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No.

628 December 1, 2008

The Case against Government Intervention


in Energy Markets
Revisited Once Again
by Richard L. Gordon

Executive Summary

Many politicians and pundits are panicked imported from troublesome regions. Fears about
over the existing state of the oil and gasoline mar- a near-term peak in global oil production are
kets. Disregarding past experience, these parties unwarranted, and government cannot help mar-
advocate massive intervention in those markets, kets to respond properly even if the alarm proved
which would only serve to repeat and extend pre- correct. Market actors will produce the capital
vious errors. These interventionists propose solu- necessary for needed investments; no “Marshall
tions to nonexistent problems. Plans” are necessary. Price signals will efficiently
This Policy Analysis reviews the academic liter- order consumer behavior; energy-consumption
ature relevant to these matters and argues that the mandates are therefore both unwise and unnec-
prevailing policy proposals are premised on a mis- essary. Finally, more caution is needed regarding
understanding of energy economics and market the case for public action to address global
realities. The interventionists do not distinguish warming.
between problems that government can remedy The omnipresent calls for more aggressive
and those that it cannot. They ignore lessons that energy diplomacy are misguided. Economic theo-
should have been learned from past experience. ry validated by historical experience implies that
They embrace at best second- and third-best reme- the diplomatic initiatives are exercises in futility
dies rather than first-best remedies for the alleged because they seek to divert countries from the
problems. Moreover, they ignore the extreme dif- wealth maximization that is their goal. Similarly,
ficulty associated with ensuring efficient policy the search for favorable access to crude oil is futile.
response even when it seems to be theoretically Despite their popularity, rules to force reductions
warranted. in energy use lack economic justification. Attacks
Fear of oil imports is premised on pernicious on American oil companies and speculators seek
myths that have long distorted energy policy. to shift blame to those subject to U.S. government
The U.S. defense posture probably would not be control from the uncontrollable foreign oil-pro-
altered by reducing the extent to which oil is ducing governments that are truly to blame.

_____________________________________________________________________________________________________
Richard L. Gordon is professor emeritus of mineral economics at the Pennsylvania State University. The issues
addressed here have been his major research topics throughout and after his academic career. For further detail, see
the “Notes” section of this paper.
The National gy by increasing efficiency of transporta-
Petroleum Introduction tion, residential, commercial, and indus-


trial uses.8
Council joined, The vast majority of both Republican and Expand and diversify production from
among others, Democratic politicians, including those in the clean coal, nuclear, biomass, other renew-
George W. Bush administration,1 are pushing ables, and unconventional oil and gas;
the National for increased governmental intervention in ener- moderate the decline of conventional
Commission on gy markets. A disappointingly large number of domestic oil and gas production; and in-
Energy Policy, organizations that analyze policy issues have crease access for development of new


likewise issued reports supporting such inter- resources.
the Council on vention. With the publication of a report in 2007 Integrate energy policy into trade, eco-
Foreign Relations, titled Hard Truths: Facing the Hard Truths about nomic, environmental, security, and for-
and the Milken Energy: A Comprehensive View to 2030 of Global Oil eign policies; strengthen global energy
and Natural Gas,2 the National Petroleum trade and investment; and broaden dia-
Institute in Council joined, among others, the National logue with both producing and con-
support of Commission on Energy Policy,3 the Council on suming nations to improve global ener-


Foreign Relations,4 and the Milken Institute5 in gy security.
additional support of additional interventions in energy Enhance science and engineering capa-
interventions in markets.6 The source for the call—the oil indus- bilities and create long-term opportuni-
energy markets. try itself—probably explains the attention the ties for research and development in all
NPC report initially received.7 While there was phases of the energy supply and de-


little new in the report, its fuller-than-usual cov- mand system.
erage of many of the issues that currently haunt Develop the legal and regulatory frame-
policy makers, the attention it has received from work to enable carbon capture and se-
the trade press, and the fact that it came from questration. In addition, as policymakers
the oil industry itself makes it a convenient start- consider options to reduce CO2 [carbon
ing point for a discussion about energy markets dioxide] emissions, provide an effective
and public policy. global framework for carbon manage-
ment, including the establishment of a
An Overview of Hard Truths and Other transparent, predictable, economy-wide
Energy Proposals cost for CO2 emissions.9
The standard 2008 case for energy interven-
tion cites the dangers of oil-import dependence The purpose of this Policy Analysis is to
and the related problem of high oil prices; the demonstrate that all but one of those proposi-
undesirability of oil use because of depletion, tions—that pertaining to increased access to
undesirable environmental impacts, or both; government-owned resources—are unsound
and the danger of global warming due to fossil- suggestions typical of the prevailing energy
fuel consumption. This is often aggregated into debate. Those proposals allegedly derive from
a call for energy independence, but energy inde- the “hard truths” that the NPC asserts about
pendence is inconsistent with oil-depletion and the world energy market, which include chal-
environmental-impact concerns. The NPC lenges to—but also acceptance of—the prevail-
report curiously rejects these standard premises ing political rhetoric. The six hard truths high-
but devises similarly unsatisfactory alternative lighted by the NPC report (which I have
rationalizations for the same policy measures as numbered for convenience)10 are as follows:
other commentators advocate. The executive
summary of the NPC report argues that the 1. Coal, oil, and natural gas will remain
United States must indispensable to meeting total project-

• Moderate the growing demand for ener-


ed energy demand growth.
2. The world is not running out of energy

2
resources, but there are accumulating report that market actors are unable to execute
risks to the continued expansion of oil profitable investments in energy. The first sen-
and natural gas production from the tence-and-a-half of claim (4) is spot-on. The
conventional sources which historically last sentence is a truism, and the text in
relied upon. These risks create signifi- between ranges from the banal to the indefen-
cant challenges to meeting the total sible. Clearly, energy imports require an in-
projected energy demand. crease in world trade and investment. Yet, no
3. To mitigate these risks, expansion of all public policies are needed to produce the pos-
economic energy sources will be required, tulated increases in trade and investment. The
including coal, nuclear, biomass, other claim regarding domestic demand and supply
renewables, and unconventional oil and points crosses the line between describing what
natural gas. Each of these sources faces might happen in the marketplace and making
significant challenges, including safety, indefensible policy suggestions. Claim (5) is a
environmental, and political or economic statement of fact that has no satisfactory poli-
hurdles, as well as imposing infrastruc- cy implication. Claim (6) is tautological, and
ture requirements for development and presages the feebleness with which the report
delivery. handles global warming.
4. Energy independence should not be con- Nevertheless, these truths provide the bases
There is a
fused with strengthening energy security. for the governmental intervention proposed tension between
The concept of energy independence is by the NPC. This is an ironic outcome. The many of these
not realistic in the foreseeable future, report, as the list of truths shows, dissents
whereas U.S. energy security can be from the import fears and resource pessimism hard truths and
enhanced by moderating demand, ex- that is popular in other studies, but promotes the NPC policy
panding and diversifying domestic ener- new and equally dubious problems that are
gy supplies, and strengthening global marshaled to justify the very same policy pro-
responses that
energy trade and investment. There can posals that the other efforts advocate. follow from
be no U.S. energy security without glob- The NPC’s case is developed in the first five them.
al energy security. chapters of the report, dealing with, in turn,
5. A majority of the U.S. energy sector demand, supply, technology, geopolitics, and
workforce, including skilled scientists carbon management (the report’s curious
and engineers, is eligible to retire within euphemism for global warming):

• The demand chapter moves from a pre-


the next decade. The workforce must be
replenished and trained.
6. Policies aimed at curbing carbon dioxide sentation of forecasts to a call for more


emissions will alter the energy mix, regulations to reduce energy use.
increase energy-related costs, and require The supply chapter is predominantly a
reductions in demand growth. review of forecasts and resource-avail-
ability studies into which concerns
There is a tension, however, between many about the difficulties of ensuring neces-


of these hard truths and the NPC policy sary investment are interwoven.
responses that follow from them. For instance, The technology chapter ranges over a
claim (1) is clearly valid, but it should suggest variety of options, with the bulk of the
nonintervention, rather than the intervention attention given to conventional and
proposed elsewhere in the report. Claim (2) unconventional sources of oil and gas.
substitutes for the standard dubious fear of Stuck at the beginning is an examination
exhaustion the equally questionable fear of a of the dangers of an inadequate supply of
worldwide failure to invest adequately in ener- people who are trained to manage energy


gy production. Claim (3) similarly is premised ventures.11
upon the odd idea that dominates the NPC The geopolitics chapter has little sub-

3
stance; it does not distinguish among the eign policies by having the Department
threats that prior writers have seen as rel- of Energy share an equal role with the
evant to policy; those that are unfortu- Departments of Defense, State, Treasury,
nate, but to which market economies can and Commerce on policy issues relating

• Continue to develop the international


adapt; and flights of fancy about oil- to energy and energy security.
access wars. The NPC displays a faith in
negotiation as a remedy, which makes no energy marketplace by expanding the ener-
economic sense, and has proved worth- gy dialogue with major consuming and


less in practice. producing nations, including China, India,

• Promote an effective global energy mar-


The carbon management chapter is so Canada, Mexico, Russia, and Saudi Arabia.
perfunctory as to have been better omit-
ted. ketplace by sustaining and intensifying
efforts to encourage global adoption of
The NPC report does not merely embrace transparent, market-based approaches
the principle of intervention; it advocates con- to energy through multilateral and
tinuation and even extension of the many ill- international institutions—including
advised energy policies that survived the par- the World Trade Organization, G8, the
tial deregulations of the 1981–1992 Reagan- Asia-Pacific Economic Cooperation, the
Bush administrations. International Energy Agency, the Inter-
The recommendations start by proposing a national Energy Forum, and the Joint

• Assist and encourage global adoption of


tightening of energy-performance standards, Oil Data Initiative.
first in motor vehicles and then in the residen-
tial and commercial sectors. The NPC also calls energy transfer programs and lend-lease
for related increases in government research arrangements.
and development, and federal demonstration
projects to highlight better industrial energy- The critical element of the report’s over-
use techniques. reach is the NPC’s call to subsidize virtually
More critically, later recommendations buy every energy resource imaginable: enhanced
into the pernicious fallacy that oil is a special oil recovery, conventional oil and gas, oil
commodity whose availability is heavily affected shale and oil sands, unconventional natural
by political considerations. Without any sup- gas, biomass, coal, and nuclear (solar power
porting evidence, the NPC transforms the pos- and wind power are praised elsewhere in the
sibility of politicization into a near certainty: report).14 A mishmash of policies is suggest-
ed to promote those energies. While the NPC
The world is entering a period in which nods toward the need for better federal lands
international energy development and management policy to facilitate the produc-
trade are likely to be influenced more by tion of energy (with particular attention giv-
geopolitical considerations and less by en to oil shale, oil sands, and unconventional
The critical the free play of open markets and tradi- natural gas), a report stressing more reason-
tional commercial interactions among able regulation would have been much more
element of the international energy companies.12 helpful than what appeared.
report’s overreach On the positive side, the report offers a
is the NPC’s call Consequently, the NPC believes that ener- laudable, but familiar, laundry list of desir-
gy should become a central focus of policy in able attributes for the world energy market.15
to subsidize every relevant diplomatic realm. The report Those attributes include

• a competitive market
virtually every calls for the United States government to13

• Integrate • stable and diverse supply with minimal


energy resource energy policy into trade, eco-
imaginable. nomic, environmental, security, and for- disruptions

4
• low price volatility
• adequate spare capacity
what is advertised—the industry’s perspective The primary
and logistical on the issues at hand. While the NPC was problem manifest

infrastructure once the source of insights from industry


diverse energy mixes experience, its aggressive use of non-industry in these energy
protection of the global environment, analyses and arguments add external views reports is their

including climate considerations that lead to incoherence.
flexibility to accommodate shifting That aside, the primary problem manifest
appalling failure


demand patterns in the energy reports noted here is their to acknowledge
transparency and reliability of commer- appalling failure to acknowledge the implica- the implications
cial relationships tions of past experience. There is nothing
new, for instance, about producer instability, of past
The NPC concludes that neglecting these the search for reliable sources of energy, or experience.
objectives in a blind pursuit of energy self- the need for finance and staff for energy
sufficiency would risk unintended and harm- expansion projects. More critically, the his-
ful consequences for both energy suppliers torical record shows the inability of govern-
and consumers alike.16 The authors, however, ment to effectively assist industry in meeting
adopt undesirable proposals to support these those challenges.
goals. In particular, the NPC seems to believe During the energy turmoil of the 1970s,
that the United States has the ability to con- economists engaged in a great effort to critical-
vince the world to embrace this vision for ly examine the then-prevailing energy problems
world energy markets, and the ability to assist and the policies adopted as reactions to those
in an attempt to translate that wish into real- problems. The basic conclusion was that no
ity. valid economic defenses existed for the inter-
ventions that were adopted. Some controversial
Common Pitfalls of “Blue Ribbon” arguments were made for alternative interven-
Reports tions, but they have not stood up. Nothing that
Unfortunately, the NPC report shares sev- has occurred since then has altered these con-
eral key defects with other recent and earlier clusions. Unfortunately, too many commenta-
reports, studies, and books that have plowed tors have forgotten previous work on these
this policy terrain.17 The NPC study is simply issues.
one of a long line of ostensibly “blue-ribbon” The NPC report—like the other studies and
reports that say more or less the same thing reports mentioned above—also pays too little
and argue more or less from the same foun- attention to the underlying economics of
dation. None constitute a serious attempt to energy. While a report to a general audience
deal with energy issues. may downplay or popularize the technical eco-
The errors found in these reports are the nomic issues, the implicit failure to recognize
inevitable result of the politics of blue-ribbon the issues in play is unacceptable. At times, the
panels. They are designed to include a wide NPC, unlike other studies, does state—albeit
variety of views, make quick decisions, and without elaboration—purported economic
are at the mercy of a supporting staff whose rationales for its proposals. None of those jus-
qualifications depend upon the decisions of tifications, however, are persuasive.19 That
the study’s administrators. As subsequent should not surprise: the passion to act regu-
material should suggest, the competence of larly inspires neglect of those economic princi-
support staff is widely variable. Moreover, the ples that undermine the case. Regardless, what
pressure to rapidly reach a consensus and was intended as a fresh look at energy issues
unite behind it often produces the bloated repeats chronic errors.
set of proposals criticized here.18 The NPC report, like most others, errs dou-
A particularly unfortunate aspect of the bly by advocating inferior, and, in the critical
NPC report is that it fails to even provide international-oil case, totally ineffective cor-

5
rective measures of a type identical to those After that, I consider the importance of
proposed in the Cheney report. Thus, even selecting the appropriate remedies for identi-
were the problems real, the proffered policy fied problems. The alleged problems highlight-
agenda would not correct them. ed by the NPC can be better and more directly
addressed by straightforward interventions
The Underlying Economics of Energy that were never considered by the NPC and
The discussion that follows offers a sum- similar studies. This is another example of the
mary of the underlying economics literature unanalytic, ahistorical devotion to pet reme-
on energy markets and governmental inter- dies that mars current energy policy discus-
vention in the same and contrasts those find- sions. These errors are another consequence of
ings with the main arguments offered in the arguing without considering the relevant eco-
energy agendas advocated by the most popu- nomics. Rather than first-best responses, the
lar public reports. NPC report embraces (at best) third- or fourth-
First, I deal with the economics of oil-im- best responses that will fall short of their poli-
port dependence, the main concern of most of cy mission, introduce unintended conse-
these blue ribbon reports. The oil-dependence quences that complicate markets even further,
danger is the subject of an extensive, but spe- or do both.
Both economic cialized, literature. Both economic theory and Finally, I examine the difficulty involved in
theory and actual actual experience suggest that the present hys- remedying market failures with government
experience teria is unwarranted. intervention, even when those market failures
Next, I turn to the alleged shortcomings clearly exist. The NPC report, like almost all
suggest that the of capital markets, which is the only plausible other such reports, is quick to argue that mar-
present hysteria is economic basis for public policy to address kets fail on a wide range of fronts, yet implicit-
energy depletion. These concerns have right- ly assumes that government remedies to mar-
unwarranted. ly become a backwater of economic analysis; ket failures never misfire. A vast literature
economists have abandoned their concerns proves exactly the opposite.
over the issue.
Following that, I address the environmen-
tal impact of energy consumption, a well- Oil Import Problems in
established interest of modern economists. As the Economics Literature
with all environmental issues, however, eco-
nomics only can suggest what to do, given that Starting well before the oil turmoil of the
the impacts from man-made global warming 1970s, economists have found oil to be a
are conclusively established to exist and prove major area for study. An enormous literature
harmful. exists, and more accumulates on a regular
Then, I consider the implications of imper- basis. The material ranges over many issues
fect information in energy markets and and cannot be fully reported or reviewed here.
whether intervention to reduce energy con- The single most critical contribution has
sumption is warranted by the same. Markets been that of Professor M. A. Adelman of MIT.
are perfectly capable of dealing with most if not Starting in the 1960s, he undertook a com-
all information-related problems in both theo- prehensive examination of the underlying
ry and practice. economics of world oil and how it was affect-
Next, I briefly discuss the current obses- ed by public policies around the world. His
sion with speculators and the impact of mar- classic synthesis book reached completion
ket manipulation on energy prices. While this just as the oil turmoil broke.20 Two decades
issue has been neglected in the blue-ribbon later, he critically chronicled the evolution of
reports discussed in this paper, it reappears oil markets from 1970 through the after-
regularly in energy policy debates and is a math of the first Gulf War, with a particular
manifestation of economic illiteracy. focus on the behavior of oil-exporting coun-

6
tries.21 Adelman was by no means the only recognize that at least one important depar-
economist to explore this terrain—and many ture from wealth maximization has arisen: the
continue to work in these vineyards at pre- nationalization of the oil industry within
sent—but his contributions have proven the OPEC countries during the 1970s. The ability
most important. of national oil companies to hire foreign man-
An interesting parallel to Adelman’s work agers, combined with prior efforts by OPEC
was produced by President Nixon’s Cabinet members to arrange that its domestic work-
Task Force on Oil Import Control.22 This was force secured training in petroleum industry
one of those rare government studies that seri- management, ensured that operations were
ously examined the issues. The effort received not undermined. Investment decisionmaking,
first-rate staffing, and sought and received on the other hand, was harmfully altered.
excellent input on the issues. Several leading During the private-ownership oil regime, for-
energy economists provided consulting reports, eign contractors concentrated on making
and interested parties were invited to provide profitable investments in capacity mainte-
input. The result was an impressive review of nance and addition. With nationalization,
the issues, focusing on the centrality of foster- however, the funds derived from oil produc-
ing and preserving competition in oil and the tion became part of a national pool of wealth,
unsuitability of the then-existing import quota and oil investments had to compete with oth-
system for oil. Unfortunately, the advice was er governmental priorities. The effects of this
ignored. on the industry illustrate the fallacy of reliance
Numerous reviews of import dangers and on allegedly superior governmental invest-
policy have since emerged with important ment skills (an issue to which I return later).28
contributions by economists at Resources for One clear consequence of an economics-
the Future, such as Milton Russell, Douglas based view of oil is that if oil policy is governed
Bohi, Michael Toman,23 and, most recently, by national self-interest, the engagement with
Ian Parry.24 The fascination with government producers—so beloved among politicians and
oil stockpiles produced several efforts.25 The the NPC—is at best a waste of time, and at worst
macroeconomic implications of oil-supply an arrogant presumption of superior knowl-
shocks have also received a great deal of atten- edge. Exporting, if profitable, will be undertak-
tion. Professor James Hamilton at the Uni- en whatever foreign diplomats may suggest.
versity of California, San Diego, is the most Conversely, unprofitability precludes exports.29
quoted advocate of the argument that oil A key point here is that, to date, the danger from
shocks cause major macroeconomic disloca- imports has been of temporary disruption of
tions, but, as sketched below, many have con- supplies due to some local crisis.30 This is a
curred or dissented.26 The most comprehen- manageable problem that free-market institu-
sive synthesis of oil economics and public tions could have handled if they had not been
policy, however, was produced by energy thwarted by intervention (another matter to
economist Robert L. Bradley Jr.27 which I will return later). Eliminating or even
sharply reducing oil imports is not a sensible
Economics vs. Politics in World Crude response to such short-term disruptions.
Oil Markets It is premature to postulate and respond to The advantages of
A long-standing conflict prevails between the risk of longer-term supply disruptions. oil trade to buyers
those who believe that the world oil supply is Indeed, it is hard to conceive of plausible long-
primarily driven by the conventional eco- term threats. The advantages of oil trade to and sellers are
nomic objective of wealth maximization, and buyers and sellers are powerful incentives for powerful
those who believe that political influences are both to maintain flows. Oil is more easily incentives for
dominant. Neither view, however, should be extracted, transported, transformed, and uti-
pushed to its logical limits. lized than any other fuel. Rival energy sources both to maintain
Proponents of the economic view generally are so costly that they prevent the energy tran- flows.

7
Once oil hits sitions so eagerly advocated by many com- mizing aspects. To be sure, the moves were
the high seas, mentators. The resulting revenues to produc- motivated by ancient enmities. However, the
ing countries dwarf what they can earn else- efforts could also be construed as oil grabs
its destination where. based on ill-conceived beliefs that more oil
cannot be A classic illustration was Richard Nixon’s wealth could be secured cheaply.
call for energy independence. Fortunately, the Similarly, Adelman’s 1995 book convinc-
controlled. old Federal Energy Administration assembled ingly demonstrates that the special relation
a team of bright young operations researchers with Saudi Arabia is a sham. Saudi Arabia, as
to synthesize the numerous studies commis- should be expected, does what is in its eco-
sioned to support the Project Independence nomic interest, which rarely means doing
initiative. Their well-designed (but necessarily what the United States wants.35 No vision of
very oversimplified) model nicely quantified oil-exporter restraint from wealth maximiza-
what experienced energy observers sensed: the tion implies either that good relations are
nature of petroleum use with its heavy con- needed to ensure supply or that the exporters
centration in the transportation sector makes are susceptible to cajoling.
substitution extremely expensive.31 The nadir of this stress on diplomacy was
Conversely, the political theory of produc- the notorious 1971 Tehran negotiations.36 As
er behavior bears a strong resemblance to was ultimately learned by reporters from
what economists call the “managerial-slack Forbes, the State Department, apparently
model” of firm behavior. In that model, pro- under the leadership of its long-time energy
ducers supposedly have sufficiently limited advisor James Akins, pushed through a pro-
objectives, so that they sacrifice opportuni- ducer-consumer deal that allowed major
ties for wealth maximization. The political increases in oil prices, ostensibly as a means of
theory of producer behavior, however, has heading off even larger price increases. Adel-
the same inherent implausibility as the slack man argued that the government’s timidity
theories that it resembles.32 would unleash even more vigorous efforts to
More critically, the key example cited to raise oil prices closer to a monopoly-profit-
buttress the argument that politics drives pro- maximizing level. The 1973-74 oil price spiral
ducer behavior—the purported Arab oil embar- was the realization of Adelman’s warnings.37
go of 1973—implies no such thing. First, there As Adelman also warned, what has been
was no embargo because selective embargos are critical is the oil dependence of these coun-
infeasible.33 Once oil hits the high sea, its desti- tries. Most possess nothing else that can pro-
nation cannot be controlled. Moreover, an duce significant incomes. Others have become
embargoed nation can easily shift to other sup- so dependent on oil that other industries lie
pliers. Adelman’s classic 1995 analysis of world fallow. Maximizing wealth and spending the
oil argues that whatever production reductions proceeds is far more rewarding to producer
that were undertaken were motivated by a states than the capricious political manipula-
desire to force up oil prices rather than by a tion of markets.
desire to punish anyone for support of Israel. Some have suggested, at least tacitly, that
Further evidence is provided by the effects the rise of Islamic fundamentalism profound-
of the critical revolutions in Iraq, Libya, and ly alters the situation. That suggestion rests on
Iran, in which rulers who were friendly to the at least two critical implicit assumptions: first,
West were replaced by rulers who were hostile that because fundamentalists are willing to
to the West. Aside from the later years of harm fellow Muslims, radical fundamentalist
Saddam Hussein’s rule in Iraq, those hostile governments would take the ultimate step—
rulers were at least as dedicated as their prede- avoided by the Iranian fundamentalists—of
cessors to the maintenance of oil supplies.34 dooming Islamic nations by ceasing oil pro-
Even Saddam Hussein’s attacks on Iran in duction; and second, that these fundamental-
1979, and Kuwait in 1991, had wealth-maxi- ists have good prospects to assume power in

8
many oil-producing states. A possible third repeat past errors and are thus of no great con-
tacit assumption is that the strategy of eco- cern. No evidence exists that these arrange-
nomic suicide could not be resisted any more ments have ever affected product allocations.
than a scorpion could resist stinging the The NPC raises an alternative, more ger-
proverbial frog that was carrying it across the mane worry regarding access: the willingness
water. While all this might occur, it appears far of governments to allow the development of
too wild a possibility to be the core of nation- oil and gas resources. A good example of this
al energy policies. Moreover, it is unlikely that problem is the reluctance of the United
any good strategy exists to prepare for this States government to lease oil-development
doomsday. rights on federal land and in coastal waters.
The belief that oil producers are motivated This is surely the best policy analysis in the
by political considerations breeds the belief NPC report. It gets lost, however, in the bar-
that some set of policies can ensure favorable rage of mostly questionable suggestions else-
access to oil relative to other customers. Of where in the report, particularly the move to
course, in markets governed by economic infer similar reluctance in the rest of the
principles, access is secured by paying the pre- world.
vailing market price, regardless of how com- In sum, the economic view of oil advocated
petitive the market may be. With textbook- here holds for the primacy of economic goals,
It is fantasy to
pure competition, everyone is a price taker, recognizes that oil markets generate vast rev- believe that
buying or selling what is economic at the pre- enues that may be and indeed often are mis- oil-importing
vailing market price. With imperfect competi- used, and acknowledges that the feasible
tion, some sellers and buyers may affect the options open to the United States and other countries can
price, but sellers will still sell to all at whatever major oil consumers are limited to avoiding redirect the
price results from the interaction.38 incentives to rig markets. Given that oil-mar-
Logic and experience suggests that the ket behavior is determined by the exporting
policies of
search for favorable access is an exercise in countries’ perception of what the market will oil-exporting
futility. All parties in the oil trade face enor- permit, it is fantasy to believe that oil-import- countries.
mous pressures not to indulge in favoritism. ing countries can redirect the policies of oil-
By definition, favoritism is bad for the pro- exporting countries. Countries cannot be per-
ducing companies and countries. Favoritism suaded to ignore their economic interests. It is
can only mean selling to less remunerative equally unrealistic to believe that dialogue will
outlets. Even the consuming countries suffer improve these countries’ knowledge of market
the consequences of diversion from what realities. If anything, their record in market
may be actual or potential allies. perception far excels that of consuming-coun-
Reality, however, has not prevented pursuit try governments. That should not be a sur-
of special relations with oil producers. The prise. Exporting-country survival depends on
classic illustration was the maneuvering to realism about markets. Consuming-country
secure rights to develop oil in the Middle East. governments, in contrast, are essentially by-
The first important case was the British gov- standers to decisions made by their citizens.
ernment’s purchase of the company that was These governments thus face little or no pres-
developing Iranian oil resources (the predeces- sure to be correct.
sor of today’s BP).39 The key symbolic start of A related form of wishful thinking is that
the United States’ embrace of the political- consuming-country governments can per-
relations approach to oil was Franklin D. suade oil-exporting countries to eliminate the
Roosevelt’s 1945 visit with Saudi Arabian king many undesirable ways in which oil money is
Ibn Saud. Other forms of deals have arisen. used. These misuses are broad and real. They
France and Japan have likewise engaged in include corruption, support of destabilizing
futile efforts to establish special relations with activities in other countries, and overinvest-
oil producers. Current Chinese efforts simply ment in armaments. Given the strong forces

9
that lead to such excesses, it is futile to expect States in seeing and trying to counteract polit-
that external criticism will have any impact. ical forces in oil markets. Danger (3) then pos-
tulates an unfamiliar proposition that others
Import Dangers Revisited also will be more errant in perceiving what dri-
Before dealing with specific issues related ves the market. Danger (4) is another example
to oil imports, various views on the subject of the untenable belief that the quality of for-
require our attention. Among the studies eign governments matters to and is cor-
criticized here, the 2006 Council on Foreign rectable by, the United States. Danger (5)
Relations Task Force has the clearest and ignores the fact that supply disruptions would
fullest listing of the problems widely believed have the same effect on a nation regardless of
to be associated with excessive reliance on how much oil it imports. Danger (6) is a
foreign oil. The task force saw six dangers: strange, unhelpful twist on an old argument.
Instead of deploring security costs, we worry
1. “The control over enormous oil rev- that others fear the existence of these security
enues gives exporting countries the costs. A direct consideration of security costs is
flexibility to adopt policies that oppose preferable.
U.S. interests and values.” (p. 26) In contrast, Bohi and Toman’s much more
2. “Oil dependence causes political realign- critical survey of the economics of oil imports
ments that constrain the ability of the identifies three relevant policy issues: the
United States to form partnerships to potentially reducible effects of higher oil
achieve common objectives.” (p. 26) prices, the macroeconomic effects, and the
3. “High prices and seemingly scarce sup- effects on the military budget.40 A discussion
plies create fears—especially evident in of each follows below.
Beijing and New Delhi, as well as in Euro-
pean capitals and in Washington—that World Oil Prices and U.S. Policy
the current system of open markets is In the early 1970s, both Professor Adelman
unable to ensure a secure supply.” (p. 27) and the Cabinet Task Force on Oil Import
4. “Revenues from oil and gas exports can Control concluded that the main concern of
undermine local governance.” (p. 28) the United States when it comes to oil markets
5. “A significant interruption in oil supply is to ensure that there is vigorous competition
will have adverse political and economic in those markets. This was precisely what was
consequences in the United States and in not being done at the time. The United States
other importing countries.” (p. 29) had for years protected the domestic oil-pro-
6. “Some observers see a direct relation- ducing industry by imposing quotas on oil
ship between the dependence of the imports.41 Denied the opportunity to compete
United States on oil, especially from the for sales in U.S. markets, exporters turned to
Persian Gulf, and the size of the U.S. market-rigging operations.
The main concern defense budget.” (p. 29) The infamous oil negotiations in 1971,
of the United first with Libya and then in Tehran with the
This list is characteristically problematic in Middle Eastern producers, were the great
States when it its failure to distinguish between what is dis- turning point. Adelman’s initial view was
comes to oil turbing but uncorrectable and that to which a that the negotiations produced price-rigging
sensible response is possible. Danger (1) is a policies that would have been avoided had
markets is to much-repeated irrelevance. As noted earlier, exporter demands been resisted, but he later
ensure that there there is nothing the United States can do to noted that perhaps the outcome would have
is vigorous affect the situation. At best, any strategies that arisen in any case. In any event, the federal
lower oil prices will lessen the power to do mis- government’s ambivalence about competi-
competition in chief. Danger (2) expresses an old concern that tion in oil markets made the creation of a car-
those markets. others will be more unwise than the United tel easier.

10
Since 1971, the oil-exporting countries to foster international trade sets a very bad OPEC member
have secured sharply higher but volatile prices. example by engaging in opportunistic restric- states often
Some analysts argued, particularly in the early tions. The United States has undertaken too
years of high prices, that those high prices were many unjustified interventions, such as in lack conclusive
less the product of production constraint by steel and automobiles; piling on more is not information
the cartel than they were the product of desirable.
endogenous shifts in global supply and The quota auction variant of this idea was
about how far
demand that would have occurred whether proposed largely to exploit a weakness inher- they can push the
the cartel existed or not.42 Subsequent experi- ent in all cartels. The fundamental insight market.
ence, however, indicates that the cartel has, in here is that if cheating on cartel production
fact, had a hand in those price fluctuations. In quotas can be concealed, cartel members will
particular, market behavior involved price col- be more willing to cheat. Hence, auctions for
lapses and spikes without major changes in export rights to consuming nations would be
the underlying demand or supply. Adelman in the form of sealed bids with the results
nicely epitomized the situation as one of a kept secret. Unfortunately, it is doubtful that
clumsy cartel.43 the secrets in question could be kept.
The reason that the cartel exhibits “clum- The many and varied problems associated
siness” is because OPEC member states often with and an oil-import-quota auction have
disagree about cartel strategy, exhibit an on- largely (and rightly) killed interest in the idea.
again, off-again commitment to agreed-upon The clearest advice for consuming states that
production quotas, and lack conclusive remains unscathed is that they do nothing to
information about how far they can push the obstruct the flow of oil in world markets. The
market on price at any given time. Thus, NPC recognizes, but does not analyze, what is
prices have cycled widely and wildly. The cur- always at the core of world oil issues—the com-
rent worldwide oil price boom, for instance, petitiveness of the market. The NPC’s stress on
followed years of historically low prices. diplomatic approaches, as noted, is an unreal-
Several ideas have been forwarded to coun- istic response to the challenge of stimulating
teract the power of the OPEC cartel, but the competition. What is really needed is to do
only credible idea that has arisen is an oil- nothing to create fears of market-access restric-
import-quota auction. That idea, which gained tion. In short, the biggest danger of imports is
some academic traction in the 1970s, has its the hysteria about them and the market-dis-
roots in the venerable international trade theo- rupting measures proposed as cures.
ry concept of an optimal tariff. The case for an
oil-import-quota auction follows from the fact The Macroeconomics of Oil
that large consuming nations collectively have Another hearty perennial is that oil-price
monopsony (buyers’ monopoly) power. Theo- instability, supposedly exaggerated by depen-
retically, one could impose a tariff that restricts dence on oil imports, has severe adverse macro-
imports and lowers prices received by exporters economic effects. In particular, it is said to cause
to their monopsony-optimum level, or else the simultaneous appearance of inflation and
that optimum-import level could be set as a unemployment. As sketched below, academics
quota. have conducted extensive investigations of this
Several problems arise, however, in imple- matter, and a wide range of views has arisen.
menting such an optimum tariff or quota. Unfortunately, formidable econometric prob-
First, determining the proper import level is lems arise in separating out the impacts of oil-
beyond the capabilities of any government price increases from those of other factors, par-
anywhere. Second, protectionist instincts may ticularly monetary policy. The most recent
lead to excessively high restrictions. Third, work, nevertheless, seems skeptical about the
exporters might retaliate and trigger a world- argument that major macroeconomic impacts
wide trade war. Fourth, a great power seeking follow from oil-price volatility.

11
Any discussion of this issue must be newer theories are much less supportive of the
anchored in the revolution in macroeconomics idea that oil-price instability can induce
that occurred in the 1970s and initiated the macroeconomic shocks. Economists Ben
third phase of the evolution of macroeconom- Bernanke, Mark Gertler, and Mark Watson,
ics.44 Prior to the appearance of John Maynard for instance, conducted an econometric
Keynes’s General Theory in 1936, economic analysis and found that the macroeconomic
instability was treated in a fragmentary, unsys- impact of oil-price shocks has historically
tematic basis. Keynes provided the basis for a been caused by improper monetary responses
more systematic framework.45 His own formu- to the shock and that a more stable monetary
lation was very loose, but several commenta- policy could have avoided the harms.50 Robert
tors, particularly J. R. Hicks, prepared formal- Barsky and Lutz Kilian likewise found that
ization that transformed Keynes’ ideas into the bad monetary policy, rather than oil shocks,
Keynesian model of macroeconomics.46 caused the stagflation of the 1970s.51
The second evolution was the rise of the In sum, while the debate has not been set-
monetarist school of macroeconomics, most tled, concerns about oil shocks have been
notably advanced by Milton Friedman, Karl greatly lessened. The literature on oil shocks
Brunner, and Allan H. Meltzer. Friedman, in reveals that formidable problems exist, in
The literature collaboration with Anna Schwartz, produced both establishing a convincing theoretical
reveals a massive history of U.S. monetary policy that analysis regarding why macroeconomic im-
formidable argued that it was inept monetary policy pacts arise, and then econometrically testing
rather than some breakdown of the capitalist the subsequent theories. The weak theoretical
problems in system that had caused economic instability, support for the fear that oil-price shocks can
establishing a particularly the great depression of 1929–33.47 trigger significant macroeconomic deteriora-
Monetarists argued that monetary policy was tion, combined with the formidable difficul-
convincing more influential than fiscal policy in deter- ties in isolating the effect of oil-price shocks
theoretical mining the course of macroeconomic events, on the economy as a whole, inspires skepti-
analysis which directly contravened much of the cism about oil-shock theories. Certainly, the
Keynesian perspective. This contention had theories do not support reducing imports in
regarding why enormous influence with many leading econ- the hope that the shocks will be sufficiently
macroeconomic omists who accepted the findings. less profound in order to justify the large,
impacts arise. The third evolution of macroeconomic clearly extant costs associated with import
thought was ushered in by a group of younger restrictions.
economists led by Robert Lucas,48 Thomas At present, the main U.S. policy for
Sargent, and Neil Wallace.49 They incorporat- addressing the macroeconomic risk of oil-
ed principles from traditional economics, such price shocks is the Strategic Petroleum
as good foresight and rapid market clearing Reserve, a public inventory of crude oil that
into macroeconomic thought. Taken to its would theoretically be available during such
outer limits, this “rational expectations” ap- shocks. Thus, doubts about the dangers asso-
proach implies that economic instability will ciated with those shocks weaken the case for
not arise, and, if it did, intervention to reverse the Strategic Petroleum Reserve. An alterna-
instability would not work. While these theo- tive explanation for the alleged suboptimal
ries are heavily criticized for assuming far level of private oil inventories is that the regu-
more knowledge that actually exists, that is the lar imposition of price controls discourages
point. Economic instability is no longer inher- optimal inventory levels and that a public
ent, but comes from precisely what economic stockpile can compensate for this.52 The previ-
theory cannot handle: unanticipated changes ously cited literature on stockpiling, however,
in public policy. suggests that considerable problems exist in
All this matters to theories of oil-price ensuring optimal release of public inventories.
shocks and economic instability because the This led me to conclude that the fundamental

12
problem was political fear of windfall profits.53 survival depends on correct decisions. In theo-
As Taylor and Van Doren observed, this is a ry, things might be so unpredictable that dis-
fundamental defect for which no credible cor- aster might arise from sudden changes that no
rective action exists.54 Every indication is that one could foresee. This is unlikely in energy.
the error of controlling prices will be repeated. The participants are always concerned about,
Thus, the stockpile has no satisfactory justifi- and act to anticipate, future developments.
cation. The large size and profitability of oil compa-
nies reflects their skills at appraising pros-
pects. If the companies fail, no one else will do
Investment Myopia and better.
the End of Oil: An alternative view employs an often used
but wildly implausible concept of market fail-
The Theory and Practice of ure–the belief that market actors will not estab-
Energy Transition lish enough procedures to hedge risks and thus
will produce inefficiently low levels of invest-
People who are alarmed about trends in ment. Ronald Coase’s point (see below) about
energy markets commonly contend that a the costs associated with transactions such as
decline of oil production is impending, yet pri- hedging is the critical analytic response to the
vate investors are not correctly anticipating criticism.56 Every possible risk is not hedged
this development. These assertions inevitably simply because most of them are too small to
link back to M. King Hubbert’s inadvertently justify establishing protective measures.
prescient prediction of a decline in U.S. oil The facts are even more devastating. The
production. Hubbert’s analysis, however, was years since World War II have seen the rise of
based on a statistical appraisal of the physical a vast array of new financial instruments.
availability of oil in the United States, not in Mutual-fund companies have introduced a
the world as a whole. stunning variety of options that differ in the
In practice, economic limits to production extent of their active management, whether
kick in well before geological limits, and that is stocks, bonds, or other assets are involved,
what happened in the United States. Oil pro- what countries are included; in what sectors
duction declined, not because of depletion, of the economy investments are made; and in
but because a superior (less-costly) alterna- which markets the shares are purchased.
tive—Middle Eastern oil—arose. The peak was Futures markets emerged for crude oil when
reached later than was desirable because of the the major oil companies lost their oil conces-
federal government’s policy of restricting oil sions from OPEC nations.
imports. Thus, it was dumb luck that the pat- Moreover, improving foresight does not
tern of decline dictated by changing energy necessarily translate into reducing oil produc- To believe that
policy matched what Hubbert expected due to tion, let alone support the conclusion that
physical limits. peak oil is near. To discuss this issue intelli- governments
The imperfect-foresight argument, in gen- gently, a review of the underlying and exten- are better
eral, is an absurdity. To believe that govern- sive literature on exhaustible-resource man-
ments are better anticipators of the future agement is necessary.
anticipators of
than private investors ignores the vast record The first widely cited item in the literature the future than
demonstrating the contrary.55 This is particu- is an article by L. C. Grey in 1914.57 Sub- private investors
larly true of the extreme pro-government sequent writers made Harold Hotelling’s 1931
claims discussed further below. These views article on the subject the iconic starting point ignores the
posit a government dispassion and wisdom of the literature.58 In the 1960s, however, nat- vast record
that is lacking in the private sector. Experience ural-resource economists such as Anthony demonstrating
shows the opposite. The private sector has the Scott,59 Orris Herfindahl,60 Richard Gordon,61
advantage of a multiplicity of actors whose and particularly Ronald Cummings,62 made the contrary.

13
When depletion the critical contributions that produced the prices and falling output over time, those out-
comes nearer, essence of this theory.63 comes are not inevitable. Rapid but decelerating
Hotelling’s theory explains the optimal shifts in demand or rapid downward shifts in
wealth- behavior of a producer who is producing a costs might lead to rising output.68 Thus,
maximizing good in which supply is fixed by nature. If the Hotelling’s argument that the net price of fixed-
demand for that good persists long enough so supply goods would rise at the market rate of
resource owners that it is profitable to hoard output, then it is interest degenerates into the general proposi-
would respond by no longer optimal to sell at a price equal to the tion that something is valuable, and thus an
restricting output marginal cost of production. Instead—because asset, only if some combination of immediate
there would be later periods in which, because payments and capital gains gives an overall yield
to provide for of depletion, no demands could be met—opti- at least equal to the market rate of interest.
later generations. mally restricting the earlier output to meet The critical point here is that exhaustibility
these later demands would be profitable. As a introduces no new market failures into the
few expositions of the theory have noted, market. If the assumptions for pure competi-
should that critical time of unsatisfied demand tion prevail, response to exhaustion is effi-
be nonexistent or simply at a sufficiently dis- cient. To make matters worse, the impacts of
tant date, efficient current behavior would market failure differ depending upon the fail-
ignore the eventual depletion.64 ure in question. Monopoly still usually pro-
When depletion comes nearer, wealth-max- duces inefficiently low output; detrimental
imizing resource owners would respond by externalities still lead to excess output. Imper-
restricting output to provide for later genera- fect capital markets, if interpreted narrowly,
tions. However, contrary to many or even most might imply excessive output. However, this
treatments of Hotelling, this would not pro- proves not to be true in general.
duce a simple, readily observable impact on The economic interpretation of the claim
prices.65 When dealing with homogenous re- that market actors demonstrate inadequate con-
sources producible at constant costs, Hotelling cern for the future is that market actors demand
argued that the “net price” (the average profit too high a rate of return on investment.69 As not-
per unit of output) would rise at the market ed earlier, in a simple ex-haustible-resource mod-
rate of interest.66 With pure competition in el, concern for the future inspires hoarding of
mineral rights, those rents would be paid as supply for future generations of consumers.70
royalties. However, because production incurs Requiring investment to produce a very high rate
costs, the market price would necessarily grow of return has the direct effect of making hoard-
at a slower rate than profits. ing less attractive. If inefficiently high interest
Other work found that resource hoarding rates are reduced, oil production may indeed be
can produce two further economic rewards. slowed because of increased incentives not to
First, Grey’s pioneering effort stressed that produce.
with the standard assumption of increasing However, this can be counteracted by the
marginal costs, output reductions raised prof- increased incentives that would arise to invest
its by lowering marginal costs. Extensions of in and operate new producing capacity. An
Hotelling’s general case showed that a further indirect effect of raising the interest cost of uti-
reward arises if resources are heterogeneous. In lizing equipment discourages investment in
that case, reducing output delays the increas- and utilization of producing capacity. Neither
ing costs of cumulative production. Several effect will always outweigh the other. For pro-
writers demonstrated that the benefit of delay- ducers that are hoarding so much that prices
ing the depletion of “better” resources was sim- are well above current production costs, a
ply the sum of the present values of the result- higher interest rate reduces the attractiveness
ing cost savings. While this is an unsurprising of hoarding. When costs are closer to price, the
result, much effort went into its derivation.67 investment-disincentive effect dominates.71
While this analysis usually implies rising In any case, the theory indicates what

14
would happen if demand for a physically lim- fied, the locale is developed. Such develop-
ited material lasts forever. Some have argued ment can continue for decades, and indeed
that it is thus a useless theory. It is better to even centuries, as conditions dictate.
contend that the theory, properly used, pro- He argues that exploration is an ongoing
vides guidance about whether exhaustion is a activity, driven not by fear of depletion, but by
pressing problem. The presence or absence of recognition that good opportunities to
the expected results thus gives evidence of the reduce costs may exist. Exploration and devel-
importance of exhaustion. opment are limited to serving immediate
Contrary to some assertions often made in opportunities to produce.
the early years of oil-price increases (see Given this, the actual endowment of most
above), oil-exporter behavior is better ex- minerals is unknown. What is known is the
plained by theories of cartelization than of amount of proved reserves—the amount in
exhaustion. Exhaustion theory implies that developed deposits and the prospects for
decisions will be consistent over time and that developing more. Neglect of this fundamen-
unilateral producer action is, if anything, tal point perennially produces concern, often
preferable. The opportunity to hoard exists reaching hysteria, on resource availability.
whatever other producers do, and indeed, the Indicators also exist about the vast physi-
less that others hoard, the more the actual cal availability of several alternatives to oil
Discussions
hoarders benefit. In contrast, cartelization and natural gas such as coal, oil shale, tar about oil scarcity
requires coordination. Consistent behavior sands, uranium supplies as extended by are heavily
also is preferable to those hoping to cartelize, breeder reactors, hydrogen, wind, and solar.
but the theory and practice of cartelization The broad prediction that ultimately the affected by
indicates that differences among potential world economy will move to one or more of the inherent lack
participants often lead to breakdowns.72 The these alternatives is probably correct but of
fitful path of oil prices since 1971 is clear evi- no practical value. We simply lack knowledge
of hard data.
dence that unstable cartelization is the most of what the optimum outcome will be.
likely situation. Neither the identity of the preferred options
Of course, discussions about oil scarcity nor the timing of the transition is knowable.
are heavily affected by the inherent lack of Moreover, the failure as yet to adopt these
hard data. For good economic reasons, data options reflects the current relatively plenti-
on the long-run availability of oil and other ful supply of oil rather than short-sighted-
minerals do not exist. Information on what is ness.
knowable, current production and actually In any case, the situation produces much
developed (proved), is often hard to come by speculation. Two broad classes of scenarios
(particularly data from fields governed by emerge. In one case adopted by the NPC, mov-
members of the OPEC cartel), and all the ing through coal and perhaps shale and tar
data are characterized by terms that are sand is undertaken before moving to one or
sometimes quite unclear or misleading. more non-fossil alternatives. Others would
However, Adelman’s work in the area tacitly skip the first stage. Clearly, the differences lie
treats the issues.73 He first notes the critical in views of the overall economics of the alter-
distinction between exploration and develop- natives. A critical consideration is whether or
ment. Exploration is the initial and far less not the direct costs of the fossil alternatives are
costly step of locating potentially valuable low enough to outweigh the perceived high
mineral deposits. Development is the much environmental costs.
more expensive step of constructing the facil- In sum, the theory and practice of deple-
ities needed to extract the minerals. Adelman tion strongly indicate that a market solution
suggests that exploration is steadily under- is vastly superior to government interven-
taken to build up a backlog of sites that are tion.
potentially worth developing. Then, as justi-

15
change, one must always keep in mind the bias
Environmental Issues imparted by the dominance of government
support in research financing. That backing
Dealing with environmental issues such as tacitly rests on the presumption that the case
global warming is tricky because the central for global warming will be confirmed. Con-
issues lie far outside economics. However, cerns are reinforced here by indications that cli-
neglect is inappropriate because important mate scientists who are not heavily involved in
economic considerations exist. massive studies are skeptical that human activ-
The case for altering fuel-use practices to ities are causing dangerous global warming.77
fight global warming involves several premis- Whatever the causes, the climatological
es. The starting point is that global tempera- effects and their economic consequences are
tures are rising. The critical second proposi- unclear. The possibility exists that beneficial
tion is that human activity is a major cause of effects will dominate. Even if not, Goklany
these rises. The third is that these tempera- calculates that mitigating the effects of glob-
ture increases are harmful. Fourth, it is pre- al warming will be much cheaper than green-
sumed that restricting the heat-raising activ- house gas emission reduction.78
ities is the most efficient response. Only the
first of these is well established.
In viewing the debate, it is necessary to get The Economics of
past the obfuscation regularly used to throttle Consumption Regulation
discussion. The world does not neatly divide
into disinterested parties nobly pursuing truth, The proposals for regulations to reduce
justice, and the American way and interest energy consumption, promote new technolo-
groups with selfish aims. It is more realistic to gies, and develop scientific and engineering
view all participants as possessing an agenda capabilities can most charitably be viewed as
that they are vigorously pursuing. A “special imperfect ways to respond to the alleged
interest” charge is a standard tactic to discredit under-pricing of oil. An alternative interpre-
opposition. Environmental groups have a bias tation is that market imperfections cause
towards finding damages to the environment. inefficient responses even to correct energy
Governments have a slant toward encouraging prices. Neither argument is satisfactory.
Proposals the continuation and expansion of their activi- Two main rationales exist for concerns
for regulations to ties. Universities want to secure research fund- over energy-consumption choices. The first is
ing. Corporations and trade associations the inefficient-capital-market contention
reduce energy believe that their industries make valuable— just criticized. The second is the assertion
consumption, and indeed, indispensable—contributions to that consumers are inadequately informed
the economy. All this should be viewed suspi- about energy options. This is an argument
promote new ciously. All will overdo; some may be right at with weak theoretic support and unaccept-
technologies, and times. able empirical analyses.
develop technical The environmental movement is particular- Concern about inefficient market response
ly suspect because of its extensive history of to price signals has emerged from new acade-
capabilities can overreach. Leaving aside phony crises such as mic efforts to discover ways in which market
most charitably DDT, Love Canal, and Alar, alarmist declara- outcomes are unsatisfactory.79 The prolifera-
tions are usually built upon mountains of mis- tion of these efforts can be explained by two
be viewed as information.74 Certainly, worries about disaster phenomena. One is the simple academic pres-
imperfect ways to from the operation of nuclear plants proved sure to develop new ideas. The other is a desire
respond to the virtually baseless.75 Studies surrounding acid to counter the onslaught on older market-fail-
rain revealed that fears about the effects on ure theories. Discontent with older claims
alleged under- forests and lakes were unjustified.76 about market failure has become vigorous
pricing of oil. When considering the issue of climate since at least the 1970s. Many economists now

16
are skeptical about our ability to determine leads to sub-optimal prices for all used vehi- Newer theories
whether inefficiency does or does not prevail cles.81 However, economist Eric Bond’s exami- of market
and about the feasibility of devising a satisfac- nation of the used-truck market suggested
tory remedy. So many false accusations and that mechanisms existed to appraise used- failure apply to
inappropriate cures have emerged in the past truck quality.82 transactions
that skepticism is essential. What is critical here is that these newer the-
Newer concepts of market failure, however, ories of market failure apply to transactions
where the rele-
are considerably more problematic. The new where the relevant knowledge is difficult for vant knowledge is
theories deal with more complex cases than one party to the transaction to secure. This difficult for one
were previously considered. The most relevant hardly applies to energy transactions. Con-
here are those that purport to demonstrate sumers can readily determine the energy-use party to the
that asymmetric information between buyer characteristics of all the energy-using equip- transaction to
and seller often produces unsatisfactory mar- ment that they purchase (the government per- secure. This
ket outcomes. A critical way in which the new haps deserves credit for forcing disclosure).
theories differ is that, unlike older work that Once information problems have been solved, hardly applies
identified conditions that always led to ineffi- performance mandates (such as automotive to energy
ciency, these new models deal with situations fuel efficiency standards) are indefensible
that may or may not produce inefficiency. because they violate basic (and sound) eco-
transactions.
While both old and new theories are difficult nomic principles about the optimal manner in
to verify (and remedy via government interven- which choices should be made. No one can be
tion), verification is more difficult with these a better judge of what is best than a well-
new theories, in which proof of undesirable informed consumer, given that performance
effects is more difficult to ascertain. preferences and consumption patterns vary by
The most relevant critique of these newer individual. Neither government agencies with a
theories of market failure is that of Northwest- mandate to reduce energy consumption nor
ern University economist Daniel Spulber.80 conservationists devoted to the cause of less
Spulber presents his analysis in two parts. The energy are to be trusted. In short, affection for
first begins by showing, as would be expected, performance standards is very bad economics.
that no inefficiency arises if the standard Viewing what passes for the empirical litera-
assumptions of pure competition with com- ture on these matters inspires total rejection of
plete information prevails. The existence of the case for intervention. For over three decades,
monopoly may or may not produce inadequate assorted research groups have generated paper
(or excessive) response. The second part deals studies purporting to prove the existence of
with the inefficiencies that might arise with var- massive amounts of neglected opportunities
ious types of knowledge gaps by the partici- that would economically reduce energy con-
pants. Spulber is quite careful to recognize both sumption. The critical problem is that none of
that private alternatives to public intervention these groups has experience in implementing
exist, and that the prospects for public design of energy choices.83 Thus, the other logical possi-
efficient intervention are dubious. He con- bility, that these studies are incorrect, seems
cludes that public supply of information to more plausible. The situation is not helped by
remedy asymmetric information is probably the willingness of conservationists to extend the
preferable to directly regulating transactions. criticism about inefficient energy use beyond
If anything, Spulber’s critique of these new small-scale users to large consumers and prod-
theories does not go far enough; too many of uct producers. These large-scale users have
the analyses that he cites, for instance, postu- greater incentives than households to investi-
late problems that are unlikely to arise. For gate opportunities to reduce energy consump-
example, Spulber notes Akerlof’s work on the tion and have organized to do so.
market for used vehicles, and how difficult it is The academic literature on government
for buyers to detect “lemons”—a problem that intervention to address these sorts of alleged

17
market failures is extensive. A notable review of sion under which the Council operates. The
electric-utility energy-conservation programs by neglect elsewhere, by definition, indicates that
MIT economists Paul Joskow and Donald these other groups found the questions unim-
Marron found serious flaws in the manner in portant. Given the general ineptitude of these
which the benefits from these programs were efforts, dumb luck is as likely an explanation
calculated.84 The central element of energy-con- as a sudden attack of good sense. However, the
sumption control—fuel-efficiency standards for persistence of the charge that oil companies
automotive vehicles (known as corporate-aver- and financial speculators routinely engage in
age-fuel-economy standards, or CAFE), is wide- price fixing, market manipulation, and collu-
ly, but not universally, criticized as undesirable, sion necessitates mention here.
even if the alleged market-failure problems pre- There is nothing new about the complaints
vailed.85 The main problems are effects of the being lodged against “Big Oil” or Wall Street
standards on other aspects of automobile per- speculators. Assertions of mischief-making
formance, such as safety,86 and the incentives to always arise when speculators are active in
increase automobile use from the higher markets undergoing major changes. However,
mileage and thus low per mile travel cost.87 such assertions have no substance. Efforts dat-
A further drawback, in practice, was creat- ing back to the 1970s and resuming in the 21st
Speculators ed by Congress when it established more century have consistently failed to support
persist because stringent rules for automobiles than for light charges of energy market rigging by privately
they are adept at trucks. As should have been expected, this owned companies operating in the United
spurred the substitution of light trucks for States.89 The charges against speculators are
anticipating price automobiles, and new types of trucks with exercises in economic illiteracy. Speculation is
trends. properties more like automobiles emerged. a bet about future prices. The bet can be won
The literature on CAFE suggests that the only by correctly predicting prices. These,
case for such standards critically depends on moreover, are wagers in games of skill.
massive consumer neglect of the value of fuel Speculators persist because they are adept at
savings. For example, a curiously ambivalent anticipating price trends. Current prices are
article written by Resources for the Future affected only if the high futures price inspires
economists Fischer, Harrington, and Parry increased stockpiling, which has not been the
shows that with consumer awareness, CAFE is case. The attacks on both oil companies and
at best redundant and has negative effects if it speculators are simply a demagogic way to
diverts investment from improving other express frustration. Confiscating profits then
characteristics of motor vehicles. Nevertheless, removes the incentives of companies and spec-
the authors support modest tightening of ulators to apply their skills to the market. The
CAFE because of other supposed benefits that OPEC countries, which are the real culprits,
their analysis did not capture. Those benefits, are beyond congressional reach, but oil com-
however, seem more speculative than the con- pany executives and financial company execu-
sumer-ignorance arguments, about which the tives must respond to subpoenas.
authors were properly skeptical.88

The Exile of
Big Oil and the Speculators: First-Best Alternatives
The Great Excluded Issues
Modern economic analysis, particularly in
Politicians often rail against the role played international trade theory, labors mightily to
by large privately owned oil companies and match solutions to problems. At least in this
speculators in energy markets. Blue-ribbon literature, the writers are careful to limit their
panels have neglected the subject. In the NPC attention to policy measures that are normally
case, this was due to the rules to prevent collu- employed, and which might work in the cases

18
considered.90 Hence, analysts are interested in increase efficiency. As a result, theories of
picking the policy instrument that most direct- government failure have proliferated.
ly solves the problem in question. Analysts only Columbia economist Jagdish Bhagwati has
consider feasible policy instruments that neatly summed up the standard uses of mar-
would have the desired effect. Thus, discussion ket-failure arguments as the “puppet government
immediately begins with examination of which approach.”91 The old-fashioned textbook gov-
qualitatively feasible policy is best. ernment possesses far more prescience and
In this literature, then, only stimulating acceptance of economic principles than do
policies are considered when stimulation is actual governments. Real governments lack the
the goal, and similarly, only retarding policies competence and the motivation to increase
are considered when restriction is the objec- efficiency. Moreover, intervention is expensive
tive. For instance, subsidies stimulate that to design and operate properly. Thus, the inef-
which is subsidized, while taxes discourage ficiencies must be great for regulation to be
that which is taxed. Industries not targeted desirable.
by the subsidies feel the opposite effect. For A remarkable article by Ronald Coase, “The
instance, a tax on coal stimulates natural gas. Problem of Social Cost,” is the critical source of
In the present case, the alleged problems are the last point and a much more modern
dangers of oil imports and of global warming. appraisal of intervention.92 In the essay, Coase
Thus, if the fears are valid, the most direct dealt with a much-discussed but badly dated
approaches are to tax imports and greenhouse- analysis of “externalities” by A. C. Pigou, a long-
gas emissions. time professor of economics at Cambridge
Unfortunately, the bundle of policy interven- University. Externalities are the incidental
tions embraced by the NPC and most others in effects of economic actions on people who are
the business of pontificating about energy poli- not directly involved. These can be harmful, as
cy does not directly address the identified prob- with pollution and noise, or beneficial, as with
lems. For instance, taxes on oil or gasoline, or pollination of plants by bees.
fuel efficiency standards for new vehicles, dis- Coase emphasized two defects of Pigou’s
courage the consumption of both international analysis. First, Pigou presumed that govern-
and domestic oil. CAFE standards have the fur- ment intervention always was needed, but
ther drawback of raising the cost of owning a Coase provided numerous examples of how
motor vehicle, but simultaneously lowering the cures to externality problems were secured
cost of using that vehicle. It becomes unclear privately. Second, Pigou asserted that, when The bundle
whether energy use will rise or fall, and the same confronting positive externalities (where by
holds true for other performance standards. The definition the costs to society were lower of policy
wide use of such standards means that they than the costs to the private producers or interventions
extend to areas such as electric appliances—and consumer), a subsidy to the producer or con-
even toilets—in which oil use is negligible. Thus, sumer was appropriate. Conversely, negative
embraced by the
they mainly hit domestic consumption of fuels externalities should be taxed. Coase showed NPC and most
that, at least in many cases, the usage should that this also was wrong; subsidizing the others in the
probably be encouraged. abatement of a detrimental externality would
produce the same result as a Pigouvian tax. business of
Coase’s insights proved remarkably imper- pontificating
Market Failure vs. vious to criticism. Two potential problems, about energy
Government Failure however, are evident. First, Coase tacitly
policy does not
assumes that the beneficiaries of the tax are not
A key aspect of the modern economic the- so different from the beneficiaries of the sub- directly address
ory of intervention is skepticism about sidy that demands shift. Second, an implicit
whether governments in fact have the ability further condition of optimum externality
the identified
and desire to remedy market failures and response is that the response should ensure problems.

19
It is only when that only firms whose total social value exceeds While Coase seems never to have made the
transaction costs their total social costs should survive. The cor- links explicit, these arguments are closely
rect social policy requires additional measures related to another celebrated contribution to
are high (but not to attain this goal.93 the literature—Paul Samuelson’s 1954 analysis
by a degree to Coase is well aware that the choice of pol- of the justification of government action.97
icy response affects the welfare of those Samuelson employed the concept of “public-
render action involved. By example, he shows that those ness,” in which a good could not be made
unprofitable) that harmed by the externality are not always the available exclusively to individuals; if one per-
government ones whom it is appropriate to compensate. son received it, everyone did. Everyone in soci-
In some cases, these victims knowingly ety then would benefit from the private con-
intervention might moved near an existing externality-produc- sumption of a public good. Private solutions,
be desirable. ing entity, about which the newcomer should however, would fail to adequately recognize all
have been aware. of these benefits. Thus, the government
Coase moves so tersely through the argu- should provide the goods.
ments that many commentators overlooked or Coase’s analysis can be restated as indicat-
misunderstood his discussion of why private ing that it is only when publicness was
action may not resolve the externality prob- involved that government intervention to
lem.94 Coase argued that when a large number address externalities might be justified. Coase
of people are involved, the transaction costs can then be credited with creating a different
associated with providing for a remedy could and superior theory of government action: it is
prove to be so steep that private action would only when transaction costs are high (but not
be difficult to implement. However, he pre- by a degree to render action unprofitable) that
sented two objections to the presumption that government intervention might be desirable.
such high transaction costs justified govern- The advantage of Coase’s approach is that
ment action. First, with sufficiently high trans- it leads to a consideration of critical problems
action costs, even if the government can act that the Samuelson analysis ignores. First,
more cheaply than private groups, the total considerable evidence exists that politicians
costs of intervention will still exceed the bene- have motivations far different from attaining
fits. High enough transaction costs can be a an efficient supply of public goods.98 Second,
barrier to both private and public externality the Coase problem of attaining an optimum is
remedies. Second, even if this is not true, a pub- formidable. Governments often lack the com-
lic solution is not necessarily preferable to a pri- petence to identify and optimally correct inef-
vate solution. Given the limitations of govern- ficiencies. Both these difficulties are extensive-
ments, the inefficiencies of a private solution ly reviewed in the economics literature, but the
may be less than those of a public one. In a fol- bad-motivation argument is stressed more
low-up article, “The Lighthouse in Econom- than the limited-ability concern.99
ics,” Coase showed that the traditional asser- The adoption of inappropriate objectives is
tion that lighthouses were a clear example of a the subject of a very rich literature that exam-
good that had to be supplied by government ines the motivations of political actors. The
was historically invalid. In the United King- starting point is Schumpeter’s observation
dom, the government took over lighthouses that, in a democracy, political actors are pri-
only after a private association successfully marily engaged in a competition for votes.100
established a system of lighthouses.95 As numerous subsequent observers have not-
George Stigler observed that Coase’s analysis ed, one key way to secure votes is to legislate an
applied to all market failures.96 Stigler stressed (economically) inefficient policy—in which a
that with low enough transaction costs, market few beneficiaries each receive gains large
failures could all be overcome privately. Coase’s enough for them to note—by creating losses
caveats about the implications of high transac- for many others that are too small for any to
tions also apply to all interventions. notice.101

20
Some observers, notably Harvard econo- sequences of this knowledge problem.108 In
mist Joseph Kalt, have examined the proposi- practice, the problem is herculean.
tion that, in some cases, action arises only Reviews of specific policies have illustrat-
from an ideological preference for interven- ed the point. Richard Posner’s wide-ranging
tion by legislators whose constituents lack review of the regulation of natural monop-
significant interest in an issue.102 Kalt and col- oly, for instance, notes many of the problems
laborators have found statistical support for related to securing the information needed to
this proposition.103 A simpler possibility is attain efficient results.109
that politicians instinctively believe that if a In any case, these basics suggest further rea-
problem arises which receives extensive atten- sons to treat recommendations for energy
tion, they can—and should—intervene. intervention by the NPC and others skeptically.
The problem of determining and satisfying Not only are their proposed remedies nth-best
demands for public goods is more loosely means of addressing identified problems, they
treated in the literature. Economists Ludwig further assume perfectly informed, hyper-effi-
von Mises, F. A. Hayek, and Ronald Coase have cient government responses that are implausi-
all argued that, among other things, govern- ble in the extreme.
ments cannot readily secure the information
needed for efficient intervention.104 Coase’s
Economists
treatment is far less extensive, but also far more Conclusion Ludwig von Mises,
general, than those of Mises or Hayek. Their F. A. Hayek, and
extended writings on socialist calculation, nev- Bad theory, bad history, and bad practice
ertheless, should have made clear the difficul- mar energy (and most other public policy) dis- Ronald Coase
ties of optimally devising plans for any kind of cussions. The shock of 9/11 has badly aggra- have all argued
government spending. The debate was started vated these problems. Across an absurdly
by an assertion by Mises that a socialist state broad range of issues, panic over remote possi-
that, among
could not be efficient because it lacked infor- bilities of terrorist actions has produced hyste- other things,
mation about the demands for commodi- ria. The present paper was written in the midst governments
ties.105 In the most celebrated response, Oscar of a political campaign in which these prob-
Lange106 replied that this problem could be lems seemed particularly severe. As suggested cannot readily
resolved by establishing planning boards to here, energy, as is usually the case, has not been secure the
measure demands and set prices appropriate spared. Even a group that should have known information
for those demands. Hayek answered Lange by better (the NPC), directed by the former head
noting that this was a much more cumber- of a company known for its astuteness (Exxon- needed for
some approach than an unregulated market- Mobil), could not refrain from a plunge into efficient
place.107 Mises asserted that the solution would this frenzy.
break down for producers’ goods because of Economic analysis shows both the defects
intervention.
concentration of ownership in state monopo- of public policy and why these faults are
lies. impervious to analytic objection. Interference
In any case, Lange was changing the subject. with international trade, for example, is rou-
His system depended upon the competence of tinely attacked by economists and adopted by
the planning board, which, after all, could be politicians. Ill-advised efforts such as that of
imposed on top of any ownership pattern. The the NPC are regrettable but predictable.
planning board as Lange envisioned it, howev- Economists periodically debate whether
er, is the expansion of the public utility com- their efforts are justified. Surely, without seri-
mission concept. Thus, it may be asked why a ous economic analysis, what comprises desir-
technique that works badly when it treats a few able reform remains unknown. Something
industries could well treat the whole economy must stand against the temptation to seek
any better. Nevertheless, the literature in this narrow political gains. Even those economists
area strangely evades discussion of the full con- who are particularly concerned about govern-

21
Bad theory, ment failure are divided about whether their report, but it was implemented as a review of the
efforts are worthwhile. Some stress the many overall debate on energy. Since the NPC report
bad history, and provides the fullest, most coherent presentation
instances in which the advice was ignored; of the interventionist agenda, it is used here as a
bad practice others believe that enough good results arise prime example.
mar energy to provide the encouragement to continue.
Clearly, the analysis here is grounded in the 3. National Commission on Energy Policy, Ending
(and most other latter view. Enough successes, both big and
the Energy Stalemate: A Bipartisan Strategy to Meet
America’s Energy Challenges (Washington: 2004).
public policy) small, have arisen to inspire hope. Opportun- Despite its name, the commission was funded by
discussions. The ities for improvement periodically but unpre- private foundations (Hewlett, Pew, MacArthur, and
dictably arise, and economic analyses that pro- Packard) rather than the United States govern-
shock of 9/11 has vide guidance can only help assist the response.
ment. The report presents, without justification,
policy proposals similar to the NPC and, despite
badly aggravated Moreover, bad policy imposes wastes that the the need for further support, was backed up by one
these problems. power to tax allows to persist. This ability to err of the most incoherent sets of supporting papers of
is not unlimited. Intolerable strains do emerge. any energy study of which I am aware.
Thus, economists should continue the on- 4. National Security Consequences of U.S. Oil Depend-
slaught on bad policy to anticipate openings ence (New York: Council on Foreign Relations,
when they occur. Perhaps future study groups 2006). The task force that produced the CFR
can be weaned away from ideas that harm report was directed by James Schlesinger and John
themselves and everyone else. Deutch. Schlesinger, a Ph.D. economist, had sever-
al important government jobs, including being the
first Secretary of Energy. Deutch, an MIT chem-
istry professor, also had government service,
Notes including several DOE posts and the CIA director-
ship. Although it should have known better, the
For more works by Richard L. Gordon, see, for task force concentrated on reducing gasoline con-
instance, AnEconomicAnalysisofWorldEnergyProblems sumption rather than directly taxing oil imports.
(Cambridge, MA: MIT Press, 1981); Regulation and Specific proposals included an increase of the fed-
Economic Analysis: A Critique over Two Centuries eral gasoline tax, tightened corporate-average-fuel-
(Boston: Kluwer Academic Publishers, 1994); “The economy (CAFE) standards, and tradable permits
Economics of Optimal Self-sufficiency and Energy to use gasoline. The CFR report also calls for for-
Independence, Mineral Wars and Soft Energy Paths,” eign-policy initiatives similar to those championed
Materials and Society 7, no. 2 (1983): 225–35; “Using in the NPC and Cheney reports. The CFR report,
Markets to Solve Natural Resource Problems,” in however, only briefly (pp. 26–31) discusses why
ResourcesandWorldDevelopment, ed. D. J. McLaren and imports are dangerous; it spends most of its time
B. J. Skinner (New York: John Wiley, 1987), pp. proposing cures.
453–72; “Energy Intervention after Desert Storm,”
Energy Journal 13, no. 3 (1992): 1–15; “Energy, 5. Milken Institute, Financial Innovations for Achiev-
Exhaustion, Environmentalism, and Etatism,” ing Energy Independence (Santa Monica, CA: 2007).
Energy Journal 15, no. 1 (1993): 1–16; and “Law and This report has its analysis backward. It proposes
Macroeconomics,” in Encyclopedia of Law and financing techniques to promote energy alterna-
Economics, Volume I: The History and Methodology of Law tives without assessing the desirability of these
and Economics, ed. Boudewijn Bouckaert and Gerrit developments.
De Geest (Cheltenham and Northampton, UK:
Edgar Elgar, 1999), pp. 660–93. 6. This listing is limited to reports generated by
organizations rather than by freelance individu-
1. Most notably in National Energy Policy, Report of als. Their inclusion would too greatly expand the
the National Energy Policy Development Group discussion even if only those dealing with overall
(Washington: 2001), henceforth referred to as energy prospects were covered.
“the Cheney report,” since it was produced by a
White House task force that was directed by Vice 7. As more fully discussed later, because of pres-
President Dick Cheney. sures to broaden input into the NPC, the partici-
pants actually came from a wide variety of areas,
2. National Petroleum Council, Hard Truths: Facing mostly outside the oil industry. However, the
the Hard Truths about Energy: A Comprehensive View leading oil industry participants took an active
to 2030 of Global Oil and Natural Gas (Washington: role in promoting the findings. The promotional
2007). The present Policy Analysis was initiated as effort was probably a major factor in the attention
a response to the NPC’s vigorous promotion of its that was initially received.

22
8. This misuses the concept of efficiency. policy, the Cheney report presents more bad ideas.
Efficiency occurs when the use of one input is It lacked supporting material.
reduced without increasing another. It is unclear
whether this is true for energy-saving actions. 18. The Cabinet Task Force on Oil Import Con-
Thus, when I discuss forced reductions in energy trols, praised below, reached a solid conclusion by
use, I avoid the term efficiency. The NPC report presenting the divergent views of the members.
apparently does not rule out reduction by taxa- Good staff does not always lead to a satisfactory
tion, but the language used implies a preference report, and good reports are not demonstrably
for tighter performance standards. It is argued more influential than bad ones.
below that taxes are preferable to standards.
19. A possible exception is the treatment of glob-
9. National Petroleum Council, p. 6. al warming. It would be correct to argue that
intervention is appropriate if the assertions about
10. Ibid., pp. 5–6. large climate damages due to fuel use were cor-
rect. The NPC report’s sketchy, narrowly-focused
11. Concern over personnel availability in some treatment of global warming, however, never rises
realms is a hearty perennial in policy proposals, to a clear policy position.
dating back at least to the 1957 U.S. panic over
the Soviet Union’s launch of its Sputnik satellite. 20. M. A. Adelman, The World Petroleum Market
More broadly, it is a variant of the standard claim (Baltimore, MD: Johns Hopkins University Press,
of interest groups that the marketplace does not 1972).
efficiently meet the groups’ needs.
21. M. A. Adelman, The Genie out of the Bottle: World
12. Ibid., p. 23. Oil since 1970 (Cambridge, MA: MIT Press, 1995).
An anthology of his oil writings also was pub-
13. Ibid., p. 24. This inflation of proposed respons- lished: M. A. Adelman, The Economics of Petroleum
es is endemic to “blue-ribbon” panels of all sorts. Supply: Papers by M. A. Adelman 1962–1993 (Cam-
bridge, MA: MIT Press, 1993).
14. A more banal and innocuous set of recommen-
dations relates to capabilities. The areas of concern 22. U. S. Cabinet Task Force on Oil Import Con-
are infrastructure needs, science and technology trol, The Oil Import Question: A Report on the
capabilities, research and development activities, Relationship of Oil Imports to the National Security
and energy data. Infrastructure needs are to be the (Washington: Government Printing Office, 1970).
subject of a Department of Energy study, and the
Energy Information Administration is told to col- 23. Douglas R. Bohi and Milton Russell, Limiting Oil
lect infrastructure data. The main idea in the other Imports: An Economic History and Analysis (Baltimore:
areas, predictably, is to do more. In the data area, Johns Hopkins University Press, 1978); Douglas R.
not only should information on current activities Bohi and W. David Montgomery, Oil Prices, Energy
be increased, but extensive studies of resource avail- Security, and Import Policy (Washington: Resources
ability are proposed. This reflects more of the eco- for the Future, 1982); Douglas R. Bohi, Energy Price
nomic illiteracy that mars the report. These studies Shocks and Macroeconomic Performance (Washington:
are not undertaken for the very good reason that in Resources for the Future, 1990); and Douglas R.
a free-market economy, resources and the facilities Bohi and Michael A. Toman, Energy Security as a Basis
to develop them are made available without any for Energy Policy (Boston: Kluwer Academic
such global information. Along with science and Publishers, 1995). The American Petroleum Insti-
engineering capabilities, the report makes further tute distributed the manuscript as a pamphlet with-
suggestions of eased immigration and changes in out charge; that version was used here. At the time,
tax and retirement plan rules in order to foster Bohi and Toman were on the staff at Resources for
work by retirement-age people. the Future, but privately prepared the report for the
American Petroleum Institute. Resources for the
15. Ibid., p. 228. Future had a policy against accepting support from
interested parties that failed to exclude government
16. Ibid., p. 227. funding.
17. Even so, the NPC report has the distinction of 24. Parry, often with co-authors, has produced a
being better than the report of the National Com- series of useful studies, one of which is cited below,
mission on Energy Policy. Vice President Cheney’s on the wisdom of various energy-related public
2001 take on the subject avoids clear analytic errors policies, particularly involving motor vehicles.
by eschewing analysis altogether. However, by mak-
ing more suggestions than the NPC, including 25. Daniel H. Newlon and Norman V. Breckner, The
many on the electric power industry and foreign Oil Security System (Lexington, KY: Lexington

23
Books, D. C. Heath, 1975); David A. Deese and Managerial Objectives in the Theory of the Firm
Joseph S. Nye, eds., Energy and Security (Cambridge, (Chicago: Markham Publishing Company, 1967;
MA: Ballinger Publishing Company, 1981); James Englewood Cliffs, NJ: Prentice-Hall, 1964).
Plummer, ed., Energy Vulnerability (Cambridge, MA:
Ballinger Publishing Company, 1982); Alvin L. Alm 33. Again Adelman’s 1995 book is a key source
and Robert J. Weiner, eds., Oil Shock: Policy Response among the many presentations of this argument.
and Implementation (Cambridge, MA: Ballinger The long lines at gas stations in the United States
Publishing Company, 1984); George Horwich and during the embargo were due to the imposition of
David Leo Weimer, Oil Price Shocks, Market Response, price controls on gasoline and their enforcement
and Contingency Planning (Washington: American by rigid rules for distribution. Price controls always
Enterprise Institute for Public Policy Research, thwart the role of price signals in supply allocation.
1984). Newlon and Breckner are the first of whom Messy rules must be imposed to deal with the
I am aware to blame the inadequacy of inventories excess of the quantity demanded over the amount
on price controls. The other books discuss the available.
problems of tapping the stockpile optimally.
34. This, too, is another argument of Adelman’s
26. His key works are: James D. Hamilton, “Oil and 1995 book.
the Macroeconomy since World War II,” Journal of
Political Economy 91, no. 2 (April, 1983): 228–48; 35. Adelman’s warning that the U.S.-Saudi special
James D. Hamilton “What Is an Oil Shock?” Journal relationship would prove a to be a fraud whenev-
of Econometrics 113 (2003): 363–98; and James D. er seriously tested is still widely ignored, as was
Hamilton and Anna Maria Herrera, “Oil Shocks well illustrated by both President George W.
and Aggregate Macroeconomic Behavior: the Role Bush’s May 2008 failure to inspire Saudi output
of Monetary Policy,” Journal of Money, Credit, and increases and Congressional complaints about
Banking 36 (April, 2004): 265–86. the inadequacy of the effort.

27. Robert L. Bradley, Jr., Oil, Gas & Government: 36. The critical works on this again are Adelman’s.
The U.S. Experience (Lanham, MD: Rowman & Both his oil books are relevant, as is M. A. Adelman,
Littlefield, 1995). “Is the Oil Shortage Real? Oil Companies as OPEC
Tax-Collectors,” Foreign Policy 9 (1973): 69–107
28. Adelman’s 1995 book makes these points. (reprinted in Adelman 1993, pp. 329–57). See also
Anthony Sampson, The Seven Sisters: The Great Oil
29. As discussed below, further considerations Companies and the World They Shaped (New York:
relate to possible consequences of dealing with Viking Press, 1975). Forbes did a remarkable report-
imported oil. Theories have proliferated on ways to ing job that showed how the State Department
counteract monopolistic behavior of oil exporters blindly fostered acquiescence with oil-country
and on the alleged macroeconomic effects of oil demands. “Don’t Blame the Oil Companies, Blame
shocks. the State Department,” Forbes, April 15, 1976. The
State Department seems to have felt that this was
30. This point is often made in the energy eco- the least bad possible outcome, but Forbes feels that
nomics literature; the previously cited Resources the State Department overestimated the strength
for the Future studies and Adelman’s works pre- and resolve of the producing countries. The State
viously cited are key examples. Department characteristically failed to compre-
hend the importance of preserving competition.
31. U.S. Federal Energy Administration, Project
Independence Report (Washington, 1974). 37. M. A. Adelman, The World Petroleum Market
(Baltimore, MD: Johns Hopkins University Press,
32. With the key exception of Oliver E. 1972). M. A. Adelman, The Genie out of the Bottle:
Williamson, the literature on slack is maddening- World Oil since 1970 (Cambridge, MA: MIT Press,
ly imprecise. Williamson, however, developed a 1995).
solid analysis of the behavior of managers who
were able to divert profits from stockholders. He Akins’s implicit rebuttal to Adelman can be found
points out that the best strategy for managers in in James E. Akins, “The Oil Crisis: This Time the
this situation is to maximize profits and then Wolf is Here,” Foreign Affairs 51, no. 2 (April, 1973):
divert the money to themselves in wages and 462–90. I can attest from direct experience that
fringe benefits. He notes that cases can arise when Akins did not understand the limitation of his
the fringe involves undertaking an unprofitable knowledge and was incapable of absorbing the
venture. A firm’s output decisions would be substantial amount of advice available to him. In
altered undesirably when it hires employees who 1968, I presented a paper at an invitation-only
will produce more costs than revenues. Oliver E. seminar in Colorado Springs that was attended
Williamson, The Economics of Discretionary Behavior: only by experienced observers of energy markets. I

24
resorted to standard economics to note that if 44. This was not the end of the evolution, but that
dollar problems became severe, devaluation is not critical here. A good survey, organized as an
would arise. Akins lectured me as if I were a stupid examination of the different macroeconomic
erring schoolboy on why this would never hap- approaches, is Brian Snowdon and Howard Vane,
pen. Of course, it did happen in 1971. Richard L. Modern Macroeconomics: Its Origins, Development,
Gordon, “Without Rudder Compass or and Current State (Cheltenham and Northampton,
Chart–The Problem of Energy Policy Guide- UK: Edward Elgar, 2005). Further insight is pro-
lines,” in The Political Economy of Energy and vided in Brian Snowdon and Howard Vane, eds.,
National Security, S. H. Hanke, ed., published as An Encyclopedia of Macroeconomics (Cheltenham
Quarterly of the Colorado School of Mines 64, no. 4 and Northampton, UK: Edward Elgar, 2002).
(October, 1969): 29–51.
45. John Maynard Keynes, The General Theory of
38. A further complication is “discrimination,” Employment, Interest and Money (New York: Harcourt
the ability to charge different prices for the same Brace; London: Macmillan and Company, 1936).
product to different parties. Whatever its role in
the history of the oil industry and in special deals 46. J. R. Hicks, “Mr. Keynes and the ‘Classics’: A
by some producers, it is not a factor in sales to Suggested Interpretation,” Econometrica 5, no. 2
large consuming countries. (April, 1937): 147–59. The resulting literature is
summarized and synthesized best in Don Patinkin,
39. This story appears in every one of the many Money, Interest and Prices, 2nd ed. (New York: Harper
histories of world oil of which the most celebrat- and Row, 1965). A good appraisal of the debates
ed example is Daniel Yergin, The Prize: The Epic appears in Axel Leijonhufvud, On Keynesian Eco-
Quest for Oil, Money & Power (New York: Simon & nomics and the Economics of Keynes: A Study in
Schuster, 1991). Monetary Theory (New York: Oxford University
Press, 1968).
40. Douglas R. Bohi and Michael A. Toman,
Energy Security as a Basis for Energy Policy (Boston: 47. Milton Friedman and Anna J. Schwartz, A
Kluwer Academic Publishers, 1995). Monetary History of the United States, 1867–1960
(Princeton, NJ: Princeton University Press, 1963).
41. Disputes arose about what parts of the U.S.
industry benefited. Clearly, the small-scale pro- 48. Robert E. Lucas Jr., Studies in Business Cycle
ducers were preserved by the combination of Theory (Cambridge, MA: MIT Press, 1981).
import quotas and state regulations favoring out-
put by such smaller scale producers. One issue 49. For the key writings of a cross-section of the
then is whether the benefits of high prices to larg- contributors to this development, see Robert E.
er producers offset the output reductions by large Lucas Jr. and Thomas J. Sargent, eds., Rational
firms inherent in the state favoritism toward Expectations and Econometric Practice (Minneapolis,
smaller producers. A second issue is the impact on MN: University of Minnesota Press, 1981).
companies with substantial foreign operations.
Adelman’s 1972 book argues that the policy hurt 50. Ben S. Bernanke, Mark Gertler, and Mark
all but the small producers. Watson, “Systematic Monetary Policy and the
Effects of Oil Price Shocks,” Brookings Papers on
42. Paul W. MacAvoy, Crude Oil Prices as Determined Economic Activity, no. 1 (1997): 91–157.
by OPEC and Market Fundamentals, (Cambridge,
MA.: Ballinger Publishing Company, 1982) is a 51. Robert B. Barsky and Lutz Kilian, “Do We Really
major example of doubts about OPEC’s role. A. Know That Oil Caused the Great Stagflation? A
D. Johany, The Myth of the OPEC Cartel (New York: Monetary Alternative,” NBER Macroeconomics
John Wiley and Sons, 1980) presented a more Annual 16 (2001): 137–83.
elaborate theory based on the wildly implausible
assertion that the transfer of control to the coun- 52. Daniel H. Newlon and Norman V. Breckner,
tries implied greater concern about hoarding The Oil Security System (Lexington, MA: Lexington
resources. As Adelman’s 1995 book aggressively Books, D. C. Heath, 1975).
argued, the greater foresight assertion in unten-
able; it is shown below that greater foresight need 53. Richard L. Gordon, “Energy Intervention After
not lead to lesser production. Desert Storm,” The Energy Journal 13, no. 3 (1992):
1–15
43. M. A. Adelman, “The Clumsy Cartel,” The Energy
Journal 1, no. 1 (January, 1980): 43–53. Reprinted in 54. Jerry Taylor and Peter Van Doren, “The Case
M. A. Adelman, The Economics of Petroleum Supply: against the Strategic Petroleum Reserve,” Cato
Papers by M. A. Adelman 1962–1993 (Cambridge, MA: Institute Policy Analysis no. 555, November 21,
MIT Press, 1993).pp. 407–16. 2005.

25
55. See, for example, Linda Cohen and Roger Environmental Policy: Externalities, Public Outlays, and
Noll, The Technology Pork Barrel (Washington: the Quality of Life (Englewood Cliffs, NJ: Prentice-
Brookings Institution, 1991). To be sure, private Hall, 1975); and Eduardo M. Modiano and Jeremy
investors can err; however, the mistakes are fewer F. Shapiro, “A Dynamic Optimization Model of
and more readily correctable. Depletable Resources,” The Bell Journal of Economics
11, no. 1 (Spring, 1980): 212–36.
56. Ronald H. Coase, “The Problem of Social
Costs,” Journal of Law and Economics 3 (October, 63. Numerous surveys of the literature are avail-
1960): 1–44. The article, a freshly written follow- able. Baumol and Oates’s text on environmental
up, and several other key writings appear in economics included a good survey of exhaustion
Ronald H. Coase, The Firm, the Market and the Law theory but only in its first edition. Richard L.
(Chicago: University of Chicago Press, 1988). Gordon, An Economic Analysis of World Energy
Problems (Cambridge, MA.: MIT Press, 1981) is
57. Lewis C. Gray, “Rent under the Assumption of another, simpler survey. Partha Dasgupta and G.
Exhaustibility,” Quarterly Journal of Economics 28, M. Heal, Economic Theory and Exhaustible Resources
no. 2 (May, 1914): 466–489, reprinted in Extractive (Cambridge: Cambridge University Press, 1979)
Resources and Taxation, ed. Mason Gaffney (Madi- produced the fullest review available, but it is
son, WI: University of Wisconsin Press, 1967), pp. unnecessarily complex.
423–46.
64. Orris C. Herfindahl, “Depletion and Economic
58. Harold Hotelling, “The Economics of Exhaust- Theory,” Extractive Resources and Taxation, ed. Mason
ible Resources,” Journal of Political Economy 39, no. 2 Gaffney (Madison, WI: University of Wisconsin
(April, 1931): 137–75. The article provided sketches Press, 1967), pp. 63–90, Richard L. Gordon, “A Re-
of numerous cases. It took later generations much interpretation of the Pure Theory of Exhaustion,”
effort to nail down the theory. Journal of Political Economy 75, no. 3 (June, 1967):
274–86, and Tjalling C. Koopmans, “Ways of Look-
59. Anthony Scott, “The Theory of the Mine under ing at Future Economic Growth, Resource and
Conditions of Certainty,” Extractive Resources and Energy Use,” Energy: Demand, Conservation, and Insti-
Taxation, ed. Mason Gaffney (Madison, WI: Uni- tutional Problems, ed. Michael S. Macrakis (Cam-
versity of Wisconsin Press, 1967), pp. 25–62. bridge, MA: MIT Press, 1974), pp. 3–15.
60. Orris C. Herfindahl, “Depletion and Economic 65. Hotelling’s analysis was much more complex,
Theory,” Extractive Resources and Taxation, ed. Mason but also sketchier, than subsequent discussions
Gaffney (Madison, WI: University of Wisconsin indicate. He presented numerous short, cryptic
Press, 1967), pp. 63–90. treatments of many different cases.
61. Richard L. Gordon, “Conservation and the 66. Hotelling, “The Economics of Exhaustible
Theory of Exhaustible Resources,” Canadian Journal Resources,” Journal of Political Economy 39, no. 2
of Economics and Political Science, 32, no. 3 (August, (April, 1931): 137–75does not make this clear, but
1966): 319–26; Richard L. Gordon, “A Reinterpre- Orris C. Herfindahl, “Depletion and Economic
tation of the Pure Theory of Exhaustion,” Journal of Theory,” Extractive Resources and Taxation, ed. Mason
Political Economy 75, no. 3 (June, 1967): 274–86. Gaffney (Madison, WI: University of Wisconsin
Press, 1967), pp. 63–90.stated the conclusion and
62. Ronald G. Cummings, “Some Extensions of the Richard L. Gordon, “A Reinterpretation of the Pure
Economic Theory of Exhaustible Resources,” Theory of Exhaustion,” Journal of Political Economy
Western Economic Journal 7, no. 3 (September, 1969): 75, no. 3 (June, 1967): 274–86.proved that this had
201–10. Cummings demonstrated that Hotelling’s to be the case. The simplicity of the case explains its
general case could be developed to show that frequent use, but the more general model must be
hoarding had a second benefit of the present value used in practice. Many attacks on Hotelling are real-
of the cumulative cost saving from delaying the ly criticisms of only considering the simplest case.
depletion of higher-quality resources. Many others
subsequently independently developed the case. 67. This is the case that was sketched by Hotelling,
For instance, David Levhari and Nissan Liviatan, which Cummings and others previously noted
“Notes on Hotelling’s Economics of Exhaustible later developed. Grey dealt with movements along
Resources,” Canadian Journal of Economics 10, no. 2 the marginal-cost curve prevailing in each time
(May, 1977): 177–192 shows that the more period and the new cases discuss the trend toward
advanced mathematics employed by Cummings supply-decreasing shifts over the time represented
were not needed to derive the proof. Two widely by the curve.
spaced efforts showed that a discrete-time ap-
proach greatly simplified the derivations: William J. 68. Richard L. Gordon, An Economic Analysis of
Baumol and Wallace E. Oates, The Theory of World Energy Problems (Cambridge, MA: MIT

26
Press, 1981); discusses this case. With rapidly Measuring the Real State of the World (Cambridge and
falling costs, prices could decline. Perpetual rapid New York: The Cambridge University Press,
growth in exhaustible resources is subject to the 2001). Easterbrook, an environmental journalist,
paradox discussed in the general literature on provides surveys of numerous key issues. His
investment: it is more profitable to trade the asset exposition suffers badly from his discomfort over
than to use it. However, in the exhaustible- the anti-intervention implications of his reviews.
resource case, where demand initially grows Simon presents a broad attack on all forms of
rapidly but then slows down, the optimal behav- resource pessimism. Lomborg’s work presents a
ior is to start before the demand-growth slow- confirmation of Simon’s views, which Lomborg
down and exhaust during the slow-growth peri- was seeking to refute. The environmentalist
od. The criterion of rapidity is a growth of more attacks on these works are illustrations of the ten-
than the market rate of interest of the marginal dency to excess rather than careful refutations.
profitability of the optimum output at any time.
75. It is indicative of the state of the situation that
69. Those familiar with financial theory will rec- no obvious citations arise on either side. When
ognize that this is a less technical description of nuclear power was a hot topic, concerns arose
net present value. about release of radiation from regular opera-
tions, large discharges from accidents, diversion
70. To simplify, here I ignore the effects (noted of nuclear material to military programs or to ter-
above) of saving high-quality resources. rorists, and the hazards of waste disposal. As all
but the last were deflated by experience, waste dis-
71. Richard L. Gordon, “Conservation and the posal became the sole concern. Critics demanded
Theory of Exhaustible Resources,” Canadian an instant solution and then opposed efforts to
Journal of Economics and Political Science 32, no. 3 develop such a remedy.
(August, 1966): 319–26.
76. U. S. Congress, Office of Technology Assess-
72. The theory of interactions among firms is enor- ment, Acid Rain and Transported Air Pollutants:
mous. The crux is that firms would like to join Implications for Public Policy (Washington: Govern-
alliances to maximize profits for the group, but ment Printing Office, 1984).
many pressures preclude that outcome. These
include too many participants to manage, sharp 77. Patrick J. Michaels, Meltdown, The Predictable
differences among firms, the difficulties of moni- Distortion of Global Warming by Scientists, Politicians,
toring performance, and the undermining of coop- and the Media (Washington: Cato Institute, 2004),
eration by fears about what the others will do. With and also his shorter writings, which provide a
the popularity of game-theory approaches to inter- moderate review of why the reaction to global
action, it is standard to relate the last problem to the warming is overdone.
classic and much over-cited case of the prisoners’
dilemma, where both of two separately interrogated 78. Indur M. Goklany, The Improving State of the
prisoners are better off not to confess. However, fear World: Why We’re Living Longer, Healthier, More
that one will confess will lead the other one to con- Comfortable Lives on a Cleaner Planet (Washington:
fess. Extensions of the theory have failed to show Cato Institute, 2007); “What to Do about Climate
experience will resolve this dilemma. A survey of the Change,” Cato Institute Policy Analysis no. 609,
empirical literature is available from Margaret C. February 5, 2008.
Levenstein and Valerie Y. Suslow, “What
Determines Cartel Success?” Journal of Economic 79. These efforts and their refutation have reached
Literature 44, no. 1 (March 2006): 43–95. the point where a new anthology has appeared:
Tyler Cowen and Eric Crampton, eds. Market
73. M. A. Adelman, “Mineral Depletion, with Spe- Failure or Success: The New Debate (Cheltenham and
cial Reference to Petroleum,” Review of Economics Northampton, UK: Edgar Elgar for the Indepen-
and Statistics 72, no. 1 (February, 1990): 1–10. Re- dent Institute, 2003). This is a sequel to Cowen’s
printed in M. A. Adelman, The Economics of Petrole- The Theory of Market Failure: A Critical Examination
um Supply: Papers by M. A. Adelman 1962–1993 (Fairfax, VA: George Mason University Press, 1988),
(Cambridge, MA: MIT Press, 1993).pp. 219–39.) which deals with the older theories. Both antholo-
gies start with examples of the assertions of failure
74. The literature on environmentalism and its and go on to present articles criticizing the claims.
defects are vast. Three key critiques are Gregg Curiously, while numerous books review the state
Easterbrook, A Moment on the Earth: The Coming of theory after the newer theories, no similar uni-
Age of Environmental Optimism (New York: Viking, fied treatment of only the case against the older
1995); Julian L. Simon, The Ultimate Resource: 2, theories seems to exist.
(Princeton, NJ: Princeton University Press 1996);
and Bjørn Lomborg, The Skeptical Environmentalist: 80. Daniel F. Spulber, Regulation and Markets

27
(Cambridge MA: MIT Press, 1989). Spulber offers Effects of Fuel Economy Standards on Automobile
an analysis of what he calls “internalities” to relate Safety,” Journal of Law and Economics 38, no. 1 (April
these theories to the persistence of government reg- 1989): 97–118.
ulation of private transactions. Spulber’s analysis is
extended—but not cited—in Glen Whitman, 87. Andrew N. Kleit, “Impacts of Long-Range
“Against the New Paternalism: Internalities and the Increases in the Corporate Average Fuel Economy
Economics of Self-Control,” Cato Institute Policy (CAFE) Standard,” Economic Inquiry 42 (2004):
Analysis no. 563, February 22, 2006. Whitman deals 279–94.
with a family of arguments for intervention when
the individual can be expected to make a decision 88. Carolyn Fischer, Winston Harrington, and Ian
that is subsequently regretted—such as to smoke or W .H. Parry, “Should Automobile Fuel Economy
to not save enough money for retirement. These Standards Be Tightened?” Energy Journal 28, no. 4
arguments lack the analytic basis of those treated by (2007): 1–29.
Spulber; despite its proponents’ claim of novelty,
the approach is merely a repackaging of the familiar 89. Among the reports published in the 1970s are
old argument that superior outsiders exist, and that Joseph P. Mulholland, Economic Structure and Behav-
they can act efficiently to correct the errors of indi- ior in the Natural Gas Production Industry, Staff Report to
viduals. What makes Spulber more germane than the Federal Trade Commission (Washington: Govern-
anything else in the vast literature that grapples ment Printing Office, 1979); Joseph P. Mulholland,
with asymmetric-information theory is his explicit John Haring, and Stephen Martin, Staff Report on an
consideration of the internality question. Analysis of Competitive Structure in the Uranium Supply
Industry (Washington: Government Printing Office,
81. George A. Akerlof, “The Market for ‘Lemons’: 1979); U.S. Congress, General Accounting Office,
Qualitative Uncertainty and the Market Mechan- The State of Competition in the Coal Industry (Washing-
ism,” Quarterly Journal of Economics 84 (1970): ton: 1977); U.S. Department of Energy, Coal
488–500. Competition: Prospects for the 1980s (Springfield: VA :
National Technical Information Service, 1981); U.S.
82. Eric W. Bond, “A Direct Test of the ‘Lemons’ Federal Trade Commission, Bureau of Economics,
Model: The Market for Used Pickup Trucks,” Report to the Federal Trade Commission on the Structure of
American Economic Review 72, no. 4 (September, the Nation’s Coal Industry 1964–1974 (Washington:
1982): 836–40. The Akerlof article, which helped Government Printing Office, 1978). Later studies
win a Nobel Prize in economics for its author, is include Jay S. Creswell Jr., Scott M. Harvey, and Louis
one of the four examples of the new theory of Silvia, Mergers in the U.S. Petroleum Industry 1971–1984:
market failure reprinted in Cowan and Crampton An Updated Comparative Analysis (Washington: U.S.
(the refuting essay was the just-cited paper from Federal Trade Commission, 1989); U.S. Federal
Bond). Two of the remaining three examples were Trade Commission, Bureau of Economics, The Petro-
from Joseph E. Stiglitz, who has generated many leum Industry: Mergers, Structural Change, and Antitrust
models of peculiarly inefficient markets. The oth- Enforcement (Washington: 2004); U.S. Federal Trade
er comes from Paul A. David. The Nobel prizes Commission, Gasoline Price Changes: The Dynamic of
awarded to Akerlof and Stiglitz for their work in Supply, Demand, and Competition (Washington: 2005);
this area prove that novelty, not validity, can U.S. Federal Trade Commission, Investigation of
secure academic acclaim. Gasoline Price Manipulation and Post-Katrina Gasoline
Price Increases (Washington: 2006); U.S. General
83. The chief offenders are a research group at Accounting Office, Energy Markets: Effects of Mergers
Oak Ridge National Laboratories and Amory and Market Concentration in the U.S. Petroleum Industry
Lovins. (Washington: 2004).

84. Paul L. Joskow and Donald B. Marron, “What 90. This differs from the complex market-failure
Does a Negawatt Really Cost? Evidence from theories criticized above that rely on policy alter-
Utility Conservation Programs,” The Energy Journal natives that are inapplicable to international
13, no. 4 (1992): 41–71. trade.

85. One of the rarer economic defenses of CAFE 91. Jagdish N. Bhagwati, “The Theory of Political
standards can be found in David Greene, “Why Economy, Economic Policy, and Foreign Invest-
CAFE Worked,” Energy Policy 26, no. 8 (1998): ment,” in Public Policy and Economic Development,
595–614. Greene argues, contrary to what is M. Scott and S. Lai, eds. (Oxford, UK: Clarendon
argued here, that exactly the right combination of Press, 1990), pp. 217–30, reprinted in Jagdish
market failures prevail to justify mandatory fuel- Bhagwati, Political Economy and International
efficiency standards. Economics, Douglas A. Irving, ed. (Cambridge, MA:
MIT Press, 1991), pp. 154–67. The emphasis is in
86. Robert W. Crandall and John G. Graham, “The the original.

28
92. Ronald H. Coase, “The Problem of Social much briefer, but still complete, discussion of the
Cost,” Journal of Law and Economics 3 (October problems caused by high transaction costs. Fox,
1960): 1–44. An alternative critique is Buchanan’s however, seems to have gone too far and neglected
thought-provoking presentation about the rele- the large number of cases in which transaction
vance of the “club goods.” Buchanan suggested costs are low enough to allow private solutions.
that private clubs served as a way for a group col-
lectively to consume a good. Thus, it may well be 95. Ronald H. Coase, “The Lighthouse in Econom-
that, in many circumstances, private-club action ics,” Journal of Law and Economics 17, no. 2 (October,
may be preferable to government action. James M. 1974): 357–76; also in Ronald H. Coase, The Firm,
Buchanan, “An Economic Theory of Clubs,” the Market and the Law (Chicago: University of
Economica 32 (February, 1965): 1–14. His treat- Chicago Press, 1988).
ment concentrates on the formal analysis of clubs
rather than the implications of government inter- 96. George J. Stigler, The Citizen and the State: Essays
vention. The Coase article on lighthouses (dis- on Regulation (Chicago: University of Chicago
cussed below) more clearly expressed concern over Press, 1975).
neglect of the club alternative.
97. Paul A. Samuelson, “The Pure Theory of Public
93. William J. Baumol and Wallace E. Oates, The Expenditure,” Review of Economics and Statistics 36,
Theory of Environmental Policy: Externalities, Public no. 4 (November, 1954): 387–89. Reprinted in
Outlays, and the Quality of Life (Englewood Cliffs, NJ: Joseph E. Stiglitz, ed., The Collected Papers of Paul A.
Prentice-Hall, 1975) and the revised edition Samuelson, vol. 2 (Cambridge, MA.: The MIT Press,
(Cambridge: Cambridge University Press, 1988) 1966), pp. 1223–25. The difficulties of that article
suggest, but do not clearly express or resolve this required several follow-ups: Paul A. Samuelson,
problem. The key point is that the correct margin- “Diagrammatic Exposition of a Theory of Public
al charge or subsidy is not sufficient to ensure that Expenditure,” Review of Economics and Statistics 37,
only socially profitable firms survive. This require- no. 4 (November, 1955): 350–56. Reprinted in
ment necessitates lowering unregulated profits by Joseph E. Stiglitz, ed., The Collected Scientific Papers of
the total cost of external costs. Standard economic Paul A. Samuelson, vol. 2 (Cambridge, MA.: The MIT
principles show the problems. It is clearest with a Press, 1966), pp. 1226–32. Paul A. Samuelson,
simple flat subsidy. It would raise the profits of “Aspects of Public Expenditure Theories,” Review of
existing and entering firms and thus offset the Economics and Statistics 40, no. 4 (November, 1958):
marginal incentives to pollution control, unless the 332–38. Reprinted in Joseph E. Stiglitz, ed., The
subsidy to a socially inefficient firm was maxi- Collected Scientific Papers of Paul A. Samuelson, vol. 2
mized at zero output. A tax by reducing total prof- (Cambridge, MA.: The MIT Press, 1966), pp.
its encourages exit, but a flat tax could lower prof- 1233–39. Paul A. Samuelson, “Pure Theory of
its by more than the total cost of externalities. In Public Expenditures and Taxation,” in Public Eco-
the standard case of marginal costs that increase nomics, eds. J. Margolis and H. Guitton (New York:
with the level of polluting activity, a flat tax equal St. Martins Press, 1969), pp. 98–123. Reprinted in
to the marginal cost of the optimal level of the pol- Robert C. Merton, ed., Collected Scientific Papers of Paul
luting activity would lower profits by more than A. Samuelson, vol. 3, (Cambridge, MA.: The MIT
the total cost of externalities. The total cost would Press, 1972), pp. 492–517. Samuelson stressed he
be the area under the marginal cost curve, which is was formalizing concepts that had been more loose-
less than the tax charge equal by definition to the ly discussed in prior writings, and that he was treat-
marginal cost times the level of polluting activity. ing an extreme case.
More complex policies could in theory remedy
these defects. 98. The argument that the provision of public
goods is the only valid role of government relies
94. The controversial nature of Coase’s arguments, upon recognizing that everything government
and the rambling way in which he presented them, does supplies a service to its citizens, and that cit-
produced much commentary that differs consider- izens are the best judges of the value of those ser-
ably in the interpretation of his work. My interpre- vices.
tation can be restated by arguing that Coase shows
that, in practice, transaction costs can range from 99. This is particularly true of the works devoted to
ones so low that private solutions are feasible, to public choice. They are strongest in treating the
ones so high that any response is inefficient. Glenn tendency to inefficient policies. However, such
Fox, “The Real Coase Theorem,” The Cato Journal treatments also have had major contributions
27, no. 3, (Fall 2007): 373–96, echoes Coase’s 1988 from economists who do not specialize in public
comments by stressing that consideration of trans- choice. The public-choice literature is weak on the
action costs is the essence of Coase’s analysis. Fox is problems of identifying and satisfying demands for
correct in that others have stressed cases where pri- public goods. This literature is surveyed in Dennis
vate solutions were possible and neglected the C. Mueller, Public Choice III (Cambridge: Cambridge

29
University Press, 2003). The Liberty Fund has Sociological Analysis (Indianapolis: Liberty Classics,
issued multivolume collections of the works of two 1981) is a sweeping critique of intervention that
leading public-choice economists, James Buchanan was his earliest comprehensive attack on social-
and Gordon Tullock. ism.

100. Joseph A. Schumpeter, Capitalism, Socialism, 106. Oscar Lange, “On the Economic Theory of
and Democracy, 3rd ed., (New York: Harper & Socialism,” Review of Economic Studies 4:53–71 and
Brothers, 1950). 4:123–42 (1936–1937).

101. The germane literature on this matter is vast. 107. Hayek’s most famous take on this is Friedrich A.
For important contributions, see Anthony Downs, Hayek, “The Uses of Knowledge in Society,” American
An Economic Theory of Democracy (New York: Harper Economic Review 35, no. 4 (September, 1945): 519–30.
and Row, 1957); Gordon Tullock, “The Welfare Two complementary articles deserve note. Friedrich
Costs of Tariffs, Monopolies and Theft,” Western A. Hayek, “The New Confusion about ‘Planning’,”
Economic Journal 5 (1967): 224–32; Anne O. Krueger, Morgan Guaranty Survey (January, 1976): 4–13. Re-
“The Political Economy of the Rent-Seeking Soci- printed in Friedrich A. Hayek, New Studies in
ety,” American Economic Review 64, no. 3 (June, 1974): Philosophy, Politics Economics and the History of Ideas
291–303; Jagdish N. Bhagwati, “Directly-Unpro- (Chicago, IL.: University of Chicago Press, 1978).
ductive Profit-Seeking (DUP) Activities,” Journal of Friedrich A. Hayek, “The Pretense of Knowledge,”
Political Economy 90:5 (October, 1982): 988–1002; AmericanEconomicReview 79:6 (December, 1974): 3–7.
George J. Stigler, “The Theory of Economic Regu-
lation,” Bell Journal of Economics and Management 108. James M. Buchanan and Gordon Tullock, The
Science 2, no. 1 (Spring, 1971): 3–21; and Sam Calculus of Consent: Logical Foundation of Constitutional
Peltzman, “Towards a More General Theory of Democracy is a critical example (Ann Arbor, MI:
Regulation,” The Journal of Law and Economics 19, no. University of Michigan Press, 1962). (Volume 3 of
2 (August, 1976): 211–40. the Liberty Fund Collected Works of Buchanan
and volume 2 of the selected works of Tullock.)
102. See for example, Joseph P. Kalt and Mark A. They start with Wicksell’s suggestion to require
Zupan, “Capture and Ideology in the Economic unanimous agreement for state intervention. At
Theory of Politics,” American Economic Review 74, least tacitly, they conclude that the unmanageably
no. 3 (June, 1984): 279–300. high transaction costs of reaching a unanimous
solution require resort to alternatives. Rather than
103. I have a cherished personal example of this. confront the daunting task of defining an optimal
When I served on the Interior Department’s coal alternative, Buchanan and Tullock simply indicate
leasing commission in 1985–86, Massachusetts the drawbacks of other approaches such as simple
Democratic Congressman Edward Markey pre- majority voting. A fundamental flaw of this analy-
sented an argument for vigorous enforcement of sis is that it presumes far more citizen input than
the coal-leasing amendments. I asked him whether arises. In practice, we citizens only get to choose a
he would continue to do so if he realized that this few participants in the decision process. Those
hurt his constituents. He expressed doubts and decisionmakers have great latitude in determining
fled before I could show him that he was clearly what to do. Undertaking exhaustive studies of pub-
wrong. The kind of enforcement that he proposed lic demand is not a widely used option. This
was likely to produce inefficiently low leasing levels. reliance on instinct should be another major rea-
The amendments mandated higher royalty levels. son for skepticism about the extension of govern-
Both effects reduce supply and thus raise prices to ment activities. The demand-revealing approach
consumers. Massachusetts, of course, consumes subsequently endorsed by Tullock has the same
but does not produce coal. drawbacks. See Dennis C. Mueller, Public Choice III,
(Cambridge: Cambridge University Press, 2003):
104. The most celebrated of his several statements pp. 162–68, for an uncritical review of the concept
on the limited abilities of government is Ronald and its history.
H. Coase, “The Problem of Social Cost,” Journal of
Law and Economics 3 (October, 1960): 1–44. 109. Richard A. Posner, “Natural Monopoly and Its
Regulation,” Stanford Law Review 21 (February,
105. Mises wrote extensively on the defects of 1969): 548–643. (Reprinted by The Cato Institute in
intervention and the virtues of free markets. 1999 with a new introduction by Posner.) Even this
Ludwig von Mises, Human Action: A Treatise on essay, which is often represented as a radical critique
Economics, 4th rev. ed. (Indianapolis, IN: Liberty of state intervention, understates the true problems.
Fund, 2007 [1949, 1966, 1996]); Percy L. Greaves Efficient public-utility regulation would seek to
Jr., Mises Made Easier: A Glossary to Ludwig von Mises’ impose efficient prices that eliminate monopoly
Human Action, presents both sides of the case; profits. Such prices are difficult to design. To aggra-
Ludwig von Mises, Socialism: An Economic and vate matters, an infinite number of efficient pricing

30
schedules exist. Efficient pricing involves selling venting monopoly profits, the required profit cuts
marginal sales at the marginal cost of production can be made in infinitely many ways. The total cut
and alleviating the central problem with a decreas- is fixed, but any amount of anything can be split in
ing cost industry. If prices on all outputs equal mar- infinitely many ways. Consider the case of ten con-
ginal costs, total costs exceed revenues. In response, sumers sharing a $10 cut. Possibilities such as $10
higher charges for some inframarginal purchases to one consumer and nothing to the rest; $1 to each
are the solution. Thus, there is the telephone consumer; and $2 each to five consumers and noth-
approach of an entry fee to allow unlimited pur- ing to the other five, are all among the infinite pos-
chase at the marginal cost of efficient output or the sibilities. Richard L. Gordon, “Don’t Restructure
electric-power approach of declining block rates Electricity: Deregulate,” Cato Journal 20, no. 3
when earlier units of consumption are priced high- (Winter, 2001): 327–58.
er than later ones. In either case, given a goal of pre-

STUDIES IN THE POLICY ANALYSIS SERIES

627. A Federal Renewable Electricity Requirement: What’s Not to Like?


by Robert J. Michaels (November 13, 2008)

626. The Durable Internet: Preserving Network Neutrality without


Regulation by Timothy B. Lee (November 12, 2008)

625. High-Speed Rail: The Wrong Road for America by Randal O’Toole
(October 31, 2008)

624. Fiscal Policy Report Card on America’s Governors: 2008 by Chris Edwards
(October 20, 2008)

623. Two Kinds of Change: Comparing the Candidates on Foreign Policy


by Justin Logan (October 14, 2008)

622. A Critique of the National Popular Vote Plan for Electing the President
by John Samples (October 13, 2008)

621. Medical Licensing: An Obstacle to Affordable, Quality Care by Shirley


Svorny (September 17, 2008)

620. Markets vs. Monopolies in Education: A Global Review of the Evidence


by Andrew J. Coulson (September 10, 2008)

619. Executive Pay: Regulation vs. Market Competition by Ira T. Kay and Steven
Van Putten (September 10, 2008)

618. The Fiscal Impact of a Large-Scale Education Tax Credit Program by


Andrew J. Coulson with a Technical Appendix by Anca M. Cotet (July 1, 2008)

617. Roadmap to Gridlock: The Failure of Long-Range Metropolitan


Transportation Planning by Randal O’Toole (May 27, 2008)
616. Dismal Science: The Shortcomings of U.S. School Choice Research and
How to Address Them by John Merrifield (April 16, 2008)

615. Does Rail Transit Save Energy or Reduce Greenhouse Gas Emissions? by
Randal O’Toole (April 14, 2008)

614. Organ Sales and Moral Travails: Lessons from the Living Kidney Vendor
Program in Iran by Benjamin E. Hippen (March 20, 2008)

613. The Grass Is Not Always Greener: A Look at National Health Care
Systems Around the World by Michael Tanner (March 18, 2008)

612. Electronic Employment Eligibility Verification: Franz Kafka’s Solution


to Illegal Immigration by Jim Harper (March 5, 2008)

611. Parting with Illusions: Developing a Realistic Approach to Relations


with Russia by Nikolas Gvosdev (February 29, 2008)

610. Learning the Right Lessons from Iraq by Benjamin H. Friedman,


Harvey M. Sapolsky, and Christopher Preble (February 13, 2008)

609. What to Do about Climate Change by Indur M. Goklany (February 5, 2008)

608. Cracks in the Foundation: NATO’s New Troubles by Stanley Kober


(January 15, 2008)

607. The Connection between Wage Growth and Social Security’s Financial
Condition by Jagadeesh Gokhale (December 10, 2007)

606. The Planning Tax: The Case against Regional Growth-Management


Planning by Randal O’Toole (December 6, 2007)

605. The Public Education Tax Credit by Adam B. Schaeffer (December 5, 2007)

604. A Gift of Life Deserves Compensation: How to Increase Living Kidney


Donation with Realistic Incentives by Arthur J. Matas (November 7, 2007)

603. What Can the United States Learn from the Nordic Model? by Daniel J.
Mitchell (November 5, 2007)

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