Lesson 2: When Disaster Strikes, What Can Markets Do? Vocabulary



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6.  When alternatives to market rationing tend to prolong the damage from the disaster; they increase costs and scarcity by promoting hoarding and wasting of resources like labor, energy, and creativity.  While rising market prices may seem to impose additional hardship, they speed up the return to normalcy by reallocating resources for effective disaster response.



  • Complaints that higher prices are “unfair” are common when disasters increase scarcity. As a result, we may see individual merchants or even whole cities substitute rationing by queuing for rationing by price.  The perception that time spent in line is “free” is misguided even in normal circumstances but particularly in the urgency created by disasters. 

  • The cost of standing in line to get low-priced gasoline was calculated in money terms by Richard Bradley and Thomas Tanton of the Institute for Energy Research, using 2005 data: “An hour in line adds about $1.00 per gallon to the pump price for the average American worker.” (Bradley, 4)

      • When time is of critical importance during an emergency, the implicit value of people’s time is surely much higher than their normal wage rates, implying that the extra costs of waiting are very high indeed.

    • Bradley and Tanton also found that first-come-first-served rationing of gasoline:

    • discourages movement of fuel into the emergency areas where it is most needed,

    • encourages hoarding – for example, by “tank-topping” –  which increases scarcity as much more gas is carried around in gas tanks than in normal times,

    • encourages “panic buying” (including such dangerous behavior as filling ice chests with gasoline!), 

    • triggers shortages, and

    • provokes civil unrest. (Bradley, 5)

  • Analysis of consumer behavior in the chaotic evacuation of Houston during Hurricane Rita revealed that rationing gasoline by low-price-plus-time-in-line had the unfortunate (but predictable) effect of encouraging people to allocate gas to less-urgent uses. Simply put, for people who knew they would be standing in line for gas anyway, standing in line with two cars rather than one added negligibly to the cost of getting out of town. If gas prices had instead been sharply higher (but there were no lines at stations) very real savings could have been realized by taking only one car and filling only one tank with the (temporarily) high-priced gas.

  • In sharp contrast to the consequences of price controls, as the historical example of the Great Chicago Fire illustrates, rising market prices send signals that reduce the post-disaster chaos and facilitate a rapid return to normal conditions – and normal prices. 




Case Study: The Great Chicago Fire of 1871

Prices Help Housing Markets Recover Quickly
Theory predicts that markets will adjust to changes in circumstances to maintain the most beneficial allocation of resources, but do they? What happens in “real life” when natural disasters, for example, significantly increase scarcity, impacting the well-being of thousands of people? Conducting experiments to test our theories is neither desirable nor possible, but historical records sometimes provide what amounts to experimental data on the operation of markets. Records from the Great Chicago Fire of 1871, for example, allow us to “test” the contention that markets, operating on their own, can quickly adapt to changing conditions and return life to normal.
Disaster relief was not considered a role for the federal government until well into the 20th century, and at the time of the fire, even state and local governments did little to expand their conventional roles of maintaining law and order and emergency rescue through police and fire departments and militias. (This is not to understate the importance of these roles. The Chicago Evening Journal noted that, “The city is infested with a horde of thieves, burglars and cut-throats, bent on plunder, and who will not hesitate to burn, pillage and even murder, as opportunity may seem to offer them to do so with safety. . . . The authorities declared martial law, and Lt. Gen. Philip Sheridan, the Civil War hero and a Chicago resident, led troops in to help preserve ‘the good order and peace of the city,’ in the words of Mayor Roswell B. Mason.”) (Phillips)
Issues of The Chicago Tribune published before and after the fire are the inadvertent sources of data for our historical economic experiment. While a doctoral student at the University of Chicago, economist Dendy Macaulay used newspaper ads, notices, and published public records to construct a picture of the post-fire Chicago housing market. Her 2005 analysis reinforces the predictions of our economic model; she found that price changes caused reallocation of resources to address the housing shortage so effectively that the Chicago housing market resumed its pre-fire development trend by the fall of 1872, only one year after the fire left one-third of the city’s population homeless and destroyed over half of its property value. (See entry in the “Catalog of Disasters” addendum to the Introduction for a complete description and overview of the economic impact of the Chicago fire.)
Macaulay also found that the significant price changes that occurred as the rental and boarding markets reacted to both supply shock (rooms and apartments destroyed by fire) and consumption shock (influx of workers in addition to returning residents whose houses had been destroyed) were short-lived. Rather than imposing long-term hardship, the changing prices effected a reallocation of resources that quickly allowed the city to recover and citizens to resume their normal activities. Among Macaulay’s findings:


  • Two months after the fire, the rental prices jumped 40% above the pre-fire, upward trend, but had returned to the long-term trend by September, 1872, only 11 months after the fire.

  • The Chicago Tribune estimated that by October 16, eight days after the fire, 60,000 residents had left the city, but over half of them returned within a few weeks. Added to their demand for temporary housing was that of workers who flooded into the city as rebuilding began. Boarding rates jumped 60% but, as with rental prices, returned to pre-fire trends within a year.

  • In all, 17,500 buildings – including homes and businesses – were destroyed in the fire. As winter approached, the Relief and Aid Society helped residents build two-room temporary shelters (16 X 25 ft.) on their burned over lots. By early November, 4000 (of the eventual 11,000) had already been completed.

  • Even before the city adopted a fire-safety building code in February, 1872, many residents decided to rebuild with more fireproof materials. Debris had to be piled along the shore of Lake Michigan before reconstruction could start, but even so, by late November, barely six weeks after the fire, 212 permanent stone or brick buildings – business and residential – were under construction.

  • Housing values, not as influenced by short term changes as the rental and boarding markets, nonetheless showed a post-fire increase of 20%. As in the other markets, the evidence of market shock had disappeared by the fire’s anniversary date in 1872.

  • Prices of houses are a reflection of their discounted future rental value. Because the market anticipated that rental values would come back down as rebuilding progressed, housing prices did not spike as much as rents and boarding rates did.

Macaulay’s investigation also turned up illustrations of how the changes in housing markets caused other markets to change – for example, the markets for fire brick and the lime-free clay used to make it. In response to the February, 1872, City Council ordinance establishing a fire-safe building code, the increased demand for fire brick caused the price from the Philadelphia supplier to skyrocket, a strong incentive to find a local source. Construction records show that the incentive worked, and much of the brick used to rebuild the city was made of clay mined from the shores of Lake Michigan. ( 21)



Source: Macaulay, Dendy. “The Chicago Fire of 1871: An Empirical Analysis.” Unpublished manuscript. University of Chicago, May, 2005).


Conclusion

In 1945, Frederich von Hayek offered us the answer to the question posed in this lesson – “When disaster strikes, what can markets do?” – by pointing out that to successfully address scarcity and satisfy people’s wants, economies must “adapt to changes in the particular circumstance of time and place.” Markets do that to our advantage not only in day-to-day life, but also in the urgency of disaster. Market prices communicate information about what is available and what is wanted and they provide incentives for both producers and consumers to make choices that reduce the impact of disaster-heightened scarcity. And, markets do so at less cost than other methods of allocation. This is not to contend that we should leave all disaster response to the market. Even in normal times, we recognize the value of institutions other than markets; we understand the important role they play in our well-being, and we depend on them to work in conjunction with markets in times of disaster. In the next lesson – “When Disaster Strikes, What Can Government Do?” – we will look at important disaster-related tasks like organizing emergency rescue, maintaining the rule of law, and repairing infrastructure.


When we consider how our institutions can best serve us in disaster, it is surely appropriate to acknowledge that there are some things the markets do not do well. But, it is also important to remember the market’s effectiveness in marshalling and allocating resources to satisfy our wants. When we appreciate what markets do, we can step back and let them work. Wal-Mart Chief Executive Lee Scott, Jr. commented after Hurricane Katrina, “We can’t more than our own part. . . . [but] There is a portion we can do, and we can do it darn well!” (Barbaro, D01) He makes a good point – for Wal-Mart and for markets.

Sources
Barbaro, Michael and Justin Gillis. “Wal-Mart at Forefront of Hurricane Relief.” The Washington Post, September 6, 2005. p. D01. http://www.washingtonpost.com/wp-dyn/content/article/2005/09/05/AR2005090501598.html (3-28-07)
Bradley, Robert L. and Thomas Tanton. “Motor Fuel and Natural Disasters: Don’t Regulate.” American Legislative Exchange Council (ALEC) Policy Forum, Winter, 2005. Institute for Energy Research, October 24, 2005. http://instituteforenergyresearch.org/TantonPriceGouging.final.pdf (04-3-07)
Chamlee-Wright, Emily and Daniel M. Rothschild. “Disastrous Uncertainty: How Government Disaster Policy Undermines Community Rebound.” Mercatus Policy Series, Policy Comment No. 9, January, 2007. Mercatus Center, George Mason University. http://www.mercatus.org/Publications/pubID.3579/pub_detail.asp (3-10-07)
Demick, Barbara. “Elephants Help Clear Tsunami Debris.” Deseret News, January 23, 2005. http://www.findarticles.com/p/articles/mi_qn4188/is_20050123/ai_n11497180 (3-28-07)
Ed. “Private FEMA – In Katrina’s Wake, Wal-Mart and Home Depot Came to the Rescue.” The Wall Street Journal, Sept. 10, 2005. www.opinionjournal.com/forms/printThis.html?id=110007238 (3-23-07)
Federal Reserve Bank of Dallas, Houston Branch. “In the Eye of the Storm: Gasoline Markets After the Hurricanes.” Houston Business – A Perspective on the Houston Economy, June, 2006. http://www.dallasfed.org/research/houston/2006/hb0602.html (3-30-07)
Fishbough, Ed and Jeff Prescott. “HCA Completes Airlift Evacuation at Tulane University Hospital and Clinic; Assists Nearby Hospitals.” HCA News http://phx.corporate-ir.net/phoenix.zhtml?c=63489&p=irol-newsArticle&ID=752385&highlight= (3-28-07)
Friedman, Thomas. The World Is Flat. New York: Farrar, Straus and Giroux, 2005. p. 136.
Hayek, Frederich A. “The Use of Knowledge in Society.” The American Economic Review, Vol. XXXV, No. 4. September, 1945. pp. 519-530.
Konig, Susan. “Private Companies Rush in to Help Hurricane Katrina Victims.” Health Care News, October 1, 2005. The Heartland Institute: http://www.heartland.org/Article.cfm?artId=17757 (3-30-07)
Macaulay, Dendy. “The Chicago Fire of 1871: An Empirical Analysis.” Unpublished manuscript. University of Chicago, May, 2005).
Phillips, Michael and Cynthia Crossen. “Will New Orleans Rebound?” The Wall Street Journal Online, September 1, 2005. http://online.wsj.com/public/article/SB112553416459828571-_ZTZWwws20Tc6H_ru8nhp4p_IKo_20051001.html?mod=blogs (3-30-07)
Salinger, Michael A., Director, Bureau of Economics, Federal Trade Commission. “Moneyball and Price Gouging.” Address t the Antitrust Committee of Boston Bar Association, February 27, 2006, p. 3 http://www.ftc.gov/speeches/salinger/060227MoneyballandPriceGouging.pdf (3-10-07)
Sobel, Russell S. and Peter T. Leeson. “Flirting with Disaster – The Inherent Problems with FEMA (Executive Summary).” Policy Analysis, No. 573, July 19, 2006. Cato Institute. http://www.cato.org/pub_display.php?pub_id=6516 (3-3-07)
_____. “The Use of Knowledge in Natural Disaster Relief Management.” Global Prosperity Initiative Working Paper, Mercatus Center, George Mason University, November 15, 2006. http://www.mercatus.org/publications/pubid.3584/pub_detail.asp (3-3-07)
Theroux, Mary L.G. “Public and Private Responses to Katrina: What Can We Learn?” Oct 20, 2005 Speech presented at the Chief Executive Organization’s Women’s Seminar, Oct 7, 2005. Independent Institute, Oct. 20, 2005. http://www.independent.org/newsroom/article.asp?id=1589 (3-29-07)
U.S. Department of State. “U.S. Private-Sector Support for Tsunami Relief.” USINFO.STATE.GOV http://usinfo.state.gov/products/pubs/tsunami/private.htm (3-30-07)
Zap2it.com. “‘Alexander’ Elephants Aid Tsunami Relief Efforts.” Zap2it.com, January 3, 2005. http://movies.zap2it.com/movies/news/pstory/0,3382,24175,00. (3-10-07)



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