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June 2002, Volume 20, Number 6

"Manipulating" the Market

by William L. Anderson

As oil and gasoline prices begin their annual rite of spring, I am waiting for another rite that occurs among media pundits and some economists—who ought to know better. That particular ritual is the accusation levied against oil companies that they are "manipulating the market" in order to force up prices. Like the oil companies two decades ago and electricity producers and distributors during the California crisis, the mantra is going to be repeated ad nauseum, "They are manipulating the market. That is why prices are increasing."

Like most charges made against businesses in the United States, these are constantly repeated as though those making the accusations actually understand what is happening in a particular industry. Of course, the allegations take on a life of their own and soon Congress and other governmental bodies get into the act and launch "investigations" to verify what is being said.

Markets for goods and services have two components, demand and supply. They are not unrelated, as a hard-core Keynesian might believe, nor are they independent, as is what is portrayed in the standard Marshallian Cross. As Carl Menger, the "founder" of Austrian economics, noted, markets begin with a human need. In our desire to satisfy our needs, we create things both for our personal use and for others. Such production leads to markets, where things are bought and sold on both large and small scales.

Austrian economics, then, is primarily demand side in its approach. Individuals produce goods and services ultimately to satisfy present demands or do so in anticipation of future demand for things.

This is not to deny the supply side of this issue. Goods and services do not simply appear out of thin air. They are created by purposeful, acting individuals in response to demand, but the amount of what is available will have its own effects.

That is because individuals rank their needs and apply goods and services to them in an order from most important to least important. For example, the highest-valued use of water is for us to drink it, since we cannot live without it. If only a small amount of water is available, we apply it to drinking, not washing our cars or watering lawns, and what we are willing to give in exchange for water (the price) will reflect the relative scarcity of water.

If potable water is plentiful, we apply it to lower-valued needs, and thus its lower unit price. In a free market, prices adjust to reflect the relative scarcity of goods and services in order to channel them to whomever is willing to give up the most goods and services in their possession in order to obtain that particular item. Thus, if water were priced according to free-market principles instead of being priced politically, one would see the price of water increase during a drought.

Obviously, all producers would like to find a way to increase demand for their products, which is the purpose of advertising. That is not always a possibility, however, and the choice to purchase more of a product ultimately lies with consumers. Although many critics of the market say that advertising is a form of "manipulation," doing things to increase demand for something is not what the Paul Krugmans of this world mean when they accuse producers of "manipulating the market."  

Do producers simply raise their prices on a whim, which is what many pundits seem to believe?  Indeed, I know of no producer of anything sold in a market who would not like to receive a higher price for whatever they are selling.

Producers do not have this kind of market power, however. For example, over the last two decades average profits for oil companies have been lower than the average profits of other firms included in the Standard and Poor's 500 index. If oil companies simply had the power to raise prices—and profits—at will, one would think they would have done so. 

This leaves us with option three, the supply side. According to critics like Krugman, energy companies have on occasion "withheld supplies" in order to force up prices, which is the "market manipulation" of which they speak, and is usually the focus of government investigations.

Assume that I decided to cut back water supplies from my sources and was able to do so. With less water available, individuals would then apply the water to higher-valued uses, which would mean they would be willing to pay more for the available marginal units of water than before. If demand for water were inelastic enough, I most likely would see an increase in my profits, at least temporarily.

Furthermore, my action would result in conservation of a scarce resource, water. At the same time, however, my actions most likely would spur others to get into the water business, thus destroying my monopoly. Therefore, such action, while having some success in its early stages, might also mean lower profits for me in the future.

However, it also needs to be emphasized that I am choosing to sell less of something that I own. In other words, because I own the water at its source, I am free to do with it what I please, provided I do not physically harm others by attempting to drown them or something else that would make them worse off. In a free market, I am also free to sell at whatever price I choose —but the market itself will discipline me should I choose to go into the water sales business.

In the case of California, Paul Krugman and others have stated that electric utilities from outside California at times held electricity "off the market" until they could obtain an outrageous price for it, and that was the source of the problems. Incredibly, they ignore the ticklish problem of California's strange policies of "deregulation" in which retail prices were capped at levels far below wholesale prices for electricity, a legal technicality that drove the state's utilities into bankruptcy. That this restriction created a classic shortage seems to have escaped these "experts."

Now, assume that the producers really did shut down the generators and sold electricity to no one, despite the fact that they could have sold to someone at prices that exceeded marginal costs. That alone is no crime, and since most utilities burn coal, natural gas, or oil to create steam necessary for turning the generators, that is what one might call "conservation," which is a word on the lips of environmentalists everywhere. Electric utilities are engaging in "sustainable production"—and for this, they are criticized? The accusers cannot have it both ways.

Most likely, however, the utilities simply sent their electricity to other customers who were offering lower prices than was California for the electric power. In other words, utilities decided—and for good reason, given the political and economic climate in California—to send electricity to customers who were more likely to pay for the product they received. Furthermore, if they wanted to force prices up by simply halting the production of electricity, once they started up the generators again, the resulting flow of new power simply would force prices down again.

The real objection, then, was not that the non-California utilities were not producing electricity, but rather that they were not selling electricity at prices deemed "appropriate" by the Krugmans of the world. Please note the implications of such accusations: these were demands that someone produce something in amounts greater than what they would prefer to make and be forced to sell the product against their will to a customer who is paying prices lower than what the producer would accept otherwise.

This is nothing more than forced labor, something the ancients once called slavery. People can repeat the mantra of "public interest" all they want, but they are actually demanding that some individuals be forced into servitude of others. If one does not believe that the political classes believe in implementation of forced labor, consider that in his "State of the State" speech to the California Assembly in 2001, Governor Gray Davis demanded that the legislature pass a law making it a "criminal offense" for in-state producers of electricity to withhold power from the market. In other words, the governor wanted the authority to tell electricity manufacturers when and how much power to produce at any time, with conditions set by the governor's administration. If this was not an attempt to create conditions of forced labor, then the term simply is nonexistent.

The case of oil and "market manipulation" is even more straightforward than electricity, if one can believe that. The problem begins at the wellhead. Once crude oil is tapped from the ground, it either goes into pipelines or onto tankers, and then to refineries. After the oil is refined into various products, from gasoline to petrochemicals, it goes into more pipelines to temporary storage until the product is finally sold on the consumer end.

Given the nature of the productive processes involving petroleum, it is difficult to "hold product off the market" for any length of time. Disruptions may occur along the line, but such delays in bringing a product to market ultimately are bad for producers and retailers, since that means that plans are being disrupted. When refineries and pipelines are being shut down for repairs, existing supplies may be squeezed under current demand—creating temporary price spikes—but the fact remains that refineries and pipelines make money by having oil flow through them, not when they are empty.

Two years ago, when new gasoline formulation regulations from the Clean Air Act Amendments of 1990 kicked in, the result was disruption in gasoline supplies, especially in cities where the EPA regulations were especially restrictive, like Chicago and Milwaukee. There is no doubt that there existed a temporary phenomenon in which gasoline producers and retailers were able to purchase oil and its derived products at relatively low prices and sell them at relatively high ones when the regulations first began to choke the market. While these higher prices also made for temporary spikes for industry profits, prices and profits quickly fell to pre-crisis levels once the market returned to normal.

The point is that charges of "manipulating the market" are not only baseless, they are downright silly—and dangerous, since they can spur political authorities to create regimes of forced labor. In a free market, involuntary servitude cannot occur. Only when the political authorities attempt to take actual ownership of property that is not theirs can a regime of slavery be imposed. By using charges of "market manipulation," the political classes and their allies are hiding a more sinister agenda. 

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William L. Anderson teaches economics at Frostburg State University (banderson@mail.frostburg.edu).

 

 

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