Politics & Policy

Lest We Forget

Krugman's fears about oil are based on silly economic errors.

In a startling about-face, Paul Krugman has renounced the principles that made him a world-renowned economist. After building an illustrious career as a champion of free global trade, Krugman reversed himself by announcing in a recent New York Times column that export giants China and India represent “a threat to our prosperity.”

As recently as last November, Krugman’s column celebrated the “export-led growth” in these and other developing nations as “an enormous, unexpected improvement in the human condition.” It was the only “upbeat” topic he could think to write about. What could possibly have changed his mind?

One simple word: oil.

After all these years as an international economist, it seems to have finally dawned on Krugman that when the third world joins the developed world, it competes with us for oil.

According to Krugman, America is helpless in the face of this “threat to our prosperity.” Early this month he wrote that “We can neither drill nor conquer our way out of the problem. Whatever we do, oil prices are going up.” In a follow-up column a week later, Krugman added, “it’s hard to see where the oil will come from to meet the growing demand … So very, very high prices are what we’ll get.”

Krugman sternly warned, “An oil-driven recession does not look at all far-fetched.”

But don’t worry. As you’ll see, even though this may sound credible when it’s solemnly intoned by someone with Krugman’s reputation as an economist, it’s all based on silly economic errors.

Indeed, Krugman is putting his reputation at risk with silliness, and it’s all for the sake of politics. Oil prices — and, consequently, gasoline prices — have risen sharply over the last year. So, stirring up fears about a new “oil crunch” gives Krugman an opportunity to take a swipe at George W. Bush about an economy that is otherwise booming in almost every respect. It’s nothing more than grasping at straws — standard operating procedure for America’s most dangerous liberal pundit.

A year ago Krugman issued warnings just as dire about another red menace — SARS. He wrote in a Times column that “experts fear it may be too late to prevent a global SARS pandemic … Even if SARS doesn’t become widespread here — and that’s not a safe bet — it can do a lot of damage to our own economy.” Since those words were written, SARS is all but forgotten, and GDP adjusted for inflation has grown 4.9 percent, the biggest jump in almost 20 years. So much for Krugman and his “experts.”

Krugman’s fears today about oil are silly for five reasons. First, the world is not running out of oil anytime soon. Citing those “experts” again, Krugman wrote that “no major oil fields have been found since 1976, and experts suspect that there are no more to find.” A week later Krugman himself had to contradict those “experts” when he wrote, “I forgot about two large fields in Kazakhstan, one discovered in 1979, the second in 2000.”

What Krugman has forgotten is history. The more oil the world has used over time, the more new oil we have always seemed to find. According to OPEC statistics, world oil usage since 1982 has been 452 billion barrels. But proven world reserves have not been depleted, as Krugman’s “experts” would have expected. Instead they have grown since 1982 from 696 billion barrels to over a trillion barrels. Yes, that means we’ve replaced oil faster than we’ve used it. Krugman finds himself in the unenviable position of defending the four most dangerous words in economics — “this time it’s different.”

Second, equally unenviable is Krugman’s argument that the law of supply and demand has been suspended in this case. He stated that oil-rich nations are in no position to pump more oil to take advantage of today’s high prices, and thereby keep prices from going any higher. He wrote that “the world’s spare oil production capacity” is only “about 2.5 million barrels per day.”

But only last Friday Saudi Arabia’s oil minister, Al-Naimi, announced his country would ask OPEC to increase production by “more than two million barrels per day.” Krugman had cited the Paris-based International Energy Agency as his “expert” on capacity. The IEA’s only reaction to Al-Naimi’s statement was to carp that “it might not be enough to have a big impact on prices.” Not even a mention of the supposed issue of limited capacity. Perhaps, like Krugman, the IEA “forgot.” Or perhaps the law of supply and demand remains in force after all.

Third, Krugman is “forgetting” the fact that as energy-intensive manufacturing activity shifts from the developed world to the developing world, we won’t need as much oil here in America. You can see it in the Department of Energy’s statistics: energy use as a fraction of GDP has been falling since the late 1940’s — and American manufacturing jobs as a percentage of total employment have been falling at the same time.

Krugman pointed out that “the U.S. consumes only about half as much oil per dollar of real G.D.P. as it did in 1973.” But by cherry-picking 1973 as the point of comparison — the year when the best-remembered “oil crunch” hit — he makes it seem as though America’s reduced energy use is solely the result of painful conservation in the face of soaring prices. The whole story includes the fact that we’ve been undergoing a long-term transition from a manufacturing economy to a services economy — a transition that has been enabled in no small part by the outsourcing of formerly domestic manufacturing.

Fourth, Krugman has “forgotten” the single most important dynamic that motivates global trade: comparative advantage — a principal so key to modern economics that Krugman’s mentor Paul Samuelson has called it the “one proposition in all of the social sciences which is both true and non-trivial.”

Here’s what comparative advantage makes clear: When each nation specializes in what each does best — and when trade occurs between these nations — all come out on top. It’s a win-win positive-sum game. So, if increasing worldwide wealth means that worldwide oil demand goes up at the same time everyone everywhere wants to drive an SUV, then bring it on: We’ll all happily be able to afford it.

Finally, even if you accept all of Krugman’s forgetful fallacies, that doesn’t mean today’s high energy prices are going to soar from here to infinity, chasing that last drop of oil. Krugman, the great economist, has made the same dumb mistake that dotcom investors made at the top of the stock market bubble — back when Krugman was arguing that technology stocks might be fairly priced with the Nasdaq nearing 5,000, and singing the praises of companies like Enron (while acting as a paid member of that company’s advisory board).

But this time it’s not tech stock prices, it’s oil prices. Krugman falsely concludes that because oil prices have been rising recently they will continue to rise forever. If he really believed such malarkey, he would buy some crude oil futures for his personal account. But if he has done that, he “forgot” to mention it.

The reality is that prices won’t go up forever from here. Why not? Because the oil market knows much more than Paul Krugman does.

Today’s oil prices already fully reflect the risk-adjusted value of all short-term and long-term supply-and-demand factors — including ones Krugman doesn’t know about, doesn’t understand, can’t predict, or “forgot.” If anything, the kind of politicized panic that Krugman and other liberal pundits are mongering is likely to temporarily inflate prices. Look for prices to settle down when cooler — and more intellectually honest — heads prevail.

So don’t worry too much about oil prices. And don’t worry about China and India being a “threat to our prosperity.” Think of it this way: The 2.3 billion people in China and India can help us look for new oil that Krugman can then “forget” about.

– Donald Luskin is chief investment officer of Trend Macrolytics LLC, an independent economics and investment-research firm. He welcomes your comments at don@trendmacro.com.


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