Monday, August 14, 2006

Can we make moral judgements about prices?

The following commentary was delivered by Professor Michael Meeropol over WAMC radio on July 7.

CAN WE MAKE MORAL JUDGMENTS ABOUT PRICES?

It’s summer. People are talking about the price of gasoline. Last month, both Senators and Congressmen debated increases in the federal minimum wage. Discussion about both of these issues reveals an interesting disconnect between the way Economists look at prices and how ordinary people do.

My students respond to rapidly rising gasoline prices by arguing that those prices are “outrageous” --- meaning they are too high. We often hear bitter complaints about “price gouging” when periods of emergency produce rapid increases in the price of some necessity, like bottled water or gasoline.

Both of these sentiments reflect a moral approach to prices that most trained economists find, well, let’s say “unscientific” though privately many dismiss it as IGNORANCE.

Why do I say this?

When economists are confronted with prices that are freely paid for products offered for sale in the market by firms that in some way or other are competing for the consumer’s dollar they argue that such prices cannot be either too high or too low.

Prices are neither moral nor immoral -- they just are. The world of supply and demand describes the interaction between the desires of consumers to buy something (coupled with those consumers’ ability to pay) and the scarcity of the resources used in the production process.[1]

By this standard, the recent rise in the price of gasoline is a result of natural forces: rising world demand for oil-based products (especially gasoline) coupled with a very slow growth in supply. The only exception to the rule that prices are part of the “natural order of things” is when some entity (like the government) interferes with the process and mandates a higher (or lower) price than the market would produce if left alone.[2]

Also, when one business corners the market and asserts monopoly power it artificially restrains supply, causing the price to rise above the “appropriate” level.[3]

The usual response from economists to the argument that the price of gasoline is too high is to remind us that even though oil corporations are gigantic, there are enough of them in the world to make the oil market “competitive.”[4]

To turn briefly to minimum wage legislation, the rationale for a minimum wage is that the market price for labor created by supply and demand -- supply being the willingness and ability of people to offer themselves as potential workers to potential employers while demand is the desire of businesses and government agencies to hire people for various jobs) -- leaves some low skilled workers with a wage that is too low.

President Franklin Roosevelt said when he signed the nation’s first minimum wage law that “No business which depends for its existence on paying less than living wages to its workers has any right to continue in this country.”[5] In this particular case, the moral imperatives of society insisted on overruling the forces of supply and demand.

And, despite what passes for economic science today, the desire to subject market prices to a moral test has a long, distinguished history in the field of economics. Adam Smith, the father of the field of economics for the English-speaking world, was himself a Professor of Moral Philosophy.[6] Before Adam Smith, we find the moral approach to prices in the work of medieval philosophers like St. Thomas Acquinas.

In the non-western world, the Koran is explicit in describing the right and the wrong ways to conduct business. Interestingly, in both the Koran and in the writings of the Christian philosophers known as the Schoolmen there is a prohibition on the charging of interest on loans. It was considered unjust.[7]

Central to the philosophical discussion of price was the idea of a just price – To a modern economist, this is a moral, ethical concept having no scientific meaning.[8]

When my students assert that the price of gasoline is too high they are joining with that long line of philosophers in believing that just because the “market” produces a particular outcome, we are not required to accept it. We can intervene to alter what the market would do if left alone. Obviously, we have to recognize how the participants in the market would respond to such intervention (I referred to the impact of minimum wage increases in an earlier commentary) but there is absolutely no reason not to subject what happens in the economy to moral judgments.

The average citizen’s inclination in correct. Most people have a moral compass by which they measure things --- even prices. Today, the economics profession is trying to take that away in the name of science – but they’re wrong.
[1] “Economists usually are opposed to any form of price control. Economics textbooks attempt to show that minimum-wage laws, rent control, price controls on gasoline, “usury” laws (which put a caps on interest rates), and so forth result in an artificial shortage of, and an inefficient distribution of, the good or service with the controlled price.” Meeropol, Surrender, How the Clinton Administration Completed the Reagan Revolution: 75. For more details of the argument, see pp 75-76 and the endnotes on pp 299-301.

[2] Government interventions creating rent control or minimum wage laws are obvious examples, but there could also be negotiated contracts (absent government intervention) which create wages that are higher than one that would be achieved by the free inter-play of supply and demand in the market, say, for Law Professors [the ABA requires a specific salary scale in return for accrediting Law Schools].

[3] In previous commentary I have written about the high prices charged for patented pharmaceuticals. See Merrill Goozner The $800 Million Pill.

[4] This argument is very imprecise. How many gigantic international firms do there have to be in order to keep them from being able to “administer” a price (that is offer a specific price and be able to hold the line on it)? In truly competitive transactions (farmers selling corn, individuals and institutions selling shares of stock) the seller basically inquires as to the current price and either accepts it or withdraws the items offered for sale. In most businesses, by contrast, they are able to quote a price and at least hold it for some time while they wait for the reaction of “the market.” Oil companies can do this and that is why their rates of profit can be quite high at times. I would argue that while the international oil companies do not collude as does OPEC, they have been able to control their prices significantly over the years and thus have higher than average rates of return on their invested capital.

[5] “Franklin Delano Roosevelt, Quotations Compiled by GIGA” available on-line.

[6] Adam Smith is known to economists for his work An Inquiry Into the Nature and Causes of the Wealth of Nations. Before writing that book he wrote The Theory of Moral Sentiments in which he made numerous arguments about the nature of humanity and its interactions – even in the economic sphere (though he did not develop those ideas until much later).

[7] This was, by the way, one of the reasons that Jews were involved in money-lending during the Middle Ages – Christians were forbidden to engage in it. In Islam, interestingly, it was okay to make deals and charge interest to non-Muslims. If you wanted to invest in the business of a fellow Muslim you could join as a partner with the promise of receiving a share of the profits but you could not lend at a fixed rate of interest. The rationale here was that it was immoral to put all the risk of repaying the loan onto the borrower – you had to share the risk by becoming a partner. For Muslim prohibitions of interest (translated as “usury” in the Penguin edition) see: Koran 2:275, 278-9. “Those who live on usury shall rise up before Allah like men whom Satan has demented by his touch; for they claim that usury is like trading. But Allah has permitted trading and forbidden usury… Allah has laid His curse on usury … Believers, have fear of Allah and waive what is still due to you from usury, if your faith be true; or war shall be declared against you by Allah … If you repent, you may retain your principal, suffering no loss and causing loss to none.” [Koran tr. N.J.Dawood Penguin Books: 354-355] For the “Sin of Usury” as described by the medieval philosophers (he specifically refers to Acquinas) see Henry W. Spiegel The Growth of Economic Thought (Prentice-Hall, 1971): 63-64.

[8] On the “just price” see ibid: 60-61. It is not that economists think ethical issues are unimportant – for the most part they argue that such issues cannot be dealt with “scientifically.” Virtually every economics textbook introduces students to the distinction between “positive” and “normative” economics. “Positive economics focuses on facts and cause-and-effect relationships. It includes description, theory development, and theory testing. … Positive economics avoids value judgments, tries to establish scientific statements about economic behavior, and deals with what the economy is actually like … normative economics incorporates value judgments about what the economy should be like or what particular policy actions should be recommended … Normative economics looks at the desirability of certain aspects of the economy … “ Macroeconomics 16th ed. By McConnell and Brue (McGraw-Hill, Irwin: 2005): 10. In other words, you can “prove” right or wrong a proposition in positive economics (at least in principle – often we don’t have enough facts to do it!) but you can “argue forever” about issues that are normative because they are based on value judgments (such as whether a price is “too high” or a wage “too low”!).