Good Fuel Economy

This article appeared in the South China Morning Post on December 3, 2007.

Any country pursuingeconomicliberalisation couldlearn much fromAmerica's successes.But, these days, Chinamight learn morefrom America'sfailures. In boomingGuangdong, energyprice controls have forced lorry drivers towait in long lines for diesel fuel. BecauseBeijing forces oil refiners to sell theirproducts at prices well below what it coststo produce them, the refiners have cut backproduction capacity, resulting in longqueues at the pumps. "Oil futures are nearUS$100 [a barrel], but the price we sell at isonly US$60. We are still losing money," aSinopec executive told The Wall StreetJournal last month.

For 17 months, planners kept Chineseoil prices fixed, while the true market costskyrocketed. Now, thankfully, thegovernment seems to have got themessage. At the beginning of last month,Beijing raised fuel prices by roughly 10 percent, in the hope of ending the shortages. Ithelped – but only allowing prices to returnto market levels will restore a healthyequilibrium of supply and demand.

China's policies have precedents inAmerica, and they're not pretty. In 1973,the oil crisis induced the US government topass oil price controls, which mostAmericans knew better as long queues atpetrol stations. Then, in 1979, the Iranianrevolution disrupted world oil supply forthe second time in a decade, creatinganother big spike in prices. US presidentJimmy Carter instituted price controlsagain, resulting, as before, in long queues.

Drivers waited hours to fill up their cars,often in lines hundreds of vehicles long. Inthe state of Maryland, governor HarryHughes proposed an "odd-even" system ofrationing, under which cars with oddnumberedlicence plates could fill up onodd days, and cars with even-numberedplates did so on even days. It was bizarre,and it certainly wasn't popular.

And, of course, once a governmentbegins to control prices and ration scarcegoods, it's hard to stop. It didn't takeBeijing planners long to recognise that theprice controls were hurting their own oilcompanies but, instead of allowing them tocharge what the market would bear for theproducts, they tried to compensate thecompanies for the losses. And, so, thelunacy of the controls compounded itself.

"The government forces state-owned orstate-controlled firms to absorb losses thatanalysts say are now running at up toUS$10 a barrel on imported crude," John Ruwitch wrote recently in the International Herald Tribune, so "for the past two years, [Beijing] also doled out hefty year-end compensation to Sinopec, the worst hit".

Sinopec controls about 80 per cent of the Chinese market for refined petroleum products, and the China Daily reports that, last year, the bailouts cost the government more than US$1.2 billion. So, Beijing essentially forced consumers to pay for the inconvenience of queueing. The Chinese government knows how much it paid out to aid ailing firms, but it will never really know how much harm it dealt the overall economy. In May last year, Beijing allowed petrol prices to rise 10.6 per cent, and diesel prices to go up 12.3 per cent. No doubt, governing bodies made those decisions on the basis of some economic analysis but, as anyone familiar with the laws of economics has to wonder, what did these economists know about demand that the consumers themselves didn't?

Often, spiking prices aren't pleasant, but they're not the end of the world, either. As my colleagues at the Cato Institute, Jerry Taylor and Peter Van Doren, point out, in the last week of September 2003, oil was selling in US spot markets for US$23.86 a barrel. Five years later, prices are four times higher, but the inflation, unemployment and recession that supposedly follow oil price shocks are nowhere to be seen.

The Communist Party has staked its legitimacy on the ability to continue delivering economic growth at what, by historical standards, is a blistering pace. Party officials seeking to ameliorate popular discontent no doubt want to shield ordinary people from spiking prices but, like them or not, market prices are a reality.

Allowing prices to rise and fall, as they will in the market, can actually relieve pressure on governments. Scarce goods are scarce goods, and even an all-powerful party can't control everything. By recognising certain adversities as facts of life, a government can absolve itself of the onus of having to put an end to them. After all, putting an end to them sometimescreates bigger adversities elsewhere.

David Donadio

David Donadio is a writer and editor at the Cato Institute.