In a word, celebrate. A glaring breakdown of basic economic understanding usually occurs when the subject of oil industry profits comes up. This is especially true when oil profits are scrutinized by elected officials.
The St. John Lesson in Apostles & Markets points out that economic profits in a free economy act like traffic signals which direct scarce productive resources in a decentralized manner to where they are needed. Profits also offer useful information about how to use scarce resources efficiently. Economics teaches that profits are residuals, something left over, benefits after all costs have been paid for. Profits motivate far-sighted people to organize and apply resources. Catholic social doctrine acknowledges the important role of profits. It “recognizes the proper role of profit as the first indicator that a business is functioning well: ‘when a firm makes a profit, this means that productive factors have been properly employed.’” (Compendium of the Social Doctrine of the Church, 340.)
If profits are useful, why do so many elected officials call for windfall taxes on oil company profits? Consider these criticisms of oil profits:
Congressman Conyers “Outraged by Republican Failures to Address Record Corporate Oil Profits and Soaring Gas Prices”
Congressman Renzi Applauds Senate for Taking a Stand on Oil Profits Issue; Calls on House to Investigate “Big Oil” for Excessive Profits”
Wisconsin Governor Jim Doyle calls for cap on oil profits.
These officials and many others in Congress seem to think the oil industry is a monolithic monopoly out to squeeze more and more profits from hard working Americans. But the facts tell a different story. In 2006 and 2007 the world’s 20 largest oil companies, including the US’s Exxon, Conoco, and Chevron, had a Herfindahl Index (HI) of less than .07. [See p. 30 of API's primer for world oil firms' shares of known reserves and production.] HI numbers measure the economic power of firms in relation to the entire industry. Industries with Herfindahl Index numbers below .10 are considered competitive, between .10 and .18 moderately concentrated, and above .18 highly concentrated. So the oil industry on a global basis is very competitive indeed. No monopoly power here.
Even more revealing is to investigate some interesting facts behind government outrage and rhetoric over excessive oil profits. According to the Tax Foundation’s analysis of US Bureau of Economic Analysis data, state and Federal treasuries took in more money by taxing the oil industry than those “excessively profitable oil companies” earned in profit. In fact, between 1977 and 2004, total oil industry profits in the United States were $643 billion in 2004 dollars. Total oil tax revenue for state and Federal treasuries was $1.343 trillion, that’s trillion with a “t”, with $533 billion going to the US Treasury and $810.1 billion to state taxes.
If we think of tax revenues from oil firms as ‘government profit’, is there ever such a thing as excessive government profits?
The next time you hear someone go on about “excessive oil profits” think about these four points:
1. Profits may be thought of as the traffic signals in a free economy that direct scarce productive resources in a decentralized way to where they are needed, and to where they will be employed efficiently in meeting human wants. This assessment of profits has been analyzed in detail by economists and supported (with moral qualifications) by Catholic social doctrine.
2. Profits in general and oil industry profits in particular are fleeting. They vary tremendously over time and can be either positive for businesses doing things right, or negative for businesses not doing things right. This is to be expected in a dynamic and reasonably free economy.
3. Oil corporation profits from 1977 to 2004 amount to less than US and state tax revenue from these very same oil firms. If there is such a thing as excessive oil company profits, is there also such a thing as excessive government profit from oil companies’ revenues?
4. Though oil-based products like gasoline and heating oil may be going up in price, which puts a strain on family budgets, these higher prices and profits will attract more resources to the development of cheaper substitutes. While we will never run out of oil, there will come a time when oil is not the biggest source of energy. Americans used to light their homes with whale oil. Not any more. Indeed the profit motive has helped raise the standards of living for millions of people by helping to replace less with more profitable goods and services.
Higher prices of oil/petrol-products will also drive the alternative energy market. Higher profits for the oil companies can actually lead to more accessibility to fuel cell technology, etc. Si, no?
As oil prices increase, the relative price of alternative sources of energy changes, making some of those alternatives more cost effective. So, si. Interesting article in today’s WSJ on how Thailand is trying to get more people to convert cars to natural gas fuel. “As oil prices climbed in 2004, the Thai government stepped up efforts to promote alternative fuels, including ethanol and compressed natural gas, or CNG.” See
http://online.wsj.com/article/SB122454641299552177.html