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 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 add up to “only a few months of national consumption.”  It would not amount to much as a percentage of world reserves, which is the relevant metric for determining the effect on price.   But if one believed there was 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 five 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.  These 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 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. 

Once the long-term goal of “energy security” policy is properly seen to be amelioration of the economic effects of such a disaster, the Republican policy of “drain America first” is seen to be precisely the wrong response.  We don’t want to maximize current domestic production.  Rather we want to leave the oil underground (or underwater) for decades, until we really need it, until we are so desperate that the economic benefits really do outweigh the costs.  (The costs are chiefly environmental, of course.  But the Republicans have often been keen on giving oil companies access to nationally owned reserves at prices that are even below market costs.   Same as hard-rock mining for mining companies, subsidized water for farmers, and grazing rights on federal lands for ranchers.  But the hypocrisy of the self-reliance rhetoric in Western states — “get Washington off our backs” –  is another story.) 

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 5 to 10 years.   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.

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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.]

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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!”