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Brooks Wilson's Economics Blog: April 2011

Saturday, April 30, 2011

Past Policy and Today’s Oil Price

President Obama has correctly stated that there is little that the federal government can do to lower the oil prices in the short run but that is where the story begins, not where it ends.  Recognizing that oil production results in pollution, environmentalists have engaged in a decades long battle to enact policies that restrict the production of oil while subsidizing renewable energy sources like wind, solar and biofuels.  These policies have been consequential; supply has contracted and equilibrium price increased.  Subsidies of wind, solar and ethanol have been expensive to taxpayers and resulted in little if any commercially viable production.  Not satisfied with subsidies alone, the government has often mandated the use of these alternative energies forcing consumers to bear the higher cost.

President Obama supports a continuation of past environmentalist policies.  David Harsanyi provides a couple of quotes that support high oil prices (“Why Isn't Obama Celebrating High Oil Prices?”).
In 2008, candidate Barack Obama was asked by CNBC's John Harwood, "So could the (high) oil prices help us?" Obama: "I think that I would have preferred a gradual adjustment."…That same year, current U.S. "Energy" Secretary…Steven Chu clarified that "somehow we have to figure out how to boost the price of gasoline to the levels in Europe."
In response to rising oil prices, President “Obama reissues call to end oil company tax breaks.”  When you tax something, you get less of it.  Taxing oil would not encourage production.  While calling for more drilling, EPA has denied Shell a permit that would allow it to drill in the Arctic Ocean in Alaska.  Shell is preparing to scrap its five year, $4 billion investment.  Dan Springer writes (“Energy in America: EPA Rules Force Shell to Abandon Oil Drilling Plans”).  The Obama administration dramatically slowed the issuance of permits for deep-water drilling after the BP blowout (“First deep-water drilling permit issued for gulf since BP oil spill”).  These policies will result in higher oil prices in the future just as past policies have resulted in higher prices today. 

There is nothing morally wrong or logically inconsistent with environmentalists’ beliefs.  Oil production, like the production of any form of energy, results in pollution.  A cleaner environment is a worthwhile objective.  Everyone wants it but everybody wants cheap energy as well.  This is where my disagreement with traditional policies supported by President Obama ends. 

Government policies to find a cheap alternative to fossil fuels have failed and there is no reason to believe that future efforts will be more productive.  Traditional environmental policy seems to underestimate the pollution caused by “green” energy sources.  Windmills are ugly and blight areas where they are located.  Ethanol production pollutes air and water and drives up food prices.  I believe the tradeoff between wealth and a clean environment is steeper than traditionalist admit and as wealth falls, pollution increases.  For example, people drive older cars and spend less on maintenance.

With no real evidence to support my opinion, I believe that support for traditional environmental policy comes largely from people earning more than the median income.  This may cause a fissure in the Democrat’s voting coalition.  Highly educated high income Democrats will continue to support these policies but the poor and many union members may not.

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Wednesday, April 27, 2011


Josh Kraushaar writes (“Gallup: Seniors Most Favorable To Ryan Budget”)
A new Gallup/USA Today poll contains a counterintuitive finding: the age group most receptive to House Budget Chair Paul Ryan's plan to deal with the budget - seniors.

The poll finds 48 percent of seniors (those 65 and over) support Ryan's plan over President Obama's plan, while 42 percent back the president.

That's the highest total among the age groups tested - a 47 percent plurality between the ages of 50 and 64 backed Ryan, and a 45 percent plurality of those between 30-49 backed Ryan. But young voters overwhelmingly sided with Obama by a 23-point margin, 53 to 30 percent.

I do not think that the results are counterintuitive.  President Obama’s health care reform takes $57.5 per year over the next decade from Medicare to fund an expansion of Medicaid, harming those who are Seniors now and those who will soon be seniors.  The Ryan plan would maintain Medicare at current inflation adjusted levels for anyone currently under 55. 

Seniors are supporting their interests and there is nothing counterintuitive in that (See Betsy McCaughy, “Medicare As We've Known It Isn't an Option” for a good comparison of the impact of President Obama’s health care reform and Representative Ryan’s proposed changes).   Permanent Link
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Friday, April 22, 2011

Downgraded Outlook

When is bad news good?  It makes that transition when it alerts us of a problem that is resolvable.  On Monday, the rating agency Standard and Poor’s downgraded the outlook for the United States federal government from stable to negative because they believe that there is a significant risk that elected officials may not reach an agreement that addresses the country’s long-term fiscal imbalances caused by unfunded entitlement programs (“S&P Affirms US AAA Rating, Cuts Outlook to Negative”). 

Some believe that the political class is so polarized that compromise is impossible.  Others, knowing that voters to not like cuts in benefits nor increases in taxes and that any serious plan will require one or both, believe that any serious plan to resolve the problem offered by one party will be used as an effective campaign issue against the other.  Good politics usually trumps serious economic reform.

The Chinese government sees the problem.  As one of America’s biggest creditors with about 2 trillion in exchange reserves in dollar denominated assets “China Urges US to Protect Creditors After S&P Warning.”  China is as trapped by our debt as we are.  Any rush to sell dollar denominated assets, like United States Treasury bonds, will quickly lead to a collapse in price seriously damaging the value of remaining Chinese holdings. 

Of course, the impact on the federal government’s fiscal crisis would be monstrous as well. The Greek debt crisis may illustrate the worst case scenario of what we could face.  Greek debt currently has a yield of over 15% on 10-year bonds compared with the German rate of 3.27%, and the U.S. rate of 3.43% (“Greek PM: Ratings agencies running our lives”).  The average maturity of the U.S. government debt is approximately 5 years.  As a back of the envelope calculation, assume all debt is held in five years notes and the yield is 2.25%.  Interest payments comprise approximately 15% of all federal outlays.  If interest rates double to 4.5%, interest payments on the debt would rise to 30% of all current outlays.  If they rose to 10%, interest payments would rise to 60% of all outlays.  If interest rates rose to Greek levels of 15%, interest payments would rise to 100% of current outlays.   

Federal government outlays are currently 24% of GDP.  To maintain current levels of expenditures on all other programs, outlays would have to rise to 44% of GDP if interest rates rise to 15%.  Not to lose the main point, it is the projected growth in unfunded entitlements that threatens our country’s fiscal stability.  Rather than vote against a party that offers need reform, the wise voter will use time as a fulcrum to leverage future cuts in entitlements.    

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Friday, April 15, 2011

I love my new 2010 Prius. They are fun to drive slow, something I thought I would never say about a car, and there is nothing like a long glide after a short pulse to increase gas mileage.  I got 53.8 mpg on my last tank of gas and anticipate exceeding 55 mpg on this tank.  The hybrid technology used in the Prius is a technological wonder but it comes at a price.  It is more expensive than similarly sized cars.  I figure that at $3.50 per gallon I will need to drive the car about 60,000 miles to recoup the initial sales price but that is dependent on a high resale value in six or seven years. 

(HT Watts Up With That) Two new inventions threaten to knock the stuffing out of the resale value of current hybrids.  Both projects are funded by Department of Energy’s ARPA-E grants.  Researchers at the University of Minnesota have figured out how to combine carbon dioxide, sunlight and bacteria and turn it into oil (“The greens worst nightmare? A CO2 to Oil process”).  If oil can be successfully produced using this technological advance, the price of gasoline would at least stabilize and could potentially fall making cars powered by the internal combustion engine cheaper to drive and environmentally less threatening. 

The second invention is a new gasoline engine that was developed at the Michigan State University (“New gasoline engine design has 4x efficiency of pistons”).  The team that made the Wave Disk Generator believe that it will provide a driving range exceeding 500 miles.  They also believe that it will be 30% lighter and 30% less expensive than a plug-in hybrid, and that it will cut carbon emissions by 90% relative to gasoline engines. 

Often, the invention is the easy part.  The more difficult part is successfully producing a good in a market setting with the invention.  Economists refer to this step as innovation.  Let’s hope that these projects are successful innovations.  What I lose in value on my Prius will make up with reduced driving costs on my future vehicles.   Permanent Link
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Thursday, April 14, 2011

The Trouble with Tribbles and Entitlements

In the Star Trek episode, “The Trouble with Tribbles,” the crew of the Enterprise docked at a space station where they found tribbles, small cuddly creatures that emit a warm, cooing sound.  Tribbles are very much like federal unfunded entitlements.  The promise of a worry free retirement with all the medical care that we desire is comforting.  Unfunded entitlements have something else in common with Tribbles; they both grow rapidly when fed, stressing food supplies in the case of tribbles and debt levels in the case of unfunded liabilities. 

The graph, “Total Revenues and Outlays,” shows actual revenues and outlays between 1971 and 2010 and projected revenues and outlays until 2021.  The graph does not reflect the budget deal that reduced expenditures by $38 billion or less than two tenths of one percent of GDP.  The vertical black line in 2011 separates actual budget numbers from the projected numbers.  The dashed red line is the average level of outlays as a percentage of GDP for the years 1971 through 2010.  The dashed blue line is the average level of revenue as a percentage of GDP for the same years.

The last two years have produced historically large deficits of 11.0 and 9.4 percent of GDP.  Outlays are higher than the historical average and revenues are lower.  Beginning in 2011, the gap between revenues and outlays narrows dramatically but both are well above the historical average of revenues and outlays as a percentage of GDP.  The CBO’s major assumptions in the projection include (The Budget and Economic Outlook: Fiscal Years 2011 to 2021”)
Sharp reductions in Medicare’s payment rates for physicians’
services take effect as scheduled at the end of 2011;

Extensions of unemployment compensation, the one-year reduction in the payroll tax, and the two-year extension of provisions designed to limit the reach of the alternative minimum tax all expire as scheduled at the end of 2011;

Other provisions of the 2010 tax act, including extensions of lower tax rates and expanded credits and deductions originally enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001, the Jobs and Growth Tax Relief Reconciliation Act of 2003, and ARRA, expire as scheduled at the end of 2012; and

Funding for discretionary spending increases with inflation rather than at the considerably faster pace seen over the dozen years leading up to the recent recession.

The CBO must use these assumptions because they are part of current law but they seem rosy.  There would be huge political blowback for politicians that allow taxes to increase or Medicare payments to decrease implying that the national debt will almost certainly grow faster than the CBO projection.  But these projections show the national debt continuing to rise past the dangerous level of sixty percent.  Beyond the projection, unfunded Medicare, Medicaid and Social Security entitlements continue to increase.

Doctor McCoy learned that tribbles would not reproduce if they were not fed.  Some economists have suggested a similar “starve the beast” strategy to limit the growth of entitlements and other government expenditures. 

Gary Becker, Edward Lazear, and Kevin Murphy present evidence in a 2003 article, “The Double Benefit of Tax Cuts,” that the Reagan tax cuts of the 1980’s starved the beast producing reform and lower spending in the 1990’s. 

In a 2008 paper, “Do Tax Cuts Starve the Beast: The Effect of Tax Changes on Government Spending,” Christina Romer and David Romer present empirical evidence that cutting taxes does not starve the spending beast.  They suggest two alternative theories that they believe better fit the data: fiscal illusion, a tax cut without a spending cut weakens voters’ association of spending and taxes leading to an increased demand for spending, and shared fiscal irresponsibility, in which supporters of lower taxes or bigger expenditures jointly agree to ignore the impact of their actions on deficits.

I see evidence that all three effects influence political behavior.  In light of the growing national debt, today I would place my money on fiscal illusion but being a small government guy, I am pulling for starve the beast. 

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Thursday, April 7, 2011

Biofuels and Government Subsidies

The United States is not the only country that mandates that food crops be converted to fuel.  These mandates are a factor driving up food costs (“Biofuel rush driving up global food prices”). 
Each year, an ever larger portion of the world's crops - cassava and corn, sugar and palm oil - is being diverted for biofuels as developed countries pass laws mandating greater use of nonfossil fuels and as emerging powerhouses like China seek new sources of energy to keep their cars and industries running. Cassava is a relatively new entrant in the biofuel stream.

But with food prices rising sharply in recent months, many experts are calling on countries to scale back their headlong rush into green fuel development, arguing that the combination of ambitious biofuel targets and mediocre harvests of some crucial crops is contributing to high prices, hunger and political instability.

This year, the United Nations Food and Agriculture Organization reported that its index of food prices was the highest in its more than 20 years of existence. Prices rose 15% from October to January alone, potentially "throwing an additional 44 million people in low- and middle-income countries into poverty," the World Bank said.
These renewable sources of fuel were to make oil importing nations less dependent on Middle Eastern oil.  Maybe we are somewhat less dependent, but not sufficiently independent to free us from military entanglements. 

The article concludes

While no one is suggesting that countries abandon biofuels, Dubois and other food experts suggest that they should revise their policies so that rigid fuel mandates can be suspended when food stocks get low or prices become too high.
My blogging voice is small, but I would be honored to be the first to suggest that governments eliminate all programs that subsidize or mandate the use of crops for fuel.
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I received an e-mail from with links to the embedded video and to and its site.  The video address a little understood characteristic of human society, spontaneous order which result in human action but are not of human design.  These orders can solve most economic and other societal problems without planned orders, which are also necessary.  Government officials often oversell the importance of their solution and fall prey to what Hayek called the “fatal conceit,” that government planners can organize society as if it were an assembly line or a military operation.  They should recall Hayek’s admonition, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”Replace this text with...
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Another Skirmish in the Happy Meals War

New York City Councilman Leroy Comrie would have his city join San Francisco’s attack on fast food chains that sell toys with meals deemed inappropriate for children by a political authority (“NYC Councilman Leroy Comrie Proposes Bill Banning ‘Happy Meals’”).  He would require that toy laden meals be light on calories, fat and sodium.  Without proof, or at least without proof proffered in the article he finds malevolent design in corporate headquarters.
It comes as no surprise that these ads and meals are also targeted in low income and minority neighborhoods that are already at risk for childhood obesity. These are the same communities that have limited access to supermarkets, limited access to healthy food options.
Assuming that fast food ads target low income and minority neighborhoods, I interpret corporate decisions differently.  Corporate decision makers are expanding opportunities of residents by offering food that provides the biggest bang for the consumer buck.  If parents want “healthy” food, these restaurants will provided it.  One wonders how Comrie views parents. His statement suggests that they have limited options, yet markets provide options that consumers desire.  His law suggests that parents are incompetent to make proper choices for their children without the guiding hand of a benevolent government.

In the article, Mason Smoot, vice president and general manager for McDonald’s in the New York Metro Area, offers a different view, my view.
Our Happy Meals make it easier for families to choose the right foods in portions just for kids. We provide options for our customers and trust them to make the decisions that are right for their families. Politicians should too.

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