History Shows Markets, Not Politicians, Should Set Gas Prices

Identical bills have been introduced in Michigan’s House and Senate to impose government price controls on retail gasoline sales. Gov. Jennifer Granholm remains undecided on signing the proposed legislation into law. Despite claims by supporters, the bills could bring higher prices and less real choice to Michigan motorists. It could also create shortages and gas lines by reducing the ability of sellers to respond to short-term demand spikes.

Fines of up to $10,000 per day could be imposed on any stations that sell gasoline at too low a price.

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The bills are a reaction by the service station industry to competition from large retail chains such as Meijer and Wal-Mart. Existing station owners claim the big firms are selling gas below cost in order to drive them out of business, at which point the price will be raised and consumers will have nowhere else to go.

Although this sounds like a diabolically clever strategy for milking a cornered market, there’s just one problem: Economic history shows that the idea of “predatory pricing” is not credible. The classic example is John D. Rockefeller’s Standard Oil Company. Textbooks continue to perpetuate the myth that Rockefeller used his near-monopoly in the kerosene market to gouge consumers.

The facts show otherwise: First, there was only a brief period during which Rockefeller held a 90 percent market share. The rest of the time, from 1870 to 1897, Standard dominated the kerosene market by a comfortable margin, but nothing like the “monopoly” of legend. Did Rockefeller price all competition out of the market and then raise prices to enrich himself and his company? You be the judge: From 1870 to 1897, the price of kerosene fell from 26 cents per gallon to about 6 cents, a boon for consumers. Higher prices were constrained by the presence of remaining competition, and by Standard Oil’s sure knowledge that any attempt to exploit its position would only spur new rivals.

There have been genuine predatory pricing attempts, and economic history is replete with explanations of how they failed. (See “Remembering a Classic that Demolished a Myth” by Mackinac Center President Lawrence Reed, at http://www.mackinac.org/3884 .)

While “predatory pricing” may not be a threat to consumers, price-control laws like those being proposed for Michigan most certainly are. Throughout history, the only price-fixing monopolies or oligopolies that have ever been sustained were those protected by governments. In recent decades, long-distance phone service, air travel, and interstate trucking provide examples of markets in which prices tumbled following the dismantling of government sanctioned monopolies or cartels, with huge benefits for consumers. This is no time to be creating a new gasoline retailers’ cartel in Michigan, which would have to be dismantled later to relieve economic problems it has caused.

Markets are dynamic. They change and react much faster than politicians and laws. Elected officials respond to many competing interests, including the advantages to be gained by protecting organized special interests. Markets respond only to the desires of consumers and the realities of supply. Holding prices artificially low when supplies are tight kills the incentive of producers to bring more product to market and thereby ease the supply crunch. Holding prices low when demand is high allows massive buying that depletes supply. Both create the potential for shortages. They also subvert conservation efforts, which would otherwise smooth out market volatility.

Big retailers like Meijer and Wal-Mart have simply come up with an innovative way to deliver lower gas prices. The winners are motorists. The losers are smaller service stations. Rather than discovering their own innovative way to compete, the latter group has run to the politicians for protection. Lawmakers have responded with legislation to freeze the gasoline retail market in its current form. Even if new marketing strategies do drive some sellers out in some places, half-a-dozen small stations selling at the same high price don’t serve the public better than two or three big ones with really cheap gas. Yet that is the kind of false “choice” this legislation would protect.

These bills are not about protecting consumers from “predatory pricing.” Grass-roots citizens are not begging legislators to “save our Shell station.” This is a classic example of a special interest using its political muscle to gain protection from competition. The threat of “predatory pricing” may be imaginary, but as George Mason University economist Donald Boudreaux points out, "Court records overflow with actual examples of how disgruntled competitors alleging predatory behavior clamor for government to hamstring their more efficient rivals."

Consumers want two things from service stations: Competitive prices and no shortages. They don’t care how tasty a station’s hot dogs are, or how nifty its logo looks. But if price competition is regulated by law, sellers will compete only over frills, not savings.

Ironically, the ultimate result of price controls on gas is that prices will rise. The availability of gas will be less assured. A few existing gas station owners may benefit, but millions of Michigan consumers will lose.