Monday, October 03, 2005

Energy Prices and the Folly of Price Controls

As a vital commodity becomes scarce, it is foolish to insist on acting as if it is just as pleantiful. This foolish game will bring a shortage on harder and faster than simply facing reality.

I have a concern that I did not express adequately in my previous blog on price gouging.

My concern is that people will demand that the government keep energy prices artificially low. They will demand such things as price caps, suspended gasoline taxes, and access to the strategic petroleum reserves, all to help lower the price of gasoline.

This may make life more comfortable for the present, but will set us up to have a truly disastrous future.

These measures only deal with the symptoms. Artificially low prices will speed up the rate at which we use these resources. This accelerated consumption means that a future shortage will strike faster and harder than it would have been if we left the price alone.

This is not an anti-capitalist “the sky is falling” rant. This is an argument about what happens when governments mess with the market place and try to fix the price of a commodity for political reasons. The society will suffer. In this case, society risks a great deal of suffering.

Imagine a group of people stranded in the desert, saying "Let's use water as if it were as plentiful as it was in Cairo when we took off.”

These people are going to die. This will be the payment for foolishness.

People demand that we keep energy prices low for the same reason. They want to pretend that these resources are still as common as they were in ‘the good ol’ days.” Ignoring reality has some harsh consequences. Those consequences could include suffering and death.

Consider how much energy is used in planting, harvesting, and shipping food to people who need to eat. Consider what will happen if that energy is not available.

The Effects of Price Controls

A higher price invites people to change their lifestyle so that they use less energy. They buy more fuel-efficient cars. They use more public transportation. They telecommute rather than travel to the office. They buy energy-efficient appliances. They switch to alternative methods to heat their homes.

There is a certain amount of inertia involved in keeping an old lifestyle. The individual who is accustomed to driving his SUV to work each day may have to feel a real pinch before he will take the bus. Existing appliances will have to break down before they get replaced. Improvements in public transportation will have to be built before they can be used. Businesses will have to invest in the infrastructure to allow for more telecommuting before more employees can telecommute.

In the mean time, people will continue to use energy at the high price. However, these high prices are necessary to give incentives for the types of changes that are needed. Price controls prevent all of these changes from taking place.

Even the threat of price controls is enough to slow the steps that people and industry take to avoid future energy problems. The energy company considering an investment in wind-power plants has to consider the possibility that governments will put price controls on oil and natural gas. The mere possibility of price controls is computed as risk in the company’s benefits-cost analysis. It makes these projects less likely.


I am well aware that high prices create problems. In an earlier blog, I criticized John Stossel for ignoring them. I will agree that steps need to be taken to address these problems. However, price controls would be a foolish step to take. It will only make the problem worse.


Rationing is an option. However, rationing comes with its own costs. Rationing is probably the best option for a group of people caught in the desert where the resource can be watched. The larger and more complex a society gets, the less effective rationing will be. Instead, rationing will threaten to make crime more profitable, more tempting, and more common.

Another problem with rationing is that it does not respond to changes quickly enough. When does the rationing end? How much rationing is best? With the market, every piece of news instantly changes the price, instantly changing the incentives to conserve and to search for alternative energy sources. In the political arena, changes take months at best, years at most, with a cloud of lobbyists obscuring the facts in an attempt to produce political advantages for their clients.

Windfall Profits Tax

The problem with a windfall profits tax is that it punishes those people who are in the best position to solve the problem. Assume that you were the leader of an isolated village that has lost its crop due to an early freeze, or blight. You have hunters who could bring in extra meat. Would you set up a system to reward them for a successful hunt? Or would you punish them? Which option stands the greatest chance of more people doing more hunting and bringing in more food?

The windfall profit tax is similar to a law punishing hunters in times of famine, rather than rewarding those who bring in extra meat after blight has destroyed the crops. It is not rational.

Consumption Tax

On the other hand, a consumption tax will serve to enhance the benefits that I mentioned above. With a consumption (sales) tax on that commodity, people will then put even more work into finding alternatives or going without in order to avoid the still higher costs of the commodity.

A consumption tax also will invite illegal black-market activity. However, the criminals' benefit is only the value of the tax. As the black-market price approaches the taxed price of energy, the black market offers no advantage, yet still provides all of the disadvantages of being against the law. Criminal profits are less, which means that people get to live their lives with less organized crime and political corruption.

The Uses of a Consumption Tax

The purpose of such a tax would be to help the poor who may suffer greatly from higher prices. It can be used to fund energy assistance programs, gasoline coupons for those working minimum-wage jobs, and subsidies for low-income households to buy fuel-efficient vehicles and appliances or to subsidize the cost of their use of public transportation.

In the mean time, the higher price will continue to discourage consumption and feed the drive to discover and expand alternative energy sources.


My fear, as I said, is that society will demand that politicians keep the price of oil (and gasoline) artificially low. This is as irrational as a group of people getting caught in the desert with a limited supply of water demanding that each person still be allowed to drink as much as they want. It is an irrational course of action that is going to cause a lot of innocent people (in the future) to suffer significantly.

The price has to be allowed to rise to give society an incentive to conserve and to invest in alternatives.

However, this rising price is certainly going to harm the poor. The rich have the power to purchase a good for trivial purposes that others need to survive. The market does not care who gets it, only that the person getting the good is able to pay for it.

To prevent this, a consumption tax which will be used to assist the poor is in order. Rationing and price controls will only make the situation worse. These are not the options that a morally responsible person could pursue.

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