April 8, 2008

April 8, 2008 | Commentary on Regulation

Supply, demand and gasoline prices

During the summer, television networks don't seem to discriminate in airing re-runs. The miserable shows get re-aired along with the good ones. Washington seems to have the same mindset when it comes to policy reruns. Failed policies are as likely to be reinstituted as successful ones. Case in point: petroleum regulation and the "windfall profits" tax.

In a ritual as predictable as Donald Trump firing an eager go-getter, Congress demands testimony from oil executives and threatens additional taxes and price regulations whenever petroleum prices rise. It's an old tradition - and one based on economic ignorance.

Bowing to flawed thinking and the popular will, President Nixon (with Congress) instituted general price controls in 1973. It was a vain attempt to control inflation. After the predictable shortages arose, price controls were eliminated on everything except petroleum products and natural gas. Not eliminating those price controls created the energy crisis of the 1970s and the memorable gas lines.

Yes, the Arab oil embargo reduced the world supply of petroleum. Yes, worldwide economic growth created more demand. However, increasing demand and shrinking supply cause higher prices, not gas lines.

This isn't a mystery. Around chapter five in every "principles of economics" class, the impacts of price ceilings are explained. They lead to shortages. The logic is clear, and the evidence is consistent and overwhelming. When Reagan eliminated petroleum price controls in 1981, the shortages and the gas lines disappeared.

Why would politicians use such tried-and-failed policies? Maybe because the public rarely understands who's actually at fault. Surveys taken in the 1970s about the energy crisis bear this out. Who did the respondents blame? Not Washington for its Byzantine price and allocation controls. They didn't even blame OPEC. They blamed "Big Oil."

In The Myth of the Rational Voter, economics professor Bryan Caplan exposes the discouraging gap between popular conceptions of economics and economic reality. With that in mind, it isn't surprising that the same 1970s-era surveys showing the energy crisis to be the biggest problem also showed the most popular solutions were those that would amplify the very things causing the crisis. A large majority wanted more stringent price controls. A near majority even wanted to issue ration coupons.

Then as now, a weakening dollar and strong economies overseas led to higher petroleum prices. Then as now, the popular culprits were the oil companies. In a result especially depressing to those of us who spent decades teaching chapter five, a recent Gallup survey found that 70 percent of Americans want Washington to implement price controls to counter the high price of petroleum. Even more unnerving is the 64 percent of Americans who think you can cut the price of gasoline by imposing "a significant additional tax on oil company profits."

In a bad-policy rerun, Congress, blaming high prices on high profits, again demands testimony from oil-company executives and threatens regulations and additional taxes. Though consumers may not realize it, none of this will help them.

Today's high oil-company profits are largely caused by high prices on the petroleum they pump from their own reserves. Anybody who owns petroleum reserves, whether it's Exxon, Venezuela, Iran, widows, orphans or the University of Texas, gets more money when petroleum prices rise.

These high prices are the result of straight-forward economics: Demand has increased more than supply. For instance, China's demand for petroleum has doubled in just the last 10 years. Unless and until supply catches up, no regulations, taxes or histrionics will bring gas prices down.

Penalizing Americans for having the foresight to buy and develop oil reserves (which an additional profits tax would do), ensures that a larger percentage of these valuable resources will be controlled by the likes of Venezuelan President Hugo Chavez and Iranian President Mahmoud Ahmadinejad. A political truth-in-advertising law would require disclosing this fact when legislators propose additional profit taxes on oil companies.

Expecting politicians to ignore popular opinion may be asking too much. But if our leaders are going to read the polls, maybe they should read some from the 1970s and then look at the careers of those who followed them.

None of the presidents who enforced energy price controls and windfall profits taxes was re-elected. Yet the president who eliminated them served two terms and remains one of the most respected figures in American history. Which re-run would you want?

David W. Kreutzer is senior policy analyst at The Heritage Foundation.

About the Author

David W. Kreutzer, Ph.D. Senior Research Fellow, Energy Economics and Climate Change
Center for Data Analysis

Related Issues: Regulation

First appeared in the Belleville News-Democrat