Market Follies

The debate over how markets function, and how they should be allowed to function, goes back at least to Adam Smith. On the far right are those who argue that the market mechanism can solve most problems by itself if left alone. Those on the far left argue that the system is fundamentally flawed and only produces poverty for the great majority of workers. Most economists and governments fall somewhere in the middle, with the right of center favoring more reliance on the operation of markets, and the left of center arguing for more, albeit selective, government control. Our two political parties generally divide the same way, with the Republicans adhering more closely to free-market orthodoxy and the Democrats more willing to use the force of government to tilt markets in the directions they favor.

This debate is ancient, and it is not going to be resolved anytime soon. But occasionally something comes along that sheds light on how markets operate and, in the process, gives some comfort to both sides while also raising some alarm bells. Such is the case currently with Covid-19, which has produced a huge spike in demand for personal protective equipment (PPE), particularly masks, but also more sophisticated medical technology products like ventilators. The South China Morning Post has published an article that looks at what is happening as the market in China responds to the demand wave that bears a close look. The huge demand, particularly for masks, has produced the predictable market response—current manufacturers are cranking them out as fast as they can, and new producers are entering the market daily. For conservative economists, this is exactly what is supposed to happen. The market is responding to a demand shift and is doing so faster and more efficiently than the government could possibly do it. The world might, at some point, in the near future, be awash in masks.

Sounds great, doesn’t it? But there is more to the story. Along with the impressive ramping up of production have come problems. One is quality. New companies coming into the market, in particular, do not necessarily know how to make the product, may use inferior materials, and will be tempted to skirt licensing and other regulatory requirements. There are already reports of inferior products that do not meet either buyer specifications or regulatory requirements in the importing country arriving from China.

Another problem is price gouging. Market economists teach us that when demand goes up, so will the price until a new equilibrium is reached between supply and demand. That is normal, but it does not account for the unscrupulous companies that will raise prices far above any reasonable level, knowing that there are panic-stricken customers out there who will pay any price. On top of that is the ongoing problem of scam artists posting offers to sell PPE when they have none and simply pocketing the money and disappearing, only to reappear with a different name and address.

So, a bit of a dilemma. Conservatives will point out correctly that the market is responding more quickly and efficiently than the government can, and lives are being saved as a result. Liberals, equally correctly, will point to the costs of inadequate regulation, the lives that will be lost because of defective equipment, and the money wasted that could have gone to more productive uses. Some of the differences will be papered over with agreement on tougher enforcement against the crooks and scammers, but there will still be a debate over the extent to which regulation and oversight should be relaxed during a crisis. We saw echoes of that during the congressional debate over the Coronavirus Aid, Relief, and Economic Security (CARES) Act responding to the pandemic, with some arguing the crisis was so severe and so immediate that we should dispense with normal guiderails and protections, and others pointing out the dangers of that.

At this point, I’m going to chicken out and leave drawing that line to others. Suffice it to say, though, that there should be a line, and it should be drawn carefully. Markets do not adequately regulate themselves, and we have seen over and over the consequences of government not paying sufficiently close attention to what is happening in the marketplace.

Finally, I want to note one further market inevitability that we should prepare for now. A demand spike inevitably means a trough at some later point. The demand for medical equipment right now is so great and so urgent nobody is thinking about that. But at some point, demand will shrink to normal levels, and many companies who entered the market speculatively will be left holding the bag. That will be true in the United States as well as China. We can certainly hope they are the crooks and shoddy producers and not the good guys, although justice is rarely that simple. But that certainly should remind us of another market characteristic—the boom and bust cycle, or, as we all learned in school, what goes up, must come down. From Dutch tulips in the seventeenth century to real estate bubbles to the financial crisis in 2008, markets have demonstrated they are not good at controlling excess. We should expect that again this time and prepare for it now.

William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies in Washington, D.C.

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