Stop the presses! I have breaking news: People are saying ridiculous things on talk radio. Just last week, I heard Oregon’s own Lars Larson on Bill O’Reilly’s radio talk show. They were talking about Exxon CEO Lee Raymond’s massive retirement package.
The news of Raymond’s golden parachute has outraged some consumers who realize that the record prices they’re paying at the pump are financing Raymond’s private jet, car and driver, etc. O’Reilly himself, a major critic of the oil companies, has vowed not to buy Exxon gasoline unless Raymond returns the money.
Larson took the opposing side, arguing that Raymond had earned every cent. Throughout the argument Larson kept referring to “supply and demand,” saying “basic economics” shows us that Raymond was paid what he was worth in a “free market.”
Yes, Lars, that’s right. That is what basic econ tells us. But maybe the questions involved in the top-level management of a huge multinational enterprise go slightly past basic economics.
So just for the sake of avoiding moronic oversimplification, let’s leave the land of basic economics for just one second and spend a little time in the wild and woolly world of “intermediate economics.” Ah yes, it is here that terms such as “supply and demand” and “free market” are more than just buzzwords chosen for their rhetorical effect. It is here where such terms have specific meanings with actual implications in management and policy decisions.
First, supply and demand is not merely the idea that if someone wants to buy something and someone else wants to sell something, they can make a voluntary exchange that is inherently fair to both sides. Rather, supply and demand is a theoretical model for understanding various aspects of exchange dynamics. It doesn’t make moral distinctions. So just because an exchange arose out of supply and demand does not in any way imply that it is fair, right, or even efficient (this goes for everyone who invokes “supply and demand” as though it somehow settles any economic debate).
In fact, one of the things that supply and demand tells us is that substantial profits arise only from monopoly power, which is when a firm has a distinct advantage over other firms that inhibits competition. Monopoly power can come from a number of sources including: selling a unique product for which there are no substitutes, government regulations, high start-up costs to enter the industry and anti-competitive practices such as collusion and price-gouging. Any of this sound familiar when discussing the oil industry?
It should.
Firms that have monopoly power can maximize their profits by raising their prices above the market efficient price (which restricts output to levels below the market efficient level). The resulting deadweight loss of market efficiency is a burden borne totally by the consumers who are paying more and receiving less.
This brings me to my point about the “free market.” It’s not a free market when a cartel is restricting output in order to drive up the price. Crude oil, the primary input for oil companies such as Exxon, is a price-controlled resource. This is not a free market. This is what’s called a “market failure.” What does all this have to do with Raymond? Maybe nothing. Maybe everything.
The debate over executive compensation is a much longer debate that has been going on for years. Many people, especially investors, don’t see the logic of a system in which executives are rewarded for success with obscene wealth while punished for failure with merely extravagant wealth. The bottom line is that the huge salaries and staggering retirement packages given to oil
executives comes from record profits resulting from the sale of a price-controlled resource at prices set through the use of monopoly power. Is any of this illegal? No. Unethical? Probably not. But it nevertheless offends the sensibilities of millions of consumers.
I hope this outrage will prompt consumers and voters to demand not just less dependence on foreign oil, but less dependence on oil period. When commentators say that alternative sources of energy are not “economically viable,” they don’t mean that they are not technologically feasible or even that energy companies couldn’t make a profit from their use. Rather, they mean that energy companies might not be able to exercise as much monopoly power and make such huge profits with alternative energy sources as they currently do with oil.
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