Tuesday, April 29, 2008

When producing becomes illegal, prices go through the roof

THE OTHER DAY I was discussing rising oil prices with some friends, who were suggesting to me that the it's the market that is to blame for rapidly rising commodity prices.  I was explaining about the power of price signals and how these get muddled when governments intervene and they interrupted me to tell me that when oil is over one-hundred dollars a barrel, it's too late to talk -- it's obvious we're already running out.

I pointed out that oil is not at one-hundred dollars a barrel because we're running out of oil -- oil is at one-hundred dollars a barrel because in many parts of the world in which oil is (or could be) produced, producing oil is now essentially illegal.

In the continental USA for instance, restrictions on drilling around the Gulf of Mexico, Alaska, Wyoming, Utah, Colorado and New Mexico and other states stymie efforts to tap into what amount to huge resources. (Opening up these areas would provide enough oil to power 60 million cars for 60 years, plus enough natural gas to heat 60 million homes for 160 years, but 85 percent of coastal waters have been declared off limits, along with similar restrictions on 75 percent of the onshore prospects. [Quoted from: Sound of Cannons. Emphasis mine.])

Meanwhile, environmental restrictions on building new refineries and expanding the productive capacity of existing refineries has made it all but impossible to expand production of the reserves that do exist.

==>ERGO 1: It's not that "we" are running out of oil, but that producing oil is rapidly becoming illegal.

==>ERGO 2: It's not a failure of markets, it's an obvious success of government: success in stifling production of the very stuff of industrial life, and in burying the ability of producers to respond to price signals in the way they need to.

THE SAME SORT OF story can be found with other commodities. The problem with price rises in most commodities is not that 'we're running out of room to grow stuff' or that 'we've got too much free trade.' What we have is another government success story.  As the story of rice shows, there is an almost compete lack of free trade in the staff of life for about half of the world's population - trade itself is slowly becoming illegal.

While the global price of rice has almost doubled, for example, adjustment to these prices has been all but impossible. Says Tyler Cowen in the New York Times in a piece called Freer Trade Could Fill the World's Rice Bowl (hat tip Paul Walker):

    Although rice is the major foodstuff for about half of the world, it is highly protected and regulated. Only about 5 to 7 percent of the world’s rice production is traded across borders; that’s unusually low for an agricultural commodity.
    So when the price goes up — indeed, many varieties of rice have roughly doubled in price since 2007 — this highly segmented market means that the trade in rice doesn’t flow to the places of highest demand.

Cowen goes on to say:

    The more telling figure is that over the next year, international trade in rice is expected to decline more than 3 percent, when it should be expanding. The decline is attributable mainly to recent restrictions on rice exports in rice-producing countries like India, Indonesia, Vietnam, China, Cambodia and Egypt.

As Walker concludes, "when trade is restricted and food exports are made illegal"there is little incentive to plant, harvest or store rice. High prices should give producers the incentive to expand production, which is just what is needed for rice. But if producers can not access those high prices on the world market because of export restrictions, then they don't have the incentive needed."  It's surely impossible to disagree with his conclusion:

There are few areas in which free trade could do more good, than in the production of food.

UPDATE: Matt B in my comments section brilliantly explains how understanding price signals leads to the proper response to rising prices:

    How different peoples' reactions would be if, instead of reading "high prices," they read "scarcity".
    It would transform the debate. The immediate question that follows would not be demands for price controls or export restraints ,etc., but instead, "how do we raise supply?"

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11 Comments:

Blogger Matt B said...

How different peoples' reactions would be if, instead of reading "high prices," they read "scarcity".

It would transform the debate. The immediate question that follows would instead be, "how do we raise supply?" and not demands for price controls or export restraints ,etc.

Prices are surely the most misunderstood of all phenomena.

4/29/2008 02:50:00 pm  
Anonymous Anonymous said...

Peak Oil's a load of S***t it's the Greenies.

4/29/2008 03:11:00 pm  
Blogger Berend de Boer said...

It seems clear to me that schools are not teaching this basic economic stuff. Anyone knows a good (online) curriculum or video series that I can propose to my school?

And the viral option: any game that really teaches this? Games do this in a stuff (not enough of X, build more to produce it), but I'm not sure kids get that. Any game that makes that really clear?

PS: spot on Matt.

4/29/2008 04:44:00 pm  
Blogger Paul Walker said...

Consider this from Johan Norberg.net:

Say what you like about the French and their agricultural protectionism, but they are consistent. In 2003, the French agricultural minister Herve Gaymard defended the CAP by saying that poor countries should not concentrate on large-scale farming and export markets:

"...food cannot be left to the mercy of market forces"

Today we have a food crisis because poor countries have not been able to develop large-scale farming and export markets, partly because of the CAP. But obviously, the French agricultural minister Michel Barnier explains that the probem is too much markets and too little protectionism.

"What we are now witnessing in the world is the consequence of too much free-market liberalism"


So all our problems are due to the market!

4/29/2008 07:30:00 pm  
Anonymous Falafulu Fisi said...

PC, did you think about Cowen's quotation before you posted it or not? Here it is:

Cowen goes on to say:
The more telling figure is that over the next year, international trade in rice is expected to decline more than 3 percent, when it should be expanding.

What Cowen actually said was (economic) forecasting, which is something that you strongly opposed to. Now, if you deny that Cowen made some bold forecasting, then perhaps you could tell me if Cowen had traveled to the future, ie, year 2009 to witness this 3% decline, then came back to announce it? I am sure Cowen didn't use any econometric model to come up with that projection of 3% decline, but econometric modeling can do the same thing but it is more robust, than guess work (assuming that was what Cowen's conclusion).

4/29/2008 08:35:00 pm  
Blogger Daisy said...

it always surprises me when people talk about the rising prices...as if they are unexpected...do people not realize what is happening in the world...do they not think there are repercussions for the actions taken? perhaps if one just said "for every action there is a reaction" and walked away it would develop some thought...but i digress...

4/29/2008 09:03:00 pm  
Blogger Paul Walker said...

To say that "over the next year, international trade in rice is expected to decline more than 3 percent" isn't say that much since the decline is attributable mainly to recent restrictions on rice exports in rice-producing countries like India, Indonesia, Vietnam, China, Cambodia and Egypt. And we already know about the export restrictions since they are now in place.

4/29/2008 09:38:00 pm  
Blogger Futuristics said...

NICE Blog :)

4/29/2008 10:59:00 pm  
Anonymous LGM said...

FF

Were you not listening to the radio over the last few weeks? As PC and Paul have mentioned, rice exports are being restricted. If you deduct that from the trade you get the decline percentage. The exact percentage is not important really. The casue is the issue here.

LGM

4/30/2008 12:50:00 am  
Anonymous Simon said...

Why would you drill new wells in North America? Surely if supply is restricted then the value of your untapped oil fields goes up.

Let the Arabs sell oil at $100 when the price hits $300 then drill.

4/30/2008 07:10:00 am  
Blogger PC said...

Berend, you said, "It seems clear to me that schools are not teaching this basic economic stuff... any game that really teaches this? ... Any game that makes that really clear?"

I'm sure there must be.

I remember a very good online game demonstrating the principle of comparative advantage, ignorance of which leaves anyone utterly unqualified to talk about human affairs.

If you Google them, perhaps, and find any more of a similar quality demonstrating other important principles, I'd be happy to know.

4/30/2008 11:57:00 am  

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