Ignore market mechanisms at your peril

To trust them or not to trust them; that is the ques­tion our nation seems to con­stantly ask about mar­ket mech­a­nisms that are sup­posed to guide resources via Adam Smith’s “invis­i­ble hand.” Some (myself included) find that alloca­tive deci­sions pro­vided by mar­kets are gen­er­ally far supe­rior to those imposed by gov­ern­ment and/or spe­cial inter­est groups. And these spe­cial inter­est groups may be either busi­ness or union related. Two recent exam­ples illus­trate clearly why Amer­i­cans should place their faith in the imper­sonal forces of the marketplace.

In the first case, we see the power of mar­kets tak­ing a seem­ingly exhaustible resource and extend­ing its via­bil­ity so as to favor­ably impact the lives of Amer­i­cans. Last week the Inter­na­tional Energy Agency (IEA) indi­cated that, based upon their best esti­mates, the United States would become the world’s largest oil pro­ducer by 2020. That’s right, the U.S. might actu­ally reach its goal of energy inde­pen­dence and beat out Saudi Ara­bia (though just barely) in oil extraction.

And what is it that may bring about this seem­ingly unthink­able out­come? Some vast, newly dis­cov­ered pool of oil off the coast? Drilling more wells in Texas or Louisiana and hit­ting the mother lode? No, it is based largely upon the use of frack­ing tech­niques to unlock the oil and nat­ural gas pre­vi­ously trapped in shale deposits.

So pre­cisely what mar­ket mech­a­nism allowed such a devel­op­ment to take place at a time when many energy ana­lysts could only dis­cuss how the world was run­ning out of oil and needed to find the next viable energy source? That’s easy; the same one that always guides pro­duc­tive resources to their best pos­si­ble use, hold­ing other fac­tors con­stant: price. The price of oil rel­a­tive to other energy sources allows the unthink­able to become reality.

In the case of oil, over the long term, the price for crude oil has been track­ing irreg­u­larly upward and giv­ing energy com­pa­nies the incen­tive to find ways to increase out­put. Some­times that has been through off­shore drilling here and abroad or uti­liz­ing heav­ier and less desir­able crude oil sup­plies. More impor­tant, new tech­nolo­gies allowed “frack­ing” to tap known but pre­vi­ously unvi­able sources of oil and nat­ural gas. In fact, accord­ing to the IEA report, the impact on nat­ural gas out­put will be even more sig­nif­i­cant than for oil and allow nat­ural gas to become the dom­i­nant fuel by 2030.

Over time energy com­pa­nies have been con­stantly whin­ing that they needed big­ger tax cred­its pro­vided by politi­cians to keep oil pro­duc­tion as high as pos­si­ble and allow for greater energy inde­pen­dence. Of course, this was just another spe­cial inter­est group clam­or­ing for unnec­es­sary gov­ern­ment aid. In fact, it was the higher oil prices that were ulti­mately respon­si­ble for mak­ing shale-based oil both recov­er­able and finan­cially viable. Not lower prices from a release of oil from the Strate­gic Petro­leum Reserve. Not a “green” energy project funded with tax­payer dol­lars. Just the invis­i­ble hand of mar­ket mech­a­nisms influ­enc­ing decision-making through prices.

To be sure, frack­ing may not be a totally safe process and could need some “tweak­ing” (as Barack Obama said about Social Secu­rity). Already, research dol­lars are mov­ing into the process of tak­ing pol­luted frack­ing water and puri­fy­ing it for reuse, not because it has been ordered by gov­ern­ment, but rather because it is cheaper than con­stantly uti­liz­ing new clean water sources.

The sec­ond case illus­trat­ing the need to trust in mar­kets also came last week when Host­ess announced the com­pany was going to be liq­ui­dat­ing its assets due to a crip­pling strike by the baker’s union. Appar­ently, this spe­cial inter­est group felt that con­ces­sions sought by Host­ess were bogus and — unlike the Team­sters that rep­re­sented other Host­ess work­ers — were will­ing to go to the mat to pro­tect wages and benefits.

Sadly (or per­haps not), con­sumers are becom­ing more health-conscious and are eat­ing fewer Twinkies and Ding-Dongs than in the past. As a result the com­pany filed, again, for bank­ruptcy pro­tec­tion and sought con­ces­sions. Appar­ently, the baker’s union is unaware that the prices paid by con­sumers (now far fewer of them) dic­tate the level of wages/benefits a com­pany can afford to pay work­ers. In this case, the pric­ing mech­a­nism and the obsti­nacy of the baker’s union may be the undo­ing of Host­ess and some 18,500 jobs.

But that’s the nature of mar­kets and the pric­ing mech­a­nism; some­times you love them and what they pro­vide (more oil) and some­times not — Host­ess and the level of wages offered to its workers.

Dr. James New­ton serves as chief eco­nomic advi­sor to Com­merce National Bank and is an aux­il­iary fac­ulty mem­ber in eco­nom­ics and sta­tis­tics at OSU-Marion and OSU-Newark. Dr. Newton’s views do not nec­es­sar­ily reflect those of Com­merce National Bank or OSU-Marion/Newark.

Posted by Jim Newton on Nov 20 2012. You can follow any responses to this entry through the RSS Feed. Comments can be made below.