High Gasoline Prices Are Your Fault?

Floyd Norris Says Demand Alone Drives Oil and Gasoline Prices

Who should be blamed for the high oil and gasoline prices? OPEC? The oil companies? The government? According to the New York Times’s Floyd Norris, if you chose any of those you would be wrong. Writing on June 23, Mr. Norris places all the blame for the current “energy crisis,” as he calls it, squarely on the shoulders of consumers. He answers the question “Why are gasoline prices so high?” with a cocky, “It’s the demand, stupid.” And as one would expect, his solution centers on public policies that would rein in consumption. Since consumers are obviously too stupid to know how much energy consumption is right for their needs, the government must step in and use enlightened force to reduce demand and bring prices down. In Norris’s view, “The real mistake in Washington came in the years after the last oil crisis, when oil prices were weak and consumers lost interest in energy conservation. Higher gas taxes and less loophole laden fuel-economy rules would have helped avert the current situation.”

It should be pointed out, first of all, that so long as oil is a scarce resource with a positive price, consumers will never “lose interest in conservation,” that is, their desire to economize the resource. Of course, the extent to which we conserve oil, gasoline, or any resource will always be subject to what we must give up in the process of “conserving.” What Norris is really saying is that consumers have refused to economize consistent with the tradeoffs he thinks they should be making.

Moreover, in a bizarre twist of logic his lament about higher gasoline taxes puts himin the position of arguing that gasoline prices are higher today because they haven’t been higher for the last 20 years. And finally, it should be noted that the fuel economy rules, namely, the Corporate Average Fuel Economy (CAFE) standards, do not lead to reduced fuel consumption because greater fuel efficiency makes driving less costly and therefore encourages people to drive more. (The most distressing problem with CAFE regulations is that they lead to smaller, lighter, and therefore more dangerous cars. Studies by Robert Crandall and John Graham in The Journal of Law and Economics have concluded that 14 to 27 percent of the nation’s automobile passenger deaths are due to CAFE regulations.)

Not a Normal Market?

Norris arrives at his conclusions about consumer responsibility for higher prices by arguing that “the oil market is nothing like a normal market.” In a “normal market” higher prices and increased profits would typically attract new producers, which would bring prices down. But according to Norris, this is not how the oil market works. He points out that non-OPEC countries, like the United States, which would be expected to increase production cannot do so because they are already at full capacity. Since the crisis we face cannot be addressed on the supply side, it must be solved through government policies aimed at controlling consumption. It is demand and demand alone that drives oil and gasoline prices. This is what government policy needs to focus on.

Norris is correct on two points. The oil market is not like a “normal market,” and the U.S. oil industry is not in a position to respond to the higher prices with increased output. But Norris completely misses the reasons for this. First, where a normal market features profit-seeking private-sector firms competing with one another, the oil market is dominated by a number of state-run monopolies, with both political and economic goals, that do not compete with one another but rather operate as a cartel. This includes Mexico, whose state-run oil industry has gone along with OPEC’s output restrictions.

Second, the private-sector U.S. oil industry is at capacity, but not because there is no more oil left to exploit. The U.S. government, in response to a politically influential environmental movement, refuses to allow exploration in Alaska’s Arctic National Wildlife Refuge (ANWAR) and off many coastal areas, and has effectively taken tens of billions of barrels off the market. The Energy Department’s Energy Information Agency estimates that the ANWAR’s coastal plain alone contains as much as 20 billion barrels of recoverable oil. What really “thrills” OPEC is not, in Norris’s words, our “loophole filled” CAFE standards that allow American consumers to drive “gas guzzling” SUVs, but our government’s restrictions on OPEC’s competition. The oil-producing countries’ most important ally is the U.S. environmental movement and its access to power in the Clinton administration’s Environmental Protection Agency and Department of the Interior.

Norris’s arguments are not only theoretically unsound; they also ignore the short-term and long-term history of oil pricing, both in this country and around the world. Norris cites as evidence for his hypothesis that “it’s the demand, stupid,” the fact that oil prices fell dramatically in 1998 because worldwide demand was down due to problems with economies in Asia. But all that proves is that market forces work. When demand is lower than expected, prices fall (duh!!). How does Norris explain the declining prices of the 16 years before 1998 or the declining oil prices of the last 100 years, all in the face of increasing demand? Let me give him a hint. It’s the supply, stupid.

While Norris compares our current oil problems to the energy crisis of the 1970s, he seems to have learned nothing from that period. That decade’s energy policy was focused entirely on demand management. From odd-even gas rationing and regional allocation schemes to CAFE regulations, interference with consumer sovereignty did nothing to end the energy problems the country was facing. The solution was found not in demand management but in the elimination of price controls and the massive supply-side response that deregulation engendered. The real problem with demand management, though, is not its lack of theoretical or empirical justification but its moral implications. Demand management is people management. It is inherently paternalistic and must, by definition, thwart individual liberty and personal decision-making. For that reason alone, those policies should be rejected by any society that considers itself free.

—Roy E. Cordato
Lundy Chair in Business Philosophy
Campbell University and Fellow,
The Institute for Research on the Economics of Taxation