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Gas Shortage: Irrational Herding or Economics?

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10/08/2008Robert R. Prechter, Jr.

The gasoline shortage in parts of the Southeast is nationwide news. Everyone has an opinion: It's hurricane Ike. It's refineries being off-line. It's dumb car owners "topping off." It's gas companies restricting supply. It's the media spreading the story. It's crowd behavior. It's irrational panic. Robert Prechter answers some questions about the gas shortage.

Q: Is the gas shortage in the Southeast due to recent hurricanes?

A: No. There have been a thousand hurricanes, not to mention earthquakes and tornados, over the past hundred years and they don't tend to cause gasoline shortages.

Q: Are greedy gas companies restricting supply?

A: If they're greedy, they're selling as much as they can.

Q: How about this quote in USA Today (9/29, p.3A) saying that the panic has been "fueled by media coverage of the shortage"?

A: If there were no newspapers, radio or TV, drivers would still see the "No Gas" signs all down the highway. It's not exactly something you can hide or would want to hide, for that matter.

Q: Isn't "topping off" contributing to the gas shortage?

A: For a day or two, maybe, but continued topping thereafter uses no more gas than would be used otherwise.

Q: What about other types of hoarding?

A: Most people don't have much capacity for hoarding. Maybe they've filled up a 10-gallon gas can. But that's a tiny amount compared to overall gas usage. Hoarding is not a fundamental cause of the gas shortage; the shortage is the cause of hoarding behavior. You can prove this point: If you could somehow stop hoarding, it would not relieve the gas shortage, but if you could relieve the gas shortage, hoarding would stop immediately.

Q: So what's our problem?

A: The shortage is due to the disruption of the free market by the state.

Q: You mean such as the EPA's mandates that distributors can bring only a certain type of gasoline to some of those areas, or the government's regulations that prevent oil companies from building new refineries?

A: Both of these decrees reduce available supplies of gas. But they are insufficient by themselves to cause a shortage.

Q: Doesn't reduced supply — scarcity — create shortages?

A: No. In a free market, shortages are impossible; there is only a price. Rubies and Picassos are scarce, but there's never a shortage of them. You can buy all you want any day of the week. Just pay the price.

Q: So how is the state causing a shortage?

A: The overriding cause of the shortage in the Southeast is state legislatures' mandates that anyone selling gasoline at market prices will be labeled a "gouger" and fined $10,000 to $25,000.

Q: That's it? That's the reason?

A: That's all there is to it. Only government can create shortages. If the price for gasoline had been allowed to fluctuate freely and rise to $5 a gallon locally, it would have provided plenty of incentive for truckers to siphon gas from other states and haul it to Georgia, Tennessee, North Carolina and Alabama. But as it stands, every one of these states has an "anti-gouging" law, and every one of their governors stood up to announce that he would vigorously enforce it. They may as well have said, "I demand a gas shortage."

Q: What should they have said instead?

A: It depends. If the governors want votes, they should threaten retailers, just as they've been doing. But if they want plenty of available gas, they should encourage retailers to sell gas at the highest price they can get.

Q: Would that help the supply and demand pictures?

A: Yes, both. On the demand side, high prices for goods and services curb consumption in an orderly way. If gas were more expensive, some people would postpone that trip to the country club for dinner. People who really needed gas to get to work or close a $50 million real-estate deal in Atlanta would pay the price. A higher price would also help supply. People wouldn't be burning gas waiting a half hour in line to buy it. And no one would be "topping off." On the contrary, people would hoard as little as possible and wait for the price to come back down.

Q: Would the price come down?

A: Of course. As wholesalers realized they could make an extra dollar a gallon in Georgia, they would burn rubber hauling gasoline there. Pretty soon, there would be lots of gas, and the price would drift back down. Other areas, from which the gas came, would experience a slight rise in the price. Prices would equalize across states, and there would be no shortage and no outsized high prices.

Q: How long would it take to get ample supplies to the stations?

A: With a sufficient profit incentive, probably about 48 hours. Certainly no more than a week.

Q: But don't some other states with anti-gouging laws have plenty of gas?

A: Sure. Suppose you're a wholesaler stationed in Texas. You're not allowed to get any more for your limited supply of gasoline in north Georgia than you can in the Florida panhandle. Where are you going to ship it? To the easiest, closest destination. Under price controls, gasoline gets allocated not by price but by other market factors — whatever reduces the cost of delivery — so the sellers can maximize profits. In the severest cases, price controls create a black market.

Q: It seems that gasoline isn't the only shortage.

A: Oh, no. There's health care, another area where the state caps prices. Sometimes the state creates surpluses, such as in housing, where government programs encourage massive mortgage indebtedness. Either way, it ends up a mess.

Q: You study crowd behavior. Aren't the public's recent actions — lining up at the pump, topping off and so on — due to irrational panic?

A: Not at all. People have good reason to line up and to hoard, which is that the state has decreed a price below the market rate. And they have a good reason to fear, too, because when the state controls a price, there is no basis upon which a person can rely on future supplies. Topping off is simply a rational reaction to disrupted supplies. So it is incorrect to charge everyday people with thoughtless anxiety in this case.

Q: You attribute many social trends to unconscious herding. But you're saying it's not the main factor in this case?

A: It would be the main factor if people were treating gas as a financial market — speculating on the direction of prices — but the current problem is economic. If some people can't get to work next week, maybe they can't afford food. So fears about the gas shortage are inherently individual, not inherently social. If the government closed all grocery stores but one, you would see huge lines. But that's not herding; it's politics and economics. People definitely are receiving information by watching others line up at the pump, but it is accurate information about the availability of gasoline, not uninformed mimicking behavior. People in Atlanta understand why cars are lined up: there's a gas shortage.

Q: Well, other people who study human behavior seem to disagree. I just read in the Atlanta Journal-Constitution ("Why We Ran out of Gas," 9/24) that a local professor says the panic at the pumps is all just "herd behavior: they see other people afraid and it snowballs." He says they're "sheep."

A: I see.

Q: He says the clamor for gasoline is simple to fix. For one thing, all we have to do to is "mandate a minimum of say, 10 gallons."

A: What does he want government to do? Put a policeman at every station to enforce this mandate? Jail people who misjudge and buy 8½ gallons? Administration would cost way more than simply letting the market function. And it will function, anyway, ban or no ban: People would start paying retailers to fudge sales receipts, buying gas from the back of a tanker at midnight, bribing the cops, and who knows what else.

Q: He says, "That would prevent topping off."

A: Right. Just as drug laws prevent drug use and blue laws prevent prostitution.

Q: He says, "You ban that and the problem will go away."

A: Bans do not fix problems. They exacerbate old problems and create new problems. For example, people down eight gallons would drive around furiously burning up two more gallons so they could top off. And where did the "10 gallons" amount come from? This sounds like ad hoc political interference, the kind politicians dream up every day.

Q: There's more. He suggests we must "have people stand up and socially ostracize people who are topping off."

A: Get people yelling at each other? That'll bring peace in the valley. Besides, the idea is inconsistent. If the herd is topping off due to irrational panic, how is the same herd going to start calmly ostracizing its members? Who's going to begin this movement, anyway?

Q: Well, according to him, "You need a leader to stand up and say that this is bad behavior, you are being bad citizens."

A: Public blaming is how McCarthy got started. I don't think we need to see leaders who caused the problem bashing people for behavior that their own actions induced. If our leaders weren't pandering to the crowd, we wouldn't have a gas shortage to begin with.

Q: Doesn't it look like herding when we watch the cars line up?

A: It sure does. But appearances can be deceiving. A specialist must be careful not to attribute every aspect of crowds to one theory of behavior.

Q: Don't you advocate that in many situations unconscious social mood is fundamentally causal to behavior?

A: Absolutely. Under socionomic causality, unconscious social mood trends are a powerful motivator of social behavior, but they pertain only in contexts of uncertainty. For example, social mood regulates trends in the stock market, macroeconomics, the social environment for peace or war, and trends in fashion and entertainment. It can even lead to expansions and contractions in supplies of commodities. But it doesn't make the commodities unavailable. The theory also allows for collective behavior aside from unconscious herding. Much crowd behavior is nonrational, but some of it is perfectly sensible.

Q: For example?

A: Such as going to the store when it has a big sale.

Q: How about when fear is a factor?

A: You mean like leaving the World Trade Center when it was burning to the ground? That's group fear, and it was rational. If you acted contrarily, you died.

Q: But this professor says that in the case of gas lines, "reality is irrelevant."

A: Reality is entirely relevant.

Q: So there is a difference between rational fear and nonrational fear?

A: Exactly.

Q: Some people think the ivory tower is to blame for antimarket thinking.

A: Academia makes room for all kinds of views. Matt Zwolinski of the University of San Diego has just posted a paper called "The Ethics of Price Gouging," which is due to be published in Business Ethics Quarterly. He concludes that so-called gouging — selling at market rates — is practical and serves "morally ethical goals."

Q: Will the gas shortage go away?

A: Sure. It'll be off the front pages when supplies catch up to the artificially low price or when the market is freed up.

Q: Politicians try to please voters. Wouldn't this imply that voters are ultimately at fault for wanting politicians to ban high profits?

A: Many people are envious of those who receive a windfall. If a retailer were smart enough or lucky enough to order gasoline before supplies contracted, he might make some extra money. I'm perfectly fine with that, but many people can't stand the idea. So they appeal to politicians to make sure it doesn't happen. These are the same people, by the way, who would not want anyone to get in the way of their seeking a higher income for their labor. Ironically, by banning so-called excess profits, they insure higher prices later, because the marketplace isn't allowed to communicate to producers the need for more gasoline, pipelines, and refineries.

Q: You sound as if this has happened before.

A: There were price controls on gas in 1973 under Richard "we're all Keynesians now" Nixon. The state mandated something called "odd/even rationing." Don't ask. I was there, and it was monumentally annoying. If you want details, Google "1973 gasoline shortage." It happened again in 1979. There were caps on "old" and "new" gas, another unnecessary restriction. There was a "windfall profits" tax. Carter told us to wear sweaters.

Q: So what's the solution?

A: Get out of the way. Let the market work.


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