Oil Sanctions and the Pretence of Knowledge
The experts aren't.
MARCH 02, 2012 by SHELDON RICHMAN
Filed Under : Knowledge Problem, F. A. Hayek
The best laid schemes o’ mice an’ men/ Gang aft a-gley. –Robert Burns
“U.S. and EU sanctions on Iran’s crude oil exports and its central bank were not supposed to affect either the volume of oil available or its price, provided markets reacted ‘rationally,’” Reuters analyst John Kemp reported this week.
Who didn’t suppose this? A biased party: the “sanctions advocates at the Foundation for Defense of Democracies in Washington” in a report called “Oil Market Impact of Sanctions Against the Central Bank of Iran.”
This was not mere academic theorizing on their part. Decisions hinged on what the sanctions advocates at the Foundation for Defense of Democracies “supposed.” Writes Kemp, “The idea that sanctions could reduce Iran’s oil revenues without boosting prices for oil-consuming countries was crucial to persuading policymakers in the United States and Europe to impose far-reaching restrictions on Iran’s oil sector.”
Well, how did that work out? If you have a car, or merely walk past a gas station on a regular basis, you know the answer.
“But the policy has backfired,” Kemp writes. “Oil prices have surged, harming consuming countries and offsetting the impact of lower exports on Iran’s revenues.”
How could things have gone so wrong? Kemp tells us that “U.S. and EU sanctions were written very carefully to include plenty of flexibility to ensure they would not risk a spike in prices” (emphasis added). No doubt the best minds in the bureaucracies were on the case.
U.S. sanctions, set out in Section 1245 of the National Defense Authorisation Act for Fiscal 2012 (HR 1540), apply only if the president determines “the price and supply of petroleum and petroleum products produced in countries other than Iran is sufficient to permit purchasers . . . to reduce significantly in volume their purchases from Iran”.
Sanctions do not apply if the president determines an importer has “significantly reduced” its volume of crude purchases from Iran, and the president can waive them altogether if it is in the national interest.
The law mandates experts at the Energy Information Administration (EIA), in conjunction with the departments of Treasury and State and the head of the intelligence community, to review the availability of alternative supplies every 60 days. [Emphasis added.]
So how could it miss? The President, a smart guy advised by a slew of other smart folks, is empowered to determine all this stuff. And then experts review other important stuff.
Can’t miss, right?
Except it did. Kemp:
Two things have gone wrong. First, sanctions are interacting with other supply disruptions (in South Sudan, Yemen, Syria) to reduce supplies and exhaust the cushion of spare capacity Saudi Arabia holds. [Oops!]
Second, the thicket of sanctions on Iran imposed by the European Union and United States is now so complex it is becoming hard to conduct trade that is supposed to be permitted. [Oops!!]
Now people will proffer myriad sophisticated theories for why sanctions on a major oil producer affected supply and price despite the experts’ best efforts — expect to see the terms futures markets, hedge funds, and money managers thrown about – but the real explanation is fairly simple:
The “experts” don’t know what they’re doing. They may think they do. They surely want us to think that. But they’ve got a problem: The matter they are grappling with does not permit the kind of knowledge they would need to design a plan calibrated to produce the results they seek. They’re up to their eyebrows in data, but what they need more than data they haven’t got, and there’s no way to get it.
The Problem Is People
Rube Goldberg had it easy. He had only to arrange a series of inanimate objects and an occasional parrot to create his problem-solving devices. The expert who tries to calibrate sanctions to harm only Iran, but not oil consumers, have to deal with people. He seems, Adam Smith wrote in The Theory of Moral Sentiments,
to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it.
F. A. Hayek had something similar in mind in his 1974 Nobel lecture, “The Pretence of Knowledge”: “[I]n the study of such complex phenomena as the market, which depend on the actions of many individuals, all the circumstances which will determine the outcome of a process . . . will hardly ever be fully known or measurable.”
Belief to the contrary is what Hayek called “the scientistic prejudice,” or “the superstition that only measurable magnitudes can be important.” This is no innocuous error, Hayek said. On the contrary, based on this “pretence of knowledge,” “far-reaching claims are made on behalf of a more scientific direction of all human activities and the desirability of replacing spontaneous processes by ‘conscious human control.’” That is, the fallacy engenders a preference for force over freedom, the slave principle over the self-ownership principle.
Another Austrian economist, Hayek’s student Ludwig Lachmann, elaborated on a critical factor that is beyond the reach of what Smith called “the man of system”: people’s expectations. To act, Lachmann explained, is to pursue a purpose embedded in a plan for the future. An individual’s plans are intimately related to her expectations. But expectations are not data available to bureaucrats. They are subjective, indeterminate, and often unarticulated. A sanctions regime calibrated to effect a precise outcome must fail because the designer cannot anticipate what expectations individuals – entrepreneurs and consumers — will form as they confront various situations.
Two individuals in the “same” situation may form widely divergent expectations. Any “experience, before being transformed into expectations, has, so to speak, to pass through a ‘filter’ in the human mind, and the undefinable character of this process makes the outcome of it unpredictable,” Lachmann wrote in “The Role of Expectations in Economics as a Social Science.” No wonder the bureaucrats fail.
Hayek ended his lecture with a moral lesson and an uncharacteristic bluntness:
The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men’s fatal striving to control society — a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.