The American Enterprise Institute together with Securing America’s Future Energy (a non-partisan 501(c)3 non-profit organization) cohosted on September 24 an event titled Trillion-Dollar Problem: How Oil Dependency Drives US Debt. The focus was a presentation and discussion of a new paper by Robert F. Wescott, Phillip L. Swagel, Jeffrey Werling, Douglas Meade, and Brendan Fitzpatrick, “Oil and Debt: A Historical and Prospective Analysis of the Impact of U.S. Oil Dependence on the Federal Debt.” The paper was commissioned by Securing America’s Future Energy, and was published as a monograph by Keybridge Research.
The speakers at the event were Mr. Kenneth Blackwell of the Liberty University School of Law; Dr. Phillip Swagel of AEI, the University of Maryland, and Keybridge Research; and Dr. Robert Wescott of Keybridge Research. I served as moderator and as discussant.
A video of the entire event can be found here. My discussant comments, edited for publication, are as follows.
This paper is in great need of rethinking, further analysis, and a major revision. It should not have been published in its current form. My criticisms can be divided into central comments and narrower observations.
- The paper discusses in some detail the purported adverse effects of oil “dependence”---presumably, consumption of oil products by the U.S. economy greater than some unspecified ideal---on such parameters as federal spending, federal borrowing and debt, inflation, and the like. But nowhere in the paper is there an explanation of why, precisely, total oil consumption as driven by market decisions is too large, with the exception of rather weak “wealth transfer,” “deadweight loss,” and “foreign policy flexibility and leverage” arguments discussed below. Perhaps more to the point, the paper does not attempt to answer a central question, to wit, the supposed adverse economic effects of “heavy” oil dependence compared with the effects, both favorable and adverse, of policies implemented to reduce oil dependence. Unless the market is making a systematic mistake and/or if market prices fail to reflect important social effects---a crucial analytic framework not addressed in the paper---“heavy” oil consumption presumably is efficient.
- The paper purports to analyze the differing effects of high and low price paths for oil, but fails to recognize that those differences depend crucially on the underlying economic conditions---demand and/or supply shifts---yielding the different price paths. If high oil prices result from, say, a supply contraction, one set of effects can be expected. If the high prices result from strong demand, presumably because of strong economic growth, a very different set of impacts would result. By failing to treat (changes in) oil prices as “endogenous”---the result of shifts in underlying economic conditions---the authors have blinded themselves to the underlying economic analytics. Oil prices might be “high” because of strong demand. That cannot simultaneously be recessionary. Economic analysis ought never to begin a conceptual experiment with a price change.
- The paper defines oil imports as an “imbalance” between consumption and production. It is not clear what this "imbalance" means analytically---there is no particular reason to believe that payments for foreign oil in some sense are worse than payments for domestic oil---but the authors then use the imbalance argument to claim that high (or increasing) oil prices yield a “wealth transfer” to foreign oil producers. This is utter nonsense. Foreign producers send oil to the U.S., and the U.S. sends goods, services, and/or capital assets to them. There is no “wealth transfer” in either direction, and the mere fact that the U.S. in the aggregate might prefer prices lower rather than higher is irrelevant.
- The paper argues, incorrectly, that high (or increasing) oil prices yield a “deadweight [economic] loss.” Apart from the issue of the source of high oil prices (discussed above), there is no “deadweight loss” defined properly. An increase in the price of oil caused by, say, a reduction in supply conditions is identical analytically to an increase in the price of oranges caused by a cold snap in Florida. There is no “deadweight loss”; there might be a reduction in national wealth, just as there might be an increase in national wealth when oil prices fall (due to an increase in supply conditions). A “deadweight loss” is the result of some market (or policy) inefficiency, the nature of which is ignored in the paper.
- The risk of supply reductions (or disruptions) is one that can be hedged by any market participant; if the risk were too high, the market to some degree would shift away from oil. The authors fail to explain what is inefficient about the market’s willingness to bear this risk. The assertion that “oil shocks” are “unexpected” is incorrect analytically; the market knows that they can happen stochastically, and so there is investment in emergency preparedness: reserves, stockpiles, offshore tankers, etc. (The ad hoc nature of our policies on the use of the strategic petroleum reserve is an issue for another day, as is the effect of expected price controls on incentives to invest in preparation.)
- The brief discussion to the effect that oil “dependence” harms national security is poor, boiling down essentially to an assertion that dependence reduces “flexibility and leverage.” What do those terms mean? The authors fail to tell us. Prices in the international oil market would be the same regardless of the degree of U.S. foreign dependence; and if the authors are arguing that “flexibility and leverage” are reduced by an implicit embargo threat, then they simply are incorrect. The embargo threat is empty; that is why the U.S. and the Netherlands, the formal targets of the 1973 embargo paid the same prices for oil as all other importers, as market forces engendered a reallocation of international shipments so that prices were equal in all markets.
- Because of the authors have failed to think through the economics underlying their analytic model, the respective modeling findings in the first and second parts of the paper are inconsistent. In the first part, a high explicit price path for oil yields a set of (adverse) effects in terms of the parameters (e.g., federal debt) addressed in the paper. The second part of the paper assumes a shift away from oil in the U.S. economy, in favor of other fuels for transportation and other sectors. But that shift must be based upon policies (or other influences) increasing the implicit (or “shadow”) price of oil; nonetheless, the high implicit price of oil in the second part of the paper yield outcomes that are the opposite of those resulting from high explicit oil prices in the first part of the paper. The authors have failed to recognize this inconsistency because the treatment of oil price paths as independent of underlying demand and supply conditions leads them, again, to ignore the underlying economics of their conceptual experiment.
- The argument that the “trade deficit” is a “concern” is poor economics: Why, precisely, is a trade deficit (or a corresponding capital surplus) “bad”? Suppose that the U.S. economy were booming and the rest of the world economy was sluggish; there would be a big trade deficit. So what? The standard argument that a (continuing) large trade deficit reflects low national saving is true; but there is nothing per se inefficient about low national saving. If people discount the future highly, then… they discount the future highly, a taste that is what it is, just as a failure to exercise more and consume more healthful food reflects tastes, relative prices, and a host of other factors that influence individual choices. To say that the outcomes are regrettable---or that "experts" bemoan them---does not mean that they are inefficient.
- To say that we would prefer oil prices lower rather than higher does not mean that there is too much oil consumption. Again: The authors fail to provide an analytic argument to the effect that oil consumption is inefficiently high.
- The focus in the paper on the federal budget is misplaced. The real issue is the effect of oil “dependence” on the economy writ large. Unless market prices in some sense are “wrong,” high oil prices are good for some and bad for others. In a policy sense, they are irrelevant.
- The discussion of federal budget deficits and federal debt is poor. The issue of deficits and debt must be driven by analysis of whether (marginal) borrowing and debt are efficient. There is a strong case to be made that they are inefficiently large, but that has little or nothing to do with oil dependence or prices, unless one were to argue that federal oil consumption is too high. The authors offer no such analysis.
- Apart from the foreign policy argument discussed above, the oil dependence argument is poor for other reasons as well. Why are payments for foreign oil worse in some sense than payments for domestic oil? The only differences are second-order effects on such parameters as exchange rates and the wealth effects of changes in prices. Unless market prices are “wrong,” consumption of foreign oil is efficient on the margin. Is there an argument to the effect that these trade flows are inefficient? The authors offer no such analysis.
- The authors argue that short run demand and supply elasticities in the oil market are low, and that therefore shifts in market conditions can yield substantial price changes; but the real issue is whether this reality reflects some sort of underlying inefficiency. Again, the authors offer no such analysis.
- The authors argue that an “incumbent advantage” (for oil-based technologies) increases the difficulty faced by competing technologies. That is incorrect. Apart from the issue of how new technologies ever get off the ground in the face of a purported "incumbent adantage", an entry barrier defined properly is a cost borne by a new technology not borne (now or in the past) by the incumbents. The higher costs---economic inefficiency---of new technologies do not qualify.
- The authors assert that electricity could substitute in place of oil as a transportation fuel. This simply shunts aside the sorry decades-long experience with electric cars, their costs, the subsidies and mandates needed to prevent a market collapse of that technology, etc. The authors argue that “Electric vehicles are achieving traction in the light-duty passenger vehicle market…” Really? Where?
- Since the topic of the paper is the effect of oil dependence on the federal budget deficit, the paper should discuss the effect of the electric auto subsidies in that context.
- The authors argue that electric vehicles may “significantly reduce gasoline consumption,” but that is irrelevant analytically. The real issue is their effect on total resource consumption. That they cannot compete without substantial government policy support suggests that it (holding constant the satisfaction of consumer preferences) is inefficiently high. That the number of charging outlets has increased from 1000 in 2008 to 13,400 in 2012 tells us little because they authors fail to distinguish between outcomes driven by market forces versus government policies. Indeed, nowhere does the paper even mention the subsidies and regulatory favoritism.
- The market chooses the “efficiency” characteristics of the vehicle fleet (abstracting from CAFE, etc.) To say as the authors do that we could reduce oil use by choosing “more fuel efficient vehicles” says little. We also could do so by replacing motor vehicles with bicycles and oxen; so what? Again: What is the argument that the market is making an inefficient choice?
- The authors assert that “carbon” (dioxide) is a pollutant. It is not; it is a natural substance unlike any other regulated under the Clean air Act. In any event, the authors fail to ask what the future temperature/climate effects would be were the U.S. to shift to an all-gas transportation fleet. In brief: In any general circulation (climate) model used by IPCC or by U.S. institutions, the effect would be effectively zero over the course of this century.
- Note that increasing federal outlays for oil, or changes in federal royalty payments, are economic transfer payments; they are not social resource costs. Therefore, they are irrelevant in an efficiency context, except to the extent that the tax system imposes a deadweight loss (excess burden) upon the economy.
- The inflation/CPI discussion in the paper is incorrect. Increases in oil prices caused by a supply reduction are recessionary; they are not “inflationary” in that a relative price shift (structural economic change) is not inflationary. (This is clear from the standard quantity equation of exchange MV=PQ. To say that such price increases affect the CPI is to say only that our measures of inflation are poor.
- The authors argue that policies engendering a shift from oil to “non-petroleum fuels” would strengthen the economy. They should then discuss that monstrosity known as the renewable fuel standard (the ethanol mandate) and explain how it has done so.