The Suez Canal Incident: An Investigation of Behavioural Economics and the Invisible Hand

Politics and Economics

Photograph: John Lau

During the infamous Suez Canal blockage dating several months back, oil stocks rose rapidly as there was a temporary suspension of oil supply to Asia. According to the Classical Microeconomic Theory, as developed by Adam Smith, the invisible hand of the market (price mechanism) is when forces of demand and supply determine prices in a market to reach an equilibrium. It has several major functions, such as signalling, incentive and rationing.

With regards to the rationing function, it allows scarce resources to be rationed such that only people who are able and willing to buy will remain within the market. The greater the scarcity, the higher the price and the more the resource is rationed. The Suez Canal is a major transportation channel for oil from the Middle East to Asian Countries; with its blockage, the oil supply in Asian Countries is severely hampered. Taking China as our example, the drop in oil supply leads to a contraction of the supply curve, causing a shortage of oil. To eliminate the oil shortage within the market, prices of oil are being bid up, discouraging demand and allowing oil to be conserved for later use. Because China is highly oil dependent, the demand for oil in the country is price inelastic. The proportionally larger increase in oil price than the decrease in its quantity supplied ultimately led to a massive price hike in oil and oil-related stocks as these stocks were seen to be highly profitable in the short term.

While the price increase amidst the Suez Canal Crisis can be explained using Adam Smith’s theory, one should never underestimate the irrationality of investors within the stock market, especially in light of recent events such as GameStop or the Global Financial Crisis back in 2006-2008. With this in mind, behavioural economics is able to play a significant role when predicting the outcome of stock markets. For instance, when the public finds out that a company has quality control issues, herd mentality may cause a significant number of shareholders to sell their stocks more than expected. While some investors sell their shares to minimise their loss, other investors simply follow suit and sell as well. This is demonstrated in the recent Suez Canal incident, where investors began to sell their stocks immediately after the Ever-Given ship was freed, causing oil stock prices to instantly plummet. Additionally, the crisis can be explained by anchoring bias, where investors rely too heavily on the initial or most recent information received. In this case, the oil stock price hike acted as an anchor for investors, causing them to believe that prices would continue to rise and thus incentivising them to enter the market.

Conversely, there is a caveat to the aforementioned speculation that investors in the incident are acting out of irrationality, as some theories suggest that they were in fact acting rationally and making decisions out of self-interest. Game Theory also plays a crucial role in the stock market. The Prisoner’s Dilemma describes a situation where, according to game theory, two or more players acting strategically will ultimately result in a suboptimal choice for both. Taking a macroeconomics example, people tend to withhold consumption during a recession due to the speculation that the price of goods will continue to drop, and that they would be able to purchase the same goods at a far lower price in the future. However, their act of withholding consumption ultimately leads to a further decrease in aggregate demand within the economy, subsequently causing a continued drop in price levels as well as a shrink in real GDP. This leads to an endless cycle of doom before the government or other parties are willing to step in and intervene. This corresponds to the rapid price increase and drop during and after the Suez Canal Blockage, as the idea that investors joined and left the market was due to self-interest rather than herd mentality.

To conclude, although economic theories such as the price mechanism and utility maximisation can provide us with insights into how the market functions, one must not forget that these economic models are built upon multiple assumptions and may not be necessarily applicable at times. The most significant of all, as discussed previously, would be the fact that people do not always make rational decisions, and that their choices tend to be affected by external factors such as emotions or biases. Only through incorporating multiple economic theories and acknowledging their pros and cons would we be able to better observe, comprehend and predict the choices that consumers and producers will make.