money prices achieves the same ideal outcome that would otherwise require an impossible amount of time and effort to reach using barter exchange without money. In contrast, rationing frustrates this outcome by driving a wedge between consumers’ personal rates of tradeoff. This encourages black markets and criminality.

This analysis is a staple of microeconomics textbooks, the kind used to teach undergraduates in hundreds of U.S. colleges and universities. Economists testify to its validity as expert witnesses in court cases of various kinds – regulatory, antitrust, civil and criminal.

Venality or Stupidity?

There is a venerable maxim governing motivation and behavior: “Never ascribe to venality that which can be explained by mere stupidity.” In a world of imperfectly distributed information and intractable subjective perception, this is a sound rule of thumb.

Yet the continual refusal of politicians, regulators and lawmakers to take seriously the best-established principles of economic theory and logic – while embracing only the quack remedies of macroeconomics – cannot any longer be put off to mere stupidity. People who are smart enough to gerrymander legislative districts to cement their incumbency and bury their mistakes in legislation numbering thousands of pages cannot be written off as simply too stupid to master basic economics.

This means that they must have ulterior motives for acting as they do. Since their actions harm the constituents they are sworn to help, those motives are clearly anything but benign.

The logical motivation would be to deliberately thwart suppliers in order to leave constituents at the mercy of government. By making the public dependent on government, the minions of government protect the permanence of their own positions by enhancing their budgets and the scope of their power.

Natural vs. Unnatural Disaster

Natural disasters are bad enough. When the free market is given free play to cope with them, their effects can be mitigated. But when politicians, lawmakers and bureaucrats are allowed to use them as vehicles to serve their own interests at the public’s expense, the long-run harm of the resulting unnatural disaster rivals that of its natural counterpart.

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