November 4, 2023 Reading Time: 5 minutes

In an earlier article, I discussed how free trade cannot be blamed for making industries vulnerable to disruptions; rather, trade makes them more robust. Free trade cannot be blamed for the shortages resulting from COVID-19. So what can? To answer that question, we need to go back and explore the legal climate of the pandemic. 

The Initial Shock

In the early days of March 2020, COVID was on people’s minds in the same way a bad flu season was: There was some concern, but mostly people went on with their lives. This attitude was promoted by public health officials, like Anthony Fauci, who said, “Now, in the United States, there is absolutely no reason whatsoever to wear a mask…Wash your hands as frequently as you can. Stay away from crowded places where people are coughing and sneezing. If in fact you are coughing and sneezing, cover your mouth. You know, all the things that we say each year.” 

By mid-March, rumors were circulating of lockdowns and other government actions to combat the spread. Then, in late March, states began ordering lockdowns. In some cases, like in Maryland, people were given just 72 hours to prepare themselves for being confined to their homes for (initially) 15 days. Additionally, for the few trips people were allowed to have outside their homes, they would need to be masked. These orders, which came with unexpected quickness, caused an initial demand shock. A sudden and unexpected increase in demand will lead to transitory shortages as the production and transportation process takes time. 

But the shortage of necessary equipment wasn’t transitory. As lockdowns expanded, the shortages persisted. Even as late as October 2020, six months after the lockdowns were originally ordered, shortages persisted. Clearly, a demand shock could no longer account for such shortages. Economists understand that when shortages exist, prices are too low and need to rise in order to eliminate the shortage. But prices didn’t rise.

Government Actions Created and Perpetuated the Shortage

One of the major reasons the shortages persisted was due to state-level price controls. Many states have legislation that prevents large price increases during states of emergency. If prices cannot rise, shortages will persist as consumers do not face an incentive to conserve and producers do not face an incentive to increase production. Given that many states kept their states of emergency, and thus their price controls, in place for years after the initial lockdowns, prices could not easily adjust. 

At the federal level, there is no formal price control legislation. Section 102 of the Defense Production Act of 1950, however, grants the President broad discretionary power to set prices and take other economic actions on items he designates crucial during a national emergency. Executive Order 13910, issued by President Trump on 23 March 2020, gave Alex Azar, the Secretary of Health and Human Services authority to designate such materials under the Defense Production Act. On 25 March 2020. Azar initially designated PPE (Personal Protective Equipment) as crucial products. Over the course of 2020 and 2021, common household products like hand sanitizer and wipes, as well as non-PPE face coverings and apparel, were added to the list. In addition to state-level price controls, these products were also subject to federal level price controls and “anti-hoarding” regulation, something which the federal government enforced.

The Defense Production Act had the real effect of removing PPE and other items meant for consumer use from the market, contributing to the shortage. For example, a Plainview, NY man was arrested and charged with selling equipment at prices in violation of the Defense Production Act. Similarly, the Department of Justice routinely seized PPE meant for personal use and distributed it to FEMA and other federal agencies, or simply destroyed the equipment. Regardless of what one thinks about these actions, the fact is they resulted in removing PPE and other necessary items from the market, preventing prices from adjusting and alleviating the shortage. 

The lockdowns themselves were also responsible for creating shortages. Manufacturing plants, shipping companies, and the like were initially caught up in the lockdowns. When governors discovered their errors, they adjusted orders to allow “essential” businesses to remain open. But these firms still had trouble ramping up production because many of their suppliers, who were designated non-essential, remained closed. Firms faced extremely inelastic supply curves simply because the governments effectively forbade them from increasing production. US manufacturing output plummeted almost 15 percent during the initial lockdowns, and would take until mid-2021 to return to the pre-lockdown level.

Status Quo versus State of Nature

Government actions such as price gouging legislation, seizure of goods, and lockdowns explain shortages of goods. These actions took place not just in the United States, but around the world. Even if protectionism can make supply chains more robust, lockdowns still would have caused the disruptions they did. To blame COVID shortages and disruptions on free trade is to make a crucial analytical error: It is to confuse the status quo with the state of nature.

There are two general ways to analyze a situation. The most common is what I like to call “state of nature” reasoning. The name invokes Hobbes in the pre-governmental world. No law, properly speaking, exists. In this pre-constitutional stage, each individual is an island unto himself, and there are no institutions to restrict his behavior. Nothing influences outcomes except the forces of nature. Many economics textbooks present economic models in this way. It is a useful pedagogical tool; we want to understand how prices would emerge in equilibrium if there were nothing pushing on them but the natural forces of supply and demand. But state of nature reasoning becomes limited once applied to the real world. State of nature reasoning is helpful to guide our thinking about the real world, but it should not be used exclusively to analyze the real world.

To understand how events happen in the real world, we need what I call “status quo” reasoning. Events do not happen in a vacuum but under the shadow of the law. Consequently, we need to understand the effects these institutions, policies, laws, and legislation have as they can have effects counter to what state of nature reasoning implies. In his famous 1960 paper The Problem of Social Cost, for example, Ronald Coase discusses how currently-existing rights indicate a tax on externalities may be inefficient if one is not very careful about applying it (indeed, the tax may be prima facie inefficient!). Economist John Nye discusses how failure to take into account the status quo leads to overestimating of the social costs of an externality, and thus estimates of corrective taxes are too high.

Protectionists make the mistake of applying state of nature reasoning when status quo reasoning is necessary. By not understanding the causes of the disruptions during the pandemic, protectionists advocate for policies that would ultimately make supply chains, and consequently the US economy, more vulnerable. To shore up supply chains, we need more trade with fewer barriers and less governmental intervention in the economy. Industrial planning and protectionism will make the economy more fragile.

Jon Murphy

Jon Murphy

Jon Murphy an Associate Fellow at the Institute for an Entrepreneurial Society and Assistant Professor of Economics at Nicholls State University (Louisiana). He holds a Ph.D. in Economics from George Mason University. Prior to joining Nicholls State University, Dr. Murphy was a visiting professor at Western Carolina University. Dr. Murphy has published in information economics, history of thought, and pedagogy research in academic journals such as The Journal of Economic Behavior and Organization and The Journal of Institutional Economics, and has testified before the North Carolina State Legislature on the issue of insurance reform. In a previous life, he was a consultant and forecaster for ITR Economics.

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