Montreal, October 15, 2005 No 159

 

OPINION

 

Chris Leithner grew up in Canada. He is director of Leithner & Co. Pty. Ltd., a private investment company based in Brisbane, Australia.

 
 

IN PRAISE OF "PROFITEERING"

 

by Chris Leithner

          Surely nothing is more obvious than the principle that the lower a good's or a service's price, the greater is its quantity demanded by consumers. Equally obviously, producers tend to supply more in response to higher prices and less in response to lower prices. Yet these principles seem to flummox most people including the highest and the mightiest in the land. It utterly escapes them, for example, that with respect to any given good or service there is simply no such thing as a fixed quantity demanded. Similarly, the quantity supplied is subjective rather than objective. Recent news reports about oil, for example, seem to imply that there is some preset amount of the physical stuff in the ground. That might be true in a geological sense, but it is flatly false in an economic sense. From place to place and time to time, the discovery, extraction, processing and distribution of oil confront producers and consumers with very different trade-offs.

 

          Some oil (say, in Saudi Arabia) may require relatively little expenditure (say, $10 a barrel) to produce; other oil (say, in the North Sea) might be produced for $25 a barrel; and still other oil (like that in parts of Canada) may be still more costly to produce. Perhaps it cannot recoup its costs at $40 per barrel, but might at $80 per barrel. When the price of oil falls, wells whose expenses exceed the revenues they generate are capped. If the price subsequently rises, or if new technology causes the cost of extraction or processing to fall, then they may be recommissioned. Not just the supply the very "goods character" of oil is subjective. Stuff that under some circumstances is not readily regarded as oil, such as oil shale and tar sands, might well be so regarded under other circumstances. As with oil, so too with any other good: the quantity supplied varies directly with price, and the quantity demanded varies inversely with price. The quantities demanded and supplied are variable (subjective) not fixed (objective) and vary according to the preferences and expectations of consumers and producers.
 

So What's "Profiteering"?

          Much huffing and puffing has appeared recently in Australian newspapers about "profiteering" and "price gouging." Not once, however, did I read anything resembling a coherent definition of these terms; and on only one occasion (James Morrow, "The Market Should Fuel Petrol Prices," The Australian, 13 September) did I read anything that even hinted at their beneficial effects. But who needs a clear definition when moral preening is the objective? It is allegedly "unfair" and "greedy" to raise prices during an emergency, and to do so "exploits" consumers (especially the young, old, poor and weak). Accordingly, any businessman who raises his prices drastically and suddenly, particularly during an emergency, is acting unethically and therefore is a "price gouger" or "profiteer" (the terms seem to be roughly synonymous).

          To say that an increase of a good's price is a consequence of sellers' greed is to say that sellers can charge whatever price they like that they can set their prices, in other words, without any regard to consumers and their demand for the good. This, of course, is patently absurd: in the market it takes two a buyer as well as a seller to tango. It is perfectly true that sellers seek to sell at the highest possible price. But it is equally true that buyers strive to pay as little as possible. Consumers endeavour to stretch their dollars as far as they will go. Is this greedy? Further, their desire to economise affords them many options. If a particular consumer decides that petrol is too dear, then he can choose to travel less, car-pool with neighbours or colleagues, or shift to a more economical means of transport. Like the producer, the consumer chooses in light of his desire to use his resources such that they maximise his welfare. Is this unfair? If not, where is it written that only producers, but never consumers, can be unfair and greedy?

          It is useful to consider this point with a different cast of characters. During the past 12-18 months, the Australian financial press has been replete with reports about the record prices received by Australian producers of primary commodities such as coal and iron ore. They export the vast bulk of what they produce. As a result, Australia's terms of international trade are presently higher than they have been at any time since the mid-1970s. A growing percentage of these growing exports goes to countries whose citizens live at considerably lower levels of material ease, comfort and convenience than Australians. Curiously, however, not once during this time have I read that Australian producers and exporters are profiteering, price gouging, acting in a greedy or unbecoming manner or otherwise using unethical means to generate their massive profits. Nobody, in short, has alleged that it is unfair and greedy to raise prices during a minerals boom; and no bastard has said that this action exploits the Chinese including that country's many young, old, poor and weak people. Quite the contrary: during a boom, any Australian multinational that drastically raises its prices is acting "in the national interest" and merits laudatory coverage in the financial press. So why is it that executives of mining companies are heroes but their counterpoints in oil companies are allegedly profiteers?
 

"Profiteers" Ration Existing Supplies

          When a hurricane approaches a major populated area, many people flee. And when such a storm destroys numerous homes, large numbers of people require emergency food and accommodation. Under the first scenario, and particularly when the two scenarios occur one after the other, people place considerable upward pressure upon the prices of fuel, food and accommodation in the affected area and along the evacuation route. Why? Because they urgently demand these things. The number of people who demand motel rooms, for example, is greater (perhaps much greater) than normal; and the stock of rooms is, initially at least, no greater and, depending upon the storm's destruction, may be much smaller than normal. The higher price they are prepared to pay signals the urgency of their demand.

          How to allocate many people to relatively few rooms? How, therefore, to minimise the number of people who must sleep outdoors or in their cars? Clearly, the many who demand accommodation must economise; and to economise is to do things like stay with relatives or friends, or increase the number of people per motel room above what would normally occur. And what is the best that is, the most efficient, effective and peaceful means to encourage people to economise? Allow prices to fluctuate freely. Let hoteliers (and grocers and petrol station managers, etc.) charge as much as people are willing to pay him for a room.
 

"In the market it takes two a buyer as well as a seller to tango. It is perfectly true that sellers seek to sell at the highest possible price. But it is equally true that buyers strive to pay as little as possible. Consumers endeavour to stretch their dollars as far as they will go. Is this greedy?"


          The point also applies more generally. Recent years have witnessed one of the most heartening and exciting developments in human history: the prospect that hundreds of millions of people, particularly in China and India, will lead something that resembles a middle-class life. The standards of living of many people are rising to the point where they demand cars and hence petrol. Where and by whom is it written that Westerners should have preferential access to fuel? How, then, to allocate the given amount of petrol at present prices among the greater number of people who wish to buy it? Allow its price to fluctuate freely. Let oil companies and petrol station owners charge whatever price their customers are willing to pay for fuel.

          When some long-term epochal development or acute disaster renders certain resources much more valuable than usual, it is vital that prices reflect this reality. It is imperative, in other words, to reduce the quantity demanded relative to supply. Regardless of the prices that (say) owners of accommodation charge, the sudden and widespread destruction of housing in a particular area means that there will not be nearly enough motel and hotel rooms for all displaced people to obtain the amount and quality of accommodation that they could under normal conditions. After a hurricane, if prices remained at the levels prevailing before it struck, then a family of four might rent two rooms one for the parents and other for the kids. Is this not greedy? But if the price of a room "skyrockets" after the storm, then the parents and children have a strong incentive to pile into one room thereby and perhaps unintentionally making the other room available to another homeless family that also demands shelter. Or perhaps they will go to Uncle Bill's and Aunty Jane's house and thus make two rooms available to homeless people who may not have families close to hand. Thanks to the "unfair" price, in other words, more families can now be shielded from the elements. Is that not a good thing?

          The greater scarcity (relative to the situation prevailing before the storm) of housing, food and water, etc., that occurs in the wake of any widespread destruction of homes is inherent even if it is temporary and prices quantify this underlying reality such that consumers have an incentive to restrain their "greedy" behaviour. It is vital to recognise that well-intentioned people who attempt to ban "profiteering" do not alter this scarcity. To prohibit "price gouging" does not conjure a single room, meal or litre of petrol into existence. People who bark at high prices after a hurricane have a beef with Mother Nature not with hoteliers and grocers. If the government imposes price controls, then those who happened to arrive first at hotels or supermarkets (or those who know politicians most intimately) would tend to consume as much as they would under normal circumstances would, in other words, act greedily under these drastically altered circumstances and thereby leave less for others. Some and perhaps many people would be left hungry, thirsty and without shelter, and would thus place even greater strain upon already-stretched charities. What on earth is right and proper about that?
 

"Profiteers" Increase Supplies

          Freely fluctuating prices not only ration existing supplies: they also provide powerful incentives to cause supplies (including labour) to rise or fall in response to changing demand. When (say) a crop failure in a certain region creates a sudden increase in demand for imports of food into that region, "greedy" suppliers from other regions will tend to rush into the famished region. They do so in order to arbitrage to capitalise upon the "unfair" prices that will prevail until more supplies arrive and thereby cause prices to fall. If the cause of the price hike (lower supply induced by crop failure) is a bad thing, then surely the cause of the price's subsequent fall (higher supply induced by "greedy" arbitrageurs) is a good thing? The consequence of their "greed" is that food reaches hungry people as quickly as possible. More food and fewer hungry people: are they not good things?

          A related point: the timing, severity and location of some natural events such as hurricanes in the Gulf of Mexico are, thanks to modern meteorology, crudely predictable. If left to their own devices, entrepreneurs may therefore decide to stockpile certain goods in storm-prone areas in the days ahead of a hurricane. If the stockpiles survive the destruction note that the entrepreneurs bear this risk then these suddenly-much-more-valuable goods are available to the people who value them most at exactly the right time and place. But to stockpile a good is to place pressure upon its supply chain and to increase costs. Stockpiling is economically feasible that is, people will take the time and trouble to build stocks only if they can reasonably expect that much higher prices will offset these risks and costs. If entrepreneurs cannot raise their prices after the disaster in other words, if they cannot arbitrage between the "pre-" and "post-disaster" markets then (apart from their personal use) they will have little incentive to accumulate stocks beforehand. Is the absence of much-needed stockpiles not a bad thing?

          This point also applies to wages. Trade unionists routinely denounce "profiteers," but never criticise people whose wages rise dramatically in the immediate aftermath of a disaster. But by their reasoning, is not the (say) electrician whose skills are in very high demand and whose prices increase dramatically after a major storm not also a "profiteer"? People will more readily work abnormally long hours under oppressively trying conditions if they receive very high wages. Many (particularly those from areas unaffected by a hurricane) will donate materials, time and money to relief efforts. But others particularly residents of the hurricane area who, all things considered, would rather be with their families or outside the ravaged area require money to overcome this desire. If wages (that is, the price of labour) rise dramatically, then many more people will be willing to work very hard for long hours under difficult conditions, and repairs can occur much more quickly than they otherwise could. And quicker repairs are good things, are they not?

          Entrepreneurs, arbitrageurs, businessmen and employees in short, human beings incentivised by "greed" typically expose themselves to inconvenience, hardship and danger in order to earn these profits. Adam Smith demonstrated in A Theory of Moral Sentiments (1759) that a variety of powerful emotions, including altruism, motivate people. Importantly, however, if you wish to induce somebody to furnish a good or service in a great hurry, then a monetary incentive tends to be a reliable motivator. In the material world, in other words, people tend to do at least as much for themselves as for strangers. The glory of freely fluctuating prices and laissez-faire capitalism the "system of perfect natural liberty" as Smith called it is that it relies upon co-operation rather than coercion. Accordingly, the supplier prospers only to the extent that the consumer benefits.

          Thomas Sowell's economic analysis of the Spanish siege of Antwerp in the 16th century provides an excellent example. As a result of Philip's blockade, the price of food in the city began to rise rapidly. Yet its population remained reasonably well fed because blockade-runners were able to evade the Spanish barricades. One interpretation is that these "greedy" suppliers sought to "take advantage" of residents' plight by selling food to them at "unfair" prices. Another is that these suppliers' circumvention of the blockade not only exposed them to considerable commercial risk (the confiscation and hence loss of their supplies): it also subjected them and their employees to grave personal danger (injury, imprisonment and execution). Surely, then, the prices they received for the food they brought into Antwerp provided reasonable compensation for the considerable costs and risks they bore?

          Alas, officials in Antwerp did not agree. They decided to forbid "price gouging" and imposed severe penalties upon violators. Blockade-runners quickly decided that under these conditions the risks of blockade running outweighed its rewards, and so they plied their trade elsewhere. As a result of the politicians' "compassion," the supply of food in Antwerp was soon exhausted, starvation threatened and the city was obliged to capitulate to Papist tyranny. Clearly, the underlying and eternal problem is not that suppliers are "greedy" it's that politicians are idiots.

 

Note: On the same topic, see also "In Defence of Price Gouging" and "Price Controls and Other Nixonian Evils."

 

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