Price gouging: Can economics justify a price cap?

Michael Giberson

A great burst of attention to price gouging economics. When i have a bit more time, I’ll come back to this discussion. But here is my quick surmise:

Even in Ely’s fixed supply situation and following Ely ignoring producer surplus, if you assume a fixed supply of bottled water and a queue of consumers each with a declining marginal utility for bottled water, it is easy to cook up examples in which a price cap mis-distributes water to the first several customers in line.

Cowen is right to point out that even in the short run supply is usually less than perfectly inelastic. In the longer run dynamic effects are also important.

Of course those first lucky customers could re-sell water to the less fortunate folks in the back of the queue … for the right price.

ADDED from newspapers and other media:

 

And one last blogger, David M. Brown at Mises Daily, “Price Gouging Saves Lives in a Hurricane.” (Which is a recycling of Brown’s post-Hurricane Charley price gouging post.)

Power demand dropping? Must be time to raise prices!

Michael Giberson

News headline reflects the stark difference in pricing strategy between competing businesses and regulated monopolies: “Xcel: Slack demand signals need for rate hike.”

The sub-headline reads, “The utility, which posted a profit increase, will ask Minnesota for approval to raise rates.” Profits are up? Must need to raise prices. Reading the article heightens the feeling that regulated monopolies just think differently.

  • “Xcel Energy Inc. reported a 17 percent jump in earnings per share for the third quarter but warned that electricity sales remain slack and that it will seek a Minnesota rate increase.”
  • “Cost-cutting efforts launched earlier in the year and rate hikes in four states boosted the company’s bottom line in the latest quarter, executives said. Yet the demand for power across the company’s eight-state service area remained slack for a utility long accustomed to growth.” — so the problem is that they’re “accustomed to growth” but don’t see it coming?
  • “Xcel intends to file a request next week with the Minnesota Public Utilities Commission for a 2013 electric rate hike, with an interim increase to be sought on Jan. 1. Madden offered few details, but said higher rates are needed to pay for investments in Xcel’s two nuclear power plants in Minnesota and to cover other cost increases.” — So they want to cover new, higher costs, which is normal…
  • “He said Xcel also will file requests this year for … electric rate hikes in Texas, New Mexico and North Dakota. … Xcel also said it won’t need to invest as much in pollution control equipment at its Texas coal-burning power plants. [Xcel] can now defer $470 million in Texas emission-control upgrades for at least five years.” — And they need a rate hike to cover new, lower costs, too.

Fossil energy subsidies and renewable energy competitiveness

Michael Giberson

Some, not all, of you believe that fossil fuel energy gain massive and undeserved subsidies from the federal government, that such subsidies way outweigh subsidies for renewable energy, and that subsidies for fossil fuels undermine the market success of renewable energy.

You may want to read Severin Borenstein’s post, “Are Fossil Fuel Subsidies Really the Problem for Renewables?

In brief, he claims that government-based fossil fuel subsidies don’t amount to much per unit of energy delivered so don’t undermine renewables, are pretty stupid anyway, and the more significant fossil fuel support is elsewhere.

So much oil that we don’t need infrastructure to develop it?

Michael Giberson

At InsideClimate News Elizabeth Douglass has a long, sprawling article tying together projections of U.S. oil production growth sufficient to turn the U.S. into an oil exporting nation and the political opposition to the Keystone XL pipeline. But the link between resource optimism and infrastructure obstructionism is a bit of a non sequitur. We ought to be careful about jumping from evidence of commercial success to justifications for more political control over commerce.

In July, the Manhattan Institute’s Mark Mills produced a report suggesting the presence of sufficient hydrocarbon resources within North America to more than meet North American needs and allow exports too. The economic potential of such development should lead us to adopt supportive policies, he said. Mills report notes similar projections coming from a variety of industry analysts and government energy agencies. Douglass’s article quotes Mills saying, “We’re about to have a gusher of oil.”

The article then describes how the lack of pipeline infrastructure has hampered oil production in North Dakota, and even more so in Alberta, such that oil at these locations trades at a significant discount to world oil prices. The lack of pipeline infrastructure leads producers to resort to more costly transportation methods – barges, trains and trucks – to get oil out. The higher transport costs cuts into the price paid to producers.

So far, so good. The tight oil boom has surprised the industry as much as the shale gas boom did a year or two sooner. Given the typical delays involved in (a) recognizing the need for a pipeline, (b) developing a plan and gaining financial commitment, (c) getting the pipeline permitted and securing the rights-of-way, and (d) actually building the pipeline, it isn’t surprising that pipeline infrastructure doesn’t yet match up to the changing patterns of production. Step (c) in that list is the big time sink, as both the politics of permitting and working with landowners has become more difficult. (Pro-pipeline conservatives ought to recognize that restraints on eminent domain are, from the point of view of the developer, part of the problem.)

The Douglass article then shifts into the politics of oil exports, noting that exports from the U.S. into Canada have been increasing lately “to the highest level in more than a decade,” at about 77 thousand bbl/day. Curiously, perhaps in an effort to dramatize the export, the article fails to explain that this is a trivial amount. No only does the U.S. produce nearly 6 million bbl/day, we also import about 2 million bbl/day from Canada. The 77 thousand bbl/day is the equivalent of returning to Canada about 3 percent of what is initially shipped south. (Data available from EIA.)

We have seen the political noise surrounding the potential exports of natural gas–the Obama administration has delayed a key report on the issue until after the election, in a move widely interpreted as helping him avoid immediate political fallout from any firm decision on the issue. There have also been scattered complaints about exports of refined petroleum products. Actual net export of U.S. crude would surely provoke additional political complaints.

The Keystone XL pipeline gets mentioned along the way in Douglass’s article, initially characterized by proponents as essential to development of new resources. But once the North American oil export prospects are discussed, the presentation shifts to the politics of the Keystone XL pipeline. In a quite clear distinction between the worldviews of commerce and politics, in politics the North American oil boom flips 180 degrees from the reason the pipe is needed into the reason the pipe is unnecessary.

“If the public realizes that [the Gulf Coast refiners] don’t need the Keystone XL … I think it would have a huge impact on support for the project,” said Anthony Swift, an attorney at the National Resources Defense Council, which has campaigned against the pipeline for years.

And not just environmentalist are arguing the boom makes the pipeline unnecessary. The article gives the last word to energy economist Philip Verleger Jr.:

Oil economist and consultant Philip Verleger Jr. said the Keystone XL will be a victim of that rapid change. Verleger is a visiting fellow at the Peterson Institute of International Economics whose opposition to the Keystone project has rankled the industry…

“The people who are saying we really need this [Keystone XL pipeline] don’t recognize that circumstances have changed,” said Verleger, who recently predicted that America will begin exporting more energy than it imports within the decade.

“The Keystone XL is going to be just like an Egyptian pyramid. Useless.”

There might be just a little bit of a slip embedded in the characterization of Verleger’s view. “Begin exporting more energy than it imports” is a phrasing that presumably incorporates coal exports into the equation, though coal is nowhere else mentioned in the article. I suspect Verleger’s views are more subtle than presented. Still, if he said the pipeline will be useless, that is a pretty clear statement.

[By the way, note that I'm not saying Douglass herself it claiming that the potential for eventual oil exports is reason to oppose the Keystone pipeline. Her sprawling article just takes notice that this line of argument is being raised.]

In Mill’s Manhattan Institute report the Keystone pipeline gets mentioned briefly, as an example of the current obstructionism that will hold back the potential economic boom that would come from truly forward looking policy. Not too surprisingly to regular readers, I’ve got to lean toward Mill’s view here.

We may or may not turn into oil exporters in a decade or two, I’m not a forecaster of such things, but it pretty clear it can’t happen if we return to a path of greater political management of energy resource flows. If Verleger thinks the pipeline will be useless, he shouldn’t invest in it and he should advise his clients not to invest in it. Other commercial interests clearly hold an opposing view, and they are willing to invest their money in the project.

If we rely mostly on the commercial worldview to direct energy resources, the pipeline probably gets built and we may well be on our way to cheaper energy and oil exports. If we instead give precedence to a political worldview to manage energy resource development and movement, energy becomes costlier and in short supply.

Politics has an appropriate role to play in addressing environmental issues, but we will all live happier, healthier, cleaner lives if we keep politics focused on solving environmental problems and let commerce direct which way energy resources flow.

An economic analysis of governance in cycling

Over the past week professional cycling has been thrown topsy-turvy by the fallout from the US Anti-Doping Agency’s report on their investigation into performance-enhancing drug (PED) use in the U.S. Postal Service team, 1998-2006. The focus of the dossier is, of course, Lance Armstrong, and the eyewitness testimony is extensive and not very surprising to those of us who have been following the sport for a long time (since 1985, in my case). Based on those affidavits, Armstrong has lost sponsorship contracts this week with Nike, Trek, and other companies, and has stepped down as the chairman of the cancer charity he founded, Livestrong (although he remains a member of its board). Friday the Dutch bank Rabobank announced the end of its sponsorship of both its men’s and women’s professional team (leaving World Champion and Olympic gold medalist Marianne Vos on a team without a name sponsor), giving as its reason that “[w]e are no longer convinced that the international professional world of cycling can make this a clean and fair sport. We are not confident that this will change for the better in the foreseeable future.” This statement suggests an economic hypothesis: doping in sport is a problem of perverse incentives and poor governance institutions, and poor governance in cycling undermines the credibility and profitability of the sport.

Professional cycling has a governing organization, the Union Cycliste International. As currently constituted, UCI decision-making is hierarchical, and riders, team directors, sponsors, and the cycling industry have little input into rulemaking. UCI’s mission is, in part, to establish rules ranging from the minimum allowed weight of a bicycle for competition to anti-doping rules and penalties. But part of its mission is also the promotion of the professional sport of cycling through its sponsored events, and increasing the size and popularity of the sport. These missions come into conflict in situations where, say, a popular athlete who brings a lot of revenue into the sport may be using PEDs — do they enforce the rules and risk the revenue hit? (Note also that this conflict of interest pervades the NFL, MLB, and other sports and sporting organizations) Their revenue mission may undermine their self-governing regulatory mission, and they thus have perverse incentives that can lead them to overlook, or try to cover up, high-profile violations of the anti-doping rules. Both the current and former UCI presidents have come under criticism for their faulty stewardship of the sport, because their past actions indicate that they associated complacency in the face of doping with more revenue and a higher profile for the sport. At best, UCI has looked the other way; at worst, it may have been complicit in concealing high-profile violations.

Another organization that plays a regulatory role in conjunction with UCI is the World Anti-Doping Agency, WADA. The infamous Festina affair at the 1998 Tour de France led to the formation of WADA in 1999, as a joint initiative of the International Olympic Committee and national governments. USADA, the U.S. member of WADA, was founded in 2000. In the current case, USADA has presented its documentation to UCI, which will state on Monday the actions it will take in response.

But WADA/USADA also have perverse incentives. Economist Roger Noll has done extensive research on the political economy of sports, and recently did an excellent EconTalk podcast with Russ Roberts (it’s long, but the doping discussion is at 46:45-57:45). Noll argues that WADA/USADA have perverse incentives because their fees are proportional to the number of infractions they catch and punish. Thus WADA earns its keep by expanding the list of prohibited items, setting unreasonably stringent thresholds for them, testing for them, and punishing their use. Rather, athletes should be able to make the rules by which they commit to abide, constrained by not engaging in illegal activities (this is complicated in the countries in Europe that have made doping a criminal offense). In other words, the sport should be self-governing in terms of determining its own rules. In WADA, athletes have almost no role in defining standards and thresholds, although there is an athlete committee.

I agree with Noll that effective self-governance is an important bulwark against WADA’s perverse incentives and the problems arising from external legal encroachment (and further government involvement) in sport. Had the UCI been effective and transparent in promoting and enforcing anti-doping policies, they might have prevented the Festina affair, or penalized it ex post effectively enough that an external public-private organization would not have been created.

But I think the institutional design issue is trickier than that. An organization like UCI would still have conflicting incentives as long as it is responsible both for the determination of rules/penalties and the testing and enforcement of those rules. Suppose the UCI implements a “good” set of rules  What incentive would the UCI have to enforce such rules?  As long as one organization is responsible for both rulemaking and enforcement this tension is inherent, and detrimental to the credibility, the popularity, and the profitability of the sport.

I’m suggesting a more collaborative, networked (dare I say stakeholder) organization for cycling governance. In this model the riders, team directors, sponsors, and industry have a voting role in decision-making, on matters from bicycle weight to banned substances and thresholds. Those rules should be transparent and allow riders due process (including no immediate public announcement except for in competition when it’s obvious) and a right of appeal (which is currently lacking). If UCI is determining those substances and thresholds, and penalties, they should not be involved in testing for enforcement, which should be administered by an independent third party. WADA/USADA as currently constituted do not meet a reasonable definition of independence, though, which is one reason why this is so tricky to change from its current dysfunctional institutional design.

Is there a way out? I think the way out is to follow the money, and that’s where the Rabobank sponsorship departure is painful in the short run but may help to realign these perverse incentives at UCI in the longer run. The way out has to be through cultural change from fans and sponsors to agitate for change at the UCI. Their leadership is no longer credible; they have lost the trust of many fans, team directors, athletes, sponsors (as reflected in Rabobank’s comments), and industry members. That lost trust now means lost revenue, and that changes the equation for UCI — losing sponsors because “the international professional world of cycling [cannot] make this a clean and fair sport” may prompt some rethinking, change in leadership, institutional change within UCI. And it should. One suggestion moving in that direction comes from Doug Ellis, co-owner of Slipstream Sports, who suggested on Twitter that “Maybe it’s time for a sponsor summit. If the people putting money into the sport demand change, there must be change.

“Please, sirs, may I have some more … subsidies for wind power?”

Michael Giberson

From The Hill’s Energy & Environment Blog:

A group of military veterans pressed congressional Republicans on Thursday to renew a tax credit for the wind industry that their party’s standard-bearer, Mitt Romney, has vowed to end.

The veterans, who are all employed by the wind industry, secured meetings with staff for House Majority Leader Eric Cantor (R-Va.), House Ways and Means Committee Chairman…

The two elements of half-hearted policy substance mentioned in the article are both suspect: “jobs for veterans,” and “reduces dependence on foreign energy.”

Over the last decade the domestic oil and gas production industry added twice as many jobs as the 37,000 jobs the wind industry claims expiration of the PTC will threaten. The only “foreign energy” we import in any quantity is petroleum, excepting some power and natural gas from Canada, and the wind power subsidy has approximately nothing to do with how much petroleum we import.

On the other hand, increasing domestic oil and gas production actually is reducing “dependence on foreign energy,” including imports from OPEC members and other sources, and even including power and natural gas from Canada.

Using military vets to lobby for wind power tax breaks? I guess some K Street lobbying genius imagined using vets would help the industry get a bit of face time with Republican lawmakers who would otherwise rather meet with representatives of some other special interest group. Don’t our military veterans deserve better than to be made into poorly-informed lobbyists for wind energy?

What’s next, retired firefighters, grizzled ex-cops, harried emergency room nurses?

Why not just round up some starving orphans and have them come plead Congress, “Please, sirs, may I have some more … subsidies for wind power?”

Matching, markets, and morality

Michael Giberson

The recent Economics Nobel announcement, which went to Lloyd Shapely and Alvin Roth for theoretical and practical innovations in matching processes, has prompted some misguided carping among market-oriented commentators. The Andrew Coulson post from Cato-at-Liberty (which Lynne quoted favorably yesterday) is one example. Robert Wenzel is another (calling it a prize for “work that really doesn’t even need to be done, if the free market were allowed to operate”).  David Henderson’s Wall Street Journal column and related EconLog post is the more thoughtful, non-carping version of the complaint.

The complaint seems to be that the matching innovations are particularly useful in non-price environments where markets are mostly absent–Roth’s applied work has been in medical labor markets, public school choice, and kidney swaps–and the commentators prefer pushing markets as a superior approach to tinkering with non-price mechanisms.

I think Virginia Postrel has a much better reaction to the prizes (and one which takes some care to try to make the main theoretical insights accessible to intelligent non-specialists, so if you’re curious about the prize please do go read her column), “An Economics Nobel For Saving Lives.” Here is a piece:

Roth, whose “market design” bridges economics and operations research, is known for developing algorithms to find the best available matches in real-world situations: medical residencies, public schools and … kidney transplants from living donors. “He likes to study markets that don’t involve money,” says Michael Rees, a kidney transplant surgeon at the University of Toledo Medical Center in Ohio who has worked with Roth on paired kidney donations.

There’s no intrinsic reason … that the kidney market couldn’t involve money, since a paid donor wouldn’t care who exactly got the kidney, as long as the price was right. About 94,000 Americans are on the waiting list for kidneys. Last year, fewer than 17,000 got transplants, about 11,000 of them from deceased donors. If transplant centers offered sufficient compensation, they could enlist enough living donors to eliminate rationing. The reasons they don’t are cultural, legal and — to someone more appalled by needless suffering than by commercial transactions — infuriating.

Roth, who recently left Harvard for Stanford, isn’t trying to change laws or attitudes about the kidney shortage. Those may change in the long term, but his concern is the present.

And, as Postrel points out, Roth’s concern for the present has increased the number of kidney transplants that have taken place over the last several years, radically improving the quality of life for the additional transplant recipients.

[U]nlike the economists, wonks and polemicists who rail against the prohibition of organ sales, Roth can claim credit for actually increasing the number of kidney transplants. “Alvin Roth has been a major contributor to the fastest-growing source of transplantable kidneys in America, and probably in the world, through paired donation,” says Rees.

Relatedly, at ThinkMarkets Mario Rizzo objects to the “economist as engineer” mindset that Roth promotes. With all due respect, I think Rizzo is wrong in his objections to the kind of work Roth does. Roth isn’t trying to play central planner, he is just applying economists’ understanding of incentives, preferences, and choice to promote institutional reforms. In fact, I would go further to say that Roth’s work is helping to reform central planner-type institutions with institutions that better respect the knowledge and values of persons affected. Sounds like good work to me.

Hayek has an interesting remark in The Road to Serfdom which seems on topic: “There is, in particular, all the difference between deliberately creating a system within which competition will work as beneficially as possible and passively accepting institutions as they are. Probably nothing has done so much harm to the liberal cause as the wooden insistence of some liberals on certain rules of thumb, above all the principle of laissez faire.”

Roth’s works seems somewhat like “creating a system” in the Hayek quote, and the carping critics mentioned above sound a lot like the “wooden insistence of some liberals on certain rules of thumb.”

NOTED: Eric Crampton has comments along the same general theme as mine, concluding that sometimes “the best we can hope to do is make things suck less,” and on these grounds Roth is a clear success.

Matching and a static environment

In my remarks the other day about this year’s Roth/Shapley Nobel, I said that I thought the work was important and useful because it led to the implementation of better institutions in situations in which prices are unlikely to emerge organically. A post from Andrew Coulson at Cato at Liberty fleshes out some reasons why his enthusiasm is limited. In his post he describes some of Roth’s work in school-pupil matching, and he observes that

The problem is that this approach to “school choice” correctly assumes that the better public schools have a fixed number of places and cannot expand to meet increased demand. So it’s about finding the least-awful allocation of students to a static set of schools—a process that does nothing to improve school quality.

Meanwhile, there is something called a “market” which not only allows consumers and producers to connect, it creates the freedoms and incentives necessary for the best providers to grow in response to rising demand and crowd-out the inferior ones. It also provides incentives for innovation and efficiency. But instead of advocating the use of market freedoms and incentives to improve education, some of our top economists are spending their skill and energy tinkering with theincreasingly inefficient, pedagogically stagnant status quo.

That’s a good point to remember when thinking about matching algorithms and institutional design — if you have a problem, like kidney matching, that is fairly static in its overall nature (although probabilistic in its actual incidence), then yes, matching algorithms are likely to yield higher total benefits/welfare/surplus. But Andrew’s right; when there’s a possibility of increasing the supply of schools or teachers, or to change the quality of them, that’s not a problem where applying a matching algorithm is going to yield as many potential benefits as a market … if you can overcome the political barriers to school competition and choice. Markets yield better outcomes in general in dynamic situations.

In that case, it’s a transaction that’s politically repugnant.

Roth/Shapley Nobel

Lynne Kiesling

I have little to add to today’s congratulations to Al Roth and Lloyd Shapley for this year’s Nobel; Peter Klein has a useful roundup of links to good commentary, with a namecheck to us, in his link to his discussion of market design back in 2007 (thanks!). Mike’s frequent posts on price gouging and ticket scalping as “repugnant” transactions are an interest shared with Roth, who is himself a prolific economics blogger.

This year’s prize rewards their work in what’s called market design or market engineering, and those names are sufficiently vague to be confusing. As Peter notes in his post and Alex Tabarrok illustrates helpfully, the Shapley-Gale deferred choice algorithm provides a rule by which parties can be matched that yields stable, mutually preferable outcomes. The Wikipedia entry for it also provides a piece of code for implementing the algorithm in a computer simulation. It’s an elegant piece of formal cooperative game theory, which Al Roth applied to situations requiring coordination but lacking prices (i.e., lacking organic markets). His work doing so has yielded substantial improvements in the processes of matching medical residents and medical schools, kidney donors and recipients, and other situations in which coordination means matching. In fact, his kidney swap design has meant many successful kidney transplants, and makes programs like the kidney swap program at Northwestern’s Feinberg School of Medicine possible. While I would argue in favor of kidney markets as a preferable way to coordinate and match (and it’s not clear from any of Roth’s writings that he shares that position), if you are in a situation where better matching can increase total welfare, then designs-rules-institutions such as these are an improvement on worse rules or institutions, such as random assignment or using a lottery.

And that’s an important context in which to think about, and expand upon, the work being rewarded with this prize. This sort of institutional design (because make no mistake, that’s what this is, because it’s designing a set of rules) pertains to situations in which, for whatever reason, organic markets and price signals have not emerged or have not been allowed to emerge. In some cases, such as kidneys, some of us decry the absence of markets while others classify such transactions as repugnant. In other cases, such as medical residency positions, strong social norms and perceptions of fair play preclude the use of cash transactions and prices to coordinate the match; it’s also not necessarily clear that a cash market for such positions would yield a superior match on compatibility grounds. So yes, it’s top-down institutional design that’s meant to address a deliberate set of matching problems. This is a good opportunity for comparative institutional analysis — compare the designed institution that’s been created and implemented top-down with a more decentralized, generalized set of market rules, and/or an actual market with prices.

Methodologically, Roth tests his institutional designs using experiments, a methodology that both Mike and I find quite congenial, and that is well-suited to comparative institutional analysis, although in experiments you do in some ways lose the organic and emergent nature of the bottom-up market process with prices.

Some of my Austrian economics friends are not impressed with this body of work, but I don’t share that opinion. Roth and Shapley are in the mechanism design strand of game theory, which means they take as given the decentralized nature of preferences and information. They are not Austrian, and their approach is certainly prone to Hayek’s (and Vernon Smith’s) “pretence of knowledge” critique that they are constructivist. That said, the Shapley-Gale algorithm and the way Roth has applied it to medical residency and other problems are explicit in recognizing that economic problems are problems of coordination in the presence of diffuse private knowledge. And if we’re being honest we have to recognize that in reality, most institutions/rules systems involve both organic evolution and conscious design.