Monday, August 29, 2005

Government Versus Economic Reality

This past week the government announced new fuel efficiency standards for automobiles. These will apply to the 2008 to 2011 model years and will mark six straight years of higher fuel requirements. The new Corporate Average Fuel Economy (CAFÉ) regulations will ratchet up standards for the entire industry, but the biggest changes will be for light trucks. This category, which represents half of all vehicles sold, includes sport utility vehicles, minivans and pickups. These “gas guzzlers” are particular targets in a time of rising gas prices. The government says the new regulations will save 10 billion gallons of gas over the lives of vehicles bought 2008 to 2011. Environmentalists claimed that wasn’t good enough and demanded stricter standards to conserve even more gasoline. This is just one more example of people believing government is superior to the free market in determining what people should buy and sell. And it won’t be the first time they’re proven wrong and the results turn out opposite to predictions. History offers no reason to expect the result will be any different this time around. When political policy clashes with economic reality, bet on reality.

The entire policy of energy conservation has been based on ignorance of basic economics, let alone the history of energy resources. When a product or resource becomes cheaper or is used more efficiently, consumption increases! Instead of “conserving,” people use it more readily—and even find new uses for it. When James Watt’s steam engine was more efficient than its predecessor, the Newcomen engine, demand soared. People found alls sorts of new uses for steam power. When computers declined in price to where practically everyone could afford them, demand soared and people found all sorts of new uses for them. The same thing happened earlier with electricity. And when automobiles became smaller and more energy efficient because of the Arab oil embargo in 1973, people drove MORE—not less—because they could go further with the same amount of gasoline. Gasoline consumption rose for two decades as energy efficient cars flooded the roads.

Energy conservation was a total bust—but that was irrelevant because the government and environmental alarmists were dead wrong about the resource. Instead of the predicted oil shortage, there was abundance. From 1970 to 1991, the world’s proven oil reserves (that is, known to be in the ground, not just estimated) nearly doubled, from 523.5 billion barrels to 1,003.3 billion barrels. And estimates beyond the proven reserves tripled, from 1 trillion to 3 trillion barrels. They have since increased further. Another “crisis” was averted not by the “far-sighted vision” of government officials and alarmists looking out for our future but by the quiet actions of the marketplace.

It is tempting to say that the Big Government advocates have learned nothing from our experience over the last 35 years. But their ignorance extends far beyond that. In 1865 the English economist Stanley Jevons wrote: “It is wholly a confusion of ideas to suppose that the economic use of fuel is equivalent to diminished consumption. The very contrary is the truth….It is the very economy of its use which leads to extensive consumption. It has been so in the past and it will be so in the future.”

For more on the futility of government automobile regulations, see my 3,000-word booklet on the subject, available from American Liberty Publishers.


Anonymous said...

Just wondering how your version of classic economic theory is affected, if at all, by non-economic poltical/policy considerations.

First, how does your theory respond to policy issues that transcend economic theory? For instance, do you agree that reliance on unreliable foreign sources of fuel poses a hazard to the security of the United States? If so, I understand your position would be that decreasing consumption of gasoline might be a laudable goal, even though it is not, purely speaking, a goal driven by economics. Within that context, I would expect you to say that increasing CAFE to achieve that goal is ignorant and ultimately self-defeating. However, I would also expect you to favor, say, a 300% increase in federal gasoline taxes, as a means of driving down consumption and encouraging the development of alternative energy sources by the private sector. As it stands, taxation represents a smaller percentage of the retail price of gasoline in the USA than in any other industrialized nation. Somehow, I can't picture you favoring such a spiking of retail prices in this way. Please share your response.

Second, doesn't economic policy also say that vested economic interests will use governmental policies that favor them at the expense of the general public? Doesn't that suggest that industries will buy government policies that enable them to maximize their profits either by driving up demand/reducing supply or by subsidizing their profit margins?

Lastly, how does your economic theory account for the externalizing of costs? If we add the price to the nation of policing the world sea lanes and fielding an enormous military establishment to secure stable sources of petroleum, doesn't that affexct your analysis?

Edmund Contoski said...

First, I do not accept your assumption about policy issues that “transcend economic theory.” That’s like talking about transcending reality. Free-market economic theory is derived from and corresponds to the real world. This is what enables us to make sense of the world and determine the appropriateness of economic actions. An idea or theory is either right or wrong; it either corresponds to reality or it doesn’t. There cannot be valid conflicting theories in biology or mathematics—or economics. Nor can there be valid “political/policy considerations” in the economic sphere that transcend biological, mathematical—or economic—theories that correspond to reality.

I do not agree that “reliance on unreliable foreign sources of fuel poses a hazard to the security of the United States.” Over 80 percent of our total consumption comes from North America. The U.S. itself is our largest source of petroleum, and Canada is by far our largest source of petroleum imports, followed by Mexico. Canada and Mexico are not “unreliable” sources. Saudi Arabia, the kingpin of Mid-East oil, provides less than seven percent of our imports, and all the rest of the countries in the Middle East only another 7 percent.

On the evening news recently, a reporter was interviewing some Mexicans trying to cross into the U.S. He asked why they were risking their lives crossing the desert. They replied that, like thousands of others, they knew the risk of dying in trying to cross the border but could not stay in Mexico because they had no money, no jobs, no food. With so many of its own people unemployed and lacking basic necessities, do you think the Mexican government is going to stop selling oil to the U.S.? Of course not. That would only make the plight of its own people even worse. The Mexican government cannot afford to stop selling oil to the U.S.

Our imports of Mid-East oil are far lower than the public realizes—and could be even lower but for government policies inimical to domestic oil and gas production. If Mid-East oil imports were disrupted or reduced, undoubtedly the price would go up. This, in turn, would stimulate U.S. production through capital investment, exploration, improved technology, and pressure to reduce government regulations and policies that “transcend” economic reality and are obstacles to petroleum production.

What are some of these “transcendent” obstacles in the form of “political/policy considerations”? One is the federal moratorium on offshore drilling —maintained since 1981 to appease the environmental lobby. This has put 85 percent of the Outer Contintental Shelf (OCS) bordering our entire Atlantic and Pacific coasts off limits. It has also put the eastern half of the Gulf of Mexico off limits, which is why the oil and gas industry was centered around New Orleans, where it was vulnerable to the Hurricanes Katrina and Rita. According to Minerals Management Services, the Gulf of Mexico is sitting on 50 percent more oil reserves than Alaska (which has more than the lower 48 states), but they off limits. And you know, of course, that Congress voted not to allow drilling in any of the 19 million acres in ANWR in Alaska.

Further, government regulations are the reason not a single oil refinery has been built in the United States for 29 years. (One company has been trying for 16 years to get the necessary permits.) The oil industry has spent $47 billion on refineries in the past decade—but it has all gone to meet environmental requirements, not to increase the availability of fuels. The constant apocalyptic pronouncements that we are running out of oil and government must “do something” to prevent catastrophic shortages invariably ignore the fact that past government actions that “transcend” economic realities are largely responsible for today’s precarious supplies—as well as for the prevention of measures for expanding those supplies.

The doomsayers always view petroleum or any other resource as a static quantity, without relevance to technology or economics. But it is technology and economics that make resources available for human use—and those are the fields which government policies prevent, inhibit or misdirect. There is a long history of predictions of shortages that never occurred, because the prophets of doom failed to account for changes in technology or comparative economics. And there is a long history of shortages caused by government policies inhibiting technological advances and forcing political “solutions” upon economic problems.

In the late 19th century there was a great scare that the industrial age would soon grind to a halt because of a shortage of coal. Today coal is superabundant. In 1914 the U.S. Department of Interior said there was only a ten-year supply of oil left. In 1952 it warned that oil wells would run dry by the mid-1960s. And in the 1970s President Jimmy Carter solemnly told us that “we could use up all of the proven reserves of oil in the entire world by the end of the next decade.” (For more on the current abundance of oil, see our posting on this blog of November 30,2005.)

Scarcely a half century ago the idea of drilling for oil deep beneath the oceans seemed technologically impossible and economically infeasible even if it were possible. Yet now deep-sea rigs drill the ground beneath 10,000 feet of water—and the cost of doing so is approaching the cost of drilling 100 feet down on lands in the riches fields of Texas or Saudi Arabia 40 years ago!

The U.S. Dept. of Energy now predicts that carbon sequestration technologies—an innovation of industry, not government—could soon add 89 billion barrels of oil (BBO) to our existing total of 21.4, and eventually add 430 BBO, giving us a total approaching that of Saudi Arabia. Max Schulz of the Manhattan Institute says new discoveries and production methods will raise Saudi Arabia’s reserves to 461 BBO compared to 261at present. Then there is Canada’s Athabasca tar sands, where 180 BBO—a fraction of the deposit—are already economic at today’s price of oil, making Canada’s reserves second only to Saudi Arabia’s current reserves of 261. The Canadian sands are now said to contain between 1 and 4 TBO—that’s TRILLION barrels of oil. And oil shale, which is widely distributed across the globe but not yet economic to develop, can meet our needs for 40,000 years at the current rate of oil consumption. Still we hear the same old economic garbage almost every day about how the world is running out of oil and how we have to reduce our dependence on oil from the Middle East. And so more government programs are proposed by the idiots in Washington and the voting public, neither of whom have learned anything from the past. Or from free-market theory, i.e., economic reality.

An increase in the gas tax—300 percent was mentioned—would be terrible. It would increase the role of government, which is largely responsible for the problem, and do nothing to solve it. A “windfall profits tax” on the oil companies is another stupid idea. Both would do nothing to increase the supply of oil. Instead of increasing taxes, the government should eliminate the gas tax and forget about the windfall profits tax. The higher prices would lead to conservation of supplies and, more importantly, would provide huge incentive for oil companies to increase production—which would lower prices. And industry would have the additional funds needed for exploration, devising innovative technologies, and building refineries. So there would be no need for subsidies or other favors from Washington.

Who knows more about increasing oil production?—the industry or the government? So why funnel money to the government. How would it use the money to increase supplies? Through subsidies? How would it know which companies to subsidize? Is the government better at choosing which company to support through subsidies than the marketplace is in “choosing” which company will be best supported through profits from the buying public?

Would government even subsidize the oil industry?—or would it instead funnel the money to build windmills and subsidize ethanol or other uneconomic energy sources? In a free market, the best product, the most efficient producer, the company that best provides what the buying public wants is the most successful. But government subsidies go to those with the most effective lobbyists, those who make political contributions, and to causes most likely to ensure a politician’s re-election. Which of these funding patterns is more likely to increase oil availability and be more beneficial to the economy? Government should have as little to do as possible with the economy. And if we had a free economy, one where government can offer no economic handouts, there would be no incentive for companies to try to curry favor and influence policy; they would have nothing to gain. Rewards would be determined by the marketplace, not by politicians for political reasons having nothing to do with economic realities.

A free economy is the only economy appropriate to a free society. The dirty little secret of the economic interventionists is that they really don’t want a free society, one where economic choices are determined freely by individuals in the marketplace instead of by collectivist solutions forced upon some people by others, namely, those possessing political power. They want a controlled society, the kind that has failed throughout history to advance either living standards or individual rights. The two go together.

Finally, the writer asks about the cost of policing the world’s sea lanes. This cost is really quite small. Remember it is not up the U.S. to police the world here. Every nation (with few small exceptions, such as Swaziland and The Vatican) are engaged in international trade, and it is to their own interest to see that their ships are secure. Their shipping is their own responsibility, not ours. And they have no interest in attacking our ships or those of any other state since their own trading and shipping would be immediately at risk. We should do what is necessary to protect our own interests, and this is proper function of the federal government. Piracy is one of only three crimes mentioned in the U.S. Constitution. (The others are treason and counterfeiting). And piracy is not much of a threat these days. Nor is terrorism on the high seas. Terrorists want targets that kill lots of people and are highly visible. Modern cargo ships have surprisingly small crews, and it would hardly be acceptable to terrorists to have a ship go down in the middle of an ocean somewhere where nobody even saw it, much less filmed it for TV. Furthermore, it would require much greater technology, expense, and wherewithal to attack in the shipping lanes rather than targets on land. Remember that Hitler did enormous damage to merchant shipping in the Atlantic during World War II, but he had an extensive and modern fleet of submarines. The most vulnerable point for shipping is in the ports, but those are the responsibility of any nation’s sovereignty and are a separate issue from policing the sea lanes.