The aftermath of hurricanes Katrina and Rita have proved a massive breeding ground for what former OECD Chief Economist David Henderson has termed “Do-it-Yourself Economics” (DIYE), which he defines as “firmly held intuitive economic ideas and beliefs which owe little or nothing to textbooks, treatises or the evidence of economic history.” The DIYE phenomenon is not restricted to the general public. Henderson points out that DIYE ideas are “sincerely held, and voiced with conviction, by political figures, top civil servants, CEOs, [labor unionists], well-known journalists and commentators, religious leaders, senior judges and eminent professors.” Sadly, these ideas might do real harm to the U.S. economy.
A sterling example comes from the august pages of the New York Times, which recently editorialized in favor of a tax on gas to keep the price at $3. The reason for keeping the price high, the Times asserts, is twofold: to defund the paymasters of terrorism in the Middle East and to combat global warming. A moment’s thought shows that the Times should realize that artificially raising the price of gas will not hurt rich Salafi ideologues but native communities in Alaska and oil-rich developing economies of the third world. In a world of falling demand caused by high gas prices, it is those who produce gas the cheapest–the Saudis and their friends–who will continue to sell it.
Meanwhile, the economy will suffer as enterprises that had been profitable cease to be so. Businesses that require affordable transportation will fail, and people will lose their jobs. That means less money going back into the economy. Recession is inevitable; the Times’ solution that we return to a welfare society based on the Earned Income Tax Credit ignores both the lessons of history and the fact that many of those who will lose their jobs have such low incomes that they do not pay tax. Moreover, as the National Academy of Sciences confirms, smaller cars mean more deaths on the road.
The result of the Times’s policy will be an oil industry concentrated more than ever in the hands of the terrorist funders, recession in America, and carnage on the roads. And this will lower the rise in global temperature by a few hundredths of a degree. Even the Times should be able to see that’s a price not worth paying.
Meanwhile, others are practicing DIY economics to say we are paying too much for gas. There has been a plethora of bills in Congress and state legislatures aimed at “price gouging.” Price gouging is a demagogic paper tiger. It is part of the natural order of economics that, when supply is scarce, prices go up. Legislating against that natural law is like legislating that p = 4, as the Indiana state legislature attempted to do in 1897.
Another instance of DIYE is public wariness and the accompanying populist charge that oil companies are making “excessive” or “windfall” profits. To the DIY economist, history is an inconvenience best ignored. The price of gas dipped to well below $1 a gallon as recently as 1998-99. At that point, it was rather hard to be in the oil business, and oil companies’ profits were badly hit.
If companies can enjoy “excessive” profits, then can they not also make unacceptably low profits? That is where the logic of windfall profits takes us; the concept relies on the idea that there is some “normal,” acceptable level of profit that is right for any company to make. This ignores the whole idea of risk and reward. Companies engage in the risky business of business in order to gain rewards in the form of profits. If their profits were to be capped, for any reason, they would be less likely to take risks. The inevitable result in the oil industry would be more expensive, less plentiful gas.
Unfortunately, the combination of these two pieces of DIYE wisdom have combined in Senator Carl Levin’s (D., Mich.) “Hurricane Katrina Emergency Temporary Price Freeze Act,” which is based on the idea that, “Most people…are forced to pay whatever the oil companies charge for gasoline” and that, “It is unseemly for a few to gain huge profits at the expense of everyone else.” Sen. Levin’s DIY economics ignores the real world. Research shows that demand for gas has fallen as the price has risen, meaning that Americans are not forced to pay more for gas than they can afford. But if Levin’s bill were to get the go-ahead, gas prices would be barred from reflecting demand, and therefore demand would outstrip supply. Long lines at gas stations and a black market would spring up overnight to reconcile the two. Some criminal-minded enthusiasts of 1970s nostalgia may even revive the practice of siphoning gas out of cars with no gas cap locks.
One final DIYE allegation that has been making the rounds is that oil companies have contributed to the supply problems by deliberately closing refineries, thus colluding to keep supply scarce and prices high. It is true that large numbers of refineries have been closed down since 1981, but this is quite separate from supply issues. The deregulation of 1981 removed the artificial props that made it worthwhile to keep small, inefficient refineries open. Instead, they were closed down in favor of larger, more efficient plants, with the result that supply actually increased. More closures were driven by the market consolidation of the 1990s, when companies merged and were further able to use economies of scale to increase supply further with fewer refineries.
However, despite the industry’s heroic efforts, the refinery system is stretched almost to the limit, as the hurricanes showed. The major obstacle to expanding capacity now is not oil-company collusion, but the increased cost of complying with environmental regulations, which is enough to make any new construction project unprofitable. Indeed, a new refinery has not been built in the U.S. since 1976!
Yet the inevitable logic of DIY economics resulted this week in a show trial in Congress of oil-company executives. At a time of rapidly declining gas prices, the executives were raked over the coals for doing what actually amounted to a tremendous job in ensuring the nation got the energy it needed during the recent disruptions with as few shortages as possible. If the DIY-economics crowd had had their way there would have been shortages, long lines at gas stations, and prices held at levels higher than they are now because of the effect of shortsighted legislation. Instead, the situation is back to normal thanks to the level-headedness of the oil and gas companies. They should be congratulated, not pilloried.
In the end, DIYE theories about the oil industry are best summed up by the rhyme from R. W. Grant’s cautionary tale, “Tom Smith and his Incredible Bread Machine”:
You’re gouging on your prices if
You charge more than the rest.
But it’s unfair competition
If you think you can charge less!
A second point that we would make
To help avoid confusion:
Don’t try to charge the same amount!
That would be collusion!
For the crime of providing people cheap bread, the fictional Tom Smith ended up behind bars for five years. Given the outrage directed at real-life oil companies from DIYE demagogues, their executives may be lucky getting off so easily.
Meanwhile, in a political world dominated by DIY economics, the only measure currently available to Congress to help send a signal that they would like to see energy supply problems eased is the proposal to allow drilling in ANWR. Twenty-five “moderate” Republicans last week succeeded in getting that proposal removed from the budget reconciliation. As George Will pointed out recently, Republicans are supposed to be the ones who understand scarcity, who understand economics. If House and Senate Republicans succumb to the DIY economics disease, they may find the public applies a real world cure and remove them from office.
– Iain Murray is a senior fellow at the Competitive Enterprise Institute.