Just this past week, the Senate passed an energy package that included provisions against “price gouging” at gas stations. This anti-gouging legislation criminalizes any attempt to charge an “unconscionably excessive” price at the pumps and gives federal agencies new powers to investigate alleged price-gouging situations. The fact is, however, that provisions against “price gouging” are vague, founded on a poor understanding of economics and designed solely to whip up populist sentiment against oil companies.
“Price gouging” is a common complaint every time demand for gasoline exceeds supply and prices at the pump go up. Politicians — mostly Democrats but some Republicans as well—rush to the cameras and accuse oil companies and even individual gas stations of raising gas prices beyond their market value in order to fleece consumers. The Federal Trade Commission is responsible for investigating price gouging allegations and habitually does so every year in response to political complaints. Just as habitually, the FTC finds that there has been no illegal activity on the part of oil companies or gas stations to gouge the consumer.
This failure to find any evidence of price gouging hasn’t convinced politicians that price gouging does not exist. Rather, it seems to have convinced them that the FTC just isn’t looking hard enough. Having failed to find price gouging under the current set of definitions, Congress has decided to change those definitions, thus presumably making it easier to find evidence of price gouging. The whole exercise has an Alice in Wonderland feel to it. “First the verdict, then the trial.” Congress is stacking the deck in favor of finding price gouging even where no price gouging may exist.
But the terms and language of the legislation are extremely vague. What does it mean for prices at the pump to be “unconscionably excessive”? No one really knows for sure. Of course, we can’t really blame Congress for not being able to come up with a working definition of price gouging. You see, the FTC couldn’t come up with one either, for very understandable reasons, as it turns out:
Congress asked the FTC to define price gouging last year. The FTC said the term mainly applied to local cases and that those could not last long without competition forcing prices down again.
"It’s difficult to understand precisely what price gouging is," said John H. Seesel, the FTC’s associate general counsel for energy. "The term is usually defined in terms of other phrases that are equally hard to get a handle on, such as ‘unconscionable’ or ‘excessive.’ "
When one examines the causes for the increase in gasoline prices and gets beyond the shrieking accusations concerning “price gouging” one finds — surprise! — that the laws of supply and demand are at work:
The government’s Energy Information Administration said this week that "continuing problems for refineries in the United States and abroad, combined with strong global gasoline demand, have raised our projected average summer gasoline price by 14 cents per gallon."
As Edward Lazear, the Chairman of the Council of Economic Advisers, points out, the anti-price gouging legislation Congress is considering only serves as a form of price controls that will bring about gas shortages and the long lines at gas pumps that typified life in the middle to late 1970s. Shortages will become especially acute in emergency situations like the one we saw in the aftermath of Hurricane Katrina. The legislation will do nothing to increase supply—which is the key to bringing down gas prices. Both Lazear and Ronald Bailey highlight the obvious point that we need more refining capacity in order to increase supply in relation to demand and thus lower prices. But Congress doesn’t want to go down that road because it will encounter a gaggle of interest groups who will counter attempts to build more refineries with the time-honored “not in my backyard” argument. Since Congress doesn’t have the courage to take on these groups and explain the economic facts of life to them, it has chosen to try to pass anti-price gouging legislation and blind itself to those very facts.
“But we have to do something about those obscene profits oil companies are making at the expense of consumers,” cry proponents of the legislation. Sorry, but that argument just won’t fly. As Larry Kudlow explains, oil companies make far less money than people think:
. . . ExxonMobil’s profits are outsized, but they come on sales of $377.5 billion, making for a profit margin of just over 10 cents on the dollar. This remains well below the profit margins of many industries, including banking and biotech where the margins nearly double those in the energy sector. The numbers are big, but the returns are middling.
And since sales and profits in the energy sector depend on the world price of oil, it’s feast or famine for these businesses. In the last decade, oil prices have fluctuated from about $10 a barrel to nearly $80. Talk about volatile pricing.
What the proponents of anti-price gouging legislation don’t seem to understand is that prices are not only useful to determine the value of a particular product, but that in a free market, they are also useful in order to give consumers and producers information about that product. If gas prices increase in a free market, then consumers and producers are tipped off to the fact that demand is outpacing supply. We can then respond to that new information and increase supply — by, say, building more refineries.
But if anti-price gouging legislation gets enacted into law, we will be deprived of free market information concerning the supply of gasoline and as a result, we will make poorer decisions in response. Proponents of anti-price gouging legislation seem to think that they are smart enough to replace the market and serve as central planners for the energy sector of the economy. But no matter how brilliant these new would-be central planners think they are, they can’t do better than the market itself at setting gas prices.
The anti-price gouging legislation that is part of the energy bill is one of the more objectionable pieces of legislation Congress has considered in recent memory. And yet, this deeply flawed legislation has passed the Senate. It will probably pass the House too, which means that President Bush should get his veto pen ready. The President has made it clear that he wants an energy bill. But it’s better to have no bill at all than a bill as bad as this.