Advancing a Free Society

The Minimum Conditions for a Sound Energy Policy

Sunday, April 3, 2011

President Obama’s Georgetown energy speech on this March 30th offers yet further confirmation why he will never be able to lead this nation to a sound energy policy. His key mistake is always to personalize issues that can only be understood in institutional terms. Once he takes that first step, a second one quickly follows: gin up some national energy policy that will make the pain go away.

His last speech is vintage Obama. In speaking about high oil prices, he rightly notes that increased world instability produces higher oil prices. He then goes on in personal terms to decry this change of events. Thus at the outset he writes in elegant but misguided prose as follows:

In an economy that relies so heavily on oil, rising prices at the pump affect everybody -– workers, farmers, truck drivers, restaurant owners, students who are lucky enough to have a car.  (Laughter.)  Businesses see rising prices at the pump hurt their bottom line.  Families feel the pinch when they fill up their tank.  And for Americans that are already struggling to get by, a hike in gas prices really makes their lives that much harder.  It hurts.

In effect, the only lesson that we can learn from this litany of private woes is that somehow the market sets prices at the wrong level because it in its hard-hearted way it is indifferent to the suffering of us all.

Unfortunately, that is exactly the wrong way to think about price responses to exogenous shocks. Those shocks are, at least for the purposes of energy policy, a given. The task of a sound policy is to figure out how best to respond to the bad news. In this instance, bad news translates into shortages, and the best mechanism for dealing with shortages is a price increase, which in its own inexorable way works to minimize the level of dislocations by inducing those who at the margin value oil least will be the first to forego its use.

The phrase “at the margin” is critical for these purposes, because it reminds us that no one faces a set of all or nothing choices in dealing with energy supplies, or for that matter the supply of any other good. Rather, the question that all competing users have to face is how much they wish to cut back on energy use in response to the signal of higher prices. In some rare cases people may just cut out all oil use. But in most cases, they will not. Rather, they will cut back to the point where the last unit purchased at the higher cost yields a comparable value.

Note that one real virtue of this system is that each person can make his or her determination independently of what other individuals choose to do. One great vice of public controls is that every potential user now has the incentive to hype its needs by pleading its case before some administrative body, which is what always happens when price controls are put into effect.

Fortunately in this case the President has not opted for price controls—at least yet. But he has made other claims that are every bit as foolish. Energy independence is a constant presidential mantra. He picks out of thin air a number—one-third—and concludes that we should reduce our dependence on foreign oil by that amount. It is always a mistake to use “end states” to justify policies, and that is what the President has done here. He has no idea whether at the margin we should be cutting oil imports or increasing them, because he has no idea what the alternative sources of energy will cost a decade, or perhaps even a month, from now.

Equally unwise is the President’s insistence that he induce American oil companies to drill right now on the permits that have been issued. But why? People who own coal don’t just dig it up because they are allowed to do so. All sorts of market and technical conditions could easily influence the timing of these drilling efforts. The information to make these decisions right lies at the firm level, not at the government level. The constant presidential jawboning can only distort those judgments. Indeed they can make matters even worse because they carry with them an implicit threat that if these permits are not used, others might not be issued.

But the bad news does not stop here. Oil is one form of fossil fuel energy. Natural gas is another. There are also nuclear, solar and wind energy to put into the mix. Once again, no one at the center knows which way any of these resources should be deployed or why. Yet this constant preoccupation with national policy is supposed to determine how each of these play out in the market place, which will lead to more unwise decisions in the name of industrial policy.

The point here is not that biofuels are useless. Rather, the critical point is that no matter how useful they are, they are not worth a subsidy. But the President never sees things this way. Once he has decided that Americans are hurt at the pump, he continues to support an ethanol policy that hurts them at the meat and dairy counters. The old Hayekian point that decentralized decisions on prices yield better information than government fiats holds true today. If only the President would learn this lesson, he would stop giving witty and high-minded speeches that point United States energy policy in exactly the wrong direction.

(photo credit: Official White House photo by Samantha Appleton)