Thursday, June 29, 2006

Peak Socialism

Anyone with a car and a pair of eyes has noticed the rise in gasoline prices in the past few years. This of course is not because of oil-company "gouging" (if they can gouge, why don't they gouge all the time?), but something is clearly going on. The most commonly trotted-out suspect is the rise in demand from high-growing India and China. An equally common view of a more long-term nature is the Peak Oil view. This school of thought notes that oil is a finite resource (almost surely true). Hence, at some point its increasing scarcity will cause its price to soar permanently. Perhaps we are there now.

Or perhaps not. One of the most common examples of doomsday pessimism – a school of thought that also includes fears of environmental Armageddon, overpopulation, Marxist predictions of inevitable revolution, and others – is the belief that we are almost out of oil. In 1874 the chief geologist of Pennsylvania, then the Saudi Arabia of its day, fretted that there were only four years of oil left. During the 1970s, a decade of rising prices, the Club of Rome published a notorious doomsday report in which they predicted the world’s oil would be gone by 2000.

Of course eventually it will be gone if nothing changes - not prices in response to tighter supplies, not quantity demanded in response to those new prices, not oil found after searching more energetically in response to higher prices, not new technology developed to use oil more economically, nothing. But of course that is not how the world works. The more property rights are protected and prices are allowed to adjust (to a great extent the same thing), the more easily the conflicting goals of oil owners and oil buyers can be reconciled. (Think of the shortages after Katrina not as a disaster but as a disaster avoided; that oil could return to market so quickly and comprehensively with only a few days’ disruption despite the devastation is an amazing achievement, one that only people in pursuit of profits could pull off.) So based on previous history the increasing desire by Indians and Chinese for oil should be accommodated, provided the market is allowed to work its magic.

But, alas, perhaps it is not. I first learned about this possibility from an article by Ronald Bailey in Reason. He notes as an aside that state control over oil resources appears to have increased in recent years. Governments find it much harder to reconcile the desires of buyers and sellers for things of value (public goods excepted) than markets do. So perhaps the increasing control of and influence over the incentives to produce oil resources by governments is taking a toll. In a brief note, two economists from the Dallas Fed note that many of the biggest oil-producing nations have large degrees of government intervention in the economy, according to a widely used index created by the Heritage Foundation.

But another interesting question is whether this problem is getting worse. The table below shows the nations with the top ten proven reserves (in billions of barrels) in 1996 and 2005 (source: BP), together with the overall Heritage rating for economic freedom (on the assumption that incentives depend more or less on the total extent to which the government is fouling up the economy). The index ranges from 1-5, with a lower score better.

1996 2005
CountryProven ReservesEconomic FreedomCountryProven ReservesEconomic Freedom
Saudi Arabia261.43.00Saudi Arabia264.22.99

Note first that in most countries overall proven reserves rise over the interval. The total rises, in fact, from 861.6 billion to 984.7 billion barrels, despite all the drilling that goes on during the period. But at the same time, economic freedom deteriorates. The average level is 3.49 in 1006 and 3.57 in 2005. (No figure for economic freedom is available for Iraq in 2006.) The difference is not great, but for the entire world economic freedom was increasing; the average Heritage ratings for all countries decreased from 3.20 to 2.98 between 1997 and 2006. And the declines in freedom have been particularly bad in Venezuela and Nigeria. While this is offset by a big improvement in Libya, it is still a very crippled economy at 4.1. In the Venezuelan case this is no surprise to anyone paying attention to what is going on there.

Private firms have their own incentives – overwhelmingly, though not exclusively, to maximize shareholder value. One way oil companies do this is by getting oil to people willing to pay for it. Governments have their own incentives – rewarding their supporters and punishing their opponents, for example. Those incentives interfere with the task of matching oil with those who wish to buy it. We would not be terribly surprised if the ascendancy of government in the oil business coincided with greater difficulty getting it to where it is most desired. The story these admittedly simple data tell – rising reserves yet higher prices – suggest that this is part of the story, maybe a big part. Even if the Indians and Chinese want more oil, the Americans and the Japanese did before them and this was accommodated without difficulty. This is a complex story to be sure and it would be a mistake to oversimplify it, but the increasing entanglement of government with petroleum is part of what we are witnessing these last few years.


Anonymous Anonymous said...

I've recently started using the term "peak Socialism". I did a google search and found that, apparently, this blog post is the first on the internet to use the term.

11:22 AM  

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