Blog author: mvandermaas
by on Thursday, August 25, 2005
Aah, the good old days!

In case you haven’t noticed, the price of gasoline has been going up lately. And, with all the predictability of the swallows returning to Capistrano, the cry has gone up from certain quarters of society for the government to do something about the situation. Unfortunately for consumers in paradise, the State of Hawaii has decided to respond to that demand by instituting price caps on gasoline.

The price caps, which will be instituted on September 1, are the result of a process that began with the passage of Act 77, which was enacted in June of 2002. Implementation of the act was delayed, however, in order for enough time to pass for a more comprehensive study of Hawaii’s gasoline market to be undertaken. One might ask whether it might have been better to do that before passing price control legislation, but I suppose we should be thankful that the legislature required this inquiry at all.

The required report was released in September of 2003, and argues strongly against the implementation of price caps. Testimony from the Federal Trade Commission noted that part of the problem is that Hawaii’s gasoline market already suffers from price control policies capping the rent that could be charged to retail dealers by wholesalers:

Wholesalers could respond to rent controls in two different ways, both of which likely would reduce the number and quality of dealer-operated gasoline stations. If rent controls have the effect of reducing the total revenues that a wholesaler receives from dealers, then the wholesaler is likely to have fewer dealer-operated stations than it would in the absence of the rent control and to spend less money maintaining the stations. Alternatively, the wholesaler might try to make up for the lost lease revenues by increasing the price it charges the dealer for gasoline (assuming the wholesale price cap on gasoline is not binding). In that case, the wholesaler effectively bears more risk, because more of its revenues would come from the sale of a commodity whose price fluctuates, rather than from rents. This increased risk increases the wholesaler’s cost of selling gasoline through stations operated by lessee-dealers. The wholesaler likely would respond to this cost increase by using fewer dealer-operated stations or investing less money in maintaining the stations. In short, the rent controls likely would reduce the number and quality of gasoline stations, increase gasoline prices, and cause inconvenience for consumers, who would have to travel farther to find gas stations.

Additionally, Hawaii had enacted restrictions on who could enter the gasoline market:

Hawaii’s law prohibiting “encroachment” (and its predecessor “divorcement” law) constrain the ability of both incumbents and new entrants to establish new stations… In 1997, Hawaii replaced divorcement with an anti-encroachment law barring oil companies as well as jobbers from opening company-operated stations within a radius of one-eighth of a mile around every dealer-operated station in an urban area and one-quarter of a mile in other areas.

Published economic research demonstrates that anti-encroachment and divorcement laws tend to increase retail gasoline prices. A National Bureau of Economic Research study found that company-operated stations can be the most efficient form of management for high-volume, low-service gasoline stations. Laws that limit marketers’ ability to establish new company-operated stations thus force them to adopt higher-cost organizational forms, and these increased costs likely are passed through to consumers in the form of higher gasoline prices. The most comprehensive of the published economic studies, conducted by a senior FTC economist, found that state divorcement and anti-encroachment laws tend to increase retail prices by an average of 2.6 cents per gallon. Another study found Maryland’s divorcement law, the first in the nation, raised self-service gasoline prices by 1.4 to 1.7 cents and full-service prices by 5 to 7 cents per gallon at stations that were formerly company-operated. We are aware of no study specifically estimating the effect of Hawaii’s divorcement and anti-encroachment laws, but we know of no reason that these laws would not have effects in Hawaii similar to their effects in other states. Indeed, the FTC warned in 1985 that the divorcement law already under discussion in Hawaii “would unquestionably increase the costs of gasoline distribution, eliminate legitimate price competition, and raise prices for motor fuel to consumers.”

The study also noted that Hawaii’s gas taxes at the time were approximately 12 cents per gallon higher than the US average.

In spite of the report’s recommendation to ditch price controls and turn toward a more market-oriented solution, the Hawaii legislature stuck with the caps. So what is likely to happen now? David Henderson from the Hoover Institution provides a succinct analysis:

What determines the price of gasoline is the amount producers are willing to supply at various prices and the amount drivers demand at various prices. At the current price of gasoline, say $2.00, the amount drivers want to buy roughly equals the amount producers want to sell. That’s why there are no gas lines. Such a “market-clearing price” evolves in every competitive market.

What happens, then, when the government decrees that the price of gasoline be no higher than, say, $1.80. The obvious answer is that consumers now can get their gas for 20 cents a gallon less. But that answer is incomplete.

At a price of $1.80, consumers will want more than they wanted at $2.00. One of the things economists are surest of is that we want more of a good when its price falls. At that lower price, producers want to supply less. The necessary result, therefore, is a shortage: the amount demanded exceeds the amount supplied.

Shortages lead to lineups. Consumers then compete with each other, not just by paying money but by spending time in line. Economists call this lost time a “deadweight loss,” a loss to some that is a gain to none.

The real kicker is that when adjusted for inflation, the price of oil has a long way to go before hitting a record high. (On a related note, be sure to check out John Tierney’s column in Tuesday’s New York Times regarding whether or not the price of oil will remain at current levels or decline over time.)

Perhaps someday we will finally learn that the market is the best way to set prices. Although, judging from history, that seems pretty unlikely. I close with this admonition from Walter Williams:

In 302, the Roman emperor Diocletian commanded “there should be cheapness,” declaring, “Unprincipled greed appears wherever our armies … march. … Our law shall fix a measure and a limit to this greed.” The predictable result of Diocletian’s food price controls were black markets, hunger and food confiscation by his soldiers. Despite the disastrous history of price controls, politicians never manage to resist tampering with prices — that’s not a flattering observation of their learning abilities.