How the COVID-19 Helps Us Understand the Economy
As the coronavirus eats through the fabric of our societies like a cankerworm, it teaches us some fundamental lessons about our economy. We ignore these lessons at our own peril.
British economist Lionel Robbins defines economics as “the study of the use of scarce resources which have alternative uses.” What does this mean? It means scarcity is a fact of life in an economy. Humans must utilize the scarce resources they have at their disposal towards, among many competing needs, their most pressing needs. Without scarcity, in the words of American economist Thomas Sowell, “there would be no need to economize — and therefore, no economics.” This is not trivial. For example, water is a scarce resource; it can be used for drinking, bathing, cooking, making beverages, swimming, etc., but not at the same time. The same water used to make wine cannot be used for a shower — at least not at the same time. We use water to address our needs in the order of their most intensity to us. That is, we create a scale of value or scale of preference. We may use water, first and foremost, for drinking to preserve our lives. After that need is addressed, we can use water to bath, then to make beverages, and the list goes on.
In the simple economy of a family, it is easy to decide what resources are utilized in alternative ways to meet the needs on a scale of value. A parent can decide this easily; There are few participants in the family economy. But in a complex and sophisticated economy based on specialization, the division of labour and knowledge, it becomes impossible for any single entity to decide what the scarce resources are to be used for, especially when many of us have different scales of value and our scales of value are unknown to others. Some societies have tried this in the past and utterly failed. People value different things differently, and even the same person values the same thing differently at different times.
So how then can we resolve which alternative use, the scarce resources we have at our disposal goes toward satisfying? How can we resolve the valuations — that is, the different scale of values or preferences — of every participant in the economy? How do we decide if alcohol should be used to make an alcoholic beverage or a hand sanitizer? How do we decide if the polypropylene should be used to make diapers or surgical masks? The simple answer — the price system. More specifically, the free price system — that is a price system without the intervention of a government or central authority. Explaining how the free price system has never been as important as it is now in this era of the coronavirus. It literally could determine issues of life and death — medical professionals are currently forced to attend to patients without protective masks, putting themselves at risks of becoming infected by the virus. Some are having to make serious ethical decisions concerning who dies and who lives. All these can be efficiently taken care of with the price system.
With the coronavirus eating through the fabric of humanity, stock markets tanking, prices of personal hygiene and anti-contagion products rising and so much uncertainty, there is a feeling something needs to be done by the government authorities of the world. Everyone is afraid. At a time when we need it the most, because of this fear, many of us are jettisoning basic economic principles that could prevent pain, suffering and the macabre, if only adhered to.
As Thomas Sowell once wrote, “The fundamental principles of economics are not hard to understand, but they are easy to forget, especially amid the heady rhetoric of politics and the media.” News headlines like, “Negotiations intensify on Capitol Hill over massive stimulus legislation as coronavirus fallout worsens,” or “NYC has issued $275K in fines for coronavirus-related price gouging” could be really confusing as to what the implications of the policies on the economy maybe.
In this piece we address two areas of concern within the economy — the price of goods and service and employment. We explain how the price system works and why it is so important. We also provide an analytical exposition on some recent news media headlines, applying basic economic principles and what the potential consequence could be for ignoring these basic principles.
How does the price system work?
Prices have one main responsibility — moving resources to those places in the economy that they are needed the most. This is determined by a rise or fall in the price of any commodity or service based on the demand of that commodity by consumers and the ability of manufacturers to supply it under specific conditions at a given point in time.
Let’s look at a hypothetical example. Drinking water has different prices in different places. People need drinking water to survive, but depending on certain factors like geographical location or technical know-how, the ability to supply drinking water defers. Drinking water is cheaper in Minnesota than in Abu Dhabi, because there are over 10,000 freshwater lakes in Minnesota and not so many in Abu Dhabi. The cost of getting the water from miles into the ground in a desert and the cost of the purifying process are added onto the price of the water in Abu Dhabi. Hence, in Abu Dhabi, the prices of water are high in relation to the prices in Minnesota.
These high prices signal to producers that water is in high demand in Abu Dhabi, hence, if anyone can, they should make it available. In a world where free trade is the order of the day, those high prices of water do not just send this signal to entrepreneurs in Abu Dhabi, they send it to entrepreneurs around the world. Let’s say the price for a gallon of water in Abu Dhabi is $5 and in Minnesota it is $0.5, this provides arbitrage opportunities for an entrepreneur in Minnesota were they to provide water from Minnesota to Abu Dhabi. If they discover that the shipping and marketing cost will be $2 per gallon, they are able to make the water from Minnesota available in Abu Dhabi at a $2.5 cost, and can charge a price of anything between $2.6 and $5. Since that Minnesotan is new in the Abu Dhabi market and has a new product that the Emiratis do not yet know of, it is in their best interest to sell at a price lower than the market price of $5. If the Minnesotan chooses to sell at even $4.9 per gallon, the $0.1 the Emiratis have less to spend on water and can use for other things makes them better off. It may be that selling at $4.9 does not move enough consumers. The Minnesotan could then sell at $3.5 and once more, Emiratis start buying the cheaper water. The other drinking water entrepreneurs in Abu Dhabi are forced to reduce their prices or stop making water all together and venture into other businesses, thereby releasing scarce resources to other areas of the economy other than water. Everyone is better off — Minnesotan and Emirati.
Prices give us information about the relative scarcity of resources and help us decide among which alternative uses we should apply those resources to. The price system makes everyone better off, with respect to the specific conditions around the relative forces of supply and demand at a given point in time. Specific conditions could change and they always do. Even in times of distress like pandemics and acts of God, the price system is the only way of effectively managing the allocation of scarce resources. But when the price system is manipulated, usually through government intervention, distortions in the allocation of resources are bound to be the order of the day, leaving the economy worse off. Hence, the price system must be “free” for us to reap its full benefits.
What does this mean for the prices of goods and services in this time of the COVID-19?
Everything! We will take this step by step.
With over 531,684 confirmed cases and over 24,054 deaths in over 175 countries/regions according to real-time data from Johns Hopkins Center for Science and Engineering (CSSE), the Coronavirus disease has put many countries in total lockdown. Measures not seen since the second world war are being taken.
The virus has taken a toll on global supply chains. China is the second largest economy and the world’s manufacturing hub. Hence, this virus is affecting the supply of many commodities and services. Microsoft announced that, “… for the third quarter of fiscal year 2020, we do not expect to meet our More Personal Computing segment guidance as Windows OEM and Surface are more negatively impacted than previously anticipated.” According to an SBM Intelligence report, “Apple’s manufacturing partners, Foxconn is currently experiencing production cuts and delays, with Apple warning that it would not be able to meet sales targets for the first quarter of the year due to production delays.” In general, if the demand for these products stays constant, their prices will increase because supply has decreased. For some products, the virus ensures an increased demand, and if supply chains are affected by the virus, the prices of those products will rise astronomically.
During this time, there is a need for personal hygiene and anti-contagion goods and services. Hence, the need for the reallocation of resources from certain areas of the economy to other areas of the economy that need those resources the most. Right now, the health care, pharmaceutical, medical research labs, public health organizations, etc. need those resources now. How do they get it? Through the demand of the various goods and services that people value. People want more hand sanitizers and Lysol wipes, hence, the demand for these goods increases. When this happens the price of these commodities increase. These high prices signal two things to two groups of people. The first is the consumer and the second is the producer.
To the consumers, it tells them that a new strain of a highly infectious virus is on the loose therefore, more people want the limited supply of Lysol wipes, hand sanitizers and face masks. Please buy only what you need so others can buy when they get to the stores later. These high prices ensure that everybody can share the limited supply of those goods. Prices make us all share. Those people who might have wanted to buy 3 hand sanitizers when could get by with 1 will only purchase 1, leaving 2 for others to buy.
According to economist and political philosopher Murray Rothbard “all products are scarce in relation to their possible use, which is the reason they command a price on the market at all. Price, on the free market, performs a necessary rationing function in which the available pounds or bushels or other units of a goods are allocated freely and voluntarily to those who are most willing to purchase the product.” If a product becomes scarcer, Rothbard goes on to say “then the price rises to perform an increased rationing function: to allocate the smaller supply of the product to the most eager purchasers. When the price rises to reflect the smaller supply, consumers cut their purchases” shifting to other alternatives, “until the quantity demanded is small enough to equal the lower supply.”
It is sometimes said that only the rich can afford hand sanitizers at those high prices and the poor are left to suffer. This line of thinking is a misunderstanding of what people value and their willingness to utilize their resources in acquiring the things they value. For example, some people who are considered low-income in the United States wear Yeezys and have iPhones which cost many hundreds of dollars. This is because when someone really values something, they are willing to utilize all the resources they have at their disposal to get it, which could include getting a loan from the bank or from a family member. If one person cannot afford the prices of these anti-contagion and personal hygiene goods, two or more people can combine their resources to buy them. Those high prices, as many people have said, are not caused by price gouging of greedy manufacturers or sellers, they are caused by a drastic increase in the demand for those commodities against a limited supply. They are caused by scarcity. A given fact of life. Remember, in the words of economist Thomas Sowell, without scarcity “there would be no need to economize — and therefore, no economics.” If we all lived in the garden of Eden there would be no reason to want for anything, there would be no scarcity. But we do not live in the garden of Eden. We live in the real world and have to deal with real world realities — one of which is scarcity.
American economist Peter Leeson explains the importance of market prices:
“Market prices… signal to producers and consumers the relative scarcity of resources. They tell producers how to combine resources in the ways that produce the most value for consumers and tell consumers when they should expand or contract their consumption of various goods and services”
Now what do the prices signal to the producers? The answer is best described by a phrase from economists Tyler Cowen and Alex Tabarrok, “A price is a signal wrapped up in an incentive.” And this is the solution to the problem of the high prices. The high prices signal to producers that there is an increased demand of these goods and this incentivizes them to make those goods available. Those high prices basically ensure that resources are moved from areas of the economy that are not very important at a given time to those that are.
For example, Peroxyacetic Acid (PAA) or Chlorine dioxide can be used in making hand sanitizers but are also used in the food and beverage industries. As the demand for hand sanitizers increases and its prices increase with it, the ingredients used to make hand sanitizers are also bid upwards. Since the demand for other foods or beverages that use any of the aforementioned chemical compounds did not increase, their prices are still low and in some cases, could start decreasing. This allows the hand sanitizer producer to be able to afford those chemicals at the high prices.
This also then incentivizes other entrepreneurs who were not in the business of hand sanitizers before to start making those products. This increases the supply of hand sanitizers, which will eventually lead to a decline in the prices. As Murray Rothbard wrote “… supply and demand always tend to be in equilibrium in the market and therefore, the prices of products as well as the factors that contribute to production are always tending toward some equilibrium point.”
We can see this movement of economic resources (capital and labour) from one sector of the economy to other sectors of the economy by looking at the stock market. When Microsoft made its announcement on February 26, 2020, concerning uncertainty around meeting targets with respect to sales of its Surface and other products in the third quarter for fiscal year 2020, its stock price was about $172. As at the time of this writing, it is $142.79. Let’s look at Zoom, the remote conferencing company. Within the same time period, on February 26th 2020, its stock price was around $106 and now, it is $134.64. This could be because since more people will be working from home, there may not be a need for more office desktop computers and sotfware accessories, but people will need telecommuting and video conferencing services which Zoom is able to provide. People are even conducting wedding ceremonies on Zoom. This increase in the value of the company is giving Zoom the ability to meet the challenges of a large percent of the population that will be working remotely, by hiring more engineers, paying for office space, buying more servers and computers for their data centers.
Another good example will be airline companies. In early March, Delta announced that it will cut its capacity in the next few months by 40%. This, they said, will result in grounding 300 planes. This would mean a reduction in airplane engineers, pilots, air hostess, IT engineers, etc. The company’s stock was trading at $45.05 at the beginning of the month. At the time of this writing, the stock is trading at $21.65. Hence, engineers that may get laid off from other companies affected by the pandemic like Delta can find jobs at remote conferencing companies like GoToMeeting, Cisco (Webex)and Zoom. Here, we see the economy effectively moving resources from the aviation sector which is experiencing lower demand to the remote conferencing technology sector, which is currently experiencing an increased demand.
But this clean and efficient process of resource allocation is only possible when there is no government intervention with the price system. If this happens, there is either shortage or wastage (surplus) of the commodity or service under question. Recent headlines like “$10 toilet paper? COVID-19 price gouging complaints surge in US,” “COVID-19 price-gouging complaints top 800 in Michigan,” and “AGs Crackdown on COVID-19 Related Price Gouging” show the rising clamor for government to intervene in the price system and the willingness of government officials to do so. One of these articles starts by saying “Attorneys General across the United States are cracking down on individuals and businesses that are selling hand-sanitizer, face masks, disinfectants, and other products at a substantial mark-up, taking advantage of product shortages related to COVID-19.”
These Attorney Generals have ensured a shortage of Lysol wipes, hand sanitizers and toilet papers. When things get difficult, we generally jettison basic economic principles when we need them the most. Of course, the prices of those commodities rose because of the panic caused by the coronavirus making people rush to the stores to buy up those commodities. Preventing prices from rising only ensures that those who get there first buy everything else and leave the rest with nothing to buy. Which is exactly what happened. For the past 2 weeks I have not been able to get hand sanitizers to buy at any store. On Amazon, the nearest time I could have one shipped to me was April 11th. Anti price gougers are causing shortages around the country.
Headlines like “… grocery stores see shortage of toilet paper, hand sanitizer,” and “How long will essentials like toilet paper be hard to get? It depends” are all over the place. One news report stated, “As coronavirus cases increase across the country, some shortages are occurring due to panic buying across the country of many household essentials like hand sanitizer, toilet paper and disinfecting wipes.”
This is no surprise. The same trees used as raw materials to make chairs, books, houses are also competing with toilet paper. Hence, if demand for toilet paper increases, its price should also increase so toilet paper manufacturers like Scott Paper and P&G can bid away more raw materials from the chair, books or construction industries, enabling them to have enough resources to provide toilet paper in the quality and quantity it is demanded.
Today you walk into any grocery store, you can find peanut butter, chicken strips or bread, but it’s almost impossible to find Lysol wipes or Purell hand sanitizers. Manipulating the price system through price controls prevents the market from adjusting itself. This has become a cliché, but the market will always adjust itself towards equilibrium to the degree there is less government intervention.
According to economist D. T. Armentano:
“The most important function of a free price (a price not fixed or regulated by the state) is its ability to serve as an indication of the relative scarcity of a commodity, and automatically ration that scarce commodity to the highest demander. As long as the price of an article is allowed to fluctuate and match the supply with demand, there will be neither surpluses nor shortages, i.e., the market will be cleared at some equilibrium price.
Government price-fixing destroys the clearing and allocating function of prices. By permanently fixing prices above or below their equilibrium values, the regulation prevents the equating of the available supply to the demand. Thus, short-run surpluses or shortages become inevitable. Even worse, the signals sent out by the fixed prices to the respective consumers and producers encourage inappropriate economic activity which tends to aggravate the original situation.
As an example, when copper prices are pegged below their equilibrium level, a short-run shortage is likely. What is worse, low prices encourage an increase in the demand for copper, as potential users switch from relatively higher priced substitutes. Likewise, low copper prices discourage the production of copper — already in short supply — since the low prices fail to cover the expected costs of copper production. In a double edged fashion, therefore, the future shortages of copper are exaggerated. Still worse, the excess demand created by the artificially fixed price of copper spills over into other commodity markets where it tends to push up the prices of other commodities or, if these prices are also fixed, cause additional shortages.”
What does this mean for employment?
With many events being cancelled, schools closing, and many people advised to work remotely, the COVID-19 will affect many jobs in the economy. While many jobs will be lost, many more will be created. Labour will move from the sector of the economy that is currently not experiencing a lot of demand (like the aviation and hospitality sectors) to the sectors of the economy with increased demand like — hospitals, medical labs, pharmaceuticals, fast moving consumer goods (FMCG), delivery services and remote conferencing technologies). These are where the new jobs will be created. This will happen without government intervention in the economy.
There is a demand for more medical professionals of all levels in the world right now. Hence, we can expect to see an increase in doctors, medical assistants, and nurses. There is also a need for researchers and scientists trying to find a vaccine and develop test kits. Hence engineers, microbiologists and laboratory technicians, with transferable skills from other industries that may have been affected by the pandemic can find jobs in university research labs, remote conferencing technology companies, delivery services companies, biotech and pharmaceutical companies. This is one example of the economy redirecting resources to areas of the economy that need them the most.
Social distancing has become a thing of value to many people in the population. Any good or service that can make social distancing possible will see an increase in demand. Most people now want food and groceries delivered, hence companies like DoorDash, Instacart and Bite Squad will see an increase in demand for their services. This will lead to an increase in prices of those services. With the increased revenue, the food and grocery delivery companies will have the necessary resources to hire more drivers and IT engineers to meet the increased demand. Also, to encourage more people to become delivery drivers, these companies will have to increase the wages they pay, and they will be able to do this because of the high prices of delivery services as a result of an increase in demand for those services.
As more people continue to buy things online, online retailers must ramp up their operations and supply chains to ensure that people get what they demand. The high prices (as a result of increased demand for eCommerce services) will enable the retailers ramp up their operations and hire more employees. Amazon recently announced that it will be posting 100,000 new jobs to “support people relying on Amazon’s service in this stressful time.” These jobs will be in “… fulfillment centers, transportation operations, stores or those making deliveries.”
Walmart also recently announced that it would be adding 150,000 more employees to “meet demand in our stores” through May
Now these roles require people to leave their houses and come to work, in a time of social distancing. A lot of people really want to be home right now but with the right incentive, will be willing to go to work. To encourage people to apply, Amazon stated it will “… be adding an additional $2 USD per hour worked through April from… current rate of $15/hour or more, depending on the region, C$2 in Canada, £2 per hour in the UK, and approximately €2 per hour in many EU countries.” To make it even more appealing, the company stated it would “continue to consult with medical and health experts, and take all recommended precautions…” in its “… buildings and stores to keep people healthy.” A $2/hour increase and an update to the company’s health policy may not be enough of an incentive for most people, but it will be for some, and the economy will be better off because of it.
The topic of employment can be a dicey one to talk about. For many of us, especially skilled and semi-skilled workers, it may be difficult for our skills to be transferable from one industry to another. We are mostly consumers of many commodities and services but producers of one. That is, we have developed skills in producing one good or service. Some of us are engineers, auditors, accountants, financial advisers, professors, etc. — producing one good or service. But we all consume hundreds if not thousands of goods and services. For example, an accountant drives a car, uses toilet paper, lives in a house or apartment, probably drinks alcoholic beverages, dines out at nice restaurants and uses the drive through at Popeyes. This is the benefit of living in society based on the division of labour, knowledge and specialization. It could make losing a job very scary. We have bills to pay and in some cases dependents and loved ones to take care of. But this does not change the basic principle of demand and supply with respect to the goods or services many of us produce at our jobs.
Many governments have announced stimulus programs, with billions of dollars to prop up many industries facing plummeting demand as a result of the pandemic. While I do not have enough space to go into details about these programs here, it is important to note that these stimulus programs are government interventions with the price system and will be bad for the economy, especially with regards to addressing the COVID-19 crises. Because it will stop scarce resources from going to the sectors of the economy that currently need them the most to fight this virus. To this effect, I will address this issue in detail in another piece.
If there is anything our political leaders and decision makers within the government need to learn is that prices, all things being equal, will always respond in an inverse manner to the supply of any commodity. If the supply increases the price will fall, and if supply falls the price will increase. The same way prices will always respond in a direct manner to demand of any commodity. If demand increases prices will rise and if demand decreases prices will fall. (The whole world literally witnessed this fundamental economic principle take place in the demand and the eventual prices for airplane tickets and hand sanitizers).
Fighting this pandemic could be considered a war, and a war can be considered a serious political problem. But to solve any political problem, one needs a good understanding of economic principles. To ignore these principles is to ensure that serious political problems become exacerbated and eventually, protracted.