Gouge Is Good

If you’ve bought anything in the past six weeks, you’ve seen shortages.  In grocery stores, you’ve see empty shelves.  Online, you’ve seen long waits.

If you know econ 101, there’s an obvious explanation: price-gouging laws.  When supply falls, the market’s normal reaction is to raise prices.  Government’s reaction, however, is to paint the market’s normal reaction as vicious exploitation – and order prices to stay flat despite reduced supply.  Shortages inevitably result.

While this story has great merit, you don’t have to look closely to realize that it’s not the full story of shortages.  Why not?  Because most businesses are neglecting a wide range of strategies to legally raise prices.   These strategies include:

1. Stop offering discounts. This is legally very safe, but the last time I shopped at Giant and Costco.com, many discounts remained.  At least at Giant, the discounts were on perishable goods, so this isn’t just a leftover from before the crisis.  Firms really do continue to sell below full price even when goods are flying off the shelves.  Why not just charge full price on every good in short supply?

2. Offer premium service. Stores can’t legally charge more for the same good.  Yet to the best of my knowledge, there is no legal impediment to offering a new good or service at a high price.  For example, stores could charge an entry fee or surcharge for shopping right after delivery trucks arrive.  (If that’s too blatant, they could just arrange for trucks to arrive right before the premium period).  Slight variation: Offer pricey preferred customer cards, so high-value customers don’t have to pay extra each time they shop.  My local bike shop sticks to a first-come-first-served model, so there are long lines for service.  They could easily offer “elite” or “platinum” or “preferred” drop-off service for double the price.

3. Impose (or raise) minimum purchase requirements.  Right now, there is a long wait for Instacart delivery in my area.  But you only have to order $50 to get delivery.  Why not a minimum order of $100?  $200?  Amazon, similarly, could limit two-day shipping to high-value orders.

4. Mandatory tipping.  Most delivery services strongly encourage or even require a tip.  Instacart, for example, has a built-in 5% tip.  They could easily raise it to 20% – then marginally cut delivery workers’ base pay so the company profits.

Why then don’t businesses apply these strategies until shortages vanish?  The usual story is that they’re guarding their reputation.  Economically illiterate customers see shortages as forgivable but price increases as vicious.  Profit-maximizing firms therefore appease them.  If customers feel like Costco is ripping them off during the crisis, Costco suffers in the long-run from loss of goodwill.

This story, too, has great merit.  But again, I doubt it’s the full story.  Beloved, high-profile companies like Costco might be acting prudently; when your reputation is solid-gold, you really don’t want to risk a media scandal.  But even a well-known firm like Giant could easily end most discounts without drawing much ire.  A newish firm like Instacart that’s exploding during this crisis could easily get away with high mandatory tips.  New customers won’t even realize that anything has changed.  And does anyone really expect my bike shop to suffer in the long-run if they offer premium drop-off service?

What then explains the legal and profitable price increases that aren’t happening?  My preferred explanation is that businesspeople – like most people – consider price increases during an emergency to be dishonorable.  And contrary to popular belief, the system generally puts fairly honorable businesspeople in charge.  The adage, “That’s just not good business” means a lot to the typical person who runs a business.  That’s why they try to make customers happy even when they know that repeat business is highly unlikely.

During normal times, businesspeople’s sense of honor helps the whole economic system run smoothly.  In a crisis, however, businesspeople’s own misplaced sense of honor prevents them from swiftly alleviating shortages with covert price increases.  Yes, price-gouging laws and customer outrage are important factors, too.  But if businesspeople felt morally justified in raising prices, they would be aggressively hunting for legal and psychological loopholes.  Few are.

I love business, and admire businesspeople. They’re doing a great job during this emergency.  Thank you, business, for keeping us alive while we cower.  But businesspeople could do even better if they believed more in themselves.  Populists notwithstanding, there is nothing “dishonorable” about raising prices to eliminate shortages.   If governments or customers refuse to see this great truth, there is nothing dishonorable about raising prices in less-visible ways.  Businesspeople, you do not merely have a right to “gouge.”  As long as shortages persist, gouging is the right thing to do.  Gouge is good!

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Commentary on State Capacity and State Priorities

Two EconLog readers’ comments on yesterday’s post struck me:

Phil H.:

Caplan’s point is a good and striking one. His conclusion is fairly extraordinary, though: He is apparently claiming that all (or a plurality) of the major decision makers in the American government are power-hungry demagogues who deliberately decided to channel money into stimulus rather than research because they are bad people.

I like a powerful contrarian claim, but this one is a little too far for me.

Fair question, Phil.  I doubt many politicians are explicitly thinking, “Research is better for society, but stimulus is better for  my career.  I don’t care what happens to human lives or the economy as long I can be king of the ashes.”  Instead, I doubt politicians are doing much thinking at all.  They go with the herd – and their own arrogance.

However, as I’ve previously argued, anything less than Vulcan rationality in a major leader is extremely morally wrong, because with great power comes great responsibility.  Normal backroom observers would probably say, “Well, these politicians are just playing the game.”  I puritanically reject such excuses.

The problem lies in the failure to acknowledge the importance of institutions and structures, and to assign everything to individual actions. Do we really believe that all of the leaders of China are “good” people, and that’s why they responded more effectively to the crisis? Is New Zealand’s good record a reflection of Ahern’s moral excellence?

I have an extremely overall negative view of the Chinese Communist Party’s behavior, and remain suspicious that they are hiding severe pandemic-related failures and crimes.  But if I knew nothing except the standard coronavirus narrative, I would consider them better people.  On the other hand, I suspect that the leaders of New Zealand are morally a cut above what Americans are used to, though of course as remote islands they have major advantages in disease containment.

My broader point, though, is that we should compare leaders to standards of common sense and common decency, and almost all fall woefully short.

There does seem to be a good case to make that the leadership of the USA has become paralysed by partisan infighting. The problem is that it’s now ingrained into the systems and institutions. Even if a Mr Smith went to Washington, that wouldn’t sort out the problem.

How does “partisan infighting” prevent such obvious measures as wide-scale voluntary paid human experimentation?  I just don’t see it.  If the parties can agree to fritter away trillions of dollars, they can agree to suspend pseudo-ethical rules that keep policymakers in the dark.

Rob:

Hey Bryan — I had always read state capacity to include the capacity to make intelligent decisions. So a state with a big military or lots of spending power, but without wise politicians or experienced bureaucrats to know how to sensibly use them, it still lacks capacity in some sense. It lacks the capacity to achieve its goals.

The whole point of distinguishing between achievements and capabilities is that achievements normally fall short of capabilities.  This is true for individuals and organizations alike.  My achievements fall short of my capabilities; don’t yours?

So you can imagine a government that has the capacity to shut down its entire economy, but not the research ability to figure out whether it should — or decide on the right specific actions that are needed in order to stop a pandemic spreading. Such a state lacks essential capacities.

This might be an unhelpfully broad concept, but I think that’s how others use the term too.

Once you define “state capacity” this broadly, blaming failure on  “lack of state capacity” is virtually meaningless.  You might as well declare that “good government causes success” and “bad government causes failure.”

The real story, I think, is that state capacity researchers are willfully equivocating – yet another case of the motte-and-bailey fallacy.

When the audience is sympathetic, “high state capacity” means collecting lots of taxes, building a strong military, constructing roads, having universal public education, and so on.

When the audience is skeptical, “high state capacity” simply means being a government that rules over a rich, modern civilization.

The trick is to use the latter definition to legitimize the concept, then use the former definition to justify more resources and power for the government.

Or so it seems to me.

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State Priorities, Not State “Capacity”

In the last few years, social scientists have started heavily appealing to “state capacity” to explain the wealth of nations.  Why do some countries prosper?  Because they have great state capacity.  Why do others flounder?  Because they have crummy state capacity.  What do floundering countries need to do in order to prosper?  Build state capacity, naturally.

Many of these same social scientists see the coronavirus as a great vindication of their research.  Which countries are coping well with coronavirus?  The ones with great state capacity.  Which countries have been devastated?  The ones that lack state capacity.  How can we resolve our current crisis?  Again, build state capacity.

Two years ago, I heavily criticized the state capacity fad.  Weak and question-begging empirics aside, the whole literature is conceptually confused.  But the current crisis has convinced me that I’ve been overly generous.  How so?  Because the coronavirus crisis plainly shows that Western democracies have overwhelming state capacity.  Check out the muscles on these governments!  They haven’t just effortlessly raised and spent trillions of dollars.  They handily shut down their entire “non-essential” economies.  In a matter of weeks, they casually disemployed many tens of millions of workers, shuttered millions of businesses, and virtually sealed their borders to trade as well as travel.  After this staggering exercise of power, I don’t see how you can fairly attribute any shortcoming of these governments before the crisis on lack of state capacity.  The sheer capacity of these states beggars belief.

Why, then, do most of the Western democracies seem to be doing such an incompetent job?  Perhaps most egregiously, the U.S. federal government spent over two trillion dollars on relief, but next to nothing on testing or research.  As Alex Tabarrok summarizes:

We would also save medical costs by suppressing the virus. (The focus on ventilators has perhaps been overdone given that ventilators in no way guarantee survival–better to stop people needing ventilators.) We would also save lives. Thus, a program of mass testing seems like a no-brainer. Yet, there is no direct funding for anything like this in the $2.2 trillion CARES bill which is stunning. Here’s Austan Goolsbee:

We literally put in a tax break for retailers and restaurants to expand their capacity but not money for production of more COVID tests.

Here’s Paul Romer:

We have an economic crisis because it is not safe for people to work or consume. Our Congress just passed a bill that will spend $2.2 trillion to deal with the crisis. Can anyone identify any spending in this bill devoted to making it safe for people to work and consume?

What’s going wrong?  Simple: Despite fantastic state capacity, the U.S. government has absurd state priorities!  Instead of squandering trillions on poorly-targeted relief, the U.S. government could have spent a few hundred billion on testing and vaccine research.  Better yet, it could have offered hundreds of billions in prizes for progress in these areas – prizes open to anyone on Earth to win.

So why didn’t this happen?  Simple: Because the people in charge in virtually every country are irresponsible, disorganized, innumerate, impulsive, and emotional.  Blaming their failures on “lack of state capacity” is like blaming Bill Cosby’s imprisonment on “lack of financial capacity.”  Cosby’s in jail because he’s a serial rapist, not because he lacked the money to hire a good lawyer.  When your resources are superabundant, the top remaining explanation for failure is your own terrible choices.

My point: As a matter of logic, success and failure depend on two factors.

Factor #1: The total resources you possess – your “capacity.”

Factor #2: How you choose to use those resources – your “priorities.”

Isn’t this obvious?  It is to me.  But I don’t think I’ve ever heard a fan of state capacity research acknowledge this obvious point, much less try to fairly adjudicate it.  I don’t think I’ve ever heard such a fan say, “You could say that some governments fail because they squander resources that are more than sufficient to handle their problems.  But using our new measure of squandering…”  I don’t think I’ve ever heard such a fan say, “You could say that some governments would succeed if they simply revised their priorities.  But using a new data set on priority revision…”  I’m tempted to say that appeals to state capacity are tautological, but even the tautologies are half-baked.

The underlying confusion: When a person doesn’t do X, we often casually announce, “He can’t do X.”  That, my friends, is a total leap of logic.  Yes, perhaps the person in question genuinely can’t do X.  On the other hand, maybe he’s simply made X a low priority.  The only way to really know is to see what happens when the person in question unambiguously makes X his absolute priority.  In slogan form: “Can’t implies won’t.  Won’t does not imply can’t.”

The same goes for organizations, including governments.  The Soviet Union failed to grow enough food to feed its people.  That does not imply, however, that the Soviet Union lacked the capacity to do so.  The real story, in fact, is that the Soviet government doggedly prioritized military might over civilian diet.

So what?  At minimum, we need to audit the entire state capacity literature.  To what extent can the problems it attributes to “state capacity” instead be assigned to “state priorities”?  Unless we miraculously discover that capacity, not priorities, explains 100% of all sub-perfect government performance, the next step is to dial-down the multitudinous simplistic pleas for “increasing state capacity” – and replace them with pleas for better state priorities.  Instead of pretending that the coronavirus crisis somehow confirms everything they’ve been claiming, this is a time for the fans of state capacity to engage in poignant soul-searching.  Western democracies have decisively displayed their gargantuan capacity.  But what good is gargantuan capacity in the hands of short-sighted, power-hungry demagogues?

There’s a great scene in Kill Bill where Vernita Green tells the Bride: “That’s being more rational than Bill led me to believe you were capable of.”  And the Bride responds, “It’s mercy, compassion, and forgiveness I lack; not rationality.”  Next time a researcher sees poor government performance and blames “lack of state capacity,” tell them, “Perhaps it’s good priorities it lacks, not capacity.”

Then tell me how they respond, because I’d really like to know.

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So Congested No One Goes There Anymore?

I was glad to see Florida beaches reopen last weekend.  Agree with me or not, though, this part seems crazy: “The beaches will be open from 6 to 11 a.m. and 5 to 8 p.m local time.”  When you reduce hours of operation, you obviously increase congestion, which in turn obviously impedes social distancing.  Upshot: If you’re going to reopen, you should reopen completely.

Is that really so obvious, though?  You could demur, “If beaches are less congested, the total number of beach-goers will increase.  A larger number of people exposed to a smaller per-person risk is more dangerous than a smaller number exposed to a higher per-person risk.”  Or as Yogi Berra put it, “Nobody goes there anymore, it’s too crowded.”  But this rationale is hard to believe, especially because would-be beach-goers can engage in other outdoor activities instead.  Picture a bunch of would-be beach-goers taking ocean-view walks and bike rides instead.

I guess the rationale of the restricted hours is that 11 AM – 5 PM will be congested no matter what.  Only self-starters, in contrast, will get to the beach before 11 AM.  How, though, would you defend the evening hours?  You don’t have to be highly motivated to hit the beach at 5 or 6 in the evening.  In the medium-run, moreover, won’t even slackers adjust their behavior to get their beach time in?

To get a little conspiratorial, perhaps the real goal of the restricted hours is to deliberately make going to the beach inconvenient.  Imagine if beaches were open from 4:04 AM to 4:05 AM.  As a practical matter, that would be the same as keeping them closed.  Current policies, in contrast, are loose enough to draw large crowds.

What’s really going on?  It’s probably another absurd political compromise.  Some leaders wanted to open the beaches.  Others wanted to keep them closed.  So they struck a misguided deal that combines human frustration with viral contagion.  Alas.

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From Telework to Flexible Wages?

Lately I’ve been stunned by reports of nominal wage cuts.  They aren’t just in the news; several professionals that I personally know have received such cuts.  Employers routinely cut total pay during recessions by slashing bonuses and hours.  Even in good times, many employers cut real wages by freezing pay despite inflation.  Yet outright reductions of nominal base pay – hourly wages for hourly workers, base salary for salaried workers – have been exceeding rare for as long as we’ve had data.  Economists have debated whether downward nominal wage cuts are bad, but virtually all economists agree that downward nominal wage cuts are rare.

What on Earth is going on in today’s labor market?

The simplest explanation is that the current recession is terrible.  Quite right; maybe it’s twice as terrible as the Great Recession.  But last time around, I heard zero first-hand reports of nominal wage cuts, and near-zero such stories in the news.  I can understand a doubling of incidents, but not this.

Another tempting tale: Workers today realize that they must take pay cuts or lose their jobs.  Alas, this trade-off is on the table during every recession.  And in every prior recession, falls in nominal base pay have stayed very rare.  What then is really afoot?

Let’s begin with a primordial fact: The best explanation for nominal wage rigidity is psychological. When employers cut workers’ nominal base pay, workers feel robbed and resentful.   This hurts morale, which hurts productivity, which hurts profits.  In contrast, when employers start doing layoffs, the fearful remaining workers respond by working harder.   Logically, of course, there’s no reason for workers to feel more robbed and resentful about a 1% nominal cut in the face of 0% inflation than a 0% raise in the face of 1% inflation.  Human beings, however, are not so logical.

Why then are nominal pay cuts suddenly on the table?  You could say, “Workers have suddenly become more logical,” but as far as I can tell, they’re crazier than ever.  But psychologically speaking, there is one radical and unprecedented change in the emotional experience of labor in the time of coronavirus: the explosion of telework.  Until recently, only 3% of workers teleworked, and a large majority of these teleworkers probably dropped by the office at least every week or two.  Now the telework share has plausibly multiplied tenfold, and our former offices are all but abandoned.

Loneliness is only the most obvious psychological effect.  Teleworkers have also lost most of their opportunities to complain and hear complaints, to feel bitterness and sow bitterness, to feel aggrieved and seek revenge.  As a result, I speculate, the effect of nominal wage cuts on morale has never been lower.

When an employer cuts the pay of a face-to-face work team, the workers constantly remind each other of the perceived affront.  They work down the hall from the executive they hold responsible for the pay cuts.  They see which fellow workers are standing up for themselves, and who’s kowtowing to The Man.  That’s how the classic mechanism – wage cuts –> bad morale –> low productivity –> reduced profits – worked.  Now, in contrast, teleworkers are stuck at home with their families.  They’re juggling childcare, housework, and safety in a chaotic situation.  As a result, they have neither the energy nor the forum to kvetch – verbally or otherwise – with coworkers.  Today’s teleworkers talk to their peers to get the job done, then get back to business.  Supervisors who cut your pay now feel more like a tiresome video than a human villain, which quells the urge to settle the score.

Think about it this way: If your firm cut pay three months ago, what would have happened?  You would have arrived at work and started griping to your friends.  A few would philosophically adjust to the new normal, but a coterie of complainers would have whined, muttered, grumped, and sputtered for months.  In so whining, muttering, grumping, and sputtering, they would have disrupted not only their own work, but teamwork itself.

If your firm cut pay today, in contrast, you’d probably just read the email, groan, and resume your duties.  You might lament your fate to your partner or close friend.  Yet now that you’re teleworking, you plausibly won’t even mention the issue to a single coworker.  You almost certainly won’t lunch with coworkers to denounce the firm’s callousness and greed.  Stripped of this social feedback loop, neither morale nor productivity will fall much.  At long last, pay cuts finally do exactly what firms desire: mitigate losses by cutting costs.

On top of all this, executives and managers almost surely feel much less guilty about pay cuts than they ordinarily would.  Out of sight, out of conscience.

How can we test my story?  Most obviously, industries that switch to telework will be much more likely to impose nominal cuts.  To repeat, that means lower nominal base pay for salaried employees, and lower nominal wages for hourly employees.  In industries where some categories of workers switch to telework and others don’t, I also predict that the switching categories will be more likely to experience cuts.  (There, however, horizontal equity norms may get in the way.  If 95% of a firm’s employees telework, management might cheaply avoid outrage by also cutting pay for the 5% who work on-site).

Note: You don’t have to think that wage cuts are socially desirable to buy my story.  For a tenured GMU professor such as myself, nominal wage cuts are all pain, no gain.  That said, thirteen years after the Great Recession started, I remain convinced that nominal wage cuts are a greatly underrated way to alleviate the grave evil of unemployment.  Nominal wage cuts don’t merely save jobs within the firm; they also save jobs throughout the economy.  Keynes opposed wage cuts, but good Keynesians smile upon them.

Think of it this way: Suppose you have $1M total to pay workers.  Which is better for Aggregate Demand: Retaining your whole workforce and cutting pay 10% – or keeping wages constant and laying off 10% of your employees?  The latter route, though timeworn, reduces workers’ spending because the marginal propensity to consume falls with income – and reduces firm’s profitability in the process.

Does this make me optimistic about the economy?  Hardly.  We’re already in the midst of a second Great Depression, and even perfect nominal wage flexibility won’t restore normalcy anytime soon.  Still, when word of nominal wage cuts reaches my ears, I feel a glimmer of hope.  Unemployment will skyrocket.  Without nominal pay cuts, however, unemployment would have been worst yet.  Unemployment will take years to subside.  Without nominal pay cuts, however, unemployment would have lingered longer still.  As I wrote a decade ago:

Is labor market rigidity a market failure?  I’m afraid so.  But strangely enough, this market failure is largely caused by anti-market bias!  The main reason workers hate wage cuts is that they imagine that wage-cutting employers are satanically “unfair.”  If workers saw wage cuts for what they are – a full-employment mechanism – they’d sing a different tune.  While they wouldn’t be happy to see their wages cut, they’d grudgingly accept that a little wage variability is a fair price to pay for near-total employment security.  Once this economically enlightened perspective took hold, employers would eagerly cater to it – and the market failure would largely go away.

According to Peter Pan, “Everytime a child says ‘I don’t believe in fairies,’ there’s a little fairy somewhere that falls down dead.”  As far as I know, he’s wrong about fairies.  But if Peter had warned, “Everytime a person says, ‘I don’t believe in markets,’ there’s a worker somewhere that loses his job,” he wouldn’t have been far from the truth.  Scoff if you must!  People can and do cause market failure by believing in it.

Teleworkers still don’t believe in markets, but at least they’re less likely to tell each other, “I don’t believe in markets” – or act on their resentment.  Thank goodness for small miracles.

P.S. Disclaimer: The best predictor of future data is past data- and we should never say, “This time it’s different” lightly.  So I wouldn’t be shocked if aggregate data ultimately revealed continued severe nominal wage rigidity despite my current impressions of drastic change.  If so, consider this piece an imaginative yet regrettable attempt to explain “facts” that barely happened…

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The True CPI Just Jumped

I recently voiced fear of coming inflation.  Yet on reflection, high inflation is already here.  While measured inflation remains low, I’ve been arguing for years that CPI bias heavily distorts official measures.  My point has always been that official measures of inflation are too high, because official measures fail to properly account for rising quality and variety of goods.  In the last month, however, all this has suddenly reversed.  Due to the coronavirus, official measures of inflation are now much too low.

How so?  Most obviously, the variety of available goods has sharply fallen.  Roughly half the products I normally buy are no longer on the shelves.  I’m hardly starving, but I’ve had to fill my shopping basket with a lot of goods I would not buy under ordinary conditions.  After many years of claiming that product variety is a great unmeasured gift, consistently compels me to admit that the loss of product variety is a great unmeasured shock in the other direction.

Variety aside, the quality of goods has also plummeted.  Most notably, shopping convenience is way down.  Back in February, I could pop into any store, swiftly pinpoint what I wanted, and buy as much as I liked without worrying about infection.  No longer.  Today’s best-case scenario is that I pay the same amount as last month for a greatly degraded shopping experience.  The actual physical quality of the goods has fallen too; I now have to settle for half-crushed bread, worse cuts of salmon, and so on.

Can’t I solve some of these problems by switching to delivery?  Yes, but that highlights yet another source of hidden inflation: outlet bias.  During the last few decades, consumers have heavily switched to innovative stores like CostCo that provide high-quality products for low prices.  Official CPI measures have failed to properly account for this transformation.  In the last few weeks, however, we’ve had outlet bias in reverse.  Stores like CostCo have been so congested (and rationed!) that many people have switched over to higher-cost, lower-quality stores they would normally avoid.

This includes delivery services like Instacart.  While I’m grateful they’re in business, Wegmans food delivered via Instacart easily costs 30% more than I’d normally pay.  The list prices are higher, there’s a delivery fee, and don’t forget the tip.  True, I don’t have to go to the store, but back in the good old days of February, I liked going to the store.  (I enjoy getting out on weekend mornings, and waiting around the house for deliveries is a drag).  Upshot: I really am paying 30% more to shop at an outlet that is inferior to what used to be available.  And I’m hardly alone.

The optimist in me says that this drastic sign-flip for CPI bias is temporary.  Yet since supply chains – especially international chains – have been seriously disrupted, much of the degradation in the quality and variety of goods that I’ve described will soon be replaced with other degradations.  You can hardly wax rhapsodic about the cheap and handy products China sells us without lamenting the many months we will have to go without.

I am well-aware that gasoline and a few other goods have suddenly gotten cheaper.  Yet overall, we have endured a rude shock.  In normal times, CPI bias means that we fail to appreciate our high and rising prosperity.  During this crisis, CPI bias means that we fail to appreciate how much we’ve lost.

Here’s to better times!

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