In the continuing battle of words over who is to blame in the California electricity fiasco, economists seem to have fallen into two warring factions: those who favor price controls, and those who do not.
Laura D’Andrea Tyson is in the former faction. Tyson, having served as the chief economic advisor to former President Bill Clinton, was able to parlay her fame into becoming dean of the Haas School of Business at the University of California, Berkeley. She is a “well-respected” mainstream economist who holds views that are general to the modern economics profession. Naturally, Tyson favors price controls.
In a Business Week column dated June 4, 2001 (”Ignoring California’s Energy Crisis Imperils the Economy“), Tyson declares that emphasizing the production of more oil, natural gas, and electricity is nothing more than a “ ‘drill-and-burn’ strategy that benefits its [the Bush administration’s] friends in the energy industry and poses unnecessary risks to the environment.” Furthermore, Tyson declares that the way to solve this crisis, at least in the short run, is to “impose a temporary cap on wholesale electricity prices.” This, she writes, “would ease supply conditions in California and the Western grid. . . .”
That an economist, and especially one who enjoys a lofty position in the economics profession, would write these things says more about the state of modern economic analysis than all of the critical articles in Quarterly Journal of Austrian Economics combined. Tyson’s article is filled with the economic fallacies—especially an inability to recognize the unintended secondary effects that occur because of bad economic policies—about which Henry Hazlitt warns his readers in his classic Economics in One Lesson.
It is not possible, however, to detail all of Tyson’s fallacies. To accomplish such a feat would require more memory than is stored in all of the computers of the readers of this page. (Deforestation of North America would be required in order to deal with all of her fallacies on paper.) Thus, I shall deal only with the highlights.
Before doing so, however, I must first look at the method of argumentation that Tyson uses. Like so many others in the economics profession, Tyson prefers to argue, not by using sound logic, but rather by employing various informal fallacies including appeals to authority, appeals to “the people,” and ad hominem attacks, along with the ubiquitous non sequitur. (Paul Krugman, who, like Tyson, falls into the category of “liberal economist,” also regularly resorts to this kind of argumentation in his New York Times column.) What follows next are Tyson’s quotes and my replies.
Rolling blackouts in California over the next several months endanger an already faltering U.S. economy. California accounts for about 14 percent of the nation’s output, more than the smallest twenty-two states combined. In the past two years, it has generated about one-quarter of the nation’s job growth. Like it or not, California’s electricity crisis has national ramifications. Yet, after weeks of secret meetings, the Bush administration’s recently unveiled energy plan does nothing to ameliorate this crisis. Instead, the White House has used the crisis to justify a long-term “drill-and-burn” strategy that benefits its friends in the energy industry and poses unnecessary risks to the environment.
Part of what she writes is true. California’s crisis does have national implications, but not as she might think. The economy’s slowdown, as Austrian economists have pointed out, is not due to California’s electricity problems, but rather to massive malinvestments that came about because the Federal Reserve—at Tyson’s urging when she served under Clinton—poured new fiat money into the economy by artificially lowering interest rates.
The real question here is not whether slapping price controls on electricity will somehow bring “prosperity” back to California; the real question is whether politicians will give in to the tortured logic given by Tyson and her allies and actually believe that forcing electricity into California at below-market prices will end the recession. Furthermore, if the Bush administration gives in to this sophistry and forces other utilities to supply the (former) Golden State, whatever progress we have made in energy production since the price-control fiasco of the 1970s is likely to be lost.
The reference to “drill and burn” speaks volumes about Tyson’s economic ignorance. Like it or not, most transportation and electricity creation is powered by fossil fuels that must be extracted from the earth and burned in order to release energy. ”Alternative” energy sources like solar energy, “biomass,” and ethanol are extremely costly and cannot come close to supplying what is currently demanded. Hydroelectric power, while cheap, is limited in scope, and environmentalists hate dams, anyway.
Tyson further displays her lack of economic understanding by declaring that this “drill-and-burn” strategy benefits the energy industries, ostensibly at the expense of other people and the environment. Liberals are fond of trashing private enterprise, declaring that no one benefits from it except for business owners, as though business was a detached, meaningless arm of our economy. Yet, Tyson’s assumption that consumers in a free-market economy do not benefit from their purchases of electricity and fossil fuels turns upside down every logical theory of exchange that has shaped economic analysis for more than two centuries. Individuals do not knowingly enter into economic exchanges unless all participants believe they will be better off after the trade takes place.
Moreover, Tyson’s contention that conventional free-market energy production “poses unnecessary risks to the environment” does not permit the reader to differentiate between what is a “necessary” environmental risk and what is not. She simply speaks ex cathedra and expects readers to agree.
According to the Bush team’s logic, soaring electricity prices in California, like soaring U.S. gasoline prices, reflect years of inadequate investment in energy production. And why have investors been unwilling to develop the necessary supplies? Primarily, say administration officials, because of government regulation, especially environmental rules. This analysis is consistent with traditional Republican ideology but inconsistent with the facts. Private companies shelved investment plans and closed operations in the oil, gas, and electricity industries in the 1990s not because of environmental restrictions but because of sagging energy prices, excess capacity, and poor profitability.
In this case, Tyson wraps a larger lie around a kernel of truth. Energy prices had fallen in real terms for two decades before last year’s price explosion at the pump. Furthermore, a number of energy companies, in order to avoid losses, have shelved some of their more ambitious plans that could not be supported by lower market prices, as Tyson says.
However, what she does not say is that one of the reasons companies have not made more investments in production is precisely because the increasingly strict environmental rules are squeezing profit margins. It has been well-documented that no new oil refineries have been constructed in the United States in two decades. The reason is quite simple: Refineries are not major profit centers in the best of times.
Thousands of new regulations that have sprung from the Clean Air Act Amendments of 1990 make profitability prospects even less, especially since the Environmental Protection Agency is well-known for levying huge fines on those who violate these tough new regulations—fines that can quickly eat up profit margins. (One must remember that oil refining is, by its very nature, a dirty business. That was something I learned growing up two miles from a major Sun Oil refinery in Marcus Hook, Pennsylvania.)
Tyson does admit, “Flaws in California’s deregulation plan have aggravated its electricity woes.” She adds, “To make matters worse, because the deregulation plan precluded long-term contracts between utilities and generators, there was no way for either buyers or sellers to hedge against the volatility of prices in unregulated electricity markets.”
While there are numerous parties, including both politicians and some short-sighted energy executives, one must remember that the California General Assembly ultimately created the restrictions that Tyson admits have helped cause this problem. Furthermore, the legislature also set the price controls that are at the center of the crisis. (Tyson conveniently leaves out this information, and for good reason: Her “ace in the hole” happens to be more price controls.)
The Bush administration is not responsible for California’s self-inflicted wounds, but it is responsible for failing to impose a temporary price cap on wholesale electricity prices in order to control their manipulation by a handful of generators and natural gas suppliers, many headquartered in Texas.
Again, we see the Tyson logical-fallacy engine in overdrive. The Bush decision not to slam price controls on wholesale electricity prices does not represent a failure, but rather a political and economic success. Her mention of some companies that sell natural gas and electricity to California utilities being headquartered in Texas is further proof of her ad hominem style of argumentation, and Tyson’s description of suppliers engaging in “manipulation” simply makes no sense at all.
Business owners do not “manipulate” supply. Instead, they choose how much of the product that they own to sell on the market at a given time. In accusing suppliers of “manipulation” of electricity and natural gas, what she really means is that these folks should be forced to sell more than what they would like at prices below what they would accept in a free market. This is nothing more than a call for the state to impose a regime of forced labor upon people who currently are politically unpopular with the political classes.
The White House sneers at such evidence [that producers are “manipulating” energy supplies], arguing that a price cap would discourage needed investment in new capacity. But not if such a cap were set at a level high enough to provide suppliers with a reasonable profit and relaxed once the short-term crisis was over.
Once again, Tyson resorts to ad hominem attacks and ad populum appeals, as discounting nonsense from “liberal” economists does not constitute a “sneer.” For one, she does not understand the origin of profit, despite her “respected” status within the economics profession. As Murray N. Rothbard pointed out in his classic Man, Economy, and State, a profit occurs because of a temporarily underpriced factor of production. One does not control prices by artificially forcing down rates of profit, nor do high profits drive high prices. Moreover, in a free market, underpriced factors of production do not remain that way for long.
Tyson’s call for “reasonable” profit levels apparently elevates her to a god-like status. Individuals do not have the capacity to determine what is a “reasonable” rate of profit. For example, is Tyson’s current salary at Berkeley a “reasonable” rate of return on the expenditures she has made in order to reach her position? Only she can determine what a “reasonable” rate might be in that case. And as for her contention that price controls on wholesale electricity would be temporary, one only need remember that President Richard Nixon’s “temporary” (ninety-day) price controls levied on oil and everything else on August 15, 1971, managed to shackle the energy industries for nearly a decade. (New York’s infamous—and apparently eternal—rent controls were enacted in 1946 as a “temporary” measure to help individuals in postwar transition back to a civilian economy.)
Although a temporary price cap would ease supply conditions in California and the Western grid, existing capacity constraints exacerbated by drought-induced shortages in the state’s hydroelectric dams make substantial shortages inevitable over the next several months.
In this sentence, Tyson manages to engage in what can only be described as economic “newspeak.” Price controls do not relieve shortage conditions; they cause shortages. The very definition of a “shortage” in economic analysis is the result of a price being held below market values. Tyson attempts to convince readers that white is black and day is night.
In the second part of this offending sentence, Tyson misuses the term “shortage.” A shortage is not the absence of supply, but rather what occurs when one does not permit market prices to reflect both the current supply of and current demand for a good.
As noted earlier, there is much more one can say in criticism of Tyson’s latest outrage, but suffice it to say that her understanding of prices and markets is not particularly keen. In Economics in One Lesson, Hazlitt writes that the ability to recognize economic fallacies—especially the presence of secondary effects—separates the “good” economist from the “bad” one. It does not take a genius, or even an economist, to recognize the category into which Tyson places herself.
