Policy Proposal: Ethical ‘Price-Gouging’
This blog entry is the second in a series where I discuss ,and argue, on behalf of a a unique policy proposal which I have either heavily modified from existing ones or I have come up with largely independently.
Contextual and theoretical background
It’s 2021 and the United Kingdom is facing a fuel crisis. But the government, and many of her ministers, are insisting that you can’t call this crisis a shortage. Over the past week, as petrol stations shut and signs display that fuel has run out, it seems very odd to say that this isn’t what it looks like. So what exactly has been going on? Semantics aside, what we have witnessed over the past week was a perfect storm: in the short term caused by the news of an ongoing lack of HGV drivers, particularly when it came to delivering fuel, which drove massive panic buying; this in turn in caused the demand for petrol and diesel at forecourts to far outstrip supply, leading to long queues and even closures as fuel indeed had run out in the way many motorists feared.
While of course there are more thorny, complicating factors (such as a combination of global supply shortages, Britain’s woes with a poor period for wind production, and difficulties accessing the European fuel, energy and labour markets after Brexit) instead I want to focus on the immediate problem at hand which are the shortages taking place at forecourts and what the role of the state is to determine how we can make crises like these much more manageable and less damaging in the future.
The government is adamant that this isn’t a true shortage as there is theoretically enough fuel to go around if people decided to stick to their normal buying habits. Of course, this is the equivalent of saying there’s no shortage of oxygen on the moon so long as nobody breathes. Panic buying, which works on the perception of an incoming shortage, evidently can cause actual shortages. This sudden event that increases demand is often termed a ‘demand shock’ by economists. Demand shocks can result in several outcomes, but why has this particular one resulted in shortages at the pump?
Well, within a totally free market, when there is a sudden rise in demand while supply remains fixed in place, prices sharply go up. Similarly, if there was a sudden rise in supply while demand remained fixed, then prices would sharply fall. So for instance, let’s say that news stories about whether or not there would be enough fuel encouraged a lot of people to buy much more fuel than they normally would — that big rush to hoard and buy more fuel would constitute an increase in demand. In this scenario, forecourts (looking to price their fuel to the level that attracts as many customers as possible) would be stupid not to raise prices and make some money off of this. The increased prices however, would cause a reaction that would deter many would-be panic buyers, thus bursting that bubble of increased demand and herald a return back to more regular pricing, or what economists call an ‘economic equilibrium’.
Nonetheless, life is never as simple as the totally free markets you would find in an economics textbook. In reality, there are both economic and political reasons for why this isn’t happening here in Britain today.
Firstly, while in the ‘textbook’ example companies work on the market forces of supply and demand, in reality most firms use a system of ‘administered prices’ wherein prices of goods are set internally; taking into account only the cost and profit margin (rather than dynamically matching their prices to match the current state of the market). Economists agree that supply and demand does affect the price of a good (like fuel) on its cost base but that may not always translate entirely to the mark-up retail or even wholesale price. That would mean that even with increased demand, trying to make a rapid change in price wouldn’t really be in line with the internal pricing practices businesses such as forecourts make. In other words, if forecourts are only ever setting the price of their fuel based on how much it costs for deliveries and sale (with profits included) then they simply won’t rapidly respond to any change in demand (like panic buying) which doesn’t also affect the price of the pre-sale good (after all, the panic buying isn’t happening at oil refineries and stock exchanges).
Secondly, there is always going to be high public pressure to keep prices “fair”. Fairness of course is subjective, but it is never a good look during a crisis where people are suffering fears (whether founded or unfounded) and companies exploit those fears to make a quick profit. Many would call such behaviours profiteering and taking advantage of some of the most vulnerable people. As such, many places, including the United States, have laws in place which outlaw an abrupt rise in prices during a crisis. Some call this phenomenon ‘price gouging’ although it’s not a term economists like to use.
Within the UK right now we do not have a textbook free market, and for a whole host of economic and political reasons never will. Unlike in the idealised textbook free market example, fuel prices in Britain have risen only minimally in response to the sudden rise in demand, largely because of pressure from regulators and the government should they have a rise high enough to constitute “profiteering” and be hit with fines or other sanctions. Consequently, the expected price rise for such a big and sudden rise in demand has not materialised (or at least not materialised fast enough) and as a result, the heightened demand continues. The end result? Shortages as supply of fuel simply cannot catch up in time.
We are then faced with a dilemma. Come the next price shock, do we really want to attempt a totally free market option — imposing higher prices on the public whenever there’s a sudden shock like the current fuel crisis, with the reward being a shortened crisis? Or should we continue to have these crises dragged out, leading to shortages and disruption because we cannot stomach the idea of big oil firms and petrol stations soaking up extra profits? The third option we have is to take money from the equation almost entirely and ration out fuel in a manner akin to the 1940s and 50s, an idea reliant on a slow moving bureaucracy , difficult enforcement and few safeguards for removal (this includes ‘anti-hoarding’ measures such as limiting the litres of fuel each consumer is allowed to purchase, including balancing which classes of personal and commercial motorist is allowed to buy what level of fuel with a morass of paperwork, IDs and verification being necessary). Alternatively, we could do what the British government is currently doing and try to match the demand increase with a supply one, perhaps even getting the army on board to assist logistics and using fuel usually reserved for tanks. That last option is so haphazard and costly I am not even going to entertain the idea of having it as a permanent solution to these kinds of crises.
Instead, we should try to improve on one of these basic options and make it fairer and more equitable. In the face of crises like this we don’t have the time and resources to squander. We need a policy towards price shocks that can harness the efficiency and swiftness of the market wedded with the concern for public welfare and fairmindedness of the state.
Here is a proposal to do exactly that.
The Policy Proposal
In an ideal world, governments would have the bureaucracy and apparatus in place to switch rationing on and off for certain goods or the ability to massively increase supply in times of sudden demand shocks. However, given the difficulty of implementation and enforcement (to avoid black markets springing up, as was rampant during Britain’s last period of widespread rationing), it is preferable to choose an option which is based within a market framework. In other words, price gouging is sadly quite necessary — and this is far from a fringe opinion: in a 2012 survey of leading economists, only 8 percent agreed with a proposal to prohibit “unconscionably excessive” price gouging during natural disasters in Connecticut. 51 percent disagreed with the proposal, 15 percent were uncertain and 8 percent had no opinion.
However, as previously noted, the current scenario of stifled price rises (whether through actual regulation or threat of regulation of price gouging) is inadequate and leads to unintended, and arguably worse, consequences than a free market response. It is, in my judgement, a lesser evil but still an evil nonetheless. The free market option leaves many people, especially the poorest in our society, well out of pocket and facing high costs in their own daily lives. We end up with what essentially becomes a transfer of cash from the pockets of some of the most needy (our essential workers and workers commuting by car) to the coffers of already profitable billion-pound corporations. This is highly problematic and requires policy change.
My solution is to implement the following three steps in order to make the free market option much more equitable and less problematic:
- Enforce and support the transition towards dynamic pricing (AKA surge pricing, demand pricing, or time-based pricing)
As previously discussed, many firms may choose to use an administered pricing structure that isn’t as sensitive to supply and demand. This is unfair and dishonest towards consumers who simply will not receive anything the true market rate at the point of payment. Unlike in industries such as hospitality, tourism, entertainment, retail, electricity, and public transport — the expected, textbook free market response is currently not possible and would face a lag to implement even if there aren’t any legal barriers to rapidly raising prices (as is mostly the case in the UK). To change this, the government should ensure that what you get at the pump is very plainly reflected in supply and demand. Compared to an administered pricing structure, this would create transparency, more responsive repricing, and saves time and costs. Although often the infrastructure, particularly digital, needed to implement this is currently lacking (especially at the forecourt level), investing in this allows the more perfect textbook free market response which can swiftly adjust to the kinds of demand shocks we’ve seen lately. - Implement a windfall tax
With dynamic pricing in place, a sudden ‘windfall’ of excess profits is to be expected for when prices inevitably rise during these demand shocks. Higher prices and a consistent supply and cost-base will ultimately result in higher profits, which is one of the central issues that makes the general public so morally opposed to price gouging at all. Taxing these extraordinary profits in one fell swoop would put that money back into the public purse, essentially under the control of democratically elected politicians rather than in the hands of the petroleum giants. This is essentially what the Labour government under Tony Blair introduced in 1997 as a one-off levy on the utilities privatised by the previous 18 year Conservative government. The similarities between this portion of the proposal and that policy ends here as the £5billion raised from that was spent on a variety of projects relating to long-term employment, schools and skills training. We can, however, do one step better. - Create a price-gouging rebate
While many would be content using the money from a windfall tax on various government spending projects (as above), fundamentally it does nothing to redress consumers themselves being left out of pocket by price gougers. That, along with the profits themselves, form the core objections to price gouging. Instead of governments spending those windfall taxes, it is best to precisely compensate those directly affected by the price gouging at the pump. Following the period of rapid price rises (the price gouging period) consumers affected (so in the case of fuel: individual motorists as well as company vehicles) can go online, or perhaps via an app, fill in a short form with receipts of the affected good (such as petrol) scanned or photographed, and claim back the cost of the price gouging in the form of a rebate from the state paid by the money raised from the windfall tax.
Advantages
Firstly, unlike a purely free market model, this system attempts to address direct grievances which make price gouging so toxic and unfathomable. It pulls the sting out of the phenomenon by proactively tackling what is generally perceived as unfair profits as well as unfair costs on consumers.
Secondly, unlike existing restrictions on price gouging, it provides a way for the market to rapidly respond to panic buying via an immediately introduced price hike which will deter many of those tempted to deviate from their normal purchasing behaviours and keep them at bay, therefore shortening the crisis itself. Additionally, as this policy introduces that price hike at the pump, it becomes taxed and regulated in contrast to scenarios where artificial shortages are created and black markets blossom, some fairly benign (like those selling jerry cans and bottles of petrol on Facebook marketplace), some dangerous (such as criminal and terrorist groups) but both reflecting the inescapable true market price.
Thirdly, this policy creates and normalises a redistribution mechanism where social injustices can be tackled at the cost of those normally would stand to be unjust beneficiaries; instead compensating back towards those directly affected. This can boost the validity and profile of proposals such as a carbon tax with a direct dividend to everyone (since everyone is directly impacted by climate change, although not everyone is directly impacted by a sudden rise in fuel price).
Addressing concerns
One large concern with this strategy is the ability to deliver the infrastructure needed to make it possible to begin with. Not only would all the companies along the petrol and diesel supply chains need to adopt dynamic pricing to maximise effectiveness, but the government’s own tax bureaucracy has to expand to meet the need of processing all the rebates. These costs however, are miniscule compared to the existing disruption we have seen under current conditions. Getting the economy moving again has its own, larger benefits, but that cannot come at the cost of economic justice for those affected (even if it’s a short time frame).
Another major concern is the lag between compensation and cost at the hands of the consumer. A rebate structure would likely occur months, perhaps even a whole fiscal year, after the price gouging period and in the meantime consumers must swallow that cost at the pump. For people who are only just about managing or on the poverty line that slight cost may make the difference into catastrophe (similar to how the removal of the relatively minor £20 Universal Credit uplift is predicted to cause). Immediate cash relief to this subset of affected consumers is bureaucratically difficult and may indeed be self-defeating as the cash, like the United States recent stimulus programme, could be inflationary, thus squeezing at the cost of living regardless. Some of these people may have to resort to short-term or ‘pay day’ lenders to fill in that gap — thankfully, regulation in recent years within the UK has made it so such lenders are no longer as extortionate and predatory as they once were, but interest is still incurred, which might make the policy slightly regressive towards those who are pushed temporarily into poverty by price gouging. However, this can be taken into account by allowing this subset of people to claim the interest on the loan repayments back on their rebates.
Conclusion
Demand shocks similar to what we’ve seen in Britain over the past week are uncommon but still happen, we only need to look at the start of the pandemic to witness the enormous windfalls and price gouging undertaken by Amazon and others as lockdowns were enforced all over the world. But like a pandemic or any other disaster, we must be prepared to face the reality that price gouging is an occurrence that will happen (even when we try to legislate it out of existence). Let’s reject the false dichotomy of efficiency and stability versus fairness, and grab each with both hands. Another way is possible.
