Airlines and Speculation
July 16, 2008
Art Carden
Standard Journal, Havre Daily News
Spurred by the claim that speculators are to blame for skyrocketing oil prices, airline executives are circulating an open letter encouraging customers to urge their congressional representatives to enact stronger regulatory oversight of “unchecked market speculation and manipulation.” This crusade has gained popular support on stopoilspeculationnow.com and in media outlets across the country. The airlines’ campaign, unfortunately, is built on a mix of economic half-truths and downright lies, which will only hurt consumers and airlines alike in the long run.
Futures markets and speculation play an important role in the economy because they allow us to compensate for risk by moving resources from periods of abundance to periods of scarcity, stabilizing commodity prices as a result. Blaming speculators for high oil prices, as economist Russell Roberts notes, is tantamount to blaming thermometers for the weather.
The airlines’ initiative exhibits several biases, which dangerously contort the truth of the economics behind today’s high oil prices. These biases, identified by economist Bryan Caplan in his 2007 book The Myth of the Rational Voter, are anti-market bias, anti-foreign bias, make-work bias, and pessimistic bias.
Anti-market bias is evident in the blame cast upon “speculation” for high prices. The executives argue that “[a] barrel of oil may trade twenty-plus times before it is delivered and used; the price goes up with each trade and consumers pick up the final tab.” This might sound plausible to some, but it is incorrect. The trades happen in response to anticipated price changes. The trades themselves are not the source of the higher prices. If speculators could raise prices and profits just by trading paper oil contracts back and forth, why would they stop at $146 per barrel?
Airlines know this very well. For years, airlines have tried to hedge their risks by speculating in oil markets; indeed, one source of profitability for Southwest Airlines has been their astute speculation in oil markets.
On www.stopoilspeculationnow.com, the airlines argue that consumers “are impacted by unregulated, secretive, and often foreign commodities futures markets.” In a globally competitive market for a fungible commodity like oil, whether the contracts are traded in Chicago, Chengdu, or Chernishevski is irrelevant. This fallacious complaint against foreign trading reflects anti-foreign bias. If anything, increased government regulation is likely to move more commodity speculation overseas in the same way Sarbanes-Oxley accounting regulations have moved other financial matters overseas.
Make-work bias reflects the common misunderstanding that the purpose of an economic system is to provide employment rather than to produce output. Airline executives argue that increased fuel prices are bad for the industry and for those who work in it. No doubt higher oil prices are hard on the industry, but they also encourage innovation and growth in other industries. In his classic Economics in One Lesson, Henry Hazlitt pointed out that “the art of economics” is about looking at how a change in circumstances affects everyone rather than a particular narrow constituency.
Pessimistic bias appears throughout the debate as people argue that high energy prices produce a net drag on the economy. This may be true in the short-term, but as economist Julian Simon argued, the human mind is “the ultimate resource.” Higher energy prices spur innovation that will reduce our dependence on fossil fuels.
To describe seemingly unlikely political coalitions, economist Bruce Yandle coined the term “Baptists and Bootleggers.” The former supported prohibition because of a conviction that alcohol consumption was immoral. The latter supported prohibition because it eliminated the competition. In this case, the airlines are the “bootleggers” who find themselves in sudden agreement with those who believe that market capitalism is the source of all our miseries.
Finally, this initiative also illustrates an important irony about the relationship between firms and free markets. It has been said that the greatest enemy of capitalism is the capitalists, and the airline industry’s call for extensive intervention shows that large corporations are not necessarily friends of the free market. Milton Friedman once remarked that it seems as if every businessperson supports free markets in every industry except his or her own, which naturally requires intervention, regulation, and subsidy.
Fuel costs are an important component of doing business, especially for airlines. However, it is unfortunate that the airlines are looking for political solutions to economic problems. High gas prices make life harder for most of us, but implementing policies that restrict the operation of the market will only compound the difficulties.
Art Carden is an Adjunct Fellow at the Independent Institute in Oakland, California, and an assistant professor at Rhodes College (Department of Economics and Business).