Oil Market Failure n the Middle East Region - Essay Example

Introduction The international economic system has gone through one of the most profound changes since 1980s as the collapse of Russia was also considered as the triumph of capitalism also. Since 1980s the changes taking place in information technology as well as communication technologies have made the more connected and as such new globalized world in which State has the lesser role in controlling the affairs of the market and as such markets worked as de-regulated entities. Functioning of oil markets is considered as one of the most debated topics since past few decades as the cartelization of the oil markets is often viewed as a failure of market forces since prices and output are heavily influenced by the cartel leaving aside the market forces to determine the correct demand and supply of oil in the international market. OPEC- Organization of Petroleum Exporting Countries- is the name which is given to the cartel of oil producing countries in Middle East in a bid to control the oil production as well as regulation the oil prices. This formation of cartels is therefore, often viewed as one of the reasons for failure of market forces at work because by not letting a market to determine the demand and supply, such actions create disequilibrium into markets. Therefore, markets are more prone to external shocks causing them not to function in their most appropriate way. This research paper will study and analyze the reasons for market failure by focusing on oil cartel working in the Middle East Region. Market Forces & Cartels Neoliberalism is the basic fundamental philosophy which advocates the lesser role of governments or other external agencies in regulating the market and emphasize giving a chance to the market forces to work for the greater good of the society. Due to this philosophical drive, most of the developed countries in the world including US and UK shifted their policy framework in a way which advocated the use of market forces as the lone regulator of the market without much intervention from the State. There were reasons behind this shift into the policy response from the developed world because of the increasing external shocks experienced by the developed countries, especially from oil embargo by oil producing countries from Gulf Region. Behind the neoliberalism also lies the fact that market forces are considered as the best regulators of the price mechanism within an economy by correctly and efficiently pricing the demand and supply and secondly, this mechanism brings in more efficiency into the system. However, any distortion in this mechanism can lead to the inefficient employment of resources hence the economy may not work at the full employment level. Cartel is one of the forms of oligopoly- a form of market structure which is dominated by few or small numbers of sellers and buyers in the market. The degree of concentration of the market power is determined by the level of influence i.e. market share controlled by each player in the market. However, with the collusion between each other, firms or players in the market attempt to alter the market equilibrium by creating an artificial monopoly in the market to charge higher profits. It is also important to note that despite forming cartels, firms may not entirely exercise their control over the market as there are other reasons which often make such efforts to fail. Such factors may include falling demand, entry of non-cartel members into the market, as well as over-production etc. Oil Cartel in Middle East The Middle Eastern countries which are part of the oil cartel OPEC includes Iraq, Kuwait, Saudi Arabia, Qatar, UAE etc. are controlling more than half of the world’s oil supply. Its mandate is to safeguard the interests of the organization at individual as well as at collective level. It also intends to stabilize the prices in the international market by regulating the supply of oil to an international market so as to insulate the member countries from the external pricing as well as non-pricing shocks. However, due to its influence in the market to regulate, OPEC’s role has largely been criticized because of the resulting inflation witnessed across the developed as well as developing world. By artificially controlling the supply of the oil, it actually creates inflationary pressures as the oil prices may greatly fluctuate between extremes as witnessed from the recent history of oil prices which showed extreme upward movements in the oil prices. It is because of this reason, that this oil cartel is considered as a failure of the market forces the reasons of which will be discussed in following section. Reasons for Market Failures Following are some of the reasons for market failures:1 Externalities Externalities are one of the main causes of the market failures. They are defined as the spill over impacts of the production and supply decisions. As such externalities can create significant market failures if the social costs and social benefits of the economic decisions are not taken into consideration. (Sloman & Sutcliffe, 2000). Externalities also result into market failures if the actions of the different players in the market affect the people other than themselves. (Sloman & Sutcliffe, 2000) therefore, viewing from this perspective, the functioning of cartel in the Middle East can be considered as a market failure. This is because of the reason that the controlling of oil supply creates strong inflationary pressures on the economies of the developing economies specially because increasing oil prices create current account deficits as such weaker economies have to finance higher oil bills. Therefore, larger resources are diverted to just one portion of the overall economic purchases. This, therefore also creates inefficiency because resources are not efficiently allocated between the different economic agents in order to achieve greater efficiency. The graph below depict how externalities can increase or decrease the social costs and benefits of any economic actions2 The externalities causes market failures because the private optimum level of output is always greater than the social optimum level of output and as such the market fails to take into account all the benefits and costs of any economic action. Legal Restrictions Legal restrictions or imposition of trade barriers through law are also one of the reasons for the failure of market forces to regulate the market. By putting artificial legal restrictions, governments actually attempt to control or influence the supply and demand of any particular good or service by imposing quotas as well as embargoes. The reasons for taking such actions include protecting the local industry as well as other sociopolitical reasons. Cartels, therefore If are formed at the government level with full control of the production. Therefore, such restrictions can create significant market failures because of the legal restrictions placed. Price Controls Setting up prices above or below the free markets is another reason for failure of the markets because in such a way either suppliers or consumers are benefited. In case of cartel, setting up price control through controlling the output level clearly provides an advantage to the suppliers therefore consumers are at the receiving ends. By setting up price controls, oil cartel basically aims to benefit from the upward movement in the price levels so that the greater economic value transfers to suppliers rather than consumers. However, it is also important to understand that the pricing fixing power of OPEC- the main cartel in Middle East has historically declined because of the discovery of oil into non- OPEC countries as well as improved response from the market forces to regulate the prices. As such it may therefore, not entirely be true that the cartel has the entire power to control the prices because they are only suppliers and with significant buyer bargaining power, the cartel may not fully exercise the price control power. Provision of Information Information asymmetries is also been cited as one of the reasons for the market failure as failing to provide correct and whole information may lead to an incorrect or irrational decision making on the part of the buyers or consumers. Such decision making invariably results into inefficient allocation of resources. Therefore, creating a significant consumer deficit. Cartel in Middle East, however regularly provides information regarding the production cuts to be taken place in future in a bid to allow buyers in an international market to re-model their options while responding to future supply side shocks. Conclusion Cartels are one of the forms of oligopoly market structure in which few firms or players in the market collude with each other in a bid to influence the production as well as prices in the market. However, such collusion can result into market failures also because demand and supply decisions are not made in most efficient or optimum level. The cartel of oil producing countries in Middle East is often considered as the failure of the market forces. However, given the actual working and power of this cartel, it may not entirely be an acceptable argument that such cartel is causing market forces to fail. References 1. Sloman, Jhon & Sutcliffe, Mark. (2000). When Market Fail. In: Vivek Suneja Understanding Business. London: Routledge. 146. 2. www.tutor2u.com. (2009). What are externalities? Available: http://tutor2u.net/economics/content/topics/externalities/what_are_externalities.htm. Last accessed 09 Feb 2009. Read More