Ending our Oil Addiction

Despite the attempts of Fox News and Glen Beck, Americans seem agreed on the need to end our dependency on oil. Aside from the ever increasing environmental toll, each year Americans transfer billions of dollars to parts of the world that have conflicting political and social ideologies. It cannot be wise to transfer billions of dollars from the middle class of America directly to the governments of countries like Saudi Arabia, Russia and Libya without obtaining the normal benefits of trade that face to face commercial interaction provides, i.e. shared knowledge, cultural exchanges and a reduction in misconceptions and tensions between the trading partners.

In the financial crisis financial institutions were allowed to privatize the profits from risky investments but were allowed to socialize the losses on these gambles through tax payer funded bailouts.  Similarly, it appears we have allowed oil companies the benefits of risky drilling without requiring them to pay the cost of preventing (not simply rehabilitating) oil spills. So how do we wean ourselves from this oil dependency?

Simplistic legislation which directly punishes oil companies or directly rewards alternative technologies will not be helpful.  Once in place, it can be enormously difficult to reverse a bad government decision. Consider a hypothetical agricultural subsidy that may have at once served a purpose, but is now no longer a benefit to society but an unnecessary cost. The actual financial benefit accrues disproportionately to a small number of beneficiaries (farmers and agricultural businesses) but the cost of the subsidy is spread across a large number of consumers.  For each dollar that goes directly to the individual beneficiary, the cost of the dollar is spread across say one hundred consumers. The beneficiary has a far greater incentive to lobby and coerce government than the individual consumer has to try to repeal the subsidy.  It is unlikely that consumers will be incensed enough to actively try to change legislation when the incentive is so small to the individual. And so we all too often end up with bad laws that benefit a few, but penalize many.

For example, the ethanol subsidy resulted in too much farm production being used for ethanol and too little for food. This in turn lead to food inflation which disproportionately hurt the less wealthy classes as their food expenses account for a higher percentage of their monthly expenditure than the wealthy.

So how do we safely steer our economy toward a solution that encourages clean technology that is environmentally sound and that has overall benefits for the public?  The market based solution would be through the mechanism of high prices. An economist will tell you that the best cure for high prices is high prices.  High gas prices make the alternatives relatively cheaper which in turn increases consumer demand for alternatives.  Entrepreneurial business with alternatives to oil become relatively cheaper and more attractive to consumers. The increased demand for cheaper goods brings in businesses chasing profits and ultimately provides a real alternative to fossil fuels.

High prices can either be achieved through taxing consumers or through limiting the supply of oil through regulations such as limiting the quantities or increasing the costs of field development and importation. To reduce the impact on the less wealthy classes (i.e. the commuting classes) the government will need to reduce the cost of transport through providing better and cheaper mass transit options. This seems to me a better form of stimulus spending than simply throwing good money at bad banks.

Ultimately, until we start to see exponentially higher fuel costs, we won’t see exponentially more fuel efficient cars or exponentially more affordable technology alternatives.

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