Policy by Illusion and Myth

George Schultz, former Secretary of Treasury, Labor, and State, and Fred Smith, CEO of FedEx, recently published a Wall Street Journal opinion piece—Making the Most of the U.S. Energy Boom—in which they argue that the US should establish a national goal of oil displacement.

They assert that forty years after the first oil embargo, “de-linking our economy from high and volatile global oil prices is even more essential to protecting our domestic and international interests.”  Surely, Mr. Schultz knows that the 1973 embargo was made worse by the ever changing blizzard of regulations that attempted to substitute government decision making for market forces.  And now, Schultz and Smith are promoting another industrial policy initiative, which like Project Independence will end up on the dust heap of flawed and failed policies, if it is pursued.

The foundation for their proposal is the myth that OPEC is a successful cartel that manipulates oil prices for its own benefit.  Last month, around the 40th anniversary of the embargo, Daniel Yergin, the pre-eminent energy historian, also had an opinion piece in the Wall Street Journal titled, “Why OPEC No Longer Calls the Shots”.  Secretary Schultz and Mr. Smith must have missed it.

Yergin points out that in 1973 developed economies consumed two-thirds of the world’s oil production.  Today, it is 50%, with consumption either flat or falling.  He also made the point that “a lasting lesson of the crisis years is the power of markets and their ability to adjust to disruptions, if government allows them to.”  Yergin’s conclusion about OPEC is reinforced by an analysis by the Oxford Institute for Energy Studies—OPEC Pricing Power—which observed that “OPEC pricing power is not constant and varies according to market conditions… (and that) OPEC does not operate in a political vacuum.”

In just the last eight years, our oil imports have dropped from 60% to 35% and our oil production has reached the highest level in 20 years.  All of this has taken place as the government has pursued an off-oil industrial policy and done little to spur production on federal lands or the OCS.

It is surprising that in their advocacy, Schultz and Smith ignore the fact that in an interconnected global economy what happens in the world oil market will impact our economy even if we do not import any oil.  A major disruption would adversely impact all economies, some more than others.  The US as a result of market forces, innovation, and the Strategic Petroleum Reserve would be more resilient but not insulated.  Our exports would drop because our trading partners would be in a deep or deeper recession and our imports would be more expensive reflecting higher oil costs.

The most disturbing aspect of the Schultz-Smith advocacy is the call for another industrial policy—“ a concerted national effort that prioritizes investment in the development of advanced energy technologies.  The history of the past 40 years is a history of lessons not learned.  The federal government has squandered tens of billions of dollars subsidizing alternatives like wind, solar, advanced biofuels, and electric vehicles.  None are ready for prime time nor will they be anytime soon. The oft repeated goals of energy industrial policy are an illusion.

The use of subsidies, loan guarantees, and tax incentives to produce government preferred alternative energy has instead promoted crony capitalism and allocated scarce tax dollars to those who bought into the government’s industrial policy. It has also validated the Bootlegger and Baptist theory of public choice which explains how political entrepreneurs use regulatory forces instead of market forces to gain profit.

Subsidy-driven initiatives such as Solyndra, Fisker and Tesla Motors, and A123 Batteries have been spectacular failures that enriched the political entrepreneurs who promoted them. Secretary Schultz and Mr. Smith would do well to heed the admonition to President Obama by former Secretary of the Treasury and economic advisor Larry Summers ,“the government is a crappy venture capitalist”.

The boom in natural gas, the result of private capital and innovation, provides a great substitution opportunity for power generation and transportation.  The incentives provided by abundance and affordability are causing a shift in power generation and transportation without the guiding hand of government. If the government wants to accelerate that shift it should remove barriers and avoid actions such as slow walking export licenses to benefit some favored businesses.  Government should also align R&D incentives so that the private and public sectors undertake the type of R&D that they are best suited to pursue.  Government research programs to develop energy systems for consumers and businesses are doomed to failure.


This article appeared on the FuelFix weblog at http://fuelfix.com/blog/2013/11/10/policy-by-illusion-and-myth/

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