One thing the coronavirus pandemic is going to prove to us is that predatory pricing doesn’t work. This shouldn’t be a surprise to anyone, as economists have been insisting for decades that it doesn’t. Despite that, we have incessant calls from those on the Left demanding that we’ve got to break up the large companies — these days, it’s Facebook, Amazon, and Google, but it’s always happened to whatever business is most dominant.
The claim is that a company with market power will lower prices to drive everyone else out of business and thereby create a monopoly. At which point, it can raise prices and rook us all royally. This is bad, so we must break up any company with market power.
There are two major problems with this insistence. The first is that the mere existence of potential competition is enough to stop people trying to exercise a pricing monopoly. Standard Oil, after all, even when it was entirely dominant, kept lowering prices to ensure competition didn’t arise; it didn’t start raising them. When it is possible for someone to reenter the market, then it’s just not possible to throw around that market power — by doing so, you give rise to that very competition you’ve just tried to defeat.
The second is that the numbers never do add up. It is simply true that the costs of crushing the competition are greater than the future profits to be made. We saw this when China tried to corner the rare earths market in 2010. Sure, the American industry went bankrupt. And then competition arose, and prices are now lower than they were when China started.
The background now is that oil demand has fallen as a result of the coronavirus. OPEC wants to reduce output to keep prices up, but Russia doesn’t want to play that game. Russia would like to crush the fracking industry in the United States. Low prices will do that — and yes, the Permian Basin is going to see some financial blood from current prices. Saudi Arabia then punishes Russia for stepping out of the cartel by lowering prices. There will be much blood in the Permian. This might even kill some of the fracking companies.
But here’s the problem — or the two problems. There’s still that potential competition there. The technology of fracking will still exist, America will still be an industrial powerhouse, and the rocks aren’t going anywhere. So Saudi and Russia never will be able to exploit high prices as a result — fracking will just reappear when prices rise. And even if it doesn’t, they’ll not be able to recoup the cost of what they’re doing.
As Craig Pirrong, an expert on these commodity markets, points out, the current price cuts are costing those two countries some $500 million a day. Even in politics and government, the equivalent of losing one Michael Bloomberg campaign each and every 24 hours is real money. Do this for three months, and that’s $50 billion or so. For a year, it’s $200 billion — that is vastly beyond what can be recouped by future higher prices.
Predatory pricing just doesn’t work. It’s entirely possible to hurt, harm, or even kill the current competition, as certain Texans are about to find out. But it’s not possible to benefit from having done so — the costs of the tactic are too high for it to be profitable.
One useful proof that we have of all of this is that the Saudis already tried this tactic in 2014. They dropped prices to kill fracking, and they certainly killed some companies, and at least one CEO drove his SUV into a wall as a result. And yet U.S. oil output has only climbed since then. The idea just doesn’t work even if some are stupid enough to try it again.
The outcome of this being, obviously enough, that we don’t have to curb market power for fear of predatory pricing. As it doesn’t work, we can leave well alone. Sure, we should intervene when someone actually has a monopoly and they’re abusing it, but then, that’s what elections are for — to turf out those in government doing exactly that.
A great deal of political economy is mutterings about how this could happen, or that could, so institute my favored policy now — or better yet, give me power. Actual economics is about testing the assertions against that reality outside the window. Given that it’s difficult to run controlled experiments with an entire economy, it’s necessary to look for natural ones, as here. One of the benefits of the coronavirus and actions surrounding it is going to be yet more proof that predatory pricing doesn’t work.
The Saudis and Russia are using pandemic-induced economic weakness to try to kill America’s fracking industry. In three years’ time, we’ll be able to see that they failed, whatever their impact on specific companies. Predatory pricing can cause pain, but it can’t win.
The coronavirus will thus enable us to react to that incessant whining from the Left with a curt “shut up!” Who says that there’s no silver lining to even the darkest of clouds?
Tim Worstall (@worstall) is a contributor to the Washington Examiner’s Beltway Confidential blog. He is a senior fellow at the Adam Smith Institute. You can read all his pieces at The Continental Telegraph.
