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  • Max Stearns

"Market Failure" and "Rent" in Harvey’s Wake

During Hurricane Katrina, an entrepreneurial man named John Shepperson saw an opportunity. In Kentucky, where he lived, generators cost $1000. If he loaded a truck with 19 of them and then drove them 600 miles to Mississippi, he could fetch double that price. Upon arrival, Mr. Shepperson was arrested and the generators confiscated. Rather than earning a $19,000 profit, less expenses for his 1200-mile round trip, Shepperson spent four nights in jail for violating the state’s anti-gouging laws. See here and here.

Immediately after Superstorm Sandy, Congress was called upon to pass emergency funding relief, and many conservative House and Senate Republicans voted against the measure. This included then-newly-elected Senator Ted Cruz, who is now asking for rapid congressional approval of funding for his home state of Texas, which was hit hard by Hurricane Harvey. See here. Despite that vote, the Sandy-funding measures eventually passed, although the money itself was slow to be spent. Cruz claimed the problem was that the bill contained two thirds, or even 70%, unrelated pork barrel spending, funding not targeted to post-Sandy relief. Politifact has demonstrated that Cruz’s claim is mistaken for, among other reasons, failing to distinguish funding for Sandy-afflicted states on a non-emergency basis from actual pork barrel spending. The latter was a notably smaller percentage than two-thirds of the overall bill. See here.

Both stories are troublesome, and each involves two closely related economic concepts: market failure and rent. The generator story involves a claimed market failure, the opportunity to charge a seemingly exorbitant price for a much needed good in the aftermath of a devastating storm. The emergency-funding legislation involves a claimed political market failure, namely the inevitable add-on of pork barrel, or special interest, items as part of a larger and vital emergency relief measure. Which of these failures we see is largely a function of who we are, by which I mean, our political ideology. Like Cole Sear, the young boy in The Sixth Sense, who looked about the world and saw dead people, liberals look about and see failure upon failure within private markets; not to be outdone, the ghosts conservatives see occupy the congressional corridors. We all tend to see that which reaffirms our world view, and our sense of what’s right or wrong. We all have blindspots.

We have already witnessed similar claims to market failure in wake of Hurricane Harvey, the $20 gallon of gas, the $99 case of water. See here. You’ve likely seen images or read memes expressing disgust at the seemingly wonton cruelty, further victimizing the victims of an unimaginable storm. I have seen posts expressing horror at these images, and ascribing hypocrisy to Ted Cruz for suddenly advocating emergency post-storm relief despite the stress this will inevitably place on the hanging-over-all-our-heads-absolute-drop-dead-deadline for Congress to raise the debt ceiling and to fund the flood insurance program.

Claims to market failure are too often conclusory labels, failing properly to account for what a properly functioning market actually looks like and accomplishes. Here are my two bold claims: Both claimed market failures—price gouging as an abusive practice victimizing the already victimized, and the legislative failure of adding pork to essential emergency relief legislation—are flawed.

To see why, I must introduce a second economic concept: “rent.” Rent is a price theory term with a precise meaning: A rate of return higher than the normal, or expected, rate of return in the economy. “Rent seeking” means finding ways to earn that higher rate of return. This can arise within private markets, as when a natural disaster raises the price of goods in particular locations. This creates opportunities to rapidly move goods to where they have higher value. Rent seeking can also take place in legislatures, including Congress. This is especially likely in those rare moments when identifiable bills are almost certain to pass due to intense, and justified, political pressures. These are uncommon events—most proposed bills die in the vine—and so when they arise, interest groups are on it. If they can tack on favored special interest items, those too will be signed into law. Both types of rent, and both forms of rent seeking, naturally arise following natural disasters. But neither is, itself, is a natural disaster. Rather, each is a natural economic consequence that looks, and in some ways is, unattractive, but is also important to understand.

Let’s begin with the private market rents. After a natural disaster, one of the worst consequences is the absence of provisions vital to human sustenance: food, water, and shelter. The value of such things skyrockets in ways that make for powerful and disturbing imagery. Calling a business out for charging $99 for a case of bottled water seems a natural response for those with a heart. But consider two very different ways to think about this. The first one is intuitive, almost visceral: persons already distressed by a horrible natural disaster now confront a financial one, a price for a critical necessity that is so high that many flood victims will be unable afford it. This is quite literally Samuel Taylor Coleridge’s “water, water everywhere; nor any drop to drink.” See here. It seems unfathomably cruel.

Now let’s look from another angle: The same high price sends an important and powerful signal: Potable (drinkable) water is worth an astoundingly larger amount in Houston than in surrounding areas unafflicted by Hurricane Harvey, where bottled water is normally priced. This means that there is an opportunity for a considerable rent. Think back to Mr. Shepperson. Imagine that some innovative person figures out how to get herself close to the center of the storm’s aftermath, gets on a boat, or does whatever is needed to transport safe water to the various places at which people are desperately awaiting relief. This requires serious thought and planning, but the payoff, or rent, will be high if successful. There is a lot of money to be made. Our hypothetical entrepreneur is, after all, chasing an ephemeral rent with no time to waste. Why? As more and more people see, and then chase, this opportunity, the result will be an influx of safe water into places hit by the storm. As this occurs, the higher, rent-driven, price of bottled water will be driven back down to its earlier, pre-emergency levels. There will be more water where it is most needed precisely because of the market signal that the seemingly exorbitant price—the gouging one—revealed to those who had the will to make it happen.

Economic conservatives tend to think in terms of making the pie grow, which demands moving resources to where they have their highest values. Progressives tend to focus on how large a slice of the pie each person gets, meaning how fair the ultimate allocation is. Neither side’s priors are right or wrong. But legal policies do have consequences. To allow more respectable slices, you have to bring in more pies. A fairer slice of a shrinking pie is less attractive than a less fair slice of a growing one. This is especially true if, over time, all have a shot at earning larger slices as a result of the opportunities that come with a growing pie.

Which of the following is more likely to get water to Texas (growing the pie) and get that water to people to drink (giving fairer slices)? Option 1: criminalize price gouging, with the hope that the government, whose track record in post-storm management is less than stellar, manages its distribution system extremely well. Option 2: Allow gouging, and perhaps even encourage giving to charities that support storm victims by purchasing essential goods and services at whatever prices the market will bear. Option 1 relies exclusively on the government. Option 2 also relies on government, hoping it does well, but it also encourages private entrepreneurs to seek rents, and charities to reward those who do so successfully, as a combined means of allowing government and markets, together, to get the job done. And even if charities do not help in the distribution, the rent opportunity alone will bring in the needed provisions and begin the process of driving the price back down. If you lived in Houston or another flood zone, which of these two options do you think you’d prefer?

The emergency funding bill, which is actually a series of related measures, see here, also creates opportunities for rent seeking, and the resulting challenges can be characterized in terms of political market failure. The rent opportunity arises for a very simple reason: Emergency spending measures following a natural disaster will almost inevitably pass in some form. The political pressure to do so is rightly enormous. Those with effective veto power, or even the power to slow things down, can translate it into a tit for tat, offering their support in exchange for this or that favored special interest payoff. Classic rent seeking involves industries seeking legal barriers to competition, also called barriers to entry. Such protections also allow returns higher than the normal rate of return within an economy, and for that reason, they are frowned upon. But these are also an inevitable feature of democratic politics. If the expected return from involvement in the legislative process is higher than the expected return for what we wish firms to do instead, research and innovate, create and sell valued goods, then behaving rationally, firms will split their time and efforts accordingly. And since most bills don’t pass, the opportunities to seek rents intensify at those rare moments when interest groups can identify bills almost certain to pass.

Many proposals have been floated over the years to limit opportunities for rent seeking such as item vetoes, germaneness rules, and balanced budget amendments, and in my scholarly work, I’ve explained why, despite their intuitive appeal, these tend not to work. We have the system we have, and nothing worthwhile is free. Yes, all else being equal, over charging in the aftermath of a disaster is bad, even unseemly. And yes, all else being equal, tacking pork onto needed emergency relief is bad, even unseemly. The problem, of course, is that all else is never equal, especially after a dire emergency, such as a devastating hurricane.

Emergencies can bring out the best and worst in us, moments of daring heroism that save lives, tremendous acts of charitable giving, and the list goes on. And it can bring out incentives to seek personal gain. Even so, sometimes those efforts can actually prove helpful, however unattractive they might first appear.

Postscript: Whether you agree or disagree with my analysis, I hope that having read this you will please consider spending a few moments contributing to a reputable charity that helps those who have been victimized by Hurricane Harvey. And please also remember our friends who have been harmed by flooding in South Asia.

I welcome your comments.

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