Abolish Price and Wage Controls

Economists tend to oppose price controls at the best of times, but the public’s willingness to allow market‐​set prices appears to diminish when emergencies hit. 

By Ryan Bourne of Cato. Excerpt:

"Economists generally oppose such anti‐​price‐​gouging legislation for two major reasons. First, they recognize that what companies can sustainably charge is limited by both competition from other sellers and consumers’ willingness to pay (meaning market prices usually reflect the localized supply and demand conditions, rather than anything nefarious). Second, they observe that repressing the price signal produces a raft of unintended consequences, not least ensuring sustained shortages of the products.

Consider the run on hand sanitizer early in the pandemic. In the absence of price controls, shelves would quickly empty at the old price and surging demand would push up the price as more dollars chased the limited short‐​term supply of the product.

But that rising price would have beneficial side effects. It would

• deter the over‐​purchase of the product, offsetting some of the increase in demand through price rationing to those who value sanitizer more highly;

• encourage existing and would‐​be suppliers to bring more supply to market by ramping up production through overtime or repurposing facilities such as distilleries; and

• discourage hoarding, encouraging those with excess supplies of sanitizer at home or in their businesses to sell the goods to others.

If this process were to play out, with the quantity supplied expanding and the quantity demanded falling somewhat again after prices rise, we eventually would end up in a world where higher levels of demand are met. The goods would be back on the shelves with more of the product consumed overall, albeit at a higher price.

In fact, allowing that process to play out might spur innovation that helps meet demand in the future. If suppliers know that demand surges lead to sharply rising prices, they would be more likely to invest in so‐​called option‐​ready supply—capacity to ensure a business can capitalize on these extreme market conditions should they occur again. Allowing prices to adjust today therefore makes future shortages less likely. As it happens, the prolonged elevation of demand for hand sanitizer in particular eventually brought in a host of new suppliers, leading to replenished shelves. But this would have happened a lot sooner, with less interim damage to consumer welfare, in the absence of anti‐​price‐​gouging laws.

We understand this in normal times. Economists have found that surge pricing for companies such as Uber enhances consumer welfare. When demand for drivers spikes, prices rise, deterring those who do not value the service highly in those particular circumstances from using it. The surging fares not only encourage more drivers onto the road but also encourage drivers to go out at times when or to areas where they expect prices to be higher, making big shortages less likely in those same conditions in the future.

Yet this did not happen in the case of hand sanitizer, which saw sustained shortages for months. This can be explained by a combination of reputational concerns on behalf of suppliers and anti‐​price‐​gouging laws.

In highly localized emergency situations, such as hurricanes and other natural disasters, established suppliers may take a longer‐​term view of the reputational downside of raising prices during a crisis. Major firms, such as Walmart, can move supplies to the affected area from other stores, largely meeting the extra demand without taking the reputational hit of being seen to “profiteer.”

Though COVID-19’s impact is anything but localized, major sellers have acted as if it is. Amazon, for example, has tried to prevent “price gouging” on its platform through fear of the reputational impact of high prices during the crisis. Economists Luis Cabral and Lei Xu also found that established sellers of facemasks were more reluctant to raise prices sharply after the outbreak of SARS‐​CoV‐​2, the virus that causes COVID-19.

So long as that reluctance persists, it’s mainly small businesses, online sellers, and a few companies that are less concerned about their reputations that are willing to raise prices to reflect the huge increase in demand. But what anti‐​price‐​gouging laws do is prohibit or deter these other sellers from adjusting prices, in turn deterring the expansion of production to meet the newly elevated demand even in major stores. As a result, anti‐​price‐​gouging laws, by restricting the sale price of a product below its underlying market price, will

• produce ongoing shortages on shelves by both encouraging consumers to load up with more product and discouraging increased production;

• reduce the incentive for people or organizations who overbuy or stockpile goods to bring more to market to serve the elevated demand;

• encourage suppliers to sell in shadow markets and for the scarce goods to be allocated by connections or bribes rather than willingness to pay;

• randomly allocate products that are available in stores to those who happen to be there when they arrive rather than to those who value them most;

• reduce the willingness of suppliers to incur the large costs of adjusting packaging and logistics required to move stock into different distribution chains (particularly important in this pandemic);

• create substantial uncertainty for companies in instances where the price gouging criteria are more subjective;

• lead to supplies of important products being redirected toward foreign markets where price caps do not apply; and

• discourage investments in future option‐​ready supply. 

The most important economic insight about anti‐​price‐​gouging laws then is that when you suppress the signal of a rising price, you get less supply of a product. This is economically inefficient because people willing to pay more find their needs unmet. These impacts are likely to be particularly damaging during a pandemic, when supply and demand conditions change drastically with lots of disruption to workplaces and supply chains that raise the costs of supplying goods in ways lawmakers might not observe.

Why are policymakers unwilling to allow the market to set prices during emergencies? There appear to be two major reasons why much of the public and many politicians think “profiteering” during a crisis is so abhorrent.

The first is that price rises might hit some groups, such as the poor, harder than the rich. The second is a more primal feeling that it is simply wrong for businesses to seek to profit from a time of adversity, particularly in the sale of goods needed for the public health effort. Both reasons appear not so much to be the fault of businesses raising prices but a lament at the economic realities that emergency situations bring.

Yes, it is unfortunate that price rises for products such as hand sanitizer affect the poor, the elderly, and even health care workers. But the alternative, as we have seen, is not plentiful, affordable products for them but sustained empty shelves and a thin online market with even higher prices.

If we do not ration by price, we need another mechanism. If you are poor but lucky enough to be at a store during the delivery of a product such as hand sanitizer, then you might indeed be better off with anti‐​gouging laws. But there is no guarantee that a system of queuing or even rationing within individual stores is better for the poor than the rich, or for health care workers than non‐​health care workers, given people’s very different needs and the opportunity cost of time searching. In fact, as we saw when there were shortages of COVID-19 tests, the rich can often use their connections to source scarce products.

Price controls often most hurt the poor. A particularly tragic example occurred in San Francisco when the city capped the fees that UberEats and other delivery apps could charge restaurants at 15 percent to “help” the restaurant industry during the pandemic.

Capping prices below market rates inevitably meant less supply of delivery services relative to demand. UberEats removed services from the Treasure Island part of the city because the price cap was below its operating costs for serving this poor community.

Put simply: price controls are economically inefficient, as preventing prices from adjusting to market realities creates sustained shortages of products. Yet there is no guarantee that these policies are even relatively good for the poor or those most in need. To the extent that policymakers want to provide relief to those struggling, controlling prices is a crude and ineffective way to do it. Given their potential to create larger shortages of goods, even those important to public health efforts, anti‐​price‐​gouging laws are highly damaging during a pandemic. They should be repealed or suspended at the state level, and Congress should steer clear of a national law.

COVID-19 has proven a demand and supply shock in product markets, and those shocks have reverberated into labor markets. Social distancing, changed consumer tastes, worker behavior (such as more working from home), and workers being more reluctant to do certain jobs given greater health risks have altered the supply and demand for workers across localized markets.

We might therefore expect wages to also adjust to these new conditions, as we have seen in certain sectors. Amazon introduced hazard pay temporarily for its frontline workers to compensate for their greater infection risks; other retailers that saw surging demand increased wages to attract more workers. Elsewhere, the big decline in economic activity from lockdowns and then ongoing social distancing actually led to cuts to nominal wages for at least four million private‐​sector workers in the early months of the pandemic—double the proportion of workers who saw wage cuts during the Great Recession. A lot of employers canceled planned wage increases as well.

Yet as policymakers prevent prices adjusting upward through anti‐​price‐​gouging legislation, they also prevent some workers’ wages adjusting downward through minimum wage laws—statutory floors for the hourly pay rate of workers. The federal minimum wage is $7.25 per hour, but 29 states have higher minimums. Some jurisdictions most affected by COVID-19 have very high local wage floors, such as New York City at $15 per hour. Half of states have raised their rates in the past three years, while the number of local governments with their own higher minimums jumped from 5 in 2012 to 52 today.

In normal times, one would expect minimum wages, if set above market levels, to reduce the demand for lower‐​productivity employees, eliminating employment opportunities or reducing hours offered compared to that seen in a free market. True, some studies have found that the aggregate impact on employment levels of modestly set minimum wages can be small and consigned to particular demographic groups, particularly in a growing economy where companies are ramping up production to meet growing demand.

But there are good reasons to think that past increases in minimum wage levels might result in much more damaging impacts on job prospects for low‐​paid workers during this pandemic.

First, a Bureau of Labor Statistics analysis at the time of lockdowns found that “occupations with lower wages are more common in the shutdown sectors than elsewhere in the economy.” Lots of businesses and industries hit especially hard by depressed demand and social distancing practices after lockdowns are those with large numbers of minimum wage workers.

Industries with high concentrations of lower‐​wage jobs include restaurants and bars (12.3 million workers), other retail (6.5 million), travel and transportation (3.5 million), entertainment (2.6 million), and personal services (2.1 million). Most industries in these sectors have not fully rebounded after reopening. Customers are reluctant to eat at crowded restaurants, vacation in hotels, and go to theme parks until a vaccine for the virus is rolled out. But faced with less demand and with less efficient workplaces, businesses in such sectors are desperate to cut costs. If they cannot cut pay rates, they will likely cut hours worked or jobs.

Of course, the supply of workers may also have fallen due to fewer people wanting to occupy roles that entail interacting with customers in the presence of the virus. But overall it seems unlikely that this effect will have exceeded the demand effect, particularly given that the pandemic unemployment insurance benefits were reduced and overall unemployment levels remain elevated. So, the pandemic is likely to have reduced underlying market wages in many sectors with high numbers of minimum wage workers, meaning minimum wage laws are likely to have more damaging effects in creating unemployment than before.

Second, the pandemic itself is likely to have exacerbated what economists have dubbed the more “dynamic” impacts on employment. During expansions, the focus for lots of businesses is on meeting rising demand rather than cost cutting through laying off workers. That means older, low‐​skilled, labor‐​intensive businesses enjoy a better general environment for their survival, despite the pressures of recent large minimum wage increases. Perhaps they might take a short‐​term profit hit or trim new hiring or cut other worker benefits.

However, a large shock such as the COVID-19 pandemic is likely to generate an unusually pronounced cycle of business ruin and creation. Many firms with old production technologies will likely disappear and be replaced by new, technology‐​intensive firms employing fewer low‐​skilled workers. That, again, will make the impact of past minimum wage hikes—which increase the cost of employing low‐​skilled labor—more pronounced.

Empirical evidence shows that minimum wage rises can be particularly harmful to job prospects during downturns. In 2009, after Congress raised the federal minimum wage, economists Jeffrey Clemens and Michael Wither estimated that states experiencing the largest rise in the wage floor as a result of the federal policy change lost several hundred thousand more low‐​wage jobs than they otherwise would have. Congress should therefore reject efforts to increase the federal minimum wage further during this recession.

Today, however, it is high state and city minimum wages that will cause the most harm to job prospects in these new conditions. Before the pandemic, in New York state alone about 1 million people worked as retail salespersons, fast food workers, cashiers, wait staff, cooks, and bartenders. Many employers will no longer be able to afford the state’s $11.80 minimum wage or New York City’s $15 minimum. For these reasons, state and local governments should rescind recent minimum wage increases and suspend scheduled hikes.

Some policymakers have woken up to the new realities. Hayward, California, is delaying a minimum wage increase until next year, and Virginia Gov. Ralph Northam delayed his state’s planned increase until May 2021. Given the very different market conditions today and the potential scarring effects of sustained unemployment, it is imperative that policymakers do not allow wage controls to exacerbate job losses and delay the jobs recovery by raising costs for expanding businesses."