If we don’t let prices for essential goods rise, we can’t incentivize making more of them
he fear produced by Covid-19 has created unexpected shortages in our lives, from toilet paper at home to masks for health care workers.
Nobel laureate Joseph Stiglitz argued that this is a market failure—that markets work poorly in a crisis:
No country in times of serious war turns to markets. We don’t use markets to allocate how our troops should be deployed, and we didn’t rely on markets for producing tanks, airplanes, and other essential matériel in World War II. We needed immediate action, with complex coordination and changing demands; markets just don’t work well in these circumstances.
Stiglitz is right that we don’t use markets to fight physical wars. Or as one governor put it, during WWII, each state didn’t buy its own aircraft carriers.
But the pandemic is a different kind of war. As I write this on April 30, New York has about 300,000 cases of Covid-19, California has 50,000, and Wyoming is under 1,000. Masks and ventilators aren’t like aircraft carriers. Each state’s health care personnel need their own masks and ventilators, in radically different quantities.
So why aren’t there enough medical-grade masks to go around? Normally, when they’re running low, hospitals call their medical supply distributor. But right now, that supplier is getting calls from hospitals all over the country, and the manufacturers who supply the distributors with masks are also running low.
What usually happens when masks are in short supply is that prices start to rise as buyers compete for the masks that are still available. The higher price encourages the manufacturer to add a night shift. Hire more workers. Work the existing shifts more intensely. If prices rise enough, companies that make other things may find it profitable to start making masks. The higher prices encourage hospitals that don’t need masks — the ones in Wyoming, say — to not hoard them, leaving them free to go to New York. Buyers of masks pay a premium, but there are a lot more to go around.
Markets are failing in America because we’re not letting them work. It’s not a market failure. It’s a policy failure.
It seems cruel, heartless, and immoral to make hospitals pay more for masks just when they are most desperately needed to save lives. But the alternative, a world where prices do not rise when life and death are on the line, is cruel and heartless, too.
If you hold prices down artificially when masks are in high demand, you destroy the financial incentive to make more masks. You also destroy any incentive to create excess capacity or stockpiles for a future pandemic.
When there’s a fixed supply of something — say seats for opening night for Hamilton at the Richard Rodgers Theatre on Broadway — higher prices just mean more money for the theater and less money for the customer. The theatre can’t add more seats to accommodate a bigger audience, so StubHub allocates the seats to the people willing to pay the most.
But for goods that you can produce more of, allowing prices to rise gives producers the incentive to make more, which eventually bring prices down toward where they were before the increase in demand. You give buyers who already have a lot of the goods an incentive not to stock up in fear of a future shortage. You give people who aren’t producing the goods the incentive to become producers — to switch from selling whiskey, for example, to making hand sanitizer. And higher prices give people an incentive to prepare for the future because they know that a stockpile is worth a lot in a crisis.
Ironically, perhaps, this seems to be happening in China, where over 3000 companies, including FoxConn and a Chinese automaker added mask making to their production lines at the beginning of the year. But it doesn’t seem to be happening very much in the United States. Why?
Markets are failing in America because we’re not letting them work. It’s not a market failure. It’s a policy failure.
Ryan Petersen, the CEO of Flexport, the freight company which has been helping demanders get access to masks and getting them flown in from around the world, explained why there is still a mask shortage in a recent blog post. The first reason he gives is hospital bureaucracy:
Typically, buyers of PPE, whether hospitals or medical distributors, expect to place purchase orders and only pay for products upon delivery, or even later.
But when demand surges by 20 times, vendors simply don’t have the money required to scale production. Factories need money to add production lines, buy raw materials, and hire workers. They need down payments so they can move…
Other more aggressive entities are paying down payments, so if U.S. buyers won’t, they don’t get the supply.
American medical distributors, governments, and even hospital chains, by contrast, have been less willing, or less able, to adapt to the new reality of paying vendors upfront, at higher prices than they’d contracted.
The second reason is fear of profiteering or so-called price gouging:
At the same time, U.S. distributors can’t pass higher prices through to hospitals in the midst of the crisis, for fear of being accused of profiteering. Foreign governments and health care systems have been less encumbered by this, showing a willingness to pay more and pay faster to get first in line. According to one rumor, the Italian government recently placed a $6.5B order for PPE. Another says that the U.K. government bought one PPE manufacturer outright.
The tragedy is that these two forces work together. If there’s fear of being accused of profiteering, there’s little incentive for the players within the supply chain to respond with urgency or to incur the extra costs of moving quickly. That includes both the producer and the distributor. American mask wmakers can’t raise their prices dramatically if at all or they’ll be vilified at best or fined heavily at worst. Distributors of masks face the same challenge.
Most states have laws against “price gouging.” In California, for example, a state of emergency was declared on March 4, 2020 which limits price increases to 10% with violators subject to a year in prison and a fine up to $10,000 and other financial consequences.
As for any masks in private stockpiles, forget about it. An auctioneer in Houston, Texas, offered 750,000 masks for bids. The state attorney general sued him for price gouging. The masks are in limbo.
The Federal government is also relentlessly eager to take the profits out of making masks available from any private stockpiles. On April 2, the Department of Justice announced that it would be distributing 192,000 N95 respirator masks and other PPE that the FBI had raided from private stockpiles. From the Department of Justice press release on April 2, 2020:
“If you are amassing critical medical equipment for the purpose of selling it at exorbitant prices, you can expect a knock at your door,” said Attorney General William P. Barr. “The Department of Justice’s COVID-19 Hoarding and Price Gouging Task Force is working tirelessly around the clock with all our law enforcement partners to ensure that bad actors cannot illicitly profit from the COVID-19 pandemic facing our nation.”
This sounds good but it comes at a cost — government has destroyed the opportunities to make profits by increasing the supply of masks. Punishing hoarders discourages people from stockpiling for a future pandemic.
It shouldn’t be surprising that supply is scarce and that governors find themselves in the medical supply business. Governor Newsom of California just spent $990 million to buy masks from a Chinese car company. Governor Abbott of Texas pledged members of the Texas National Guard to work on a mask-making shift with a Dallas-based mask manufacturer to make sure there are masks for Texas.
The current mostly price-free system is punishing the people who deserve to be protected — the health care workers on the front lines. Megan L. Ranney, MD, an ER doctor at a Rhode Island hospital running low on supplies was quoted in a recent New York Times story saying:
The supply chain is still unpredictable and unreliable in every way possible… The need for an organized, equitable distribution system is dire.
In light of the crisis faced by health care workers like Ranney, a central stockpile of critical supplies available for the nation seems like a good idea. And you can understand how governors would prefer such a system to avoid having to pay for masks out of state budgets.
It sounds efficient. But how well would a federally-run system actually work in practice? Would it be first come first served? Would the Federal government know how many masks to make and what kinds? How would it decide to allocate masks and using what method for getting masks to hospitals and doctors. And not a hypothetical Federal government. The one we actually have. The one that awarded generous PPE contracts to “unproven vendors.”
Outside the U.S., efforts by national governments to amass masks and protective equipment have not gone well. In Canada, the government threw out 2,000,000 N95 masks from the national stockpile in 2014 (they had “expired”) but failed to replenish the supply — widespread shortages of masks, ventilators, and swabs were reported there when the crisis began. In England, where 82 health care workers have died from the virus, Boris Johnson’s government has been condemned for failing to provide enough protective equipment because of a failure to stockpile or acquire new masks and gowns. Just as in the United States, health care workers are wearing garbage bags and makeshift masks for protection. In Spain, over 12,000 health care workers have the virus and the socialist government is being sued by doctors for the government’s failure to provide adequate PPE.
Pride or fear or kindness will motivate you. But money makes it easier to indulge your kindness.
I don’t want the federal government in charge of all the masks in the nation. Instead, let prices go up today for masks and create the incentive for more masks tomorrow.
Not all the news is bleak here in the United States. Even when prices are held down, executives in companies may respond in a crisis out of price or in return for recognition or simply to keep the government from nationalizing their production under the Defense Production Act.
3M, the largest manufacturer of N95 respirators in the U.S., says that it has doubled production in the last two months to about 100 million per month with plans to double that number in the next 12 months. That’s great, but I wonder if they could get there quicker if they could charge more for masks. 3M has been under attack from President Trump for selling some of their masks to Canada and they’ve been under attack from 20 attorneys general demanding that 3M police the price distributors charge for their masks.
Incentives matter. Pride or fear or kindness will motivate you. But so does money. And because responding with urgency is usually expensive, money makes it easier to indulge your kindness.
The Washington Post reports that at Braskem America, a company that makes polypropylene, the material used to make masks, workers moved into the factory and worked 12-hour shifts day and night to boost production. Workers were paid for all 24 hours each day, at a higher hourly wage.
Monadnock, another supplier of polypropylene bought two more machines to triple their output. The Wall Street Journal reported that the company expanded overtime and raised their prices to fund the increase in labor costs.
“People are saying, ‘Name your price,’” said Keith Hayward, Monadnock’s managing director. “We don’t work like that.”
Maybe they don’t work quite like that. But they do raise the price to cover the costs of that overtime and those new machines. That’s the way markets work. You get more stuff when you let the price go up. We should use prices in a crisis, not just in normal times.