Tuesday, August 30, 2005

Fix it until it gets broke

I am growing alarmed over the latest political rhetoric on the oil "crisis". Here's the adminstration talking emergency powers again: WHEN the energy crisis degenerates into a "worst case scenario" President Gloria Macapagal-Arroyo will be forced to use "coercive powers" to enforce energy conservation, MalacaƱang said Saturday.However, given the present situation of world oil prices soaring to record highs, Press Secretary Ignacio Bunye said "regular laws will work."

This is practically warning of a regime of price controls and rationing - just wait for the oil price to hit some unknown trigger level.

Or take this clueless commentator: What do you remember about earlier oil crunches? Newsroom colleagues ask those who’re older (the Associated Press prefers the 1978 phrase “near-elderly” for us.)

Which one? The World War II fuel crunch? Or the 1973 artificial shortage, stemming from the Opec embargo?

Fuel dumps were bombed in that now dimly remembered war. Japanese forces controlled gasoline stocks. We read by coconut oil lamps. The horse-drawn carriage reappeared. Our 350-cavan "batel" sailed from Batangas to Cebu in seven days. And we hoofed it. One walked four hours on 20 kilometers of eerily deserted roads to reach the city from our evacuation home.

In 1973, you could only buy five liters at a time. So, people coasted from one gas pump queue to another. You hauled five-gallon containers “just in case” a station allowed an extra sale.

Abroad, 55 miles per hour speed limits were clamped on. President Jimmy Carter called for the “moral equivalent of war” to reduce dependence on foreign oil. That included filling the US strategic petroleum reserve and research for alternative energy. He was not reelected.

Habits die hard. Wasteful use of fuel continued. Few politicians think beyond the next election -- or impeachment -- even in countries that have no oil wells.

Unfortunately, it's apples and oranges, folks. Wartime and price controlled regimes are different from a free market regime, which is closer to reality now after oil industry deregulation (RA 8179 of 1998). We will not see queues and rationing as long as we allow prices to freely balance supply and demand.

Here's more: If use pulls ahead of production by even a fraction, oil prices could soar to triple-digit levels, Maas warns in The New York Times magazine. That’d trigger a global recession and affect almost every product, from cell phones to medicine.

Eh? Use pulls ahead of production due to economic growth, no? And high prices would choke off that growth? Okay let's grant it for the sake of argument. Then what? You guessed it, prices would start to go down - because the reason they went up in the first place is gone! Actually what would mostly likely happen is that economic growth would soften (not halt entirely), which stabilizes demand, under a higher price band than pre-2004.

Here's some more: But today’s record prices are straining producers. Indonesia, for example, is laying the basis to whittle back fuel subsidies. Even Saudi Arabia is feeling the strain as the world burns 84 million barrels daily.

Yup, they're "straining" all right - straining to maximize their already soaring profits! If you're getting this rich you must be stressed out too! And about the Indonesians - I guess somebody told them that the fuel industry didn't subsidies anymore under this high price environment?

Now if gasoline hits say sixty pesos (over US$ 1 per liter), lots of politicians are going to insist on price controls. Why? Same reason Malacanang is mulling emergency powers - to make it appear that they're "proactive". I'll take their apathy anytime!

But wait - even now one Senator has filed this bill. Jamby Madrigal wants to repeal the Oil Industry Deregulation Act of 1998. Go figure. I guess she wants to go back to a regime of price control-cum-subsidy. That after some lip service in Section 2: "It is the State’s policy to uphold a truly competitive economy that releases the creative energy of free enterprise and fair competition." Aaaargh!!!

Let me review some elementary economics again, folks:

  1. If we implement a fuel price ceiling without industry subsidy, supply of the fuel will decline, relative to supply at the free market price. And definitely relative to demand at the ceiling price - hence the need for rationing, which is constly to monitor and enforce.

  2. If we implement a price ceiling and avoid supply shortfalls by extending industry subsidy, the cost will be great - inevitably, greater than the benefit consumers enjoy under low prices.

Why no. 2? The argument requires one to think "at the margins". Bear with me now: At the free market price, additional consumption (say an extra 1%) no longer provides additional net benefits to consumers; alternatively, the additional benefits to consumers are already below the price of the additional 1%. That's why they no longer add to their consumption! Similarly, from the producer's viewpoint, an additional 1% production costs more than the price. That's why they no longer add to their production! So if government introduces a price ceiling with subsidy, increases consumption by say 10%, they are promoting more consumption and more production - that means the additional cost is above the additional benefit. Society is worse off in this scenario. Now producers need to receive at least the cost of the additional 10%; but the amount they can recover from consumers has even been reduced, due to the price ceiling. This adds to the subsidy burden of the government.

Sure the policy has benefitted consumers. And maybe producers are no better and no worse off, if just the right amount of subsidy is given. But the subsidy itself needs to be paid for; charged to whom? The Filipino taxpayer, i.e. the same gas-guzzling public which received the subsidy in the first place. Now what's bad is that the amount of subsidy exceeds the benefit received by the taxpayers in the first place. So they end up getting shafted - though they don't know it. Nobody wins. Except the trapos who got some public relations mileage. The real crisis happens the minute we pander to their populism.

[Trapo, "Traditional politician"; in Filipino, "a rag"]


Anonymous said...

gosh, what smart politicians we have (they do have different incentives), and i can't believe the president is even considering this (well she is a politician now). if we have price ceilings and rationing, consumers pay for the price of gas in other ways anyway by lining up longer for gas and dealing with shortages.

Econblogger said...

You got it right, anonymous. Then Jun Mercado's experience makes sense; if we put rationing back in place, then we have failed to learn from history and are therefore condemned to repeat it.

Anonymous said...

Interesting thought on the wasted time spent lining up during rationing. That's actually a deadweight loss since nobody is capturing that value. If you assume each person in the Philippines earns on average P30/hour (what's the real number?), and 30 million wait in line for an hour (assuming % of population only) per week, then we have a deadweight loss in the order of almost P1 billion per week. Unrefined, yet makes the point.


by the way, you should consider deleting those Spam comments. They're kinda annoying.

Econblogger said...


Thanks for the advice. Turned on word verification too. Am new at this thing, so I appreciate your understanding.

Anonymous said...

Sure no problem :) Didn't mean to sound so harsh.

Also, I found this site that shows you how to show the latest 10 comments. It's quite useful since people can immediately just pick the most recent comments (rather than go through each post):