Slavish devotion to common but wrong-headed ideas about economics is never more in need of exposure than when the subject is oil and the Persian Gulf. Here wrong-headed ideas about economics can get someone killed.

But there they were on full display last January in the New York Times, under the title “Axis of Oil,” when an editorialist stated, “Our fortunes are tied to the good offices of the big [petroleum] producers three decades after the oil shocks of the 1970′s.” The editorialist takes from this the need for the feds to do more to encourage/mandate energy efficiency. Foreign-policy elites take from this the need to keep authoritarian producer-states happy with the United States of America, which usually entails foreign aid, deference to their geopolitical interests, direct and/or indirect U.S. military commitments, and rhetorical support for the thugs who make life miserable for the now-famous denizens of “the Arab street.”

However, the argument that the only thing standing between us and a horrific, 1970s-style oil price shock is the good will of Persian Gulf oil producers is dangerous nonsense—the kind of nonsense that some think largely responsible for our present life-and-death struggle with al Qaeda.

The fact is that oil producers make decisions regarding how much petroleum to bring to market based not on how they feel about the West on any particular day, but on how to maximize revenues to their treasuries. The producing states’ self-serving representations to the contrary do not constitute evidence that anyone should take seriously.

The truth of that observation was settled conclusively in an exhaustive review of OPEC’s record over the past several decades by MIT economist M. A. Adelman (see Genie Out of the Bottle: World Oil Since 1970). Adelman finds that never once in OPEC’s history has the cartel or any member in it left money on the table to pursue some political objective. For instance, when the Ayatollah Khomeini kicked the Shah out of Iran in 1979, the oil kept flowing. When U.S. bombs rained down on Libya’s Moammar Gadhafi in 1986, the oil kept flowing. We had to impose an embargo on Iraq’s Saddam Hussein to get him to stop selling oil to the world market. And Castro Mini-Me Hugo Chavez labors mightily to get the oil flowing again to his hated enemies in the capitalist world.

Anti-American regimes stand to gain nothing by holding back oil from the world market. Where else would they find the revenue to fund terrorism or other “martyrdom operations” in the Middle East? To pay for their police states? To beef up their militaries? To build dozens of mansion/temple/monuments to themselves? To buy off opponents of their regimes?

Meanwhile, ostensibly pro-American Persian Gulf regimes have frequently turned into the fiercest price hawks of all. Take, for instance, the Saudi government, a group of potentates who supposedly have a “special relationship” with the United States. The Saudis took the lead in organizing the 1973 oil embargo and production cutbacks, sending oil prices from $2 a barrel to $7 a barrel. In 1974, despite promises to the contrary, they initiated another round of production cutbacks and tax hikes, sending oil prices to $11 a barrel. In 1978 OPEC, under Sheik Yamani’s direction, quietly established a goal of raising the price of crude oil to just below the cost of producing synthetic liquid fuels, which suggested a price of $60 a barrel (a whopping $136 in today’s terms). They began their campaign in January 1979, when a series of Saudi production cutbacks set off the second price explosion, culminating in prices of $34 a barrel ($60 a barrel in today’s money) by October 1981.

The only reason that crude oil prices never reached the levels dreamed of by our Saudi “friends” was the advent of independent oil commodity markets (particularly futures markets) and, in the words of the Kuwaiti oil minister at the time, because of “a consistent underestimation of potential supply and a consistent underestimation of the consumers’ ability to adjust their demand [which] . . . led OPEC to overestimate their strength.”

Prices Collapse

A price war followed, and after desperate Saudi attempts to stop it failed, Vice President George Bush traveled to Riyadh in 1986 to implore the Saudis to arrest the price slide because—I kid you not—the administration publicly feared the impact of cheap oil on the world economy. (Privately, it was probably more afraid of the impact on domestic producers, who were quite near death’s door by this time.) Since by this time the Saudis were feeding the collapse to inflict pain on competitors who needed a lesson in production discipline, they naturally responded to Bush’s pleas by . . . increasing output still more.

Once the price war was over, the Saudis encouraged Iraq to put the screws to Kuwait to punish that country for its history of cartel-breaking overproduction. According to Adelman, only when “the enforcer turned robber” in 1990 did Saudi Arabia reverse course and call for Western intervention. But even then, the Saudis fed the resulting price spike by refusing to increase production for over a month, and their refusal to fully tap their excess production capacity prolonged the economic damage.

Blind to this record of predation, the editorialist argues that “For now, at least, OPEC is helpfully trying to keep prices between $22 and $28 a barrel. It knows that allowing prices to hover above the $30 mark hampers global economic growth.” But what does the cartel care if the global economy goes into the tank? After all, their fattest economic years coincided precisely with the global economic stagnation of 1973–1981. These regimes typically have nothing else to sell to the market and little investment abroad. A slump bothers them not in the least.

The truth is that the cartel is well aware that sustained prices above $30 threaten to bring a flood of non-OPEC oil and increased interest in conservation. Those are the two hammers that nearly killed the cartel for a decade beginning in the mid-1980s. Of course, better to tell the gullible that filial commitment to the West explains cartel management rather than cold economic self-interest.

Adam Smith once wrote that it was not from the beneficence of the butcher, the baker, and the brewer that we got meat, bread, or beer. Likewise, it is not from the beneficence of the OPEC cartel that we get gasoline. Believing otherwise is dangerous nonsense.

Skyrocketing wholesale power prices in California and the daily threat of brownouts and blackouts have cast a pall over deregulation. “Liberals,” led by California Governor Gray Davis, blame a restructuring law passed in 1996 for the crisis, arguing that it left the state vulnerable to market manipulation by greedy power producers. Conservatives for the most part agree that the 1996 reforms are the culprit. They charge, however, that the ham-handed regulations attached to those “reforms”—primarily the prohibition of long-term contracts between utilities and power generators and the mandatory imposition of a centralized daily spot market—are largely responsible for the price spike. The right also argues that California’s regulations, crafted by environmental activists and antigrowth consumer groups, have long discouraged investment in new generating capacity and that the blackouts represent a long overdue flock of chickens coming home to roost.

While both sides are busily settling political scores, the real story of what happened in California is largely being missed. Accordingly, the important lessons that this crisis teaches about regulation and electricity are largely being overlooked: retail price controls are a recipe for disaster; and state regulators have little idea how best to efficiently organize important industries and certainly shouldn’t attempt to do so under the mantle of “deregulation.”

The Architecture of California’s “Deregulation”

Unlike the deregulation of the airline and trucking industries—which largely curtailed regulatory oversight of those industries and freed markets to go in whatever directions that market agents thought best—the “deregulation” of the electricity industry in California was heavily proscriptive and not, on balance, a loosening of regulatory controls at all. California simply replaced the old set of regulations with a new set of regulations, some of which were less interventionist than the old, some of which more.

The central thrust of the restructuring was to create a competitive wholesale market for electricity. Any investor who wished to get into the power business could henceforth do so. But politicians feared that the utilities would use their control of the electricity grid to “rig” this new marketplace so as to disadvantage competitors. Reformers thus adopted a whole new set of regulations and government interventions to ensure that a competitive market would arise:

•Mandatory Open Access. Utility companies were forced to allow any generator who desired access to the grid to gain such access at terms, conditions, and prices established by the state.

•Vertical Disintegration. Incumbent utilities could no longer sell the power they generated directly to consumers. Instead, utility generators could only sell power to the centralized state-managed power exchange in a day-before spot market.

•Centralized Power Exchange. Any power the utilities needed for its customers had to be purchased from the state-managed power exchange through the year 2003. Other parties could buy through the exchange on a voluntary basis. The exchange was charged with procuring power in a voluntary day-before spot market made up of bids from non-utility power generators.

•Utility Retail Price Caps. Regardless of the power source, utility rates were frozen in place until the source recouped its share of “stranded costs,” which were levied by a tax on all ratepayers.

•Independent System Operator (ISO). The day-to-day operation of the grid (that is, the management of electricity traffic along the wires) would be directed, not by the utilities that actually owned the grid, but by a state official answerable to a 26-member advisory board made up of representatives of grid users. The ISO was further empowered to procure electricity on an emergency basis if on any given day the amount of power procured in the centralized power exchange was insufficient to meet demand.

Industry consultant Charles Cicchetti, former chairman of the Wisconsin Public Service Commission, echoed the thoughts of many when he wrote at the time, “Two things should be obvious. First, none of this should be called deregulation. Second, it is difficult to see how any of these myriad regulatory schemes, unless altered significantly but perhaps not fundamentally, will lower prices.”

California’s electricity market under the new regime, however, appeared to work reasonably well from 1997 through the spring of 2000. Even though the hoped-for retail competition for electricity ratepayers never fully materialized, wholesale electricity prices dropped to nearly $30 per megawatt hour (MWh), the equivalent of 3 cents per kilowatt hour (kWh), in May 2000. Those low prices allowed utilities to make a reasonable return on sales even with the rate cap.

Nor were any storm clouds apparent on the horizon before the crisis occurred. We have searched in vain for any industry report, analysis, or study that warned that a supply crunch was about to hit the state. On the contrary, the National Electricity Reliability Council (NERC) issued an advisory suggesting that California’s reserve capacity heading into the summer of 2000 stood at 15 percent, a reserve that was roughly the same as those held by other states.

The Roots of the Crisis

California’s happy state of regulatory affairs changed radically in 2000-2001 when two large supply shocks and a demand shock simultaneously struck. None of those shocks was triggered by state policy. All of them, however, had a serious impact on wholesale electricity prices.

Supply shock number one was a massive demand-driven run-up in regional wholesale natural gas prices, the fuel input for 49 percent of California’s electricity capacity and nearly all its peaking capacity. From 1998-99, the average price of natural gas delivered to utilities in California was $2.70 per million British thermal units (Btu). By December 2000, however, wholesale gas prices had risen to an average $25 per million Btu. Given that 90 percent or more of a generator’s cost of producing electricity stems from fuel costs, simple math demonstrates how those prices have driven electricity prices. Gas prices of $25 per million Btu, for instance, translates into a production cost of $400 per MWh for the most efficient gas-fired plants (or, alternatively, 40 cents per kWh) and $500 per MWh (50 cents per kWh) for the least efficient power plants.

While those prices are subject to daily fluctuations, the price of natural gas at the time of this writing still averaged around $15 per million Btu, a 455 percent increase over last year’s price. That translates into $240-$300 per MWh for gas-fired electricity.

Remember, the price of electricity in the state-managed California power exchange is set by the highest price paid to any generator, so this hike in natural gas costs for the least efficient power generators set the price for all the electricity sold throughout the exchange, even power produced from other fuels.

Supply shock number two was caused by a three-year dry spell that dropped western water tables and thus reduced regional hydroelectric generation by 20 percent since 1998. Things became even worse in 2001 with streamflows in January only about 60 percent of average. The practical effect of this falloff in hydroelectric generation was essentially to wipe out California’s reserve capacity, leaving the state with little generating capacity to fall back on during peak demand periods.

Making everything worse was the fact that electricity demand shot skyward first last summer with unseasonably warm temperatures (a 13 percent increase in cooling degree-days across the Pacific region from 1999 to 2000), and then last winter as a consequence of the coldest winter on record since temperatures were first systematically recorded in 1895. Demand for heat in December 2000 grew over the demand in December 1999 by an amount greater than the annual consumption of Finland, Norway, and Sweden combined.

Two important points thus emerge. First, each of those phenomena driving the price spike was an “act of God.” No state politician, regulator, or businessman could have headed it off. Second, no regulatory system—not the pre-1996 regulatory regime, not the post-1996 regulatory regime, not a completely laissez-faire regime, and certainly not any of the various regulatory regimes in other states—could have prevented wholesale electricity prices from climbing to record levels under these circumstances.

The NOx Hammer

While environmental regulations in general affect both generating costs and the ability to site new capacity, California’s requirement that generators have sufficient nitrogen oxide (NOx) emissions credits before going on-line has had a particularly important role in the price spiral.

In the winter of 1999, NOx credits were selling for about $2 per pound. By the summer of 2000, those same credits were selling for $30-40 per pound, where they have stayed ever since. Since an efficient gas-fired plant emits about a pound of NOx per MWh and an inefficient plant emits about two, that translates into an additional cost of $40-80 per MWh. California regulators moved last January to waive NOx permit requirements for power generators for the next three years, but the damage was done.

While it’s true that the NOx program affects only those generators in the L.A. Basin—the source of only a fraction of the state’s power—observers forget that the highest cost source of electricity sets the price for all electricity sold through the state power exchange. Aaron Thomas, a manager at AES Pacific, points out that generators in the L.A. Basin “are setting the clearing price for everybody in California. And to the extent that that market is influencing markets in the West, all of a sudden you’re getting these basin units driving costs for 50 million people in the West.”

The Damage from Price Controls

In September 2000 the state of California imposed a $250 per MWh price cap on electricity sold to the state power exchange. Since wholesale prices ranged between $150-$1,000 per MWh depending on the time of day, generators responded by dramatically curtailing their sales to the California exchange.

Moreover, since retail electricity prices were for the most part capped at between 6 and 7 cents per kWh ($60-$70 per MWh), generators that stayed in the market had no incentive not to hold up the power exchange for the best price available when the ISO came calling for emergency power to avert blackouts. After all, the wholesale price demanded by the generator would not have any effect on demand whatsoever . . . a sort of dream scenario.

Regardless of how much market manipulation might have been going on, simple math demonstrates that most of the price spike was real, reflecting higher input costs. Yet the price cap encouraged ratepayers to consume more electricity than was available. Blackouts were the inevitable result of attempts to regulate and legislate basic economic laws out of existence.

Unexpected shortfalls in transmission capacity, incidentally, also contributed to the blackouts. The main transmission line between northern and southern California (Path 15) has at times been limited to half its normal capacity, significantly complicating northern California’s power supply. It’s no coincidence that most of the blackouts have been concentrated in that region.

The Blame Game

While all informed parties largely agree with this story, some remain unconvinced that it fully explains the high prices and the lack of power. A thorough review of cost data by analyst Edward Krapels, an executive with ESAI Power and Gas Services, demonstrates in a recent issue of Public Utilities Fortnightly that, while the December price of wholesale power can be completely explained by the set of supply and demand shocks discussed above, an average of $50 per MWh between April and November of 2000 cannot be readily explained by increases in the cost of production.

Although one answer is that “strategic behavior” on the part of generators might explain that gap, another is that the shortage last summer caused numerous power plants to run flat out for months, postponing needed maintenance and repairs that came due this winter. Approximately 40 percent of the state’s generating capacity, after all, comes from plants 30 years or more old. Power plants have accordingly been out of service at various times this winter in unprecedented numbers. During the first blackout on January 17, for instance, fully 11,000 megawatts of in-state power was off-line due to repair and maintenance work, about a third of the power typically required during peak winter time periods. During times of shortage, of course, prices will rise to whatever the market will bear.

Many have argued that California is short on electricity because environmentalists and consumer activists have blocked new capacity, slowly starving the state of needed power. Yet only once in the past ten years has neighborhood opposition blocked a power plant in California. Moreover, since Governor Davis was elected in 1998, California has approved the construction of nine power plants, with another 22,600 MW of generating capacity somewhere along the licensing process. A new study by Resource Data International concludes that “Even in the West, where shortages and unprecedented high prices have been the rule in 2000, more than enough new capacity is under development to bring power markets into balance and perhaps provide a mild over-correction within the next couple of years.”

A better explanation for why more capacity wasn’t built in California during the 1990s is simple economics. Wholesale electricity, after all, was “dirt cheap” there throughout the decade. Profit opportunities were minimal. The supply shock was completely unforeseen. Moreover, since investors couldn’t be sure how regulatory changes would affect their businesses, it’s natural that investment was curtailed during the legislative and regulatory struggle of the mid-to-late 1990s.

Exclusive concern over California’s generating capacity, however, ignores the fact that the power market in the west is one, large interconnected system. There is no reason in principle to demand that California internally generate all its power; we would not, after all, demand that Rhode Island produce all the food it consumes. Importing power across state lines is no more economically risky than importing power across county lines. So whatever obstacles that might have prevented new facilities in California should not have affected overall power availability.

Self-Inflicted Regulatory Wounds?

A frequent argument forwarded is that, since other states are doing fine, there’s something about California’s “deregulation” plan that has caused the crisis beyond environmentalist meddling. After all, the average price for wholesale power in California was $313 per MWh in the middle of January 2001 compared to $74 per MWh in New England, $63 per MWh in New York, and $39 per MWh in Pennsylvania, New Jersey, and Maryland.

While it’s true that some of the states that have restructured their electricity regulations have perhaps done a better job of it than California (Pennsylvania, for instance, did not force their utilities to sell off nearly as many generating assets as California, allowed long-term contracting for power, and established a more robust retail and wholesale market of competing suppliers), it’s not true that the price differentials between power in California and the power in those states have anything to do with the “better” regulatory climate. It has to do with fuel composition.

Remember, the main drivers of the spike in California are the increased costs of natural gas and the decline in water tables that has crippled hydroelectric generation. States east of the Rocky Mountains, however, rely almost completely on nuclear and coal-fired power for their electricity during the winter (and only a few rely heavily on natural gas during peak demand periods in the summer). That alone explains why the electricity crisis has been confined thus far almost exclusively to California and its neighboring states.

If major exogenous supply and demand shocks were to hit those states touted as deregulatory “successes,” they would find themselves experiencing the same meltdown going on in California. Bruce Radford, editor-in-chief of Public Utility Fortnightly, explains:

As I see it, the Texas law (Senate Bill 7, the Texas Electric Choice Act, signed in 1999 by then-Governor George W. Bush) contains the same basic failing as did Assembly Bill 1890, the California law—it creates a tariff structure for Texas that will surely run aground if electricity prices don’t behave as expected. Just like California, the Texas law creates a rate freeze keyed to revenue levels set under the old regulated regime, and then mandates a guaranteed rate cut on top of that for residential and small commercial customers (6 percent in Texas, instead of 10 percent, as in California), good until Jan. 1, 2007 (both with adjustments allowed for fuel cost increases).

So if power prices in Texas should spike out of control between now and 2007, more than warranted by fuel costs, you could have the same mess as in California—utilities buying high and selling low.

The same critique applies to Pennsylvania, Michigan, Maryland, and all the other states occasionally trotted out as examples of deregulation “done right.”

Some might be tempted to argue that California “went wrong” then by eschewing coal and nuclear generation, but that’s questionable. Natural gas-fired generation made perfect sense in the 1990s; it was cheaper and easier to build than coal and nuclear plants. Nor was California alone in relying on natural gas for new capacity. Virtually all new power plants built throughout the nation in the 1990s were gas-fired. Remember also that decisions about new capacity are made not by state politicians or regulators but by private investors. While state authorities do have the final say over whether a plant does or does not get a license to go on-line, they do not dictate to investors what kind of plant to site.

Long-Term Contracting: The Way Out?

Many on both the left and right believe that the prohibition against long-term contracting for power is at the root of the crisis. The idea that long-term contracts can reduce electricity costs in the long run, however, is extremely dubious. First, below-market prices in the short term can only come at the expense of above-market prices for years to come, and locking in long-term prices at the summit of a price spike is hardly the best way to minimize cost in the long run. Second, long-term contracts do not offer a “better deal” than spot market purchases. They simply reallocate the risk of price volatility from the consumer to the producer. But producers require a premium to accept this reallocation of risk. Generators are not about to offer prices that will, over the long term, return them fewer profits than sales on the spot market. In fact, spot-market prices for electric and gas utilities have historically been more favorable to consumers than contract prices.

What if California’s utilities had signed long-term contracts before the wholesale electricity price spike hit? Wholesale prices would still be sky-high. Independent power producers would be obligated to sell power at, say, 6 cents per kWh despite the fact that it cost them 15-100 cents per kWh to make that power. It wouldn’t be long before the independent power plants started to declare bankruptcy and tear up the contracts, which is what happened during the mid-1980s in the natural gas industry. It’s already happening to the few generators (including the natural gas giant Enron) that signed long-term contracts in California.

Nor would long-term contracting have stopped the blackouts. No matter how the contracts were written, it would not have changed the fact that exogenous supply and demand shocks have curtailed the supply (and, accordingly, increased the price) of electricity. As long as the state prevents retail prices from reflecting that scarcity, demand will outstrip supply and shortages will occur.

An axiom of economics states that the most expensive source of supply at the margin must set prices for all sources of supply. If it didn’t, shortages would occur. So if 95 percent of all the utilities’ power were supplied by long-term contracts (as the Governor hopes) at 6 cents per kilowatt hour, as long as 5 percent of that power were coming from the spot market, the price they’d charge to keep the lights on would reflect the spot—not the contract—price.

H.L. Mencken once said that “Democracy is the theory that the common people know what they want and deserve to get it good and hard.” That appears to be the case in California today. A recent poll asked Californians whether they would prefer a regime that capped the retail prices of electricity but produced the occasional blackout or a regime that decontrolled retail prices but eliminated the blackouts. Two-thirds favored the former. In essence, Californians demonstrate the fact that there’s a little bit of East Germany in all of us.

The simple fact is that high prices for power must be paid. Since it’s politically difficult to have ratepayers pick up the tab on their monthly bill, California’s politicians have decided to have taxpayers pick up the tab out of the state budget surplus. So Californians will not escape high prices. The problem with paying bills that way, however, is that the high prices will not affect electricity demand and thus will not play their intended role in allocating scarce goods as they would if they were simply passed on through the market.

The California electricity crisis is not really a story about environmentalists gone bad, deregulatory details left unattended to, or unrestrained capitalists running amok. It’s basically a story about what happens when price controls are imposed on scarce goods.

The Kyoto Protocol obligated the industrialized nations to reduce their industrial greenhouse-gas emissions to 7 percent below their 1990 level by 2012, a stipulation that translates into a 33 to 40 percent reduction in current emissions. Yet the Protocol never spelled out exactly how the signature nations could go about accomplishing this within the framework of the treaty. Until that’s resolved, no Senate in its right mind would sign on to such an agreement. Thus, the never-ending roundtable of postnegotiation negotiations.

The Clinton-Gore team knew full well that Americans aren’t about to swallow the steep energy taxes levied by European governments or accept their economic equivalent—onerous greenhouse-gas emission restrictions via regulation. So they frantically tried to negotiate less painful mechanisms to comply with the Protocol. International emissions trading, long championed by the Clinton administration, would indeed significantly reduce compliance costs, but European Green hostility to anything that even faintly smells of capitalism left that option a nonstarter.

The Clinton-Gore team therefore went to The Hague with another idea; sequestration. Why not allow nations to offset their emissions by increasing the storage capacity of natural carbon sinks? After all, the net effect of reducing greenhouse-gas emissions by 15 percent is the same as increasing the terrestrial absorption of greenhouse gases by 15 percent, and it’s a lot cheaper. Moreover, adopting sequestration strategies has the secondary advantage (from the environmentalists’ perspective) of increasing the global expanse of forests and related ecosystems. The Europeans, however, reacted as if the American plan were some sort of Satanic subterfuge, and the talks collapsed in acrimony.

This decade-long political dance surrounding global warming has now made a few things perfectly clear.

First, the Green lobby is primarily interested in reducing domestic fossil-fuel consumption, not in reducing greenhouse-gas buildup per se. They’re not about to let the industrialized nations off the hook by opening the door to compliance strategies that subvert their campaign to remake those communities in their own primitivist image.

Second, symbols count far more than substance. According to British climatologist Tom Wigley, the über-alarmist of the Kyoto camp, the Protocol signed in 1997 would only reduce global temperatures by 0.13 degrees Fahrenheit below where they otherwise would be by the year 2050. To actually stop the warming would require an infinitely more radical restructuring of industrial society.

Why then this holy crusade for a treaty that—if you accept the global warming hypothesis—would do virtually no good whatsoever? Because the treaty is a symbol of our willingness to act, not a credible action plan itself.

Finally, Green politicians are not primarily interested in achieving serious greenhouse-gas emission controls. They are primarily interested in posturing and posing for domestic constituents. As long as the Green lobby refuses to punish political champions who fail to deliver on their agenda, politicians thought to be “fighting the good fight” are just as well off, and maybe better off, than politicians who actually win the good fight.

Since concrete emission restrictions are hard to deliver and are by necessity products of messy compromises that might anger their base, there are good reasons for Green politicians to content themselves with hot rhetoric and symbolic gestures of concern rather than with accomplishing anything. That’s particularly true when there are potentially real costs to these programs that could quite possibly trigger a terrific political backlash against their proponents if they were ever put in place.

Symbolic Gestures

The first two observations aren’t particularly remarkable to dedicated public-policy observers, but the last one might well startle some. Yet political scientist David Mayhew of Yale University has identified this phenomenon time and time again. In his magisterial treatise titled Congress: The Electoral Connection (Yale University Press, 1974), Mayhew points out, for instance, that for all the Sturm und Drang surrounding the Vietnam War, the peace movement in Congress was remarkably lethargic. Still, antiwar voters were no less mobilized and valuable because of it. Ronald Reagan’s frequent rhetorical flourishes on behalf of the right-to-life movement and occasional symbolic gestures of support were enough to lock it into his political coalition. That support would have been no more valuable had he actually rolled back abortion rights. In fact, the inevitable backlash would have reduced the value of that support.

In the final analysis, there’s only one way to reduce industrial greenhouse-gas emissions: raise the price of fossil fuel consumption. And, if we’re serious about reducing greenhouse gas buildup in the atmosphere, we’d have to increase prices to the point where few if any of us would ever again voluntarily buy gasoline or coal-fired electricity.

Now ask yourself: when was the last time that swing voters in this country (the only voters that really matter to politicians) voluntarily embraced truly significant and identifiable economic burdens in order to alleviate problems that might be confronted five or ten decades hence? Answer: never. The looming catastrophe surrounding Social Security, for instance, tells us all we need to know about the willingness of the American public to sacrifice in any significant manner for future generations.

The Green lobby knows this, which is why they push not energy taxes but energy efficiency, renewable-energy subsidies, and a whole host of programs that make no sense from a global-warming perspective, but nonetheless advance long-standing movement agendas. Mandatory energy conservation and efficiency improvements, for instance, serve primarily to reduce the marginal cost of energy-related services. But as any economist can tell you, reducing the marginal cost of something when demand is elastic will increase consumption. This is true in spades in the energy market. Increase the fuel efficiency of cars and watch vehicle miles traveled shoot through the skies. Reduce the cost of running air conditioners in the summer and watch people turn the thermostat down further during hot July afternoons.

The Kyoto Protocol may be dead, but it was only a symbol. New symbols will inevitably be found. Yet the policy it symbolizes—a serious global effort to reduce greenhouse-gas emissions—never had a chance in the first place. Global warming will still be marshaled to justify this or that Green program or this or that rent-seeking operation in Washington, but the Green campaign for a “radical transformation of society” (Al Gore’s words) died its thousandth death in The Hague this November.

Jerry Taylor
Director, Natural Resource Studies
Cato Institute

The mantra of “sustainable development” is constantly on the lips of the international agencies and nongovernmental organizations helping lesser-developed countries. The concept seems innocuous enough; after all, who would favor “unsustainable development”? But the fundamental premise of the idea—that economic growth, if left unconstrained and unmanaged by the state, threatens unnecessary harm to the environment and may prove economically ephemeral—is dubious. Indeed, the policy prescriptions that are generally endorsed by those concerned about sustainable development are inimical to our best environmental and economic interests. This is so for three reasons:

• If economic growth were to be slowed or stopped, it would be impossible to improve environmental conditions.
• The bias for command-and-control regulations on the part of those endorsing the concept of sustainable development will only serve to make environmental protection more expensive; hence, we have to “purchase” less of it.
• Strict pursuit of sustainable development, as many environmentalists mean it, would only do violence to the welfare of future generations.

The debate surrounding sustainable development is important because it advertises itself as a comprehensive governing philosophy for the 21st century. Indeed, Vice President Al Gore has called the need for environmental protection the best “central organizing principle” of the modern state. This is heavy stuff. It puts sustainable development in the pantheon of other “central organizing principles” proposed for the state over the years—such as rule by class or race and absolute rule by majority. While environmental protection is certainly important, making it the government’s chief principle would concentrate tremendous power in the hands of those who believe only they can best direct human affairs. The results of such experiments have been less than spectacular and usually counterproductive, to say the least.

What Is Sustainable Development?

Despite its institutionalization, sustainable development is rather difficult to define coherently. The United Nations Commission on Economic Development (UNCED), in its landmark 1987 report, Our Common Future, defines it as that which “meets the needs of the present without compromising the ability of future generations to meet their own needs.”^[1] But that definition is hopelessly problematic. How can we be reasonably expected to know, for instance, what the needs of people in 2100 might be? Moreover, one way people typically “meet their own needs” is by spending money on food, shelter, education, and whatever else they deem necessary or important. Is sustainable development, then, simply a euphemism for the creation of wealth (which, after all, is handed down to our children for their subsequent use)? True, there are human needs—such as peace, freedom, and individual contentment—that cannot be met simply by material means, but sustainable-development advocates seldom dwell on the importance of those nonmaterial, non-“resource-based” psychological needs when discussing the concept.

Thus, sophisticated proponents of sustainable development are forced to discard as functionally meaningless the UNCED definition. Otherwise, the UNCED definition can be read as a call for society to maximize human welfare over time. An entire profession has grown up around that proposition. It is known as economics, and maximizing human welfare is known not as “sustainable development” but as “optimality.” Can it really be that Adam Smith’s The Wealth of Nations was the world’s first call for sustainable development?

Economists David Pearce and Jeremy Warford, two of the world’s more serious thinkers about sustainable development, disclose that by sustainable development, many advocates mean “a process in which the natural-resource base is not allowed to deteriorate.”^[2] This is generally known as the “strong” definition of sustainability. The “weak” definition allows the natural-resource base to deteriorate as long as biological resources are maintained at a minimum critical level and the wealth generated by the exploitation of natural resources is preserved for future generations, which is otherwise “robbed” of their rightful inheritance. Weak sustainability, then, can be thought of as “the amount of consumption that can be sustained indefinitely without degrading capital stocks.”^[3]

Unfortunately, both “strong” and “weak” definitions of sustainable development pose problems as well. As Robert Hahn of the American Enterprise Institute points out, the narrower the definition, the easier it is to pin down, but the less satisfactory the concept.^[4] That does not, however, reduce the concept’s utility as (in the description of the Competitive Enterprise Institute’s James Sheehan) “an overarching political philosophy merging the twin goals of conservation and controlled economic development.”^[5]

The Pitfalls of “Strong” Sustainability

What is “the natural-resource base” we are directed not to draw down? Resources are simply those assets that can be used profitably for human benefit. “Natural” resources, then, are a subset of the organic and inorganic material we think of as constituting the biological “environment,” since not all of that material can be used profitably.

What can be used productively by man changes with time, technology, and material demand. Waves, for example, are not harnessed for human benefit today and thus cannot really be thought of as a “natural resource.” But the technology to harness the movement of waves to generate energy certainly exists, and the day when the cost of doing so is lower than the cost of alternative energy sources is the day when waves become a “natural resource.” Uranium, to cite another example, would not have been considered a resource a century ago, but is most certainly thought of as such today. Petroleum was not an important resource 100 years ago, but today is thought of as perhaps the most important one to modern society.

Thus, what is and is not part of any society’s “natural-resource base” changes. Conserving today’s base does not ensure that tomorrow’s is secure, and drawing down today’s does not necessarily mean that tomorrow’s is in jeopardy.

Moreover, the relative abundance of a society’s natural resources can change dramatically with technological advance. For example, there are 6,784 trillion fewer barrels of oil in the ground today than there were in 1981, the year in which relative oil scarcity was greatest.^[6] At first glance, then, one might think that the natural-resource base has deteriorated. Yet oil is more abundant today than it was 17 years ago. After adjusting for inflation, the price of a barrel of Saudi crude has declined by 62 percent and U.S. crude by 64 percent since 1980.^[7] The reasons for this increased oil abundance are several-fold. First, new technologies have emerged that make oil discovery and production far more efficient and thus less costly. Second, greater efficiency in using resources (a reaction to previous run-ups in petroleum prices as well as ongoing technological advances) has helped reduce the amount of oil necessary to produce a unit of goods or services and, hence, the relative abundance of the energy-resource base. Indeed, according to the U.S. Energy Department’s Energy Information Administration, the amount of petroleum and natural gas necessary to produce a dollar’s worth of GDP has declined by 29 percent since 1980. The story is not unique to petroleum; all resources have become far more abundant—not more scarce—throughout the twentieth century (and indeed, throughout recorded history).^[8]

If sustainable development, then, is understood as an admonition that the aggregate size of the natural-resource base (absent any consideration of demand) should “not be allowed to deteriorate,” then it is not particularly helpful. It posits wrongly that absolute (as opposed to relative) scarcity is the primary threat to the economy and human society at large. And the theory is oblivious to the ongoing process of resource creation. As economists Harold Barnett and Chandler Morse explained in their classic work, Scarcity and Growth, as resources become more scarce, people will anticipate future scarcities, prices will be bid up, incentives will be created for developing new technologies and substitutes, and the resource base will be renewed.^[9]

Wild-Eyed Optimism?

Is Barnett and Morse’s optimism regarding “just in time” delivery of new technologies and resource subsidies justified? Well, historical experience would certainly seem to justify their optimism. Those who find the theory counterintuitive betray a fundamental misunderstanding of the genesis of resources. Natural resources do not exist independent of man and are not materials we simply find and then exploit like buried treasure. On the contrary, they are created by mankind. As resource economist Thomas De Gregori points out, “humans are the active agent, having ideas that they use to transform the environment for human purposes. . . . Resources are not fixed and finite because they are not natural. They are a product of human ingenuity resulting from the creation of technology and science.”^[10]

The late David Osterfeld thus concluded that “since resources are a function of human knowledge and our stock of knowledge has increased over time, it should come as no surprise that the stock of physical resources has also been expanding.”^[11] Obsessing on conserving present resources is akin to a farmer obsessing over conserving eggs rather than the chickens that lay them.

The sustainable-development imperative betrays an ill-considered bias for natural as opposed to man-made capital. In truth, the wealth created by exploiting resources is often more beneficial than the wealth preserved by “banking” those resources for future use. Daniel Boggs has criticized the “rhetoric [that] says we didn’t inherit from our parents, we are borrowing from our children.”

Argues Boggs: “This is usually designed to make us ashamed to use anything. Logically, it should also make us hate our parents for using up some of ‘our’ oil, or iron, or whatever. Yet, our parents did build this world for us.” He went on to point out that previous generations “created the resources that far more than replaced, in truth, what they used. And I am confident that we can do the same for our children. I would certainly rather have medicines and satellites and other technology than a few more billion tons of some rock or another.”

It comes down to free choice, Boggs said. “We each can set our own economic time horizons. If we really think our grandchildren will be better off with shut-in oil wells than shares of IBM, we can buy them up and shut them in. But others should be free to make their own decisions.”^[12]

Doubt from Within

There is growing doubt within the ecological community about whether stocks of natural capital are naturally constant at all. “Strong” sustainability assumes that ecosystems naturally evolve towards some equilibrium and eventually stabilize. But within the academic community, the lack of empirical evidence supporting that assumption has led to a wholesale questioning of the equilibrium paradigm.^[13] The consequences are significant.

• If ecosystems do not tend toward stabilization, then policies intended to promote “sustainable” capital are unnatural and without ecological merit.
• If resource stocks are not functionally and structurally complete, then “sustainable management” of those stocks will prove suboptimal, and
• If ecosystems do not tend toward stability, then calculations about the economic or ecological value of natural capital are impossible on a macro level.

Uncertainties surrounding the nature of ecosystem evolution and the means by which resource stocks can best be maintained have two main implications for policy analysts. First, conclusions about whether or not certain economic activities are “sustainable” is more problematic than some would like to think. As sustainable-development theorists Robert Costanza and Bernard Patten concede, “A system can only be known to be sustainable after there has been time to observe if the prediction holds true. Usually there is so much uncertainty in estimating natural rates of renewal, and observing and regulating harvest rates, that a simple prediction . . . is always highly suspect, especially if it is erroneously thought of as a definition.”^[14]

A second implication is that preserving indefinitely certain ecological states is less a matter of ecological necessity than social preference. Geographer M.J. Harte of the University of Waikato, New Zealand, notes that the issue of natural capital necessarily involves people’s preferences. Without that dimension, Harte says, “economists cannot claim that any one ecological state is superior to another because their recommendations are not clearly supported by ecological theory and practice.”^[15] For Harte that means the “contribution to human well-being” should be given weight at least equal to environmental considerations in decisions about development.

The “strong” variant of sustainable development is thus built on an erroneous theoretical foundation that cripples its usefulness to policy analysts.

And finally, while sustainability can be an important consideration for certain economic or social arrangements, it does not necessarily follow, as economist Wilfred Beckerman notes, that sustainability should be the overriding criterion for public policy. After all, there are innumerable human undertakings that are highly desirable—even necessary—but unfortunately not indefinitely sustainable. We must distinguish between sustainability as a purely technical concept and optimality, which is a normative concept. Many economic activities that are unsustainable may be perfectly optimal and many that are sustainable may not be desirable, let alone optimal.^[16] I.M.D. Little and J.A. Mirrlees observed rightly that “Whether a project is sustainable (forever?—or just a long time?) has nothing to do with whether it is desirable. If unsustainability were really regarded as a reason for rejecting a project, there would be no mining, and no industry. The world would be a very primitive place.”^[17]

Nobel-prize-winning economist F.A. Hayek concurred, pointing out that we have only sustained development as a society by refusing to embrace the policy prescriptions of “sustainable development” advocates. “Industrial development would have been greatly retarded,” Hayek wrote, “if sixty or eighty years ago the warning of the conservationists about the threatened exhaustion of the supply of coal had been heeded; and the internal combustion engine would never have revolutionized transport if its use had been limited to the known supplies of oil.”^[18]

The Incoherence of Intergenerational Equity

It is fashionable in certain intellectual circles to argue, as does Edith Weiss, professor of international law at Georgetown University, that future generations have as much right to today’s environmental resources as we do, and that we have no right to decide whether or not they should inherit their share of those rights.^[19]

Yet the idea that those not yet even conceived have tangible rights to resources is dubious to say the least. First, it is philosophically inconsistent. Those disembodied beings are said to have rights, yet the moment they are conceived, they are legally held to have no rights whatsoever. Leaving aside the ethics of abortion, to be consistent, those who defend the rights of future generations must by the same logic oppose abortion (a position few environmentalist activists hold, given their allegiance to population control). Once individuals are conceived, we do not maintain that they have a right to all the resources of their parents. If, for example, a retired couple spends $50,000 on a trip around the world, we do not argue that the couple has violated the resource rights of their children. Thus, individuals are said to have absolute resource rights before conception, no resource rights (indeed, not even the right to life) from conception to birth, and then only limited resource rights until death. If the theory of intergenerational equity is to be taken seriously, this obvious lurching arbitrariness will need to be expunged.

The concept of intergenerational equity, moreover, is hopelessly incoherent. If the choice to draw down resources is held exclusively by future generations, then are we not some previous generation’s “future” generation? Why is the present generation bereft of that right? If the answer is that no generation has the right to deplete resources as long as another generation is on the horizon, then the logical implication is that no generation (save for the very last generation before the extinction of the species) will ever have a right to deplete any resource, no matter how urgent present needs may be. If only one generation (out of hundreds or even thousands) has the right to deplete resources, how is that “intergenerational equity”?

Furthermore, the notion of resource rights for future generations is premised on the argument that one has a “right” to forcibly take property from someone else in order to satisfy a personal need. Although that is an argument best left unexplored here, suffice it to say that such a claim is so expansive and fraught with peril that few philosophers have taken it seriously.^[20]

The Meaninglessness of “Weak” Sustainability

What if we embrace the “weak” definition of sustainable development—allowing natural resources to be depleted as long as they are maintained at a “minimum critical level” and that the proceeds of their use be preserved for future generations? Weak sustainability is certainly a more reasonable proposition, but that’s largely because it is functionally indistinguishable from the economists’ concern with maximizing human welfare. As economist David Pearce—a strong proponent of “weak” sustainability—concedes, sustainable development “implies something about maintaining the level of human well being so that it might improve but at least never declines (or, not more than temporarily, anyway).”^[21]

The two apparent qualifications of “weak” sustainability are really no qualifications at all. If we understand “minimum critical level” as the natural-resource base necessary to sustain human life, then one certainly does not maximize human welfare by consuming resources beyond that point. If, on the other hand, it means that each and every natural resource—regardless of its utility to mankind—be preserved at some “minimal critical level,” then, without reference to costs and benefits, the concept is simply anti-human and inimical to the interests of future generations.

As a thought experiment, assume that the only way we could have preserved the American bison at a “minimum critical level” was to leave the Great Plains largely untouched by agriculture. Would the sacrifice of what was to become the world’s most productive cropland in order to protect the great buffalo herds have been in either the economic or social interest of future generations? A policy paradigm that refuses to consider the costs or benefits of such decisions is incapable of making a moral argument about the interests of future (human) generations. But to include cost and benefit calculations in such decisions brings us right back to the economic concept of “maximizing welfare.”

The admonition that the proceeds of such tradeoffs be preserved for our children is redundant. Since all wealth is eventually inherited by future generations, there would appear to be no rationale for a special state-supervised “account” to be established for their benefit.

Sustainable Development: An Intellectual Rorschach Test?

In sum, it is hard to overemphasize the wrong-headedness of sustainable development as a useful policy construct. As two distinguished scholars of the economic development—Partha Dasgupta and Karl-Goran Maler—point out, “most writings on sustainable development start from scratch and some proceed to get things hopelessly wrong. It would be difficult to find another field of research endeavor in the social sciences that displays such intellectual regress.”^[22]

If sustainable development is the answer, what is the question? Society has managed to “sustain” development now for approximately 3,000 years without the guidance of green state planners. The result is not only a society that is both healthier and wealthier than any other in history, but a society with more natural resources at its disposal than ever before. One could reasonably argue that the best way to sustain development—or to maximize human welfare—is to protect economic liberty and confine state authority to protecting life, liberty, and property.^[23] That is, the best way of sustaining development is to reject “sustainable development.”

Notes

1. World Commission on Environment and Development, Our Common Future (Oxford: Oxford University Press, 1987), p. 8.
2. David Pearce and Jeremy Warford, World Without End: Economics, Environment, and Sustainable Development (New York: Oxford University Press, 1993), p. 8.
3. Robert Costanza, “Ecological Economics: A Research Agenda,” in Structural Change Economics, vol. 2, pp. 335–42; cited in M.J. Harte, “Ecology, Sustainability, and Environment as Capital,” Ecological Economics, vol. 15, 1995, p. 158.
4. Robert Hahn, “Toward a New Environmental Paradigm,” Yale Law Journal, May 1993, p. 1750.
5. James Sheehan, “Sustainable Development: The Green Road to Serfdom?” Competitive Enterprise Institute, manuscript, March 1996, p. 1.
6. Annual Energy Review, U.S. Department of Energy, Energy Information Administration, http://tonto.cia.doe.gov/aer.
7. Energy Information Administration.
8. Julian Simon, ed., The State of Humanity (Cambridge: Blackwell Publishers, 1995), pp. 279–442.
9. Harold Barnett and Chandler Morse, Scarcity and Growth: The Economics of Natural Resource Availability (Baltimore: Johns Hopkins Press, 1963).
10. Thomas De Gregori, “Resources Are Not; They Become: An Institutional Theory,” Journal of Economic Issues, September 1987, pp. 1243, 1247.
11. David Osterfeld, Prosperity versus Planning (New York: Oxford University Press, 1992), p. 99.
12. Daniel Boggs, Presentation at Global Issues Seminar, Harvard University Center for International Affairs, October 7, 1986, p. 14.
13. See for example, J.J. Kay, “The Concept of Ecological Integrity, Alternative Theories of Ecology and Implications for Decision-Support Indicators,” in Economic, Ecological, and Decision Theories: Indicators of Ecological Sustainable Development, ed. P.A. Victor, J.J. Kay, and H.J. Ruitenback (Ottawa: Canadian Environmental Advisory Council, 1991), pp. 23–58.
14. Robert Costanza and Bernard Patten, “Defining and Predicting Sustainability,” Ecological Economics, vol. 15, 1995, p. 194.
15. Harte, p. 162.
16. Wilfred Beckerman, Through Green-Colored Glasses: Environmentalism Reconsidered (Washington, D.C.: Cato Institute, 1996), p. 145.
17. I.M.D. Little and J.A. Mirrlees, “Project Appraisal and Planning 20 Years On,” Proceedings of the World Bank Annual Conference on Development Economics (World Bank, 1990) p. 365, cited in Beckerman, p. 146.
18. F.A. Hayek, The Constitution of Liberty (Chicago: University of Chicago Press, 1960), pp. 369–370.
19. Edith Weiss, In Fairness to Future Generations (Dobbs Ferry, N.Y.: Transnational Publishers, 1989). For a summary and sympathetic critique of Weiss, see Paul Barresi, “Beyond Fairness to Future Generations: An Intragenerational Alternative to Intergenerational Equity in the International Environmental Arena,” Tulane Environmental Law Journal, Winter 1997, pp. 59–88.
20. See Gerald MacCallum, Jr., “Negative and Positive Freedom,” Philosophical Review, July 1967, pp. 312–34; Roger Pilon, “Ordering Rights Consistently: Or What We Do And Do Not Have Rights To,” Georgia Law Review, vol. 13, 1979, pp. 1171–96; and David Kelley, A Life of One’s Own: Individual Rights and the Welfare State (Washington, D.C.: Cato Institute, 1998), forthcoming.
21. David Pearce, Economic Values and the Natural World (London: Earthscan Press, 1993), p. 48; cited in Beckerman, p. 147.
22. Partha Dasgupta and Karl-Goran Maler, “Poverty, Institutions, and the Environmental-Resource Base,” World Bank Paper no. 9 (Washington, D.C., 1994); cited in Beckerman, p. 143.
23. See generally Osterfeld as well as David Landes, The Wealth and Poverty of Nations: Why Some Are So Rich and Some Are So Poor (New York: W.W. Norton, 1998); Nathan Rosenberg and L.E. Birdzell, Jr., How the West Grew Rich: The Transformation of the Industrial World (New York: Basic Books, 1986); and James A. Dorn, Steve H. Hanke, and Alan A. Walters, eds., The Revolution in Development Economics (Washington, D.C.: Cato Institute, 1998).