Increasing the Energy Independence Ante

Three weeks ago, Cato released my policy analysis, “The Gulf Oil Spill: Lessons for Public Policy”. I argued that governmental intervention in the energy market was ill-advised and documented the depressingly numerous efforts to do more of just that by those who should have known better. On October 31, a working paper that went far further than any I had criticized appeared on the Internet. That paper – written by Robert Ames, Anthony Corridore, Edward Hirs, and Paul MacAvoy, who curiously label themselves the Yale Graduates Energy Study Group – argues for a Presidential proclamation ordering a moratorium on all oil imports save those from Canada. The withdrawal from global oil markets would be phased in over a decade.

As one might expect, there are many problems with their argument.

First and foremost, their case depends upon far greater certainty than is justified on the danger of foreign-supply disruptions, the effects of an embargo on domestic consumption, and the timely emergence of various domestic alternatives to foreign crude, particularly coal-to-liquid technology and biofuels. This ignores horrendous prior experience (something the authors tacitly recognize at the end of their paper by listing the bad energy initiatives of the past).

Their bottom line, however, is that the supply response will be so great that it will generate producers’ profits that far exceed the losses to consumers. The calculation, however, is Orwellian in its premises and is an analytically invalid measure.

Standard international-trade theory indicates that trade restrictions almost always harm the country that imposes them. Trade, nationally and internationally, arises because it is cheaper to swap other goods to get, say, petroleum, than to produce petroleum at home. The Yale Graduates’ calculation covers only the lesser part of the effect – the gains in the import-replacing industry. The larger cost of losses in export industries is ignored.

The Yale Graduates, moreover, effectively assume away the result possible in theory, but not in practice, of an astute level of import control that produces a net gain from lowering import prices without, as the Yale Graduates propose, severely reducing import volume.

In a country already burdened with enormous costs of ill-advised government policies, the last thing we need is such another governmental plunge into a fantasy world. The resulting waste would make Obamacare seem a bargain.

A second, related technical concern is that their calculation of embargo costs departs from standard practice by including the direct cost to oil consumers. Such costs are generally excluded from such calculations because, if import disruption were as probable as the authors assert, people would hedge against them. If they hedge, the cost will be zero.

The hypothetical indirect costs from alleged inflationary and unemployment effects are the usual concerns regarding foreign-supply disruptions. The standard method is to translate these costs into an estimate of the appropriate offsetting level of defensive import restriction. However, while the vast relevant literature is inconclusive about the magnitude of the impacts, it has never before produced figures that imply total elimination of imports. Regardless, Chantale LaCasse and André Plourde pointed out in 1992 that as long as the United States is engaged in any international trade, it will be affected by any oil shock. There is simply no way to wall-off the United States from major economic events abroad.

Objections also arise at several more fundamental levels.

First, the effort would be a horrendous policy initiative. Decades have been spent since 1933 trying to restore international economic integration to its 1914 level. So drastic a step as embargoing oil imports would set a very bad example.

Second, the exclusion of Mexico would violate the North American Free Trade Agreement and, almost certainly, U.S. obligations to the World Trade Organization. Examination of present and prospective patterns of oil imports indicate that the total ban would hurt clear friends as well as actual or possible enemies.

Third, even if the Presidential power to impose oil-import moratoriums (last exercised by President Eisenhower) still exists, its exercise is even more inadvisable that it was in the Eisenhower case. Critics of President Eisenhower correctly argued that the national-defense rationale for keeping foreign oil out of the United States was a fig leaf designed to disguise the real aim of the policy - to protect the independent oil producers who were the prime beneficiary of state production controls. The proposed phased-in embargo would restore the nightmare of quota allocation that messed up the initial Eisenhower program and its implementation by the Kennedy and Johnson administrations.

Fourth, a presidential moratorium would be another unwise assumption of executive power. No president can be trusted correctly to implement such draconian import restrictions or, for that matter, any similar interventions into industry. To make matters worse, no President could be in office for the whole ten-year phase-in period.

It’s hard to believe that serious people could propose such a thing. Exposure to modern economics has greatly reduced errors as gross as this, but obviously not completely.

Note: The cited paper has a peculiar history. A precursor was Robert M. Ames, Anthony Corridore, and Paul W. MacAvoy, “National Defense, Oil Imports, and Bio-Energy Technology,” Journal of Applied Corporate Finance 16 no. 1 (Winter 2004) 28-50. The latest version was posted on the Social Science Research Network, but in four different browsers, the link refused to access the paper. A Google search yielded access to a substantially identical article (with the author order reversed) presented in 2010 to the United States Association of Energy Economists.