A staple of any Principles of Macroeconomics class is a review of the economic situation of the 1970s. That decade, from my perspective, began when President Nixon closed the gold window to remove the last constraint to the political class’ desire to fund the Great Society and the Vietnam War. From that event, the decade digressed through hyperinflation, stagflation, the Keynesian system’s fall from grace, Herb Stein, gas lines, Watergate, Gerald Ford, WIN buttons, wage and price controls, Jimmy Carter, malaise, the 55-mile speed limit, and bad pop music. It ended when the state bequeathed lower marginal rates in 1981.
It turns out that most Principles of Economics students today were born in 1979, so their idea of a gas crisis is something that follows an eating binge. Indeed, gasoline prices have declined steadily throughout their lifetimes, although this has been masked by the steady increase of excise taxes that has occurred during their lifetimes as well. Nonetheless, explaining the gas crisis and its relation to price controls is hampered because, to today’s freshmen and sophomores, the crisis is like disco: It was a peculiar event they have only read about and are thankful they did not had to live through.
At least, not yet. For the last three years, OPEC has been trying to reassert its cartel and force crude oil prices to rise by cutting back its supplies. Successful cartels are difficult to maintain in the long run as the incentive for individual members to cheat is too great. This is one of the primary factors that caused OPEC to lose ground since its glory days in the 70s and why it has been an ineffective force in global oil markets for almost two decades. Only recently have its efforts to revitalize the cartel been successful. By cutting back supply, OPEC has succeeded in raising the price of crude oil 45 percent since March of last year. In New England alone, diesel prices have doubled in recent months.
Certain segments of the organized trucking industry are up in arms and protested in Washington last week. Citing an inability to pass the higher fuel costs on to customers, the protest centered on demands that Congress make the nation’s Strategic Petroleum Reserves available to force prices back down. One group demanded action to counter the “economic assault” being waged against the United States by the OPEC countries. This rhetoric should be taken seriously since the U.S. government has already displayed its willingness to go to war in response to concerns over rising fuel costs.
Such efforts to intervene in the oil markets display massive ignorance of the role prices play in allocating scarce resources. In the market, the prices are formed via the interaction of consumers and producers. Rising prices serve as signals to producers as to which goods require increased production. Over time, the reactions of these producers will cause prices to fall.
Consider the high prices that were charged for computers just ten years ago, when few dominant firms characterized that market, and contrast it with the computer market of today, when even better machines are marketed at much lower prices. This result is so commonplace for all goods sold in the market that we take it for granted. Any economic polices that impede this process should be abolished.
The fact that the gasoline shortages persisted in the 1970s illustrates that such policies were in force at that time. In the 1970s, OPEC was able to reduce the world’s oil supply and force the world gas price to increase. Under normal market conditions, such an effort would disrupt sectors of the economy that are tied to oil, but only in the short run. Rising prices would encourage consumers to direct consumption toward those uses that are most important to them (this is called marginal thinking) and they would encourage producers to find more oil.
But as anyone who ever listened to the BeeGees can tell you, such normal conditions didn’t prevail in the 1970s because of government intervention in the oil markets. While gas prices rose during that time, they weren’t allowed to rise to the levels dictated by supply and demand conditions.
Due to price controls, the market’s response to OPEC’s attempts to maintain a successful cartel was muted, causing the cartel to be successful much longer than it otherwise would have been. At the time, this policy was seen as being humane, meant to help good people such as those poor truckers we read about in the news today. In fact, it delayed the adjustment process and prolonged the suffering of all consumers of oil. The oil crisis came to a quick end when price controls were finally removed in 1981.
One action that state and federal governments could implement immediately would be to eliminate some of the taxes that currently combine to add as much as 60 percent to the price of a gallon of gas. Such a commonsense remedy might not be as politically appealing as standing up to OPEC, but it would undoubtedly reduce much of the strain being faced by independent truckers and their families.
But beyond that, the best policy is simply to do nothing, as difficult as that may be in an election year. Let the price system work. Non-OPEC countries would love the opportunity to market their oil at lower prices than those being caused by the cartel, much like Dell Computers loved the opportunity to market a cheaper alternative to IBM’s machines.
An unhampered price system will diffuse OPEC’s efforts much faster than policy measures from bureaucracies in Washington responding to an “economic assault.” This was the economic lesson of the 1970s and it was learned the hard way. Let’s hope it is heeded today.
