There are consequences to ignoring economic reality.
Back in August, an article in The Atlantic titled “Sometimes You Just Have to Ignore the Economists” stirred up controversy. The article, authored by Zephyr Teachout, was primarily focused on Kamala Harris’s recent support for price control laws.
The article begins by claiming that Kamala isn’t proposing price controls in normal times; rather, she’s opposed to “price gouging” which is already against the law in many cases (such as during natural disasters).
Here’s the problem with this argument. Kamala’s comments about price gouging are related to how high prices are right now. In other words, she’s talking about non-emergency situations:
As president, I will take on the high costs that matter most to most Americans, like the cost of food. We all know that prices went up during the pandemic when the supply chains shut down and failed. But our supply chains have improved, and prices are still too high.
So, no, Kamala isn’t advocating for the status quo. She wants to ratchet up price controls to a whole new level of “normal.”
The consensus among economists is that price controls are foolish in normal times, and, as the author of the piece points out, economists tend to dislike them even in emergencies!
So do price controls make sense in emergencies? Are economists wrong? Well, let’s address the author’s arguments.
Can Supply Meet Demand?
The first argument Teachout makes goes as follows:
Regular people seem to understand a few things that economists don’t. During an emergency, such as a natural disaster, short-term demand cannot be met by short-term supply, setting the stage for sellers to exploit their position by raising prices on goods already in their inventory. The idealized law of supply and demand predicts that new investors would rush in, but the real world doesn’t work like that.
This is wrong for a few reasons. First of all, even a completely unresponsive short-term supply does meet increased demand. It does so through the form of higher prices. That is, even if supply cannot move, higher demand is satisfied because higher prices drive marginal buyers out of the market. The price of goods in an emergency should be higher because more urgent uses are forgone when a person decides to buy the item in question.
Second, Teachout underestimates the ability of businesses to increase supply in the short run. Funnily enough, she talks as if stores are happy about their inability to increase supply. She says, “After the disruption, everything goes back to normal—except with a big wealth transfer from the public to the company that raised prices.”
But the truth is that it’s more profitable for businesses to increase supply during these emergencies, so a system of open competition will reward those best at doing so. So while we can claim in online articles that the supply is unresponsive, people with actual money on the line will benefit from finding creative ways to prove us wrong.
The Best of a Bad Thing
Teachout acknowledges that prices help ration, but she dislikes the rationing method. She says:
[T]he other big problem with the textbook economics take on price gouging is the assumption that temporarily higher-priced products will find their way to the people who value them the most. That might be true in a world where everyone has the same amount of money to spend. In the world we actually inhabit, that is not the case.
Let’s begin by conceding a point here—when economists say the price system allocates goods to those who “value them the most,” what is really meant is that goods are being allocated to those willing and able to pay the most money to obtain them. If you don’t have much money, then you’d have to borrow to compete.
The problem is that the author’s proposed system of rationing (insofar as there is one) is much worse than the price system.
When an emergency hits, goods (like clean drinking water) become more scarce. That means people will compete more vigorously to acquire the water. One way to compete is to raise the price you’re willing to pay. This method is nice because people acting in their self-interest will be more conservative with their usage of water (because it’s more expensive).
If you add a price control, however, there is no incentive to reduce consumption. As a result, people can do things like buy 50 cases of water. Price increases punish those who increase their consumption a lot. If the price of a case of water goes up $10, and you try to purchase 50, you’re out $500 more due to the price increase.
I can already hear price control advocates—why not just limit the quantity people can purchase? Well, first of all, with this system, rich people can still beat out poor people. If you’re rich, you can hire other people to help you circumvent quantity restrictions.
The other problem with this system is that some people legitimately have more urgent uses for water than others. A family of eight having the same quantity restrictions as a single person is a ridiculous standard, but that’s exactly how grocery stores restricted quantities where I lived during Covid. With price rationing, if there are four cases of water, the family of eight might be able to outbid a single person for the third case. In a world with a quantity restriction of two per shopper, there’s no chance.
There are innumerable extenuating circumstances of such complexity that it would be impossible to create any sort of planned system to cover them all. The better option is to let people express urgency with money. Again, this may mean that the rich have more buying power, but at least in this system they are punished for bulk buying, and wealth can circumvent alternative rationing systems anyway.
If your concern is the poor being outbid by the rich, a simple wealth transfer would be much less disruptive than distorting economic signals with price controls.
Rationing is not a good thing. No one likes it. But it is better to ration well than to ration poorly.
The Homo Economicus Strawman
Next, Teachout trudges out a familiar strawman to economists: Homo economicus. Here’s what she says:
The laws recognize that consumers, not being the coldly rational Homo economicus of academic models, are going to be less price-sensitive during disaster; their desperation can be exploited.
This is a strange comment to make. There’s nothing about “academic models” of economics that precludes us from recognizing that people become less price-sensitive during disasters. The demand curve can change such that people are less sensitive to prices. In economics jargon, we say demand becomes more inelastic. There is literally a textbook economic law called the “second law of demand” whereby people will have more inelastic demand in the short run when a price increases.
Regarding exploitation, again, no one is happy that supply may be inelastic in the short run (remember how the author’s argument implies that stores would increase supply if they could), so the question is: What system would be better?
But I want to take a step back and ask: Does the opposition to price controls rely on some blind faith in a view of humans as rational cost-benefit calculators with perfect information as in the Homo economicus model? Not at all. This comment betrays a misunderstanding of one of the most powerful arguments against price controls.
The Nobel Prize-winning economist F. A. Hayek famously wrote an article called The Use of Knowledge in Society. What Hayek argued is that the price system is valuable because prices embody and communicate knowledge in society in such a way that buyers and sellers don’t need to understand the information comprehensively.
If, for example, a copper mine collapses, there will be less copper available in the short run. In a well-functioning society, we would want people and firms to curb their copper consumption in response to the increased scarcity. In the market system, when the supply decreases due to an incident like this, prices rise, and this leads to a decrease in consumption.
Notice, consumers didn’t need to know about the mine collapsing to curb their consumption. The price increase caused them to act as if they knew.
This is especially important when we recognize that some knowledge cannot be easily codified. For example, riding a bike is knowledge that you can’t pass on by writing down. This kind of non-codifiable knowledge is called tacit knowledge, and one advantage is that prices include even tacit knowledge.
In our prior example, it’s hard to figure out who needs water in a crisis more urgently. How do we weigh the concerns of a large family against the concerns of someone with a medical condition that requires him to have more water? How can we account for the urgency of desires? Asking seems wholly inadequate—talk is cheap. Prices can embody this urgency in a way that normal communication cannot.
What does this have to do with Homo economicus? Well, the oft-criticized Homo economicus model assumes perfect information. Hayek’s argument implies that markets are valuable because we do not know everything we would like to know. In other words, the best arguments against things like price controls have little to do with cold, callous academic models.
Order or Chaos?
During a crisis, which approach sounds better: Should we suspend all the normal rules that people have built their lives, plans, and routines on, or is the maintenance of those rules more important than ever?
In 2021, my co-author Rosolino Candela and I published a paper on price controls during the pandemic, and we argue that since prices are a form of communication, to disrupt their use is a form of violation of free speech and expression. In this way, price controls can be viewed as a violation of Constitutional rules.
Whether lawyers want to accept the fact that prices are communication devices is its own issue, but our paper had a simple point based on the work of economists James Buchanan and Geoffrey Brennan, who together wrote The Reason of Rules. Our point was that consistent constitutional rules are even more important in crises because people rely on these rules when making plans.
Allowing price communication during normal times but disrupting them in disaster situations by replacing them with arbitrary quantity restrictions or bureaucratic bean-counting allocation exacerbates the chaos.
Ironically, support for price controls during a disaster only worsens Teachout’s previous fears about short-run supply being unable to grow. If markets have stable, consistent rules which enable communication, they will be able to plan more effectually for disasters. If they are subject to arbitrarily decided and adjudicated price rules, creative solutions will be stymied.
This brings us back to our fundamental question: Should we sometimes ignore economists? I confess I’d be the first to give a hearty “yes” to this question, but for reasons vastly different from those proposed by Teachout. Often, economists who get involved in politics embrace ways of thinking that are conducive to political appointments, but they abandon sound economics along the way. Those economists should often be ignored.
During the 1970s stagflation, when Arthur Burns famously told Congress that “the rules of economics are not working in quite the same way as they used to,” what he really was saying was that the old Keynesian consensus—that inflation and unemployment can’t happen together—was wrong. And he was correct. It was wrong because it wasn’t based on sound economics.
So, my rule is simple. When economists are not doing good economics, we should ignore them. But when they are doing good economics, it behooves us to listen to them.
The question is not whether we should sometimes ignore economists. The question is whether we should ignore economics. If our society answers “yes,” we do so at our peril. As the economist Ludwig von Mises wrote:
The body of economic knowledge is an essential element in the structure of human civilization; it is the foundation upon which modern industrialism and all the moral, intellectual, technological, and therapeutical achievements of the last centuries have been built. It rests with men whether they will make the proper use of the rich treasure with which this knowledge provides them or whether they will leave it unused. But if they fail to take the best advantage of it and disregard its teachings and warnings, they will not annul economics; they will stamp out society and the human race.
Reproduced with permission.
