Unintended Consequences in Energy Policy
Costly Policies Have Reduced Economic Freedom and Ended Lives
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Filed Under: Pursuit of Happiness
Tags: auto safety • CAFE • Clarence Ditlow • Corporate Average Fuel Economy • energy crisis • energy policy • Ford Fiesta • gasoline price controls • Iraq • Mandatory Oil Import Quota Program • oil price controls • OPEC • Ralph Nader • Rapid Deployment Force • Richard Nixon • unintended consequences • United Auto Workers
On the first day of every economics class I teach I start with The Ten Pillars of Economic Wisdom. This is a list I have put together of the ten most important principles in economics. Pillar number six is, “Every action has unintended consequences; you can never do only one thing.” U.S. energy policy illustrates this to tragic effect. Costly policies that have reduced economic freedom and had nasty economic consequences riddle the landscape.
Start with the Corporate Average Fuel Economy (CAFE) law, which requires each auto producer in the U.S. market to make fleets that average at least 27.5 miles per gallon for cars and at least 20.7 mpg for trucks. (Former President Bush and Congress increased that to 35 mpg by 2020, with no lower standard for light trucks.) That law had the unintended but totally predictable consequence of making cars less safe. The reason is that one relatively cheap way to raise fuel economy is to make cars lighter, and the lighter they are, other things being equal, the more dangerous they are to their occupants. In 1989 two economists, Robert Crandall of the Brookings Institution and John Graham of Harvard University’s John F. Kennedy School, found that, adjusting for the downsizing of cars that would have occurred anyway, the CAFE laws would cause an extra 2,200 to 3,900 deaths over the life of a 1989-model-year car.
But the CAFE law is itself the result of another unintended consequence of government policy, namely price controls on oil and gasoline. President Nixon’s economy-wide wage and price controls, imposed in 1971, did not cause much difficulty at first. But when the Organization of Petroleum Exporting Countries (OPEC) raised the world price of oil from about $3 a barrel to about $11 over a few months in late 1973, Nixon’s price controllers refused to allow refiners to pass on the whole increase in the price of gasoline. The result was a massive shortage of gasoline, with long lines at the pump. Rather than remove the controls, Nixon had government officials start allocating the gasoline by various arbitrary criteria, a process the Ford and Carter administrations continued.
Government officials in the Ford administration and in Congress noticed that American car buyers were not buying as many high-fuel-economy cars as these officials thought they should. In other words, Americans were responding to the artificially low price of gasoline by acting as if the price of gasoline were low! Gee, what a surprise. Of course, instead of removing the price controls, Congress and Ford decided to regulate the fuel economy of new cars—that’s how we got CAFE. Like all regulations, this one bred its own lobby, featuring Ralph Nader and Clarence Ditlow. They had been, until that time, advocates of car safety. But they wanted enforced fuel economy even more.
That’s not the end. One way the companies could meet their CAFE targets was by importing small, high-fuel-economy cars from their foreign production facilities. The United Auto Workers union noticed this and lobbied for—and achieved—separate standards. Auto companies then had to hit the standard with their domestic production and, separately, with their imports. That caused the companies to produce more small cars at home rather than import even successful cars from abroad. According to William Niskanen, the chief economist at Ford in the late 1970s, Ford dropped its Fiesta in the late 1970s not despite, but because of, the car’s potentially large market: Ford feared that its German-made Fiesta would “steal” sales from its U.S.-made Escort, thus lowering its domestic CAFE average.
Moreover, even the increase in the world price of oil engineered by OPEC in late 1973 was in part the unintended consequence of U.S. energy policy. Why? Because OPEC had been formed in response to President Eisenhower’s restrictions on oil imports. As economist Ben Zycher points out, in 1959 the U.S. government established the Mandatory Oil Import Quota Program (MOIP), which restricted the amount of imported crude oil and refined products allowed into the United States. It also gave preferential treatment to oil imports from Canada and Mexico. Two major growing sources of supply at the time were the Middle East and Venezuela. By reducing a major market for Middle Eastern and Venezuelan oil, the import-quota system drove down the demand for that oil, causing its price to fall in February 1959 and again in August 1960.
In September 1960 governments of four Persian Gulf countries—Iran, Iraq, Kuwait, and Saudi Arabia—facing discrimination against their oil, joined with Venezuela to form OPEC. Their goal was to get monopoly power to offset the monopsony power created by the U.S. oil import quota system and thus get higher prices. Although OPEC was at first relatively powerless, by 1973 the governments of eight other countries—Algeria, Ecuador, Gabon, Indonesia, Libya, Nigeria, Qatar, and the United Arab Emirates—had joined. In 1973, OPEC made its move.
From the CAFE to the Mess Tent
CAFE laws and other fuel-economy standards are not the only unintended consequences of U.S. price controls on oil and gasoline. One can even speculate reasonably that these price controls led to two major wars initiated by the U.S. government. The reason is that instead of blaming their government for lines at gas stations, Americans have tended to blame foreign governments—especially the government of Saudi Arabia, the leader of the OPEC cartel and its largest producer. In 1979 President Carter formed the Rapid Deployment Force to train for combat mainly in deserts. President Reagan kept this force and renamed it the U.S. Central Command.
Whatever Carter’s motives or understanding in forming this force, the hardwiring in Americans’ minds led them to associate gas lines with nasty Middle East governments rather than with the nasty U.S. government. That made them more willing than otherwise to support intervention in Middle Eastern affairs to secure the continued flow of oil. Thus when Henry Kissinger claimed in August 1990 that Saddam Hussein’s invasion of Kuwait, if left unopposed, “would cause a world-wide economic crisis,” many Americans believed him. In a Wall Street Journal article that month, I showed that, in fact, the absolute worst harm Hussein could do to the U.S. economy, even if he grabbed Saudi Arabia and the United Arab Emirates, was a loss of less than half of 1 percent of GDP annually. But because so many Americans feared the return of gas lines, they were more open than otherwise to a U.S. attack on Iraq.
Later, in 2003, the U.S. government still had the military capability to invade Iraq. The stated issue this time was Saddam Hussein’s alleged weapons of mass destruction. Still, the fact that the U.S. government had the capability to attack Iraq was due in part to Carter’s buildup of the Rapid Deployment Force.
As poet Robert Burns might say, “Oh what a tangled—and tragic—web government weaves when first it practices to intervene.”
Comment by David T on 13 March 2009:
Terrific analysis. This requires a lot of historical knowledge and is not obvious to anyone who has not studied many aspects of government policy and business. Please write more like this on other related topics!
Comment by Richard Sharpe on 13 March 2009:
I think you mean <a href=\"http://en.wikipedia.org/wiki/Walter_Scott\">Walter Scott</a> who wrote:
Yet Clare\’s sharp questions must I shun,
Must separate Constance from the nun
Oh! what a tangled web we weave
When first we practice to deceive!
A Palmer too! No wonder why
I felt rebuked beneath his eye;
Comment by Chris on 14 March 2009:
The short-sighted nature that our political process promotes leads to unintended consequences. Great example. For your readers who want a comprehensive look at the historical fact presented above, there is a great law review titled, Market Fragmenting Regulation: Why Gasoline Costs so Much (and Why it’s Going to Cost More) 72 Brooklyn L. Rev. 939. Morriss and Stewart.
To this discussion I’ll reemphasize what Weber (a sociologist) said long ago: bureaucratic inertia is a fact of life. He said it more eloquently. Clearly, precedent is flexible and ironically stable and even more ironically, predictable. Laws do have their place in society. Unfortunately, we have many law makers who are self-righteous legalists; this attitude forgets the rationale behind the law. It’s very frustrating to see some of these policies have such negative effects. What can a student from humble beginnings do anyway?
Comment by FELTON WILLIAMSON JR. on 19 March 2009:
MID-EAST PEACE & THE PRICE OF OIL
Energy is the life blood of our civilization and the lowest cost energy is oil. Our problem is that lowest cost oil is controlled by “totalitarian” governments. These governments control huge quantities of very cheap oil and profit from creating conditions that threaten to interrupt the supply of oil.
Even a short interruption in the flow of oil can have a catastrophic effect on our economy, so any threat of interruption of the oil supply causes the price of oil futures to soar. Soaring oil prices create huge profits for the oil producing “totalitarian” governments. The tactic of causing conditions that threaten to interrupt world oil supply has been successful in increasing the price of oil from less than $20.00/barrel at the end of 2001 to over $140.00/barrel by the middle of 2008. Unfortunately, the oil controlled by these totalitarian governments cost much less to produce than the oil resources controlled by relatively free governments.
The major cost of producing oil is the capital expense required to convert the resources to oil reserves (cost of drilling the well). Once the capital investment is made, it can only be recovered by harvesting the oil. If the decision to make that investment is based upon an artificially high price and the conditions that created that price are removed and the price of oil drops such that the company cannot service the debt, the company will go bankrupt and lose control of its property. This is very close to what happened in the 1970’s energy crisis. Who in their right mind would invest in a business that has a competitor that has the power to destroy the business?
Are we really being victimized by the manipulation of oil prices by foreign powers? Look at the record. Oil was selling for less than $20.00/barrel near the end of 2001. Oil prices started to rise with the attack on the World Trade Center. Prices rose $30.00/barrel by early 2003, but then dropped to $20.00/barrel just before mid 2003. It became evident in late 2002 that the U.S would invade Iraq. The price of oil began to rise but dropped back to $20.00/barrel on initial military success. Hostile relations between Iraq and Iran were a restraint on both countries. When Iraq’s military capacity was eliminated, Iran was free to create problems in the area.
Using ever increasing oil revenue, Iran funded insurgent activities in the Mid-East. When oil prices declined, Iran would test rockets with the capability to reach oil tankers in the gulf or have various quasi military groups attack Israel. Each attack or saber rattling reversed the falling oil prices. By mid 2008 the price of oil reached almost $147.27/barrel on concern over Iranian missile tests. When concerns over the missile test subsided, the price of oil dropped back to almost $35.00/barrel.
Guess what happened? Hamas, a group of criminals funded by Iran, declared an end to the truce with Israel and stepped up rocket attacks. To defend itself from the rocket attacks, Israel attacked Hamas, and oil prices increased to over $45.00/barrel. Can there be any doubt why we pay so much for oil?
The purpose of our government is to protect us from the initiation of force both foreign and domestic. Our government has not protected us from those who use force to steal our wealth by manipulation of oil prices. How can our government protect us from the aggression of these “totalitarian” governments?
First, look at the facts.
1. The natural order of consumption of natural resources is to consume those with the lowest recovery cost first. To do otherwise would be to artificially increase the cost of the resource.
2. The “Strategic Petroleum Reserve” has been ineffective in protecting us from artificial surges in oil prices.
3. The baseless restrictions on development of domestic natural resources are aid and comfort to our enemy, enhancing their ability to manipulate prices.
4. The ability of OPEC to manipulate oil prices makes it very unlikely that private companies will convert oil resources to reserves in a quantity to destroy the “totalitarian” government’s monopoly power. Even if they tried, the low cost of Mid-East oil available to the “totalitarian” governments would make the effort futile.
5. The use of force by these totalitarian governments to manipulate the price of oil can only be defeated by the use of force.
6. In our society, the government has a monopoly on force.
7. Over the last ten or so years the use of military force has been ineffective in maintaining a stable source of energy.
8. As long as the “totalitarian” governments have access to vast unearned wealth of manipulated oil prices, there will be no peace in the Mid-East.
9. Conventional military force does not offer a long term satisfactory solution.
The solution to the problem is to create a “Strategic Petroleum Production Reserve” instead of the “Strategic Petroleum Reserve”. The United States has enough fossil fuel resources to last well over a hundred years. The problem is that these resources will cost much more to convert to reserves and harvest than Mid-East oil. Mid-East oil is not now and will never be available at stable and reasonable prices as long as it is a monopoly controlled by “totalitarian” governments.
The fossil fuel resources of the United States are oil, coal and shale oil and are adequate for well over 100 years usage. Following the doctrine of consumption of the natural resources in the order of lowest recovery cost, these resources would be developed when the “cheap Mid-East” was depleted. If the monopoly exercised by the “totalitarian” governments could be broken, the natural order of the consumption of natural resources could be restored.
How do we solve the problem? The government should create the “Strategic Petroleum Production Reserve” by contracting with oil companies to convert our fossil fuel resources to reserves and maintain these facilities so that production could be started when oil prices reached a predetermined level. Part of the contract would allow for continuing research to reduce the cost of conversion of shale oil and coal to petroleum products. The cost of the project could be paid for by using the “stimulus package” (makes a lot more sense than the “bridge to nowhere” or congressional earmarks), release of the “Strategic Petroleum Reserve”. Limited production and a small tax on imported oil (even with the tax, the oil would cost less than we pay now) would be used to pay the maintenance and research cost. As the cheap Mid-East oil is depleted, the oil price level that triggered “Strategic Petroleum Production Reserve” activity would increase. The value of the “Strategic Petroleum Production Reserve” would increase with the increased trigger price.
Eventually, cheap Mid-East oil would be depleted and “Strategic Petroleum Production Reserve” would come “on line” and produce much of the world’s energy requirements. When “Strategic Petroleum Production Reserve” comes on line; companies managing the facilities will repay the initial cost of the project. Remember, any money repaid to the government would come from the users of the energy. In the meantime we would all enjoy a price of energy based upon cost and reasonable profit, not monopoly force.
Today, a reasonable price to trigger the “Strategic Petroleum Production Reserve” production would be around $22.50 a barrel with a $2.50/barrel tax on imported oil. I may have guessed a trifle high on the trigger price.
Comment by Eric H on 24 September 2009:
While I’m in agreement with the general drift of this post, I think that subsequent research has found that the “additional deaths due to CAFE because of vehicle weight” hypothesis has been called into question if not discredited. The Wikipedia entry on CAFE seems to cover the bases.
Comment by fishydude on 25 September 2009:
Sounds like proof that Our Dear leader’s pulling of the 35MPG mandate is part of his plan to reduce health care spending.
Crash fatalities cost less to treat than crash survivors.
It also proves my thesis that the worst actions of Bush were when he tried to “play nice” with demoncrats.
Comment by Scott on 21 October 2009:
This is amazing, no wonder our energy policy is what it is now. Sounds to me like we need to get rid of the CAFE standards and other government regulations, stop depedning on Middle East oil, and start drilling our own oil right here in the United States. I don’t believe the naysayers who state we don’t have enough crude oil in our own country. We have plenty of oil right here, all we have to do is tell the EPA and the tree-huggers to go to hell, and then start drilling. We won’t have to get involved in the Middle East anymore.