All Commentary
Sunday, March 1, 1981

Planning for an Emergency? Let the Market Work!

On September 30, 1981, the Emergency Petroleum Allocation Act will expire. Some members of Congress and the Department of Energy are beginning to think about extending the emergency provisions of the law, or drafting new standby plans. The National Petroleum Council’s committee on U.S. emergency preparedness has begun work on a study of the nation’s ability to cope with a cutoff in oil imports between now and 1985. The war between Iraq and Iran makes this entire issue newsworthy, and critical.

The NPC committee is developing a plan to coordinate industry and government in several areas: curtailing demand, substituting other fuels, distributing available supplies to priority users, determining when to tap the Strategic Petroleum Reserve, and relating U.S. emergency planning to obligations under international agreements.

Although several committee members at a recent meeting made strong statements in favor of the free market, there is an emerging danger that any such study or plan will most strongly endorse mandatory allocations, price controls and rationing, and will attempt to prevent profiteering, speculation, and black-market trading. A new study prepared for DOE by Resource Planning Associates of Cambridge, Massachusetts, came to just such conclusions—due to the methodology they used in their study. This is the result of a common prejudice against the free market—the belief that it is capricious and accidental in its operations and that only a deliberately built structure could possibly be “rational” or “equitable” in an emergency.

There are several important economic and philosophical issues that we hope the NPC committee will note as it completes its study. In sum, they involve the nature of dislocation, information, motivation, and equity. Underlying the prejudice against profits is a misunder standing about market behavior and our society’s basic coordination process. The free market is an example of a coordination system in which millions of people can quickly adjust their activities to one another without the need to know details about who, what, why, where, and the like. If a certain price goes up, consumers are informed, and motivated, to reduce consumption—and producers are informed, and motivated, to increase production. A higher price will also attract new producers or purveyors of substitute products into the market.

An emergency, such as the sudden cutoff of oil from the Persian Gulf, would cause a massive dislocation in the American economy. The OPEC nations have said that their next embargo would not be targeted at any one country because the international oil sharing agreement would blunt the effect; so any oil cutoff would affect the entire industrialized world. The problem for the victims of such a cutoff is to adjust to the smaller energy supply. What is the quickest, most efficient, most adaptable process of economic innovation? The unconstricted free market has proven itself time after time.

Of course, there are political ways for individuals to adjust to a changed environment, and there are economic ways. The political ways are available only to a privileged class of people who have the power to insulate themselves from the problems and force everyone else to bear a double burden. In contrast, the economic ways of adjustment to changed circumstances ultimately benefit all members of society; the poor benefit even more in the long run because economic opportunity and growth are not suppressed by the political authorities in the process of erecting rigidities and special privileges for favored, more powerful groups.

The economic adjustment process is first and foremost an information problem. The issue is how to discover the most efficient path away from the dislocation. Importantly, the information most needed to answer the millions of specific questions is not centralized in Washington; it is not even statistical information. Nobel Laureate F. A. Hayek, in his famous analysis, “The Use of Knowledge in Society,” (American Economic Review, Vol. 35, September 1945, pp. 519-30) demonstrated that each individual’s perception of economic opportunity and knowledge of local supply and demand conditions is actually more important than the kinds of data that government agencies can collect. During an emergency, the least effective thing to do would be to wait passively until some central authority gave instructions.

Only the process of a free market, with scarce resources allowed to command prices that ipso facto communicate important data about the urgency of needs and the availability of supplies, can make effective and speedy use of the information that each person has. You only have to think about the aftermath of a major hurricane or an earthquake to understand how important are the efforts of every individual, and to appreciate how valuable an effective communications system can be. If the supply of imported oil should be cut off, the price people might be willing to pay in different cities and for different uses of the available domestic supply would be the only effective mode of communication. Our experience with Department of Energy allocation regulations in 1973 and 1979, when motorists lined up at gasoline pumps, testifies to the inefficiency of the bureaucratic non-market.

In planning for an emergency, society will need the help of every capable person. Not only must each individual’s particular knowledge be available for use, but the motivation to use it must be there. It is easy for government to take motivation for granted because cliches of duty and patriotism are common coin in Washington. Yet, as every school teacher or office supervisor knows, without real, self-interested motivation, people will only pretend to do what they are supposed to do; real accomplishment will be mini-real. Not only should the emergency preparedness study recommend that free market prices be used to allocate oil supplies, but those who deliver oil to the market should be permitted to keep their profits. Without genuine, after-tax rewards for producers and suppliers—and even speculators, who attempt to predict future requirements (and often lose money)—the free-market process won’t operate. No amount of wishful thinking about brotherly love and self-sacrifice will help bring energy to the people who may need it most during an emergency.

The dominant theme during an emergency ought to be: Solving the problem. The risk, however, is that greed, envy, and spitefulness will take over. Some people are going to be hurt more than others when the crisis begins. That is the nature of a crisis—it happens during earth quakes and hurricanes, and economic crises are no different. There is a common view that everyone ought to suffer equally, or at least that no one should profit from another’s pain. This is the logic of price controls and rationing. It is also the clever façade under which greed, envy, and spitefulness operate.

Economics, as a science, can demonstrate certain regular consequences of policy decisions. The results of price controls and rationing are shortages and misallocations. In the wake of shortages and misallocations, we usually observe bribery and corruption also. When the economic process becomes corrupt, it is much less efficient because resources are diverted from solving the original problems that concerned the policymakers, and much productive effort is directed instead toward making the corrupt system work. Nobody in his right mind should want to see corruption and inefficiency, especially during an emergency.

The question of equity, therefore, is me most difficult political issue to resolve. Greed, envy, and spitefulness will have advocates who will worry very little about solving the long-run problems of the crisis—that is, adjusting to the economic changes that are forced upon us. They will concern themselves, instead, with questions about redistributing other people’s money and helping particular groups at the expense of others. Politicians love this sort of game; it makes them appear valuable both to special-interest groups and to the innocent, trusting voters back home.

As we have seen, however, the long-run problems of the crisis can only be solved by a free market, and those active in the market who make the right decisions will earn financial rewards. The correct expression of equity, then, is not a matter of redistributing but of protecting the honestly earned rewards of those who contribute toward solving economic problems. After all, ending a crisis has to be a better solution to the emergency needs of the poor than patch-work measures that just make it easier to suffer.

What specific recommendations should the National Petroleum Council make in its report on emergency preparedness? One recommendation in particular would have more impact than hundreds of detailed plans and descriptions of petroleum needs and transportation facilities. This would be the simple declaration of public policy that in an emergency the government will bind itself to respect the private-property rights of its citizens and that the courts would enforce the common law of contracts.

The uncertainties imposed by government make private planning impossible; the expectation that speculative profits would be outlawed makes it impossible for the free market to hedge some of the risk.

There is no happy medium between government planning and private planning for a future emergency. Government planning crowds out private planning, just as a fox in the hen house stops the production of eggs. The only way the United States may survive a major energy emergency between now and 1985 is to open the way for private planning and a free market to prepare for rapid and efficient adaptation to any crisis.