US price gouging and EC competition law
This entry was added to http://www.reckon.co.uk/headlines-franckblog on 25 October 2005.
Full blog table of contents available at Contents | viewpoint: Franck.
Prompted by hurricanes, The Becker-Posner Blog discusses US State laws against "price gouging" this week. These statutes prohibit price increases for essential goods such as petrol in the aftermath of a natural disaster, although increases can be justified by higher costs incurred by suppliers. Posner thinks that such laws are "a profound mistake", and Becker agrees.
Posner complains about the "unpardonable vagueness" of these statutes, and a bit of googling for them confirms that they look (to this non-US eye) pretty badly drafted, ranging from a complete lack of specificity (a gap which has apparently not been filled in by case law) to excessive specificity e.g. specific values for percentage increases or margins that are deemed too high.
But besides these points, the basic argument advanced by Posner and Becker against price gouging laws is similar to that in a three-year-old article from the Ludwig von Mises institute: all argue, on the basis of standard price and scarcity theories, that imposing price controls on essential goods at the time where such goods are in heavy demand and/or short supply due to an emergency situation will inhibit the operation of price signals to contain demand or reveal new sources of supply, and instead lead to more rationing by non-price methods such as queueing.
In their latest articles, and much to their credit, Posner and Becker go beyond "Economics 101" and consider how their opposition to price gouging statutes can be reconciled with established judge-made law limiting rent extraction that exist in the context of salvage at sea, and in the Alaska Packers case where an agreement made under pressure of a strike by workers whose work was essential to a business' survival.
Posner's argument for distinguishing price gouging
Posner attempts to distinguish price gouging statutes from prohibitions on ransom extraction in the context of salvage at sea and striking workers by arguing that petrol suppliers in the aftermath of a hurricane "have not created the situation that resulted in a reduction in supply".
The logic seems to be that any duty not to extract a ransom must arise from being at fault for, or at least a cause of, the emergency that enables the ransom to be extracted. This is explained in the context of the striking workers by establishing a parallel between collusive withdrawal of labour through a strike and collusive withdrawal of supply in a market through a cartel. Clearly the legal position is different (the cartel is illegal whereas the collusive strike does not seem to be) but Posner argues that the parallelism in their effects is enough to justify the extension of the prohibition on exploitation to the case of the strike.
However, I cannot understand how Posner applies this test to the salvage at sea case. One can surely assume that neither the rescuing ship has not created the situation in which a sinking ship is in need of help, and yet the law (according to Posner) prohibits the rescuer from charging whatever it likes in exchange for the rescue. And, in fact, instead of applying his test about causation of the emergency, Posner seems to argue that the distinguishing feature in the sea salvage case is that:
"there is no one else competing for the rescue service — there is just one ship in distress".
Something seems to have gone wrong in that argument: if there were two independent ships in distress in the same area, and only one rescue ship who is unable to rescue both sinking ships, then the sinking ships would be competing for the rescue service. Yet surely the rescuing ship would still be prohibited from extracting an unreasonable payment from whichever sinking ship it decides to help. (Irrelevant aside: does admiralty law constrain the choice of the rescue ship's captain as to which ship to rescue?)
Becker's (non-)argument for distinguishing price gouging laws
Becker agrees with Posner that price gouging laws are undesirable, and that they can be distinguished from the specific prohibition on ransom-extraction in the cases considered by Posner. (He also over-generalises the point to "price controls" and cannot resist a swipe at old Mao, but I won't comment on that today.)
Becker claims that, in the case of salvage at sea:
"controls are warranted because there is not time during a rescue effort to work out what would be the appropriate sharing rule".
This seems to me to be a false argument. The premise that there is no time to engage in commercial negotiation during the rescue seems unjustified given that, in the case hinted at by Posner as the source of the law, there was actually a negotiation and an agreement, but the court held it to be unenforceable. Even if it were true that there was no time for negotiation during the rescue, there would be plenty of time in the admiralty courts later on to argue what the outcome of a "hypothetical negotiation" before the rescue would have been. Yet my understanding (admittedly tenuous) of the law on these matters is that the basis of remuneration for salvage is not the outcome of such a hypothetical negotiation, but instead an amount considered (by the court) to be sufficient to encourage mariners to engage in salvage operations whenever they reasonably can. Thus the fair reward should be enough to cover the costs of the salvage, the risks incurred in the salvage, and the costs and risks incurred in attempted salvage operations where nothing valuable was actually saved.
In other words the law sets actual rewards so as to try and align expected reward with expected cost to enable mariners to make the right decision about when to bother rescuing. This logic leads to rewards for valuable cargo which are much lower than the value of the cargo, whereas an actual or hypothetical negotiation would be expected to result in most of the value being transferred to the rescuer.
Thus, the fact that the law of salvage at sea makes the outcome of a negotiation unenforceable unless it is objectively fair disproves the validity of Becker's basis for distinguishing that law from price gouging laws.
Becker's basis for distinguishing Alaska Packers is equally ropy:
"The attempt of the Alaskan seamen to hold up the owners for higher wages while at sea presumably broke an implicit contract that wages are fixed for the duration of the fishing trip."
An implicit contract seems a contradiction in terms: a contract is an agreement based on an actual meeting of minds, it cannot be implicit. Perhaps he means a tacit contract (where minds meet without explicit communication)? But then the court would have found that this contract had been modified by the agreement to end the strike and therefore would have enforced payment of the higher wages. If, for some weird reason, it could be argued that the "implicit contract" could not be modified by further agreement (although I cannot imagine how this could be the case), then presumably the court would have said so and would not have needed to consider whether the increase was excessive — and Posner would just be misleading us by citing the case in his article. I somehow don't think that Posner will have got his law wrong on what he says is a well-known textbook case. The reason why the court did not require payment of the higher wages was that the agreement to amend the wage rate was unenforceable on grounds on unconscionability, because the increase secured under duress was excessive and unfair. The exact reasons for that judgment are the issue of interest here, and talking about implicit contracts helps no-one.
What has this got to do with EC competition law?
I promised in the title that this article was about EC competition law, not just the price of petrol in the US or the arrangements for rescuing sinking ships. It's time to deliver on that promise.
Article 82 of the EC Treaty, and the equivalent provisions of the UK Competition Act 1998, prohibit "the abuse of a dominant position" insofar as it affects relevant trade. Abuse is left undefined in the statute, almost a blank canvas for the courts to build on.
One of the things that the courts have built on the basis of Article 82 is a prohibition on exploitative abuse. If a firm has a dominant position in a market (essentially, if it is not constrained by competition), then it has a "special responsibility" not to charge excessive or unfair prices. And what characterises an unfairly exploitative price, according to case law such as United Brands, is that it represents the exploitation by the dominant firm of:
“opportunities arising out of its dominant position in such a way as to reap trading benefits which it would not have reaped if there had been normal and sufficiently effective competition” (paragraph 249).
Whilst this makes clear that exploitative abuse is determined by comparing the prices charged with those that could have been charged under a counterfactual hypothesis of "normal and sufficiently effective competition", it does not provide a statement of how such "normal competition" might be defined. This is because, in United Brands, the court found that the European Commission has failed to prove exploitative abuse, and determining that the Commission had failed to discharge its duty to investigate the matter properly was enough to reach a conclusion.
Subsequent cases, perhaps most clearly in the UK the Napp case (where exploitative abuse was proved) have clarified the concept to some extent. I won't put a full review of case law here as this would take too much space (and time), and might unduly pre-empt a paper that one of my colleagues is currently preparing on the subject. But what seems reasonably clear about exploitative abuse under Article 82 is that:
- If a firm engages in an exclusionary abuse that has the effect of restricting competition in a market in which it has a dominant position, and if that restriction leads to higher prices than would otherwise had been achievable, then charging such higher prices is an exploitative abuse.
- The concept of a restriction on competition that is not "normal" extends wider than just illegal restrictions, but it would be presumptuous to try and build an exhaustive list.
- Exploitative abuse arises irrespective of whether the dominant firm is to blame for the abnormal restrictions of competition or not: under Article 82, abuse is an objective concept characterised by particular conduct (here, charging high prices) in particular circumstances (here, that there is a dominant position and that there is not normal and sufficiently effective competition); whose fault it was that the particular circumstances came about is not relevant.
Does this body of law, which prohibits excessive prices on the grounds of undue exploitation, have anything to do with price gouging? I think it does. Whilst the matter has not, to my knowledge, been tested in court, it does not seem mad to suggest that a restriction on competition induced by an emergency would, at least in some circumstances (yet to be defined by the courts), mean that there is not "normal and sufficiently effective competition".
If so, a supplier in a dominant position would be prohibited from exploiting such a restriction on competition.
The application to the case of the strike-induced ransom could simply be that the collusion between workers was by itself an abnormal restriction on competition, in which case exploitation of the dependence of the fishing company would be wrong (irrespective of the legality of the strike itself). Whilst this is the logic of Posner's argument, it seems to go too far in prohibiting the use of strikes in pay negotiations. My guess (not an informed one as I don't claim to understand any industrial relations law) is that a strike is only an abnormal restriction on competition if it has the character of an unfair "ambush" — e.g. if it takes place in far-away Alaska during a short fishing season — but not if it merely exposes a wider economic dependence of the employer on its organised work force.
The principle underpinning exploitative abuse in EC competition law also seem to go some way towards explaining admiralty law on salvage at sea. If the circumstances of the emergency mean that only one potential rescue ship can help, then there is a dominant position (in the supply of rescue services) and a lack of competition for such services which might be considered abnormal. If so, the rescue ship must not charge more than what could have been charged in conditions of "normal and sufficiently effective competition", which does not seem to be very different from the admiralty law idea of the minimum amount that would encourage a marginal supplier of salvage services to give it a go, disregarding the particular impossibility of competition in salvaging a particular ship.
For all my criticisms above, I think that both Becker or Posner were quite close to that analysis in their different ways:
- Posner focused on the lack of competition which characterises the salvage scenario, but for some reason which I cannot fathom seemed to consider the lack of competition between sinking ships to be relevant whereas it seems to me that the lack of competition between rescue ship is the important point: to use EC competition law jargon, the special responsibility (not to extract an unfair ransom) only exists if the rescuer has a dominant position (faces no effective competition).
- Becker identified the short timescales for any transaction, but seemed not to realise that the relevant effect of these short timescales is the impossibility of competition (you cannot invite tenders for other ships to rescue you), rather than the purported impossibility of negotiation.
Application to price gouging
The UK has, as far as I know, no restriction on price gouging in emergencies. I don't think that petrol prices went up all that much during the "fuel strikes" a few years ago, but it is a reasonable hypothesis that retailers of petrol had no more of a dominant position during the emergency than at other times. Why the combination of rivalry, reputation effects and many other things led to a particular level of prices is a mystery to me, and Article 82 respects that mystery by only restricting prices when there is not effective competition.
And this is where the beauty of Article 82 (or, more accurately, of the judge-made law based on Article 82) really manifests itself:
- If there is effective competition (whether from existing operators or from new entry), then the Becker-Posner argument against a price gouging prohibition that interferes with the invisible hand of price formation in the market has force. In these circumstances, there is no dominant position, and therefore Article 82 allows the market to work unimpeded, e.g by constricting demand and/or revealing alternative sources of supply.
- If there is no effective competition or potential competition, such that there is a dominant position, then the simple pro-market argument falls away. And in these circumstances the effect of Article 82 is to protect purchasers against unnecessary exploitation of any abnormal restrictions on competition, allowing only the prices what a normally competitive market would have allowed.
The practical application of Article 82 hides some traps for the unwary. Particular mistakes to avoid in the context of exploitative abuse in an emergency would include:
- Confusing the allowed price with the price before the emergency: this would amount to disregarding the effect of the emergency on costs as well as its effect on competition. Instead what is required is an estimate of what the price would be if the costs were what they are but competition had not been abnormally restricted. This may actually lead to the same sort of calculations as the cost justification for price increases under some US price gouging statutes.
- Confusing the price under normal conditions of competition with an estimate of the sustainable price level under contestable market theory, or an estimate of marginal cost: this would amount to assuming that normal and sufficiently effective competition is characterised by effective competition from new entry, or is perfect competition, and such an assumption would be unwarranted. Instead the specific restrictions on competition that are abnormal must be identified and hypothesised away in order to assess the allowable price.
There are probably many more subtle errors that could be made and that I have not thought of. In fairness, estimating what the price would have been under conditions of normal and sufficiently effective competition may not always be easy. But it is rare for a good law to be very easy to apply.
Are US price gouging statutes a good thing after all?
My conclusion from the above discussion is that Article 82 provides a satisfactory solution for the issue of price gouging in emergencies. It allows competition to work unimpeded when it can, and it provides a subtle (but conceptually reasonably straightforward) form of price control to protect consumers against the unfair exploitation of abnormal circumstances in situations where there is no scope for competition.
The admiralty and common law examples cited by Posner appear to provide a similar form of protection against unfair exploitation, in some very specific cases. (And at least some other common law restrictions on enforceability of unconscionable agreements, for example the distinction between penalty clauses and liquidated damages under English law, can be seen in a similar light.)
US federal antitrust law, as far as I understand, contains no general prohibition on the abuse of a dominant position. Whilst the Sherman Act and the FTC Act prohibit many of the things that would be exclusionary abuses (and probably some other things which EC law would not prohibit), there seems to be nothing against exploitative abuses; except, that is, rules on sinking ships, striking fishermen, and badly drafted State statutes on price gouging.
Posner rightly points to the fact that price gouging statutes seem to give rise to unjustified restrictions on free competition. But I think his implicit prescription to do away with the prohibition on price gouging would also remove the protection that people demand (reasonably, in my view) against being unfairly exploited in an emergency.
Perhaps what Posner really means is that the US should import something like Article 82 into its law. But I doubt it.
Closer to home, perhaps some EC competition law specialists should stop pretending that they can, or should, bring the application of EC competition law more in line with US federal antitrust law, and instead celebrate the fact that the two are very different, nowhere more so than in the context of exploitative pricing. And that our law is better than theirs.
Key links
- The Becker-Posner Blog
Price gouging articles by Posner and Becker.
- Article 82
The EC (and UK) prohibition on abuse of a dominant position, including exploitative abuse.
- Viewpoint: Franck
My regulation and competition economics blog.
Entry added by Franck Latrémolière on 25 October 2005
There may be comments and notes on this page. You can contribute by using the "Add a comment" button above. Advice on making contributions (including trackback) is in the Guidelines.
Last changed by Franck at 11:48 AM on Thursday 3 November 2005.