Consumer Advocate in Chief?

Consumer Advocate in Chief?
Tuesday, May 10, 2011
by Gary Galles

In response to the run-up in oil and gasoline prices, President Obama has chosen to follow a well-worn script -- looking for political advantage by pretending to protect voters from the evils of the marketplace. However, his attempt to portray himself as consumer advocate in chief is nothing more than calculated pretense.

At a town hall meeting in Reno, President Obama said,

Last month, I asked my attorney general to look into any cases of price gouging, so we can make sure no one's being taken advantage of at the pump. Today, we're going a step further. The Attorney General's putting together a team whose job it will be to root out any cases of fraud or manipulation in the oil markets that might affect gas prices -- and that includes the role of traders and speculators. We are going to make sure that no one is taking advantage of the American people for their own short-term gain.

That statement was reinforced by a memo from Eric Holder to the Financial Fraud Enforcement Task Force, stating,

Together, we will continue to be vigilant in monitoring for any wrongdoing with respect to rising oil or gasoline prices, so that Americans can be confident that they are not paying a penny more than they should at the gas pump -- and that there is no violation of federal or state law, collusion, or fraud with respect to the price of the gasoline upon which our economy so vitally depends.

One problem is that the implicit accusations of gouging, manipulation, and collusion being made against marketplace behavior involve legally ambiguous or undefined terms. What evidence could prove, rather than just assert, that gouging was taking place? What qualifies as prosecutable manipulation? And not only is collusion already illegal (so authorities should have already been vigilant on that score, requiring no special announcement or task force), a long list of past industry investigations have found no evidence of it. Those words are just vague but ominous-sounding accusations intended to divert any blame and anger that might be directed at the administration onto others who can be made into scapegoats.

Consider gouging. How would it be defined? Political attempts at a definition are usually made in terms of charging "excessive" prices or failing to charge "fair" or "reasonable" prices. For example, in 2007 the then-Democrat-controlled House of Representatives passed a bill that could lead to fines of up to $3 million per day for gasoline price gouging, defined as charging a price that "grossly exceeds the average price … offered for sale by that person during the 30 days prior" or "grossly exceeds the price at which the same or similar gasoline … was readily obtainable in the same area from other competing sellers." Unfortunately, none of those adjectives or adverbs have clear meanings.

Unfortunately, however, investigations or laws built on such undefined terms fail to meet the basic purpose of the rule of law. That purpose is to make clear beforehand what is not allowable, so that decision makers know the limits on their actions, and know that within those bounds, they can pursue voluntary arrangements without needing to worry about political extortion or prosecution.

Effective social cooperation can only be built upon clear rules that constrain government arbitrariness as well as abuses by others. But potential government prosecution for violating an essentially undefined law leaves every decision's legality subject to the whim of a judge or executive-agency functionary, exercised after the fact. No one can know what actions are safe from prosecution. And combining arbitrariness with huge potential punishments is an open invitation to government abuse.

Threatening prosecution for supposed gouging should be adamantly rejected; it expands Americans' exposure to arbitrary acts, including inherently selective prosecution, rather than offering protection against them. Worse, those arbitrary acts are backed by government's coercive power, which far exceeds any alleged "market power" it is supposedly combating; "market power" has to be continually earned through voluntary interactions in the face of competition.

Since gouging is undefined, any prosecution for it would effectively create law after the fact and apply it to prior behavior. The unfairness, as well as arbitrariness, of applying rules retroactively is obvious. What would happen if referees could change the rules of a game after the fact? What if casino payoffs could be changed by the house after the roulette wheel stopped? What if your employer could retroactively lower your wages for last year?

Not only is making the law retroactive inherently unfair, it also violates the plain wording of Article I, Section 9 of the Constitution. That section bans ex post facto laws, reflecting "Federalist 44," where James Madison describes them as "contrary to the first principles of the social compact, and to every principle of sound legislation … all of them are prohibited by the spirit and scope of these fundamental charters."

Why would the president make a public show of toughness using an approach and terms that fail basic standards of logic, fairness, and constitutionality? Because it gives him power without responsibility.

With standards for prosecution that are never spelled out, the administration can manipulate firms' behavior by threatening prosecution (which is always very costly for the accused); the state can thus preen as a defender of "the people" without being bound by effective accountability or constraints. After all, because the standards are unknown, political machinations cannot be easily fingered as the cause.

This approach works the same way as civil-rights legislation. Its supporters adamantly denied that it would ever create quotas, and yet it created them: firms didn't know what would be called illegally discriminatory, so to protect themselves from the uncertainty and cost of litigation, they often began relying on quotas.

Accusations and punishments that can essentially criminalize behavior that is legal until, after the fact, it gets selectively redefined as illegal cannot advance Americans' general welfare. It is a grandstanding abuse of government power that reveals its blundering incompetence in yet another area of our lives.

Demanding investigations into whether higher gas prices reflect manipulation or collusion is just a much an example of political posturing.

Absent a smoking-gun conspiracy, which is already illegal, not to mention impossible if the government was really protecting us, manipulation or collusion is unprovable from current prices. The reason is that multiple political and market forces, with impossible-to-quantify effects, are pushing prices up, so that there is no way to know what the competitive price should be, especially because the relevant costs are forward-looking rather than historical. Without that knowledge, one cannot demonstrate that some foul play has artificially raised current prices.

Particularly critical to manipulation or collusion charges, and especially charges made to blame speculators who supposedly change prices with no real economic basis, is the uncertainty about future oil supplies. A refiner planning to stay in business must replace oil used up in current gas production. The relevant cost of that oil is therefore not what it cost to buy it in the past, or even in the present, but what it will cost to replace it in the future.

However, no one can know what that cost "really" will be in the face of the present uncertainty -- with the complications of heightened unrest in many oil-producing nations added to those of economic growth in other parts in the world, ethanol mandates, and the falling value of the dollar relative to other currencies. Without all that information, there is no way to demonstrate gouging or collusion.

California's earlier switch from MTBE to ethanol and its unique cleaner-gas "recipe" is a historical illustration. No one knew exactly how much the prices per gallon should rise to cover the billions in added costs. It depended on a host of variables, including how many gallons would be sold, the risk and therefore the return companies "should" earn on their investments, how much further future regulations would raise costs, etc.

The effects of such issues on "competitive" gas prices would need to be accurately quantified before anyone could possibly show manipulation or collusion by proving that prices are "too high." However, this cannot be done.

But that does not stop political scapegoating of "big oil." The mere accusation is designed to put the burden of proof on oil companies and traders, who cannot produce numbers that definitively disprove the charges. Of course, lost in the process is the fact that their accusers cannot prove them either. But the posturing buys votes from ignorant citizens.

What should we make of government gouging, manipulation, and collusion witch hunts that cannot possibly prove what they are supposedly looking for? What about when such scapegoating is combined with a host of government policies that substantially raise oil and gas prices (e.g., inflationary policies that have driven the exchange value of the dollar down and so raised oil prices, drilling and development restrictions, environmental exactions that prevent development of new refineries, taxes that dwarf any profits earned by "big oil," etc.)?

We should recognize that government does not protect us against the evils of the market, and that its rhetorical posing as consumer advocate is both dishonest and dangerous. Instead, what we need is more reliance on the market to protect us against the evils of ill-advised government policies and grandstanding.


Gary M. Galles is a professor of economics at Pepperdine University

http://mises.org/daily/5261/Consumer-Advocate-in-Chief