Let me begin by thanking you for this opportunity to offer a few thoughts on the California electricity market. And let me offer my gratitude in particular to Sally and Lisa, and PRI generally. Now that I think about it a bit, jokes about Communism and about self-promoters are not a bad way to begin a discussion of a takeover of the electricity market takeover by the state government. The same institutional incentives that operate the public schools, the Department of Motor Vehicles, and all of the other source material for late-night comedy punch lines will have a heavy hand in the delivery of electric service to Californians. And do not be fooled into believing that this situation will be short-term or temporary; because pricing, investment, siting, and other central decisions will be heavily politicized, powerful interest groups will be created with incentives to perpetuate the system. No other outcome is possible even in principle because politics by its very nature is the art of wealth redistribution.

In any event, I’d like to defer to a later date a discussion of the narrow economics and public policy analytics of the new system that now is evolving before our eyes, particularly since the details of the long-term contracts into which the state is entering still are unclear in many specifics. That is the case also with respect to such regulatory issues as the degree to which the government will find ways to confiscate private sector capital, whether through explicit or implicit means.

Instead, I would like to address a different set of underlying issues that are somewhat more philosophical or normative in nature. These issues are and will remain highly relevant because the political battle over the future evolution of the California electricity market fundamentally is an ideological one. That is going to become blindingly clear in the not-very-distant future when Harvey Rosenfield and his allies present us with one or more ballot initiatives designed both to make people and business firms more rather than less dependent upon government, and to transfer wealth to their political constituencies.

Make no mistake about it. The long twilight struggle over the California electricity market now just beginning is about far more than the mere price of kilowatt-hours and not-in-my-backyard obstructionism. It is fundamentally an ideological battle as well; and businessmen and women as a crude generalization simply are not very good at fighting such fights. That is not a criticism. The business sector is good at producing things that other people value—a theme to which I will return in a few minutes—and tends to be staffed with people who are good at just that. The skills useful for an ideological battle are very different, and few people are good at both.

And so I would like to deal this evening with just that ideological dimension of the current situation. Accordingly, I have entitled this talk, “In Defense of Price Gouging and Profiteering.”

No, I am not kidding. Those terms—epithets really—roll easily off of the tongues of pundits, politicians, preachers, and other assorted philosophers; but the precise meaning of those words remains entirely obscure.

Let us begin with the classic example of a major natural disaster—an earthquake perhaps, or a hurricane—in the aftermath of which there results a dramatic rise in the market price of, say, bottled water. Why has that happened? Well, it is really quite simple despite the efforts of economists to make it far more complicated than it is. As a result of the earthquake, the demand for bottled water—the value that people place upon it—rises sharply, and supply declines, perhaps because of transportation bottlenecks and the like. And so, voila! The market-clearing price, that is, the price that leads the market to demand and supply the same quantities, rises, significantly in our example.

Consider an entrepreneur charging that price. He will be accused, by a broad array of people, of “price-gouging” But what does that mean? As a result of the earthquake, there simply is less water relative to demand; that is the unhappy reality. Some method must be used to allocate the available water among consumers, all of whom are anxious to obtain it. One method is rationing by price; those who refer to that mechanism as “price-gouging” obviously find it unfair. That certainly is true if by “unfair” one means that some people—the poor in this case—will tend to be denied. But because there simply is less bottled water available—there is no getting around that reality—any rationing system will deny some in favor of others. Suppose that we impose price controls so that the amount demanded exceeds the amount available. We could force people to wait in line for bottled water, a system that favors those with more flexible schedules or with relatively low time values. That is what we did when we maintained binding price controls on gasoline in 1973 and 1979. What is fair about that?

Alternatively, we could simply allocate each person a certain number of bottles. If we allow people to resell their water, we are back to price gouging, but by consumers rather than producers. If we do not, people who arguably really need more bottled water—people who are ill, people with small children, etc.—will find it excruciatingly difficult to obtain it from those who are using it to bathe their dogs, unless they revert to the time-honored wartime technique of trading, say, sexual favors for water. Is that “fair”?

The plain reality is that any system of allocating the available water will favor some people and not others. What about a footrace to the local water warehouse? That would favor the swift and the young. Don’t laugh: For years, college football tickets were given to students on the basis of who showed up at a particular office first. How about letting people just fight it out, as has happened often enough in the tragic history of man. That would favor the young, the strong, and males rather than females. Suppose we allow beauty to be the criterion. A lot of guys like me would go awfully thirsty. And, again, don’t be too quick to laugh: During the gasoline crunch of the 1970s, there was a substantial amount of anecdotal evidence to the effect that young attractive women had an easier time of it than everyone else. That was utterly believable and wholly predictable. Was it “fair”? Well, it depends on who you are and the system under which you think that you will be able to compete most effectively. Where people stand depends on where they sit.

And so the moral disadvantage of “price gouging” relative to other methods of allocating a good suddenly more precious remains entirely obscure. People seem viscerally to assume that the poor are deserving and that rationing other than by price will make them better off. But that is a fallacy: We need to be told what alternative rationing scheme will be used, and why that would be better for the poor. We need to be told how the poor will fare in other markets when the nonpoor, prevented from bidding up the price of water, instead bid up the prices of other goods. And we need to be told how the poor can be made better off when government pursues policies—price controls—that make the aggregate economic pie smaller. Do not be surprised to discover that when the Harvey Rosenfields, Harry Snyders, and Gray Davises of the world speak, the answers to those fundamental questions remain shrouded in rhetorical fog.

What is quite clear, on the other hand, is that price gouging—allocation by market price—provides powerful incentives to conserve for those who can do so with relative ease; and powerful incentives for people and businesses to find ways to supply more bottled water. Does anyone want to argue that those are undesirable outcomes? Price rationing may or may not be good for the poor, but, then, any rationing scheme is bad for someone. Unless we want to argue that the poor have a greater moral claim than others—a position that I would criticize sharply—the widely assumed but poorly reasoned premise that price gouging—rationing by price—is morally deficient is, in my view, a popular fallacy.

Let me turn now to the equally dubious concept of “profiteering,” an operational definition of which is nowhere to be found. I had a spirited email exchange with a very prominent Los Angeles Times columnist recently after one of my op-ed columns appeared, and he accused me of encouraging “profiteering,” apparently because I made the rather obvious point that charges of “profiteering” are irresponsible and demagogic, and unlikely to improve the investment climate in the state. I asked this gentleman—you would recognize his name instantly—to give me an operational definition of “profiteering.” His answer? “Excessive profit contrary to the larger public interest.” Well, thanks for clearing that up!

The first obvious point to be made is that the business sector—with the exception of Wall Street bankers pursuing risky schemes in third-world countries when liberals occupy the White House—does not receive bailout money from the taxpayers if investments turn sour. So negative “profiteering” is perfectly acceptable. One would presume, therefore, that positive profiteering also would be acceptable, since risk-taking must mean both accepting downside risk and enjoying upside potential. But that is not the position of those bemoaning large profits: Only positive profiteering is unacceptable. Well, lo and behold, if potential losses are unlimited, but potential gains are constrained, average expected returns by simple arithmetic cannot be competitive over time. And so private investment would collapse, forcing—you guessed it—the government to take over the economic sector of interest. Let me therefore expand a point that I made earlier: The central ideological goal of those attacking the electric generation industry is not consumer welfare or environmental protection or compassion for the poor or any other such lofty objective. It is instead greater dependence by everyone on a bigger, more powerful, and more coercive government, and, therefore, an ever-expanded scope for the political left in terms of the use of political and regulatory processes to confiscate private property.

More fundamentally, investment is a willingness to forgo current consumption in the pursuit of greater wealth later. To say that a return is expected from an investment is to say that the investment is expected to yield a stream of goods and services valued by other people. Never forget that phrase. That value takes form in the prices that individuals are willing to pay, determined by their own subjective valuations of the usefulness of given goods relative to that of available alternatives.

You may believe that those subjective valuations in some sense are “wrong.” You may believe that they differ systematically from what can be considered “rational.” The choices made by others may differ from those that you would make. You may believe that people somehow are manipulated or brainwashed in the context of their personal values. But the fact remains that human preferences—the relative worth that people put on particular goods relative to that placed on alternatives—are shaped by a myriad of influences. Parents. Genetics. Friends. Churches. Advertising. Politicians, Arnold Schwartzenegger movies, ad infinitum. I have yet to hear anyone offer a coherent argument to the effect that some influences are more legitimate than others.

So let us think about an entrepreneur contemplating an investment. The investment is made over some time period, at the end of which a product emerges, satisfying, he hopes, some demand on the part of people, for which they will be willing to pay… something. Will costs be higher than foreseen? Will the anticipated development period prove too optimistic? Will people’s preferences change, will unforeseen competitors arise, will future prices prove lower than forecast, will government rear its ugly head? Who needs these headaches anyway?

A good question, that last one. Altruism is wonderful, generosity is precious, and to love and be loved is a priceless human experience; but as Adam Smith pointed out 225 years ago, it is better to depend for our daily bread upon the self-interest of the baker rather than upon his charity. It is expected returns that induce human action reducing the degree to which life is solitary, poor, nasty, brutish, and short. It is fundamentally the profit motive that leads human beings as they actually are to behave as if they care about the well being of strangers.

Those returns, obviously, are yielded by the market prices that emanate from the values placed by people on given goods and services. Those values are determined by human preferences, whatever their source. If we are to defend individual liberty—the liberty of people to better their lives as they deem appropriate, as they choose among alternative paths in the pursuit of happiness—then we must defend the market prices yielded by individual choice behavior, and the profits attendant upon them, whether low or high.

Make no mistake about it: The ongoing attack on “price-gouging” and “profiteering” in the electric generation industry is only the latest manifestation of the long-term ideological battle by the political Left against individual liberty, because it is that freedom that stands in the way of metastasizing government power. Speaking of which: We now have the California state government confiscating contracts, threatening to confiscate transmission and hydrogeneration assets, threatening to confiscate the assets of utility and generation company shareholders, threatening to fine people who use “too much” electricity, whatever that means, and on and on. We have suppliers forced to sell electricity to California, despite the fact that the last time I read the 13th amendment to the Constitution, it said something rather sharply unfavorable about involuntary servitude. During the winter 1977 natural gas crisis, caused by federal price controls, we had the Ohio state police barging into people’s homes to check their thermostats, without warrants, without statutory authority, without any Constitutional basis whatever. Someone ought to ask Harvey Rosenfield, Harry Snyder, or Gray Davis if that road is likely to yield greater “fairness.” The exercise of this growing government power as always will be characterized by ineptitude, ignorance, and an overriding instinct for political self-preservation. And unlike the entrepreneurs, who have to persuade people to buy their product at a mutually acceptable price, the Rosenfields and Snyders of the world—unelected, unappointed, and unaccountable—have no basis whatever to claim that they “represent” anyone at all other than themselves.

The business sector must resist the short-term temptation to apologize for what it does and for the profits attendant upon that productive activity. It must not seek approval from the morally superior—it will never receive it in any event—and it ought not wring its hands about high prices and profits, because its ideological foes will not do so when they decline, as they inevitably will. Moreover, it ought to bear in mind that productive activity driven by the profit motive is the true path for consumer and environmental protection, as any fool realizes after seeing the conditions of consumers and the environment in the third world and historically under state socialism. Above all, it ought to be prepared to fight on both practical and philosophical grounds; entrepreneurship enjoys a moral basis that is sound and not difficult to explain.

Thank you very much.

Benjamin Zycher is a senior fellow in economics at the Pacific Research Institute and a senior economist at Rand.