TCS Daily

Levin Flunks Econ 101

By James K. Glassman - May 10, 2002 12:00 AM

Carl Levin needs an economics lesson. The Michigan Democratic Senator recently chaired hearings on what was behind last year's sharp rise in gasoline prices. While he admitted that his staff's investigation "did not discover any evidence of collusion," he nevertheless raised the specter of conspiracy - something he called "parallel pricing."

"In Michigan," he said, "the price of gas seemed to leap up overnight by the same amount across all brands of gas at all stations.... It may not be illegal, but it is not a coincidence." He added, "If there were real competition in the industry,...why would the prices of different brands go up and down together?"

In fact, as anyone who has taken Economics 101 understands, in a highly competitive market for a commodity like gasoline, prices always move up and down together.

Take wheat. All the wheat farmers in the United States get the same price on the same day for the same grade of wheat. What moves the price is not collusion among tens of thousands of farmers and wheat buyers, but supply and demand. When there is a bumper harvest, all the prices go down together. When a harvest fails, all the prices rise together. If demand for wheat increases, prices also increase - again, together. Check out the prices in the newspaper every day. One commodity, one price. Is Sen. Levin targeting the wheat industry next?

The retail gasoline business is intensely competitive, with 180,000 individual stations and new "hypermarketers" like Wal-Mart turning up the heat even more. The top five retail brands have a market share of less than 50 percent. As for refineries: there are 150 in the U.S., owned by 63 separate companies.

When we asked the owner of one of the largest gas stations in the Washington, DC, how he sets prices, he answered, "I look down the street." He tries to pass on wholesale price increases to his customers, but he can't charge more than his competitors - even if he wanted. If you are selling the same thing, then the seller who sets the price lowest, sets the price for all sellers.

As Frank Pellegrini of Time magazine put it, "Carl Levin is determined to get angry about Big Oil and high gasoline prices no matter what the evidence says." But why? That's the real question. Why is Levin, along with colleagues like Sens. Joe Lieberman (D-Conn.) and Ron Wyden (D-Ore.), so intent on trying to show a conspiracy when none exists?

Simple. They want to deflect attention from actions they themselves have taken that have raised gasoline prices the old-fashioned way - by restricting supply.

How? Levin and Lieberman were among the 54 Senators who rejected opening part of a federal preserve in Alaska to drilling. They backed the Environmental Protection Agency rules on regional formulations have restricted the flow of gasoline. And, because of oppressive regulations they favor, no new refinery has been built in the U.S. since Marathon Ashland Petroleum's Garyville, La., plant 25 years ago.

In any case, someone should tell Levin that monopoly power is supposed to lead to higher prices, not to the more volatile prices that his hearings spent so much time trying to explain. Some facts: In January 1997, the price of a gallon of regular gasoline averaged $1.22; two years later, it was down to 91 cents; two years after that, it was $1.40, but by January 2002, it was $1.10.

If oil companies are colluding, why have gas prices fallen by half, after inflation, over the past 20 years? And why is the current price of a gallon of regular gasoline 23 cents lower this week than it was a year ago? The strategy of "conscious parallelism," which Levin says "may lead to the same effect as outright collusion," doesn't seem to be working too well. In the first quarter of 2002, earnings for ExxonMobil fell 58 percent; for BP, 57 percent; Chevron Texaco, 70 percent; Conoco, 84 percent; Marathon, 84 percent.

Other than a recession, the best way to knock down gas prices is to increase supply. And the best way to do that is to open up new areas for exploration and end senseless restrictions on refinery growth. But Levin, Lieberman and Wyden won't do that. In fact, they would like to cut supply further. So prices rise. Hey, guys, it's Economics 101.

James K. Glassman is a resident fellow and John Lott a resident scholar at the American Enterprise Institute. Mr. Glassman is also host of

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