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.