Market-Based Management®

Markets Fail When You Make Them

Ok, I made a bad prediction in my previous post about gasoline coming to Georgia in the wake of Hurricane Ike. I know it was a bad prediction, because I drove to Atlanta Airport on Sunday and did not see a single gas station with petrol (although news reports say about half do). So why was I wrong, and why has the market appeared to fail? First of all, my prediction was based on the premise that the market would be allowed to work. Gas can be found in the Southeast—just not in Atlanta. Why did every station I saw in rural Mississippi and Alabama earlier this week have gas, while those in Atlanta did not? The answer is that it would be illegal to sell the gas available in the country or suburbs in Atlanta proper. The American gasoline market is not a single unified market, but a deeply fragmented patchwork of markets where federal clean air mandates dictate what types of gasoline (called boutique fuels) can be sold where. Because of its air pollution problems, only a special boutique fuel can be sold in Atlanta. After hurricanes Katrina and Rita, the federal government wisely suspended these fuel mandates and momentarily recreated a national market for gasoline. While this measure did have a temporary effect on air quality, it prevented many of the shortages that we now see today. Unfortunately, the feds did not follow this policy after Ike, but kept the mandates in place, which is the reason that Atlantans wanting to fill up either have to wait for scant fuel deliveries or dive to the suburbs or country.

Another curious going on is that when there is gas in Atlanta, prices do not appear elevated and are roughly on par with those before the hurricane. So why with all this scarcity, are gas stations charging prices close to pre-hurricane levels? The answer probably lies in the overt threats from state and federal officials that they will go after price “gougers” for selling gasoline at high prices. As I mentioned in the previous post, the Georgia price “gouging” law is fairly toothless and not even currently applicable (the governor has to declare a state of emergency for the statute to come into force). I erroneously believed that the benign nature of this law would not impede rises in Georgia gas prices and subsequently encourage conservation and supply. However, most gas station owners are either only vaguely aware of this or think the feds will get them instead. The effect has been a de facto price ceiling on gas prices in the Atlanta area, which gives motorists the incentive to snap up gas when it is available, rather than weighing much higher prices (say $8 a gallon) and buying only a few gallons at a time. This is exactly what I—and everyone else ay my neighborhood station—did when a gasoline shipment arrived. As a result, folks who would otherwise drive around with half or quarter tanks fill them up (and top them off) whenever possible. I am running with a full tank right now but would have left more for my fellow Atlantans had the price been higher. Unfortunately, the situation has unleashed my (and apparently everyone else’s) inner speculator.

Why there will be Gas in Georgia

With the approach of Hurricane Ike, I started to wonder if I should fill my gas tank prior to the inevitable disruption in the nation’s refining network. However, a quick google search revealed that Georgia (where I am) has a very tame anti-price “gouging” statute, which only comes into force when the governor declares a state of emergency (unlikely considering the state of emergency is in Texas). At the same time I noticed that those states neighboring Georgia (primarily Tennessee, South Carolina, and Florida) have more strongly worded statutes, and their public officials have been making noises about enforcing them come the inevitable spike in prices. In a market economy, prices provide the knowledge governing production, distribution, and consumption. If you monkey with this system by implementing a de facto price control in the form of an “anti-gouging” law, then you recreate the foolishness of the price controls of the early and late 70s. Of course, the full impact depends on Ike, but even if some shortages occur in Georgia; we will certainly fair better than our neighbors to the north and south.

Not from the Onion but it belongs there

At first I thought Don Boudreaux over at Café Hayek had a hold of my leg with this post about the Onion Futures Act of 1958—until I noticed that he had linked to this Wall Street Journal article and a quick Google search turned up that there really is an Onion Futures Act of 1958. The Onion Futures Act bans futures trading in onions, and came into effect after onion farmers blamed “moneyed interest” and “speculators” for volatile onion prices. The act still remains on the books, and (as far as I know) no other bans on commidity futures exist. So with folks blaming oil prices on “moneyed interests” and “speculators,” what would a ban on oil futures do to the price? Of course onions ain’t oil, but since no other commodity has suffered the same ban, it remains the only example we have.

Despite the ban, onion prices continued to remain volatile. Actually, they became even more volatile after the prohibition of futures trading. Contrary to what had been believed, onion futures trading had actually helped to stabilize prices. Futures are an excellent hedge on risk and a valuable knowledge process. They encourage traders to do their homework and collect and vet mounds of information on what might be the future price. This allows consumers and producers to plan on these prices and respond accordingly. Hopefully, decision makers will come to understand the valuable knowledge provided by futures market and not repeat the onion mistake.

The Importance of Vetting Knowledge

MBM talks a lot about collecting and sharing knowledge. However, we sometimes don’t stress the need to understand exactly what that knowledge means. Often what appears a clear connection is really quite meaningless. I was reminded of this by an article in today’s Arizona Republic (HT: Coyoteblog). The article complains that consumers are being “gouged” by faulty gas pumps. Apparently, about 9 percent of Arizona’s inspected gas pumps failed tests by the State’s Department of Weights and Measures. The article is full of innuendo and numbers implying there is something rotten in the state of Denmark (or at least Arizona). Despite the tone of the article, the fourth sentence begs some curiosity:

Half of those [pumps] were malfunctioning to the detriment of customers.

Faulty pumps are not good, and people getting ripped off is not good; but if half of the malfunctions cause detriment to customers, then what about the other half? Are some of the good people of Arizona getting a little free gasoline? Of course, I do not doubt the need for governments to standardize and inspect weights and measures (the practice dates to the Magna Carta (clause 35) in the Anglo-American tradition), but the little nugget on the impact of these inaccuracies tells us that this situation is probably happenstance or, at worst, neglect on the part of the pump owners. Interestingly, the article also mentions that it can cost up to $800 to recalibrate a pump, which considering the thinness of margins in retailing gasoline (only a few pennies on the gallon), is probably incentive enough to recalibrate infrequently—as opposed to deliberately fiddling the pumps. Furthermore, as the fine for a first time offense is only $300, it makes perfect sense for the gas station owners to have the state come out and do the inspections for them (paying the fine and fixing the affected pumps should be much cheaper than constantly re-calibrating of all of them). So, while malfunctions of 1 out of 11 inspected pumps causes us to quickly jump to conclusions, a little vetting of information reveals nothing more than perhaps the nature of pumps, happenstance, poor incentives, or the combination of all three—meaning only a few lines tell the whole story, and they don’t match the rest of it.

Dutch Invent Robotic Gas Attendant: Will probably be banned in New Jersey

As silly as it sounds, ordinary folks are not allowed to pump their own gas in some parts of this country. I tried to do so once on the New Jersey Turnpike and received quite a talking to. Having others pump my gas has always made me feel uncomfortable, but thanks to some clever Dutchmen, I can remain in the comfort of my vehicle and enjoy full service without the guilt.

The new robotic gas attendants cost about $111,000 (HT: Drudgereport), so it will be interesting to see if they end up being economically viable. However, profit margins in retailing gasoline are only a few pennies a gallon (gas station owners make most of their money selling all of the other things people buy while they fill up), but perhaps the lure of robotic attention will allow gas retailers to add a few extra pennies in margin. Considering the winter we are having, I would have been more than willing to drive out of my way and pay more for robotic service. Once again, the combination of entrepreneurship and technology has conspired to make human life much better.

Economists Heart the Planet

A new report from the Energy Information Administration (EIA) shows that U.S. emissions of carbon dioxide (CO2) declined by 78 million metric tons or 1.3 percent in 2006 (HT: Volokh Conspiracy). Meanwhile, according to the Bureau of Economic Analysis (BEA), the U.S. economy grew by around 3.1-3.2 percent in 2006. The confusion is already setting in, and everyone is pointing fingers at the weather. Indeed, I can think of few instances (if any?) where an economy grew rather robustly and experienced a fall in CO2 emissions.

One of my favorite topics in our recent Sustainable Economic Development course was the role of development and the environment. A lot of people think that there is a tradeoff between the two—a country can have either a developed, growing economy or a clean environment. However, most scholarship suggests that economic growth and environmental protection are linked. This is initially because as economic growth starts to satiate more peoples’ most pressing needs (food, water, shelter, work, etc.), folks can then concentrate on the things that are important but less so than basic needs—like the environment. Hence, a certain level of development is needed to have an environmental movement at all (ever wonder why environmental movements seem to be dominated by people from rich countries?). Secondly, as societies grow richer, they acquire the resources necessary to solve more environmental problems. They can then afford the new water treatment plant or finally manage to replace their old, dirty power plants with new ones. True, there is usually an uptick in pollution as economies get going, but environmental damage per unit of GDP actually starts falling at around $6,000 per capita GDP. For example, in the U.S. the economy has roughly tripled over the last 30 years, while the amount of pollution has halved. However, this is not a new trend. Pollution in the U.S. peaked in the 1920s—meaning that emissions of major pollutants actually started declining fifty years before the creation of the EPA. Nor is this trend due to some mistakenly perceived decline in manufacturing; U.S. manufactures are actually churning out more “stuff” than ever before.

The reason for this trend is simple progress. As people discover better ways to do things, they inevitably cause less environmental damage. New machines, cars, and appliances are almost always cleaner and use less energy than those they replace even in the absence of new regulations. The result in the U.S. has been a steady decline in major pollutants, such as nitrogen dioxide (NOX), sulfur dioxide (SOX), carbon monoxide (CO), etc. That being said, the emission of one particular gas (sorry there are differing legal and economic opinions as to whether it is technically a pollutant) has bucked this trend. This gas is carbon dioxide (CO2), and economies tend to produce more of it as they grow and demand more energy.

Despite the rise in CO2 emissions common to economic growth, some have postulated that these emissions will eventually follow the major pollutants and decline. The thought has been that CO2 simply will just begin to decline at a much higher level of GDP than other gases. Well, the EIA’s numbers could very well indicate the beginning of this trend. Of course, it could be the weather, or a strange combination of circumstances, rather than the beginning of a long-term trend. However, CO2 emissions don’t fall outside of recession very often (if at all?). Let us hope that this is the beginning of a long-term trend and not unusually pleasant weather; but rather the fact that as Americans grow ever wealthier they are replacing their older, less efficient homes, cars, appliances, and machines with newer, more environmentally friendly ones.

(In) Elastic Gas

Here we go again with the gas prices. Although the reasons behind high gas prices are often complicated, there is a major cause that is always almost ignored when people talk about gas prices—elasticity.

We are all familiar with the concept of supply and demand. If a price goes up, then suppliers will supply more quantity and consumers will demand less. When prices fall, consumers will buy more, while suppliers cut back on production. Easy enough, but people often forget that, while price changes will cause buyers and sellers to alter their behavior, the question remains, “but by how much?” Economists measure “by how much” with a concept called elasticity. If a price change of a good causes people to alter their consumption or production behavior dramatically, then the good is said to be elastic. If the quantity supplied or demanded changes very little in response to a change in price, then the good is said to be inelastic. The problem with gasoline is that both its supply and demand are highly inelastic. As gas prices rise people complain a lot (I know I do), but we really do not cut back our consumption very much. The same is true with supply. With prices high, refiners would love to bring more gasoline to market, but they are running into capacity, maintenance, and regulatory roadblocks, so, at least for the immediate future, they can only squeeze so much gasoline out of their capacity—no matter what the price does.

Unfortunately, this leaves the consumer in a tight spot. The law of supply & demand dictates that the quantity demanded must equal the quantity supplied. Something has to give and that something is price. Since peoples’ gasoline consumption barely budges with rising prices, then prices have to rise considerably in order to bring the quantity supplied and demanded into equilibrium. To put it another way, if the U.S. wanted to halve its gasoline consumption, then it would not merely be a matter of doubling the price, but most likely quadrupling or quintupling already high gas prices. There is already a lot of talk about gas prices, and there is only going to be more. However, with all the hot air to be bellowed and ink spilt, there will likely be nary a mention of the “e” word.

More on Oil Profits, Deux

The New York Sun has an editorial today castigating various members of Congress for entertaining the notion that converting oil company profits into federal government profits is somehow good for the American consumer. Analysis of the flaws with this approach, by the Mercatus Center's Al Walling, is again mentioned.

And Russ Roberts, who's critique of these schemes was featured on National Public Radio this week, will be a guest tonight on CNBC's Kudlow & Company at 5:30 EST, where once again he will discuss the problems with a "windfall" tax on oil companies.

More on Oil Profits

Speaking of Russ Roberts, check out his appearance yesterday on National Public Radio to discuss the U.S. Senate's hearings on fuel prices. A quote:

"Those Senate hearings on the high cost of gasoline prices should be really brief. Three words: Supply. And. Demand."

You have to sign up for a trial subscription to read all of it, but Al Walling's op-ed in The New York Sun assessing Senator Clinton's call for an additional $20 billion tax on oil company profits is also worth a read. Choice quote:

"Threatening to make businesses give back their money is a surefire way to prevent their expansion and push gasoline prices even higher. . . Senator Clinton somehow believes that $20 billion in new taxes will lead to lower gasoline prices, but since when has taxing something ever made it cheaper?"

Walling, like Russ Roberts, is a scholar with the Mercatus Center at George Mason University, a top economics-oriented research organization, in my not-so-humble opinion.

Energy and Free Markets Primer

I will be making discounted copies of the book Energy: The Master Resource available on the MBM bookshelf at Hot Commodities in the next week or so - $5 per copy (it sells for $19.95 on Amazon).  For those who don't mind reading on-line, the text of the book along with its graphs / tables is available in Adobe PDF format as well for free.

The book is an excellent introduction to the energy markets as well as to free market principles -- a more gentle introduction than, say, Julian Simon's Ultimate Resource 2 (which is an outstanding book, but weightier - if that's a word). 

From the back cover of Energy: The Master Resource:

"Energy is uniquely essential to modern life and human progress; it is the master resource.  This book describes how the ultimate resource, the human mind, has harnessed energy to meet the world's increasing needs

Through history, human knowledge, creativity, and sweat have overcome technical, resource, and environmental challenges to convert energy into useful work.  The authors persuasively argue that given the right incentives, inventive people will make energy's future even brighter than its past."

Speaking of the MBM bookshelf -- please post comments on selection, suggestions for more interesting / sellable topics.  I will be withdrawing the Sowell Basic Economics book -- not moving at all (probably looks too big / intimidating for the newby and too basic for those with econ backgrounds).