Freitag, August 07, 2009

Another Example of What Happens When Governments Interfere...and the Swine Cycle

Today's Handelsblatt has an article, on page 10, about the situation in the German river transport industry.

This industry transports goods on the rivers in Germany, usually unpackaged bulk goods like coal or grains, but also junk metals and the like. They are transported on specially designed and constructed ships, relatively small, operated usually by a family that lives on these river freighters. More often than not you can see a compact car parked on the back of the ship and laundry hanging up to dry, sometimes you see a few kids playing.

The article points to a market distortion, created by state guarantees by Dutch Banks to the outfits that build these ships, such that there are far too many ships out there on the market, which, coupled with the recession, has led prices to drop drastically, making it actually cheaper to not operate ships, rather than accept ruinously low-priced jobs.

The reason for the subsidies? The Dutch government guarantees loans made to purchasers of new river freighters in order to ensure that the shipyards that make these ships don't go belly up. Given that these loans are guaranteed and hence risk-free, there are now significant overcapacity in the market, as too many ships chase fewer and fewer jobs.

Market laws don't care why there are too many ships: all these laws do is describe how the markets react. Which, in this case, is leading increasingly to the virtual destruction of the German river shipping business, as long-term operators are forced into bankruptcy as new operators, who are themselves operating at a loss (but no one cares since the loans are guaranteed and equity hasn't been eaten up entirely), leading to the introduction of swine cycle market inconsistencies.

Swine cycle?

This is something we industrial economists see all the time.

Basically, the swine cycle operates thus:

Farmers have a number of swine. They are raised for slaughter, there being a rather small and limited market for swine milk. With markets in equilibrium, the farmers bring enough swine to market to meet demand. When one farmer adds a few swine, he makes more money, which the other farmers note with envy, leading them to add a few to their next batch. When all start doing this, there is an oversupply of swine and the prices fall: farmers cut back on raising swine, since it isn't profitable. Of course, when everyone has cut back on production, there aren't enough swine brought to market and prices start to rise, leading to ... one of the farmers adding a few swine.

This cycle repeats forever. The Swine Cycle is a classic lesson in supply and demand, temporal effects and human behavior.

The Dutch government's decision to support its river freighter shipyard builders has led to an oversupply, leading to a collapse in prices (driven as well by the recession), with new owner-operators driving out the older owner-operators while running their businesses at a loss. The result will be a significant capacity limitation on the market, leading to higher prices for those few that survive, but at the same time making it very difficult for transportation of such goods when demand picks up.

The solution? Well, the damage has been done. If the Dutch government had subsidized its shipyards directly by, for instance, providing a subsidy for employment during a downswing, the excess capacity could have been avoided. Demand and supply in the river freighter business would have been left alone: instead, by distorting the market and increasing capacity, demand and supply have adjusted, but to a point where no one in the river shipping industry can make a profit.

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