Speculative preparedness

Jeff Kaufman discusses an interaction between price controls and emergency preparedness:

Let's say you see a potential pandemic coming, and you produce a product that could be critical. Maybe you make respirator masks, maybe you make ventilators, maybe you make PCR test reagents. You can see that if you and your competitors don't ramp up production and the pandemic happens, there will be a shortage. What do you do?

[...]

[One] option is to ramp up production now, speculatively. Start paying workers extra to work longer shifts and run your assembly lines around the clock. Train extra workers. Find what you're bottlenecked on and figure out how to get that ramped up too. If the pandemic fears were overblown you lose a lot of money, but if the pandemic happens people need what you have so much that you can charge high prices. How much to ramp up production in advance depends on how likely you think the pandemic is, and how much you'd be able to increase prices if it does happen.

Except we have laws and customs against price gouging: if the pandemic does happen, you are going to have a lot of trouble raising your prices. The laws generally do allow passing along increased costs, but the problem here is that your costs were speculative. Let's work an example. (...)

The punchline of the worked example is that if you think that there's a 50% chance of an emergency that will make your products ten times as valuable, it's still not worth it to start producing extra now at double the cost. (Caveat: US price-gouging laws are per-state and the worked example is for New Jersey. More-common price-gouging formulas make it not worth it to start producing extra now at even very small extra cost.)

What's to be done? Jeff again:

It's too late to fix this for the current situation, but I see three main ways out of this for the future:

• Allow price gouging: don't restrict what prices people can sell things at.
• Allow speculative production: require companies to disclose and document production plans, require them to share their probability estimates of how likely they think things are to be needed, keep them honest by allowing third parties to bet against them at their published probabilities.
• Have a government that will put in emergency ventilator orders at an early stage of the crisis even when they may not be needed, stockpile masks for potential pandemics, and generally stay on top of things. (...)

There's another way, and it lets the markets work, but it requires strategic planning, so it is far too late to apply in the current situation. The key insight is to have the speculative surplus go to the consumer.

If there's a 50% chance of an emergency that doubles the marginal value of, e. g., ventilators, then existing consumers should already be expanding purchases. Not to profit from resale, mind you, but to benefit directly if the emergency does play out.

And then, with the early demand surge, ventilator/mask/&c. producers can increase their output, other firms (those whose products are or will be least valuable, as reflected in demands and present clearing prices) can get into the ventilator business, and we can align our collective incentives now with our strategic plans for the future. Bureaucrats don't get the chance to sink agreements by demanding "more time to assess" negotiated deals. Markets and price signals can work -- without the social harms of apparently-exploitative price hikes.

So why didn't that happen this time? Some hypotheses...

• Some organizations did speculatively prepare early enough to have helped (say, starting late January in the US). They, personally, are currently doing far better than they would be otherwise -- though they weren't able to shift the demand curve early enough to make very much extra supply available for others.
• Some businesses saw the opporunity, but didn't have the resources to take the risks of speculative preparedness. This suggests that "ability and will to take strategic risks" is a potentially massive benefit of Cowen-esque "big business" (see also), especially given that interventions for employees' health at sufficient scale are effectively interventions for public health.
• Internal politics, principal--agent problems, and/or social pressures prevented some organizations from acting in their own interests, especially when forced to act under uncertainty.
• Some organizations (especially outside the for-profit sector) simply don't consider it their business or remit to make speculative investments -- even investments in their line-of-business goods that arguably they understand the best of anyone in the market.
• Private citizens generally don't consider it their business or remit to make speculative investments in consumption goods, now to the general detriment.
• Organizations and/or private citizens were underinformed, or otherwise unable to make the necessary quantitative judgments.
• Speculative preparedness was strongly discouraged by governments who then also failed to implement pre-emptive command-and-control, resulting in no effective incentives for suppliers and predictable effects.

I am certainly not confident in this whole list (and I'm certain it's not complete), but in quieter times it will be worth asking which people and organizations made choices that contributed to more efficient allocation of resources this time around, and which found themselves unable to do so, and why, and what we will have to do better in the future.