In the wake of the April oil well blowout off the coast of Louisiana, policy-makers are rethinking the issue of off-shore drilling.    Clearly the last decade’s neglect of safety rules by federal regulators needs to come to an end.   But what larger implications should we draw for domestic oil drilling? 

The tension has long been between those who give primacy to the environment, on the one hand, and those who give primacy to business on the other.    Probably some of the first group oppose all oil drilling and some of the latter support all oil drilling (even when the government unconscionably offers oil leases on federal lands at below-market rates, as it often has historically).    As so often, the right answer lies in between. (more…)

The National Journal asks for reactions to a recent blog post by Greg Mankiw regarding the reasons why US investment has fallen sharply. 

I agree with Greg that the dominant empirical fact about investment is its procyclical volatility (the main reason investment has been depressed for the last two years is that the economy has been depressed), and also that the recent credit crunch made it worse.   But I don’t agree with a third item on his list: “the policy environment seems adverse to business.”   As in many areas, it is when we get to the politics that I disagree. 

Greg cites trade policy, fiscal imbalances, and energy costs, in support of his proposition that the current policy environment is anti-business.    Let’s consider each of the three.

Trade.  I wasn’t happy in September when the White House put tariffs on imports of Chinese tires.  But President Obama, despite the pressures of the most severe recession since the 1930s, has yet to succumb to any protectionist measures as big or as blatantly in violation of international trade agreements as were Ronald Reagan’s quotas on Japanese auto imports or George W. Bush’s tariffs on steel imports, in response to the 1981-82 and 2001 recessions, respectively.  (Greg, of course, was the Chair of Bush’s Council of Economic Advisers.)

Budget.   Most of us think that the $787 billion fiscal stimulus and the distasteful banking rescues were necessary responses to the recession.   But let’s address the serious question of the bleak longer term fiscal outlook. It is known to those who look carefully at the budget numbers that Obama’s recent actions are a distant 4th on the list of contributors.   (OMB, CBO, GAO and respected private economists.)   #1 in the long term (by far) are the future costs of Social Security and Medicare, the approach of which we have been watching for several decades.    #2 are the effects of Bush’s tax cuts and spending increases (including foreign wars and the expansion of Medicare benefits, among other things).    Substantially smaller is #3, the loss of tax revenues from the recession that began December 2007.   A distant #4, as I say, is the recent fiscal stimulus.  (The banking layouts are being repaid, usually with a high return for the Treasury – as the Administration had predicted, to critics’ ridicule.)   I believe that as the recovery becomes better established Obama will, as he says, take much more serious steps than his predecessor in the direction of long-run fiscal consolidation.   But only time will tell. 

Energy costs.  Greg Mankiw in fact believes that a system of energy taxes or cap-and-trade would increase the efficiency of the economy, even though it would raise the relative price of energy.  (This is all the more true if the comparison is to past policies of subsidizing oil and other fossil fuels.)   Greg founded the Pigou Club on this principle, and I heartily congratulate him for it. 

I am skeptical that investment is currently depressed by perceptions of an anti-business climate.    But if the average businessperson does in fact have the perception that recent Democratic administrations have been worse for business than Republican administrations, I suggest setting aside campaign rhetoric and looking at actual history.   Start with the fact that, in the graph in Greg’s blog post, investment growth was substantially higher during the Clinton Administration than during the Reagan or Bush Administrations.   Investment will recover when the economy does.

I was recently asked by the National Journal to comment on what I thought was a desirable path for tax reform, if one could wish away political constraints that normally handcuff politicians.   My answer was, of course, to tax energy, particularly carbon emissions, and use the revenue to reduce other taxes.  As I and many others have noted often in the past, taxes on oil or gasoline hit many birds with one stone.

Discussion of energy taxes has always been political suicide. But here are several twists that could potentially increase the ability of the electorate to swallow them politically:

1) The energy taxes would not go into effect until the economy fully recovers from the current recession, thereby avoiding an abortion of the recovery. But the plan would be announced in the near future (thereby sending desirable allocational signals to firms building power plants or pursuing renewable energy research).

2) Such measures could be on stand-by, to be enacted in the event of a major unfortunate geopolitical setback in the Middle East or a tragic terrorist event, which would galvanize public opinion to do something sensible for the first time about the extent of US dependence on oil imports.

3) A tax on, e.g, gasoline could be designed to put a floor under the current price. The status quo always generates less political resistance than a tax that raises the price.

4) The revenue from the first penny per gallon could be earmarked to fund the deficit in social security benefits of those retiring in 2027, for example. They were born in 1962, and know who they are. The revenue from the second penny could be used to finance the benefits of those retiring in 2028, and so on. (Numbers are illustrative. I haven’t done the actual calculations.) The result would be to create a constituency for keeping the tax in place, namely those whose retirement benefits are funded with the proceeds.

Politicians are often tempted to think that a policy to help one goal, say air quality, must also help lots of other goals, say economic growth.  Economists are more likely to presume tradeoffs, and to use the principle of targets and instruments.  That principle says that you cannot expect to hit more than one bird with one stone, except by coincidence.

At the American Economic Association meetings in San Francisco, January 3, I was on a panel titled “Energy and the Environment: Policy Advice for the New Administration” (along with some real energy experts; I am a relative latecomer to the area).  Within the framework of targets and instruments, I proposed a matrix such as the one that appears below. (more…)

Ten years ago this summer, President Clinton’s Council of Economic Advisers, of which I was a Member, responded to requests from the Congress, which was then under Republican control, to explain in analytical terms what would be the economic effects of the Kyoto Protocol on climate change that had just been negotiated among the members of the UN Framework Convention on Climate Change.  Our response was a document called the Administration Economic Analysis.   It relied on some of the leading Integrated Assessment Models, and showed that the costs of Kyoto could be relatively low provided international trading of emission permits were freely allowed, and provided developing countries participated in the system.    Not zero costs, as wishful thinking by some techno-optimists would have it.  Not prohibitive costs, as some skeptics would have it.   But moderate costs — relatively low if measures could be implemented sensibly.

Integrated Assessment Models are designed to assess both the economic costs and the environmental benefits of action to reduce emissions of greenhouse gases.   For 15 years, the Energy Modeling Forum (EMF), under the leadership of John Weyant at Stanford University, has periodically brought together the modelers to compare results and exchange ideas.   It was gratifying when we discovered that the economic model we had used to estimate costs was near the middle of the pack of ten leading academic models according to the EMF, in terms of the estimated impact on energy costs  for example, contrary to suspicions that we must have low-balled the estimates.

Exactly ten years ago, in August 1998, I attended the Energy Modeling Forum’s annual workshop in Snowmass, Colorado, Climate Change Impacts and Integrated Assessment.   My assignment then was to explain the Administration Economic Analysis to this group.  Unlike most American economists, I believe that something along the lines of the Clinton-Gore version of Kyoto offers the most promising path to address the problem of Global Climate Change.

 
President Bush yesterday eliminated a 27-year executive moratorium on off-shore oil drilling (NYT, 7/15/2008, p.A13), a move also supported by presidential candidate John McCain. 

The Democrats responded:

(1) that this was an election-year stunt,

(2) that the move would be too small to make a difference

(3) that it would bring no downward pressure on oil prices at the crucial short-term horizon, and

(4) that it would not ultimately help move the country in the direction of energy security. 

The Democrats have the right answer, but are perhaps giving the wrong reasons.

 No doubt they are right that it is a political stunt.  A Congressional ban on offshore drilling has been in effect since 1981, so the President’s action is moot.  But making a political point in this way is in itself fair game.  The Republicans are trying to blame high oil prices on the Democrats.   Similarly, the Democrats’ response could well be the right one from the viewpoint of political gamesmanship.

But I should try to stick to economics in my blog, rather than politics.  The issues can be slippery; but let’s take the bit in our teeth and drill down on what would make for good for policy.

On grounds of good economic policy the Democrats’ chosen arguments seem to me beside the point.  It is true that the oil in the offshore sites would not be enough to have much effect on the world price.  It does not amount to much as a percentage of world reserves, which is the relevant metric for determining the effect on price.   “The Department of Energy estimates that there are eighteen billion barrels of technically recoverable oil in offshore areas of the continentail United States that are now closed to drilling…[A]t current rates of consumption, eighteen billion barrels would satisfy less than seven months of global demand.” (The New Yorker, Aug. 18, 2008, p. 28.)  But if one believed there were no cost to more domestic oil drilling, then one should conclude that every little bit helps.  Basic economic theory tells us to judge proposals by the ratio of benefits to costs, not by the absolute magnitude of the benefits.

Regarding point (3), both parties are responding (unsurprisingly) to the American public’s great sensitivity to short-term prices for gasoline (in the summer) and home heating oil (in the winter).  No doubt high prices are causing a lot of hardship.   (And even if it takes ten years to develop new oil reserves, the knowledge that the oil was coming should put a bit of downward pressure on prices today.)   But market prices are high today for a reason.   What is the market failure that would call for government intervention in the oil market?

The most obvious market failures are the externalities that characterize air pollution and emission of greenhouse gases.  The ban on off-shore drilling was originally enacted in response to damaging coastal oil spills;  in the years since then we have also learned that the atmospheric damage from oil consumption is far greater than we had realized.  The environmental externalities of course are reasons for higher prices, not lower.   I am struck every time I see an article on politicians’ commitment to action on global climate change sitting side-by-side in the newspaper with an article on their opposition to oil price increases.   

I realize that higher energy taxes are politically out of the question at this point.   But I could imagine legislation that would automatically raise energy taxes if and when oil prices fall, thereby putting a floor at recent levels and providing industry with the clear incentive to undertake the long-term investment in energy-saving equipment and technology that we badly need.  Rebate the proceeds by fixing the AMT, or removing the payroll tax on low-income Americans, one answer to the income distribution point.  In any case McCain’s proposal for a gas tax holiday is a spectacularly bad idea.

The other obvious market failure that might justify government intervention in the market is national security, and here we come to argument number (4), and the central point of my post.  While Americans need to recognize that achieving complete energy security is an impossible goal, it should indeed by a national objective to reduce our dependence on imported oil.  We could thereby reduce our need to fight messy wars in the Mideast and to coddle unpalatable autocrats worldwide.  But, in the first place, conservation — not new drilling – is the largest and most sustainable component of such a strategy.   In the second place, as high as world energy prices are now by historical standards, this is not the worst-case geopolitical crisis that we should be seeking to protect our economy against.  That worst-case scenario is a prolonged loss of world access to Gulf oil stemming from some combination of military conflict with Iran, anti-Western popular uprisings in the region, terrorism, and/or nuclear or radiological weapons. 

Thus the Democrats have it precisely backwards. The problem with Republican proposals to re-open domestic oil drilling is not that we desperately need the oil right now, whereas new oil discoveries would not come on line for 10 years or more. Rather it is that we might truly desperately need the oil in 20 or 30 years, and so don’t want to use it up over the next decade.

Everyone is looking for someone to blame for high prices of oil and other mineral and agricultural commodities. Speculators (among others) are high on the list, followed by the Federal Reserve. While I don’t think blame is necessarily the right concept here, I have been arguing that low real interest rates have worked to raise real commodity prices through a number of channels. Each of these channels could be called “speculation,” if speculation is defined as behavior based on expectations of future prices.

A number of commentators, including Don Kohn and Paul Krugman, have argued that low interest rates and speculation cannot be the sources of the problem, because oil inventories are low. It is true that low interest rates, other things equal, should in theory increase firms’ desire to hold inventories.

US crude oil inventories do not appear to be especially low in the graph above, showing June 1998-June 2008 (from Bloomberg). But it is true that they are not especially high either.

We are talking about relatively integrated world markets, however, so it is world inventories that should matter most. According to the International Energy Agency’s Oil Market Report, oil inventories held in developed countries have been above average during most of the last year, as the next graph shows. They rose sharply in January 2008, which happens to be the month when the very aggressive cuts in US interest rates took place. These numbers are far from conclusive, but still…

The theory is meant to explain the mystery why prices of virtually all mineral and agricultural prices are high, not just oil, and in some ways fits others better. Inventories of some commodities are indeed high now. The price of gold, the last graph shown, is a good example. Here the evidence supports the theory (1) that easy monetary policy has driven up the price, and (2) that one channel is low interest rates making it more attractive to stockpile the yellow metal. But, as with oil, the biggest inventory is the one underground.

[Thanks to Pravin Chandrasekaran.]

Dear readers: If you wish to comment on this post, please go to:
http://www.rgemonitor.com/us-monitor/252799
or http://www.rgemonitor.com/us-monitor/bio/660/jeffrey_frankel .
I am turning off the comment function on my own site, because I am tired of sorting through 35 spam posts on my blog every night.

Economists frequently complain that even when 98% of the profession agrees on something (say a free-trade proposition), the media will go to lengths to dig up an economist from the 2% minority in order to balance one from the 98% majority, in their feverish and misguided attempt to appear unbiased and balanced on every issue, even issues that don’t really have two sides. The New York Times op-ed page has outdone itself today by publishing “The 18-cent Solution” by Bryan Caplan. The “callout” heading is “Found: an economist who backs the summer gas-tax holiday.” The impetus, of course, was the question posed to Hillary Clinton by a reporter: can you name a single economist who supports the idea of a summer suspension of the federal gasoline tax?     Newshour gave up on trying to find one.

In this case, the NYT evidently couldn’t find an economist who really takes the minority position on economic grounds, or even on reasonable political economy grounds. (The profession is all-but-unanimous on keeping the gas tax, as Greg Mankiw notes. And for good reasons.) Rather Caplan’s argument is a convoluted political rationalization: (1) the high gas prices engender populist anger that might lead to bad policies, (2) yes, a gas tax holiday is a bad policy, but (3) one can make a political argument for the gas tax holiday because it is not as bad as some of the other “populist nonsense: price controls, rationing, windfall profits taxes…” that we might get instead. This political argument is a bit of a stretch as it is, but he then goes on to make it absurd by supporting “a pairing of an excess profits tax with a gas tax holiday” on the grounds that it is not as bad as “an excess profits tax all by itself.” Apparently two bad policies are better than none.

This sort of reasoning makes me sympathize with political scientists who tell economists to leave the politics to them. A more straightforward political argument would have been “Hillary is the best candidate and so one can justify anything that will get her nominated.” Or the symmetric argument for John McCain, who originally proposed the gas tax holiday in April. But the New York Times editors, sensibly, would not have chosen to print such op-eds, out of the hundreds that are submitted every week. So they printed instead an economist’s political argument too complicated for them to understand. If they are going to do this, they might as well print economists’ economic arguments too complicated for them to understand, which they are seldom willing to do.

Bryan Caplan is a perfectly competent economist, with a Ph.D., a job and an interesting book and everything. (He may be a bit too desperate for publicity. But those of us who live in glass weblogs can’t throw stones.) Why would he spout the nonsense that is in this op-ed? The answer is very clear: it is the way to get into the New York Times. He gleefully admits as much on his blog today: “I’ve finally made the Gray Lady: Today’s New York Times features my op-ed inspired by Sunday’s post, I’ll Shill for Hillary. I hope critics don’t misrepresent me as an economic apostate; I’m not dissenting from the standard analysis… look on the bright side: I’m in the New York Times. Sweet!”

Bryan: A suggestion. You should now write a letter to the New York Times retracting your op-ed on the grounds that you should have known that readers would incorrectly infer that you were supporting the policy on economic grounds. [Arnold, can you help out here?] If you do this, the Club of Economists might let you back in. Plus, you will have gotten your name in the NYT a second time! “Sweet!”