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Thursday, August 04, 2005

Calling on Brad DeLong

Guest post by John McGowan

I know Brad DeLong reads this blog because he picked up on my Amnesty International post some time back and, more recently, he told us about his own close encounter with Foucault’s work in response to one of Michael’s theory posts.  I also know that Professor DeLong is not running an Ann Landers service for the economically challenged.  But I am encouraged by his having just today posted a request to the physicists of the world to help him in his perplexity about the attraction between negative and positive particles.  So here’s my request for help from the economists of the world.  It comes in two parts.

1.  In its article on the energy bill last week, the Washington Post writes about “the oil and gas industry, which has seen record profits in recent months.” My question:  how does the rising price of oil translate into more profits for Exxon?  Let me explain why I don’t think that question is as dumb as it first appears.  (Of course, it may be just that dumb.  If so, that’s what I want to know.)

For whom is the cost of oil rising when it goes to $60 a barrel on the oil market?  In other words, is that $60 for refined oil, the kind that’s ready to go into my car, or is that for the crude stuff that Exxon then has to refine.  In other words, are Exxon’s costs rising at all—or is the rise of oil prices completely demand driven?  Who is buying what from whom on the oil market?  (Why would Exxon be buying refined oil from itself?  I thought the whole point of the vertical command of the industry by the big players was that they controlled the product from the moment it left the ground until the moment it got into my gas tank.  So where does the transaction that makes oil $60 a barrel take place in the process—and between what buyer and what seller?)

Furthermore, if the oil market is completely demand driven, why hasn’t the price gone up even further?  The American public has hardly reached its intolerance point for gasoline prices.  So far, the public’s gone little beyond grimace and bear it.  In other words, the companies have got the consumer by the balls.  Why not just squeeze harder?

A less crude way of putting this.  Princeton, at $50,000 a year—give or take five thousand—still has more people who want the product than it can supply.  Economic theory suggests Princeton should just raise its tuition to the point where it has 1000 applicants willing to pay that price for the 1000 places available in its freshman class.  Clearly, non-economic considerations—including, among other things, squeamishness about all-out capitalism in the education business and a desire for quality control in admissions—keep Princeton from following that strategy. But what keeps Exxon from maximizing what it charges for its product?

Finally, take the question in the reverse way.  If Exxon’s costs for oil are going up, that doesn’t translate into record profits unless they add a surcharge to their consumers.  If it cost Exxon $1.80 to produce a gallon of gas last year and they charged you and me $2.00, they get 20 cents profit.  If it costs them $2.00 to produce a gallon this year, and they sell it to you and me for $2.20, they should be showing the same—not increased—profits.

So record profits can only (it seems to me) come from one of three things.  Either they keep the percentage of profit the same and thus the increased revenue of more expensive gas means that the profits increase—with that increase being a larger sum of profit but not a higher profit margin. 10% of 6 million dollars is more than 10% of five million dollars.  Or Exxon uses the fact of higher costs to also slip in an increased profit margin.  They used to sell you a gallon at 10% above cost, but now they sell it at 11% above cost.  I do wish the financial pages of the newspaper would consistently distinguish between sums and percentages when talking of record profits.

The final possibility is that the oil futures market is pricing oil way beyond its current actual cost of production.  And if that’s the case, then high oil prices on that market are, at least in the short term, simply a bonanza for oil companies.  Maybe that’s the case.  I don’t know.

I think I have suitably demonstrated just how much I don’t know.  Needed: a basic explanation of how the oil business works.  And how that translates into what I am paying for gasoline and how the oil industry is enjoying record profits.

2. I have an even larger question.  Did the increased emphasis on “primary responsibility to the shareholders” since the mid-1980s bring about a marked change in what are considered acceptable profit margins for big American companies?

Here’s an anecdotal way to explain the import of this question.  I taught at the University of Rochester from 1984 to 1992.  When I arrived in Rochester in 1984, Kodak employed 54,000 people in the Rochester area.  In 1986 (or so), Kodak was the target of a hostile takeover bid because the company (an absolute model of a paternalistic employer and civic booster) was seen as “underperforming.” The company fought off that takeover bid, but within eighteen months the CEO had been fired, a new management team was brought in, and well before the recession of the early 1990s, Kodak had embarked on the downsizing that now has it employing less than 30,000 people in Rochester. 

Now, I know that Kodak’s transformation has many complex causes.  And perhaps it really was entirely due to the exigencies of a marketplace in which, unlike the oil companies, Kodak has just about no ability to raise the prices on any of its products even while the cost of employing Americans kept rising.  But Kodak’s first move toward cutting costs was not a response to direct competition or to the market’s resistance to its products.  It was about increasing the profit margin.  A once acceptable profit margin had now become unacceptable.  To what extent has the return of ruthless capitalism in the past twenty-five years been driven by this insistence that companies return less to their workers and their communities and more to their stockholders?  In other words, to what extent is the free market in companies (the free market in capital investments) hurting American workers more than a free global market in goods?  What could prevent a “race to the bottom,” with each company going to the group of investors willing to pay the most for it because they were also willing to wring the most profit out of it once they gained control?  How far have we already proceeded in this race to the bottom?  Are there numbers (i.e. about profit margins) that document that movement?

A final unrelated note.  Since I am trying to cajole Professor DeLong into the Ann Landers role, it would be churlish of me to ignore a similar request.  So, in next week’s post, I will take up the postmodernist’s call (in the comments to my post last week) for some reflection on Martha Nussbaum’s attack on the work of Judith Butler.  For those of you who like to come to class having actually done the reading, you can find the Nussbaum piece here.  But not to worry.  I have lots of experience talking about books my audience hasn’t read.  They usually assure me that they got a lot out of the talk anyway.  To which I, of course, must always reply: just think what you would have gotten out of it if you had read the material.

Posted by John McGowan on 08/04 at 10:58 AM
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