Aiyar, Boudreaux and Price Gouging
Published by Yazad Jal January 10th, 2005 in EconomicsSwaminathan Aiyar’s excellent column on economics and current affairs is a Sunday staple for me. But even he can get it wrong at times. Yesterday’s column was one such (rare) occasion. Aiyar is saddened by rising prices in tsunami affected areas and by the general insensivity of the market mechanism (this from a long time supporter of markets).
… victims hit by the tragedy will be hit again by higher prices during rehabilitation. This is the dark side of the market economy. In most conditions, free markets are benefactors, but they can produce unfair outcomes when natural disasters strike.(snip)
But what happens when a natural disaster strikes? A drought causes food prices to rise, precisely when incomes fall (farmers have less output, labourers have less jobs). The price mechanism exacerbates the problem instead of being self-correcting.
Don Boudreaux somehow anticipates Aiyar in a brace of articles written two weeks back. Boudreaux shows how the price mechanism / markets play a positive role (yes, even when prices rise) and how the alternatives are much worse. The first article focusses on the theoretical aspect.
To prevent the price of some staple good (say, lumber) from rising to its market level in the wake of a natural disaster is to camouflage the underlying reality. The underlying reality is that the disaster (1) appreciably reduced supplies of lumber available in the devastated area – both by destroying inventories of lumber and by destroying supply lines; and (2) appreciably increased the demand for lumber in these areas. In short, the underlying reality is that the value of lumber to people in these devastated areas is now significantly higher than it was just before the tidal waves hit. These people need lumber more than they did before, and there’s less lumber immediately available.
This reality is unfortunate, but it is, well, real. Being real, it must be dealt with. It cannot be hollered, hoped, dreamed, prayed, or legislated away. And it means that the welfare of the people whose homes and businesses (not to mention love ones) were destroyed is much lower than it would have been had the tsunamis not hit.
(snip)
But I’ve learned that many people are unconvinced by this argument. “What about poor people?” the Unconvinced understandably ask. “The poor who can’t afford to pay market-clearing prices will be forced to do without.”
Seems true. But I’m not so sure – at least, I’m not sure that the poor will fare worse when prices are not controlled by government than when prices are controlled.
Luckily Aiyar is not openly calling for price controls. Boudreaux presents the economic case well and also asks a few novel questions.
Are the poor likely to have a comparative advantage over the non-poor at creating and protecting black markets? Are the poor likely to have a comparative advantage over the non-poor at taking advantage of personal and political connections? Are the poor likely to have a comparative advantage at deploying violence as a means of acquiring goods?
The follow up post presents the point with a nicely drawn illustration.
Aiyar also talks of distress sales, the lack of insurance and ends with a warning for those involved in relief and rehabilitation (R&R).
Estimates of sums required for R&R typically fall short of actual needs, since they fail to anticipate that disasters themselves will drive up prices of required materials and services.This is the iron law of supply and demand. The more the aid that flows in, the more it will push up prices.
That’s only partly true. If all aid flows in as cash, then prices will rise (more paper money, same amount of goods => inflation). But a lot of the aid comes in as inkind assistance in the form of goods like food and temporary shelter. These goods are already paid for at the point of origin by the aid agencies and the supply of goods-as-aid will act as a dampner on rising prices.
18 Responses to “Aiyar, Boudreaux and Price Gouging”
- 1 Trackback on Jan 11th, 2005 at 3:26 pm
But a lot of the aid comes in as inkind assistance…
Yazad, but how much aid comes in finished-goods form? Food, Clothing, Medicine, very basic necessities. You’re right that supply of these increases and price drops etc.
But most non-cash aid is for stuff like rebuilding infrastructure, which creates a lot of local demand for cement etc. So the initial cost estimates of the AID agencies end up as under-estimates.
Another insightful thing Aiyar talked about is the distress sales of assets due to lack of credit. And the consequent inability to buy them back later at ultra-high demand-fueled prices. This is very sad but very important to look at. Are any AID agencies looking into this?
As usual Yazad you are pushing the market too hard. Lucily for the rest of us the world is a lot more compassionate than you will ever be. I suspect you would be singing a different tune if your house and life posessions had been washed away and you were left bankrupt and then you were informed that everything was know 10 times more expensive because it was just a ‘market’reality’.
Like I have saud before it is easy to pontificate from a comfortable armchair. Occassionaly step into the real world and see what its like there - then perhaps people would actually take your suggestions seriously instead of dismissing them as yet more theoretical BS from an armchair pundit.
Aiyar states the very point that makes price increases matter. He speaks of fishermen have their boats destroyed, but fish prices are rising. He claims it doesn’t help the fisherman.
But with price rises, now a fisherman could get a loan for a new boat, and pay it back with interest. Even in a primative economy, he could probably find family or friends to raise a loan from.
Or he could make a deal with another fisherman to purchase a new boat
together that they could not have afforded by themselves, then make
enough money fishing together for one of them to buy out that boat and
the other to buy a new boat.
With emergency price fixing, the fisherman have no chance to purchase
a new boat…
So disaster price rises help by encouraging additional production (as well as additional distribution to the disaster area).
Ck,
If I were in a disaster, I would prefer high prices to price controls. I would welcome both the opportunity to outbid people who don’t have as much need as I for the goods in short supply, as well as the quicker rate of replenishment that comes from high prices and is so critical in a crisis.
Lucily for the rest of us the world is a lot more compassionate than you will ever be. I suspect you would be singing a different tune if your house and life posessions had been washed away and you were left bankrupt and then you were informed that everything was know 10 times more expensive because it was just a ‘market’reality’.
Luckily Ck, I will find “good samaritans” like yourself who will pay twice the real value to washed out assets - just to prove that they/you are “making a difference”. Be careful denying this ;)
CK, compassion is irrelevant. Those with compassion will give whether or not government imposes price controls on suppliers. The question is whether or not suppliers will supply in sufficient quantities to meet the need.
Right. YOur house has been destroyed, everything you own is gone and you have no money and are out on the street - and you beleive that you should have to pay 10 times the market price?? It is not an ebay bidding competition when you have to sit on the wrekage of your life and try and outbid others. I think all of you will be singing a very different tune if it was your house and life that was destroyed. I beleive that ‘market forces’ will be the last thing on your mind.
Yes there is such a thing as compassion and such a thing as responsibility to fellow human beings and only those who have experienced a loss like this will know what it is.
Ck,
Just wondering - does the assumed moral high ground result in socialistic thought or is it vece versa?…..am really curious.
Dear Nilu - I appreciate the honesty you display on your blog saying
So I am going to read your ‘bullshit’ but refuse to ingest it and will politely puke it up all over your ‘useless’ , ‘confused’ ’stupid’ posts.
I love it when I don’t have to be original. Nil kantan has done all the work for me. But why such a low opinion of yourself. I actually like reading some of the posts on your blog despite you yourself finding it so incoherent ;)
Many people lost most or all of their valuable property and I would imagine that some even lost all of the cash that they had. I can’t imagine that too many of the (mostly poor) people affected by the tsunami had bank accounts. Prices serve two purposes in the market: there is the price as incentive to produce and the price as a way to ration scarce goods. There is nothing particularly fair about rationing goods with high prices when many simply cannot come up with the money to pay for them due to circumstances completely outside their control.
That being said, I still think that high prices offer a very important incentive to produce and transport goods after a disaster, especially considering that the destruction of infrastucture in coastal areas will make getting goods to market that much more difficult.
And CK is right, compassion does still exist in the world and especially in the immediate aftermath of a disaster. But psychology dictates that once some time passes after the tsunami, companies and individuals that were previously willing to take losses (or miss out on profit opportunities to less scrupulous competitors) to not appear greedy will start to lose patience and raise prices.
So I would say that government-imposed price controls are still a bad idea in this case, especially because they can have such unpredictable consequences. Aid agencies can help relieve the burden of higher prices for poor people, especially once the immediate task of feeding and sheltering victims gives way to the more long-term reconstruction and rebuilding effort when markets need to be allowed to function.
CK,
If my house were destroyed, I would ask for assistance. If I received assistance, I would be grateful to those who provided it. I would not ask the government to fix prices. Those who wish to assist can pay the market price. This solution leaves room for compassion, and for the price mechanism to ensure that needed supplies are provided to all who are in need.
Ck,
Let us assume for the sake of argument that the govt announces price controls.
1. Disasters lead to scarcity in that region. Only economic incentives ensure that goods are sold from other regions to the affected area.
2. Law enforcement officials are too busy in disaster relief efforts and in ensuring law and order (i.e. preventing looting) to worry about enforcing regulations.
3. Regulations cannot be enforced in disaster prone areas that are not in the ambit of a functioning law and order systems anyway. e.g. Banda Aceh, Northern Sri Lanka.
Won’t the system reverts back to a state wherein no controls exist?
I think the answer, for this non-economist, must lie somewhere in between the role of compassion (Ck) and the role of an entirely free economic system (Yazad and others).
Yes, as Mark points out, compassion dries up, and is therefore not a good enough driving force to improve devastated lives over months and years.
But yes too, the inevitable rise in prices and shortage of supplies is a source of distress for those devastated lives. (In one form or another, I heard complaints about this while travelling in Tamil Nadu after the tsunami).
Fred Cuny, whose thinking I believe anyone interested in the aftermath of disasters should get acquainted with, saw much wrong with the way we approach relief. In Guatemala after the 1976 quake, vast shipments of blankets began coming into the country: an absurdity for a country in which making blankets was a big part of the economy. He was also critical of sending food to disaster areas — this works to impoverish farmers in nearby areas, and thus compounds disaster. (In fact, Cuny referred to relief efforts as the “second disaster” visited on victims).
The point is, you’ve got to pay attention to local conditions, first and always. From the time I’ve spent in disaster-hit areas, I’d say that means there’s a role for both compassion and free pricing — therefore, for a middle ground between the two.
But above all, for being clear-eyed, practical and willing to stay away from preconceived ideas of any kind.
Where does the market system say “no” to compassion? All that is being said is that there should be no government price fixing. If prices rise, let them. That does not in any way stop others from supplying goods for free (or lower rates) if they wish.
Therefore, Dilip, I don’t see an either-or situation with markets and compassion. I see both peacefully co-existing. Not as an exception or a contrived “third-way,” but as the natural way.
Came across this paragraph while reading about Fred Cuny.
(Emphasis mine)
Source:What ’s wrong with the humanitarian relief system
I don’t see an either-or situation with markets and compassion.
And knowing you, Yazad, I know that’s true. But I’m reacting to earlier comments here: First, Ck who says the world is more compassionate than you’ll ever be; then RKB, who says compassion is irrelevant.
The reality, orthe best way if you like, has got to lie somewhere in between those views.
Ah yes Dilip. Both CK and RKB are wrong to some extent.
Markets as institutions will also reflect human emotions. After all, a free market, is basically a collection of humans engaged in voluntary exchange. Good economics will look deeply into the whys and hows of that voluntary exchange.