TCS Daily

No War Over Oil

By Arnold Kling - February 4, 2005 12:00 AM

"Many of the leading neoconservatives who pushed hard for the Iraq war are going green. James Woolsey, the former director of the Central Intelligence Agency and staunch backer of the Iraq war, now drives a 58-miles-per-gallon Toyota Prius and has two more hybrid vehicles on order. Frank Gaffney, the president of the Center for Security Policy and another neocon who championed the war, has been speaking regularly in Washington about fuel efficiency and plant-based bio-fuels."
-- Robert Bryce, Slate magazine


Irving Kristol wrote in The Neoconservative Persuasion that neoconservatives "tend to be more interested in history than economics or sociology." If neoconservatives want to launch a war over oil using hybrid automobiles and plant-based bio-fuels, then I fear that the cost of their economic ignorance could make the invasion of Iraq look cheap by comparison.


What upsets neocons and others is that with oil prices high, Saudi Arabia and other oil producers earn a large windfall. We seem to have considerable xenophobia concerning the Saudis. For example, Andrew Sullivan recently featured a letter from a reader which said, "It angers me that the political, economic and military security of my country depends in large part on the continued goodwill of a bunch of fanatical men wearing dresses who dream about the 7th Century." Apparently, hatred of the Saudis is so intense that America's most prominent gay conservative approves of attacking them as "men wearing dresses."


Review of Oil Econ 101


In Oil Econ 101, I tried to explain why there is no way to extricate ourselves from the market for Saudi oil. Briefly stated, the point is that oil is oil. Think of every country's production as flowing into one big pool, where it all gets mixed together before consumers draw on the oil for consumption. Given the commodity nature of oil, we cannot arrange to reduce demand for Saudi oil alone. If we are going to reduce demand, it has to be for oil in general. The effect of even a 10 percent reduction in world oil demand on the number of barrels of Saudi oil consumed would likely be minimal, because Saudi oil is the cheapest oil and hence the least likely to be rendered uneconomic to produce.


The point that I made in Oil Econ 101 is that it is possible, and sensible, to separate economic issues from political issues. That is, it is possible to confront Saudi Arabia concerning policies that allegedly contribute to terrorism without first reducing our demand for oil. In fact, in a narrow sense I believe that we have brought the Saudi government around to the view that the militants are the bad guys. Their government has made some moves in the direction of arresting bad guys and reducing funding for terrorism.


In the larger sense, the United States has not done much to stop the flow of hate rhetoric emanating from mosques throughout the world. I am disappointed by the slow progress in The Battle of the Mosque. I would be confronting the Saudis over these sorts of reports, for example. However, I think that our laxity on the issue of Mosque-centered incitement and terrorist recruitment represents a lack of focus on the part of the Administration, for reasons having nothing to do with oil. My sense is that the Administration is more squeamish than I am about taking on Islamic extremism as a religious issue and more hopeful than I am about the democratization strategy for undermining radical Islam.


Why do so many people want to wage economic warfare against the Saudis? Certainly not because of any evidence that economic warfare is effective. We have had sanctions against Cuba for almost 50 years. Did the Castro regime fall? Why do we believe that if oil prices were lower that the Saudi regime would topple or, if it did, that the new regime would be democratic?


Economic warfare is a "feel-good" approach that provides a false sense of accomplishment. It is a form of protest politics rather than a serious effort to influence policy. See Don't Smoot the Weasels or Free Trade with the AARP.


Costs of Conservation


Energy conservation sounds like a painless way to lower the Saudis' income. Who could be against conservation?


The point to keep in mind is that any oil conservation program will do two things. First, it will reduce our ratio of oil consumption to Gross Domestic Product (GDP, the total value of goods and services produced each year). Second, oil conservation will reduce GDP. The reason it will reduce GDP is that we will have to substitute other factors of production, including labor, capital, and more costly forms of energy, in order to conserve on oil.


I have received emails suggesting that the United States should aim for a 10 percent reduction in its energy consumption, because this would cause a significant drop in the price of oil. But how much would this reduce our GDP? Perhaps by as much as 10 percent. Even if it only were to reduce our GDP by 5 percent, that would be $500 billion. If your goal is to change the foreign policy of Saudi Arabia, my guess is that there are ways of doing so that would cost less than $500 billion.


The reality is that energy conservation is a feeble tool for foreign policy. Significant conservation could be very costly to our own country. It might have only a small effect on Saudi oil revenue. It is not at all clear that a drop in Saudi oil revenue would bring about favorable changes in their policies toward terrorism.


Conservation Tax


The most cost-effective policy for trying to reduce the oil revenues received by Saudi Arabia would be some sort of tax that encourages energy conservation. A very high gasoline tax (more than one dollar per gallon), perhaps along with taxes on other oil-based fuels, such as jet fuel, would serve that purpose. Although a gasoline tax would make our economy less efficient and reduce our GDP, it would succeed in transferring some revenue from the owners of oil to our government.


Compared to a tax, other policies, such as fuel economy standards for automobiles, would be less effective. Raising the fuel economy of new cars would do nothing to discourage people from driving older cars with low gas mileage. Moreover, if the price of gasoline remains the same, better fuel economy in cars might encourage people to drive more, with little or no net reduction in gasoline consumption.


Even a fuel consumption tax would not reduce world demand for oil by as much as it would reduce our own consumption of fuel products. That is because as the price of oil declines, demand will increase in other countries.


Another adverse effect of a fuel consumption tax would be on the incentive to explore and produce oil elsewhere. Peter Huber and Mark Mills argue that there are large oil reserves in the Western Hemisphere that are uneconomical to exploit at low oil prices. A fuel consumption tax would tend to keep those reserves untapped, so that the market share accounted for by Saudi oil would remain high.


Alternative Energy


In my view, the worst policy option of all is to subsidize the use of alternative forms of energy. If other forms of energy are not economical on their own, then taxpayer subsidies are only harmful. The use of subsidized alternative energy does more damage to our own economy than to Saudi Arabia's.


We have a real foreign policy issue regarding Saudi Arabia. We should be leaning on the Saudis to reduce funding for radical Islamic schools and mosques.


However, I believe that trying to contort our economy in order to reduce oil consumption is a poor way of addressing the real foreign policy issue. It would be difficult and very costly for the United States to manipulate the price of oil downward. Even if we were to succeed in lowering the price of oil, it is not clear that this would have much effect on the Saudi policies that concern us.


Although engaging in the protest politics of trying to reduce the price of oil would be ineffectual, it would not be inexpensive. We could easily cost our economy hundreds of billions of dollars in annual GDP for many years.


In contrast, if we were to invade Saudi Arabia, it would cost less and we could be more certain of achieving the desired policy changes there. Does that make an invasion a good idea? No. The point is that launching an economic war to try to reduce the price of oil is an even worse idea.


TCS Daily Archives