Several years ago, I asked each of the students in my freshman economics class to write a short paper on the hot topic of the day, the California energy crisis. Blackouts, "rolling brownouts" and skyrocketing prices for electricity were taking a serious toll on the economy of our largest state.
Almost all of them wrote that the problem was caused by an imbalance of supply and demand. Some thought that the problem was one of not enough new power plants; others thought demand was simply too high and we needed more conservation.
One student said he thought the problem was that energy corporations were manipulating the markets. I told him that he was entitled to his opinion, but that we didn't study that in our class. We studied free-market systems in which such activities were not possible, so he would need to choose another topic.
A few years later, of course, it was clear to anyone studying the California crisis that the student was right. Enron, not the causes I had encouraged my students to write about, was the problem.
Now attention has turned to another energy problem, the price of gasoline. And there are still the same supply-and-demand papers for students to write. But this time around, the words "price gouging" come up often. Price gouging happens when there is not enough competition to keep prices in line with costs of production. For years OPEC has been a textbook example of entire countries acting to limit competition among them so they can sell crude oil at higher prices.
Many now think the major oil companies are doing the same thing.
In March of 2006, the Senate Judiciary Committee called in top executives from the country's largest oil companies to find out why gasoline prices had risen 60 percent in five years and topped $3.00 per gallon in many places during the months following Hurricane Katrina.
At issue was whether mergers in the industry had gone too far and thereby reduced competition to dangerously low levels. On the face of it, the evidence was compelling. First, there were the profits - $100 billion by the top players in a single year. Then there was the matter of the 2,600 mergers in the oil and gas industry that the Government Accountability Office had tracked since 1991. Of these, the ExxonMobil nuptials of Number One and Number Two had given birth to an annual profit of $36 billion, the largest ever for a single corporation.
All of this raised some interesting questions from the senators. If these mergers were reducing costs like they were supposed to, why were gas prices rising instead of falling? Since OPEC was charging refineries so much more for crude oil, how could those companies be posting record profits? Shouldn't we be rethinking the $14.5 billion in tax incentives for energy companies that had been built into our last energy law?
Meanwhile, the attorneys general of Illinois, Iowa, Missouri, and Wisconsin weren't buying the supply-and-demand story for natural gas. Consumers in their states were stuck with heating bills $250 above the preceding year, even though consumption had gone down, not up, by five percent. To make matters worse, the extra money being raked in by the energy companies was not being used to expand supply. Little wonder, then, that the attorneys general rejected "the usual prescription about biting the bullet until the supply-side comes around" and called for increased public oversight of energy markets.
Business Week, in its Feb. 28, 2005, issue, carried a story on Pfizer, the world's largest pharmaceutical corporation.
The story provides a good example of why Americans are becoming increasingly concerned by costs for health care, especially prescription drugs for which patents limit competition. Everyone knows that developing new pharmaceuticals is expensive; Pfizer spent $7.7 billion on research and development in 2004. Less well-known is that advertising and promoting pharmaceuticals is considerably more expensive. While the company employs 15,000 scientists and support staff to develop drugs, it employs 38,000 sales representatives to market them. Pfizer spent $3 billion on advertising alone in 2003, making it the nation's fourth-largest purchaser of ads. The total cost to Pfizer for sales and administration was $16.9 billion, over twice as much as the $7.7 billion spent on research and development.
Thanks to Lipitor, Viagra and other "blockbuster" drugs, Pfizer made the Top 10 list of most-profitable corporations in the United States. Its shareholders saw $11.3 billion added to their wealth, an increase of 596 percent over the previous year. Nevertheless, I probably was not the only one dismayed to see I had three choices for erectile dysfunction drugs, but no choice whatsoever in 2004 for a flu shot.
If we focus on another vitally important sector of our economy, food production, research evidence shows that all is not well there, either. A study at the University of Nebraska and the University of Connecticut (Review of Industrial Organization, 2002) investigated the effects of mergers and acquisitions among 33 food industries ranging from meatpacking to candy products. As these industries continued to grow, they could become more efficient and therefore supply markets with products at lower prices, or they could use their increased market power to increase prices for their products. The results? Only 14 experienced lower costs because of increased concentration, and nine actually saw their costs increase as they got bigger. Mergers and acquisitions actually led to higher food prices in 24 of the industries and lower food prices in only 3 of them.
As important as it is, ownership of products is not the only ticket to such breathtaking profits. A corporation can also own the market in which goods and services are bought and sold. At first blush, a privately owned market seems like an odd idea. Markets are thought of as "free markets" in economics texts. Granted "free" usually means unencumbered by government interference.
Increasingly, the market in which many goods and services are exchanged is owned by a small collection of very large and very powerful corporations. The example most often cited is Wal-Mart, the world's largest corporation.
Health insurance companies provide another example of private markets that are by no means "free." Insurance companies do not produce drugs or examine feverish children. Nor do they seek medical care. They simply provide a costly mechanism for the exchange of goods and services between buyers and sellers.
An article in Business Insurance (4 April 2005) indicated that combined profits for the three largest health insurers were over $6 billion. The profit increases from the previous year for the three giants were 41.8 percent, 235 percent, and 60 percent.
The "highlight of the year" was the "tremendous level of consolidation" which "improve[d] the companies' negotiating clout with providers."
Richard A. Levins is professor emeritus of applied economics at the University of Minnesota. This is the second in a series of excerpts adapted from his book “Middle Class/Union Made," available from Itasca Books at www.itascabooks.com or 1-800-901-3480. Reprinted with permission of the author.