Wednesday, May 03, 2006

You Pay Your Money, You Take Your Chances

I finally decided to go in for TimesSelect. I am greeted by Tom Friedman's column, "Let's (Third) Party," where I read this gem about gasoline prices:

Like someone who will tell the truth: The only way Americans are ever going to enjoy relatively cheap gasoline again is if we raise the price now with a gasoline tax— and fix it at that higher level for several years — so investors know that it is not coming down, and therefore it makes economic sense for them to make the long-term investments in alternative, renewable sources of energy. That is the only way to break our oil addiction and ultimately bring down the price.

That's a fascinating "truth." Note that he is not writing here about the externalities associated with our dependence on oil--he is writing about the direct consumption of it through gasoline. So in order to have cheap gasoline later, we should insist on having expensive gasoline today, even if the price of gasoline would fall in the interim. That is beyond silly.

I understand that post-9/11, Friedman has been frustrated by the failure of the President to launch a national initiative about anything, but particularly about our energy consumption. I share much of that frustration. I even advocate for a higher gasoline tax (because of the externalities associated with its consumption and instead of idiotic CAFE standards). I also wish more people understood Brad DeLong's very cogent point that the correct side of this debate to be on is to have people face the market price of gasoline and certainly to do nothing to shield them from it (again because of the externalities). But Friedman is doing the same sort of pandering as the politicians he is criticizing when he holds out the promise of a future with cheaper gas as the rationale for his proposal.

It doesn't have to be complicated. Estimate the monetary cost of the negative externalities associated with gasoline use, set the appropriate tax, and then do nothing else. The market price then sends the correct signal to investors about how to take advantage of new opportunities in alternative energy.

13 comments:

Anonymous said...

As a customer of Times Select the best feature is the 100 free articles per month I can dig out of the NYTimes archive.

Anonymous said...

My favorite saying is "you can't legislate an economy into being any more than you can legislate new physics into being".

Legislators can't reduce gas prices. Innovation can, but that runs at the speed of the market.

There is a corallary though: "You can legislate economies into the trash bin."

Anonymous said...

I remember Nixon and Carter. The two of them with wage and price controls and screwing around with gas made a real mess of the economy.

ADR said...

Amen - a very common sense approach. Friedman's comments recollect the Vietnam-era quote "we had to destroy the village to save it."

Thomas Green said...

I don't think this article tells the whole story. I've been a reader of Friedman's columns for years, and he has long been a strong advocate of a higher gasoline tax. I have not yet seen the entire column, but I know for sure the quoted passage only reveals part of his reasoning. By raising the gasoline tax to lower fuel prices prices, our dependence on Middle Eastern oil will go down. The high prices we pay at the pump now are esentially subsidizing anti-American governments in the Middle East(or if you want to say, subsidizing governments that support the very terrorists we are fighting). I know for a fact that Tom Friedman believes that the gas tax is a way to lower prices in the long run, while at the same time divert funds from bad governments and into benefitial U.S programs such as health care and education. Thus he feels that the tax corrects a negative externality. Professor Mankiw has said on this blog that he is a strong advocate of pigovian taxes.

Tom Maguire said...

My first, second, third and fourth reactions to Friedman's strategy for cheaper future gas was the same as Prof. Samwick's.

However - if Friedman was thinking at all, he may have been thinking that whale oil is not as expensive now as it was before alternatives (such as drilled oil) hit the market.

So maybe he sees a day when gasoline is a relatively cheap yet unnecessary fuel.

Still doesn't make much sense, though.

Tom Maguire

Java said...

Actually, I think your absolutely wrong in asserting that Friedman's point is "beyond silly."

You economists need to stop thinking so statically. Yeah, if we lived in a static world, then all you would want to do is take into account negative externalities. (In theory. Of course, in the real world, there really is not a meaningful way to "price" externalities. To take an example, if dependence on oil props up backwards regimes that in turn oppress people, how exactly do you "price" that externality?)

But if you live in a dynamic world, then things get more complicated. Our world, the real world, is a dynamic world, not a static world. Thus, the real world is more complicated.

Think about this. Higher gasoline prices are one way to provide incentives for the development of new technology. That is, a dynamic effect. In the short-run, alternative energy sources may be more expensive than gasoline. In the long-run, economies of scale and improvements in technology could bring down those prices. Furthermore, alternative energy sources may not be subject to extreme fluctuations due to international relations or foreign politics, but rather remain stable and predictable.

Overall, it emphatically not "beyond silly" to think that new technology could provide fuel at low prices that were not as subject to sudden spikes.

Of course, one could argue that such a subsidy to the development of technology should be provided directly by government rather than distorting production and creating deadweight loss. But that ignores another sort of deadweight loss of direct incentives. That is, the government chooses the winner. One advantage of rewarding innovators through higher prices is that market competition chooses the winner.

Andrew Samwick said...

Java,

I don't think that the dynamic/static distinction is relevant here. I acknowledge that Friedman has a position (higher gas taxes) that I support. I'm pointing out that in this column, he advocates them for the wrong reason (lower energy prices in the future). The right reason is the negative external effects--contamination of the atmosphere and propping up non-democratic regimes.

Your point about new technology also doesn't seem like a reason for government involvement in the pricing of gasoline. Absent the externalities, the technology is only welfare improving if it delivers energy at a lower cost than what we currently pay.

Your point about economies of scale is obviously relevant, but I think of it more in the distribution rather than the production of household fuel. We use gasoline because we have gas stations. If we had other fuels to be dispensed in a similarly dense network, that obviously makes the alternatives more viable. But that doesn't naturally lead to a tax on the fuel currently dispensed as the appropriate policy.

Andrew

Kyle said...

Hello! came to your site from the Greg Mankiw site. I have a BS in economics and have worked in the oil industry for years. (now I am back in college) I have to say that I have come around and now think that we need some sort of fuel tax. HOWEVER, I would make it revenue neutral by cutting other taxes.
It is absolutely imperative that we do the following; 1) reduce use of fuel by more efficient vehicles, 2) reduce emissions 3) reduce dependency on foreign oil (not just the mid-east but Venezuela and Mexico also), also
4) we need to lift the restrictions on domestic drilling and on nuclear power.
A fuel tax, and, or a tax on the weight of vehicles could help a lot. But it should go hand in hand with other tax reductions.
I know this is just pie in the sky, but most economics is only theory anyway.

bakho said...

CAFE standards may be lame, but they are certainly not idiotic. The implementation of CAFE standards under Ford and then Carter helped decrease oil consumption by over 20%. In fact, it took almost 20 years for oil demand to return to 1980s levels.

http://www.eia.doe.gov/emeu/aer/...ges/ sec5_20.pdf

I support high gasoline taxes, but mostly as a means of keeping gas prices high enough to maintain support for CAFE standards. After all, we have efficiency standards for all kinds of appliances like air conditioners, water heaters, washing machines, refrigerators, etc. because they work. Most people are innumerate and cannot calculate the total costs anyway and will go for the cheapest price up front they can get.

Raising gas prices is not a very effective means of improving fuel efficiency for a variety of reasons. I like the idea of a gas tax much better if the tax goes to fund alternative fuels research and investment in infrastructure and technology that reduces demand for oil.

Anonymous said...

The problem with oil is that the price is not set in a free and open market. Pricing considerations are influenced to a great extent by the fact that the vast majority of the remaining resourse is not in the hands of countries with a vested interest in a free market economy and in many cases outwardly hostile to democratic institutions. Even thouogh it is not a limitless resource, oil should be a lot cheaper than it is today. A US tax - say 50% of imported crude above $30 per barrel - a price that most foreign producers can get rich on - should be imposed NOW before all the price increases between now and the point of real consumer resistance become just more contributions to corrrupt regimes and maybe even wind up funding terrorist activities.

Anonymous said...

um...estimate the social cost to come up with the tax to whack on top of oil, seems to be a lot less than simple to me.

Anonymous said...

"By raising the gasoline tax to lower fuel prices prices, our dependence on Middle Eastern oil will go down."

Nope. It will go UP--becuase the ME can produce oil cheaper than the US. The marginal source of oil is US wells. The marginal source will become uneconomic. Dependence will go UP.