The Gulf Oil Spill and the Myth of Affordable Energy

The gulf oil spill (more accurately, the underwater gusher) has brought a new focus on U.S. energy policy. The spill has put the oil establishment on the defensive, but it is trying desperately to use the mantra of "affordable energy" to deflect criticism. "We need the oil that comes from the gulf to keep the economy moving," Sen. Mary Landrieu (D-LA) told the Wall Street Journal. "Affordable energy affects every sector of the economy," a spokesman for the American Petroleum Institute wrote in a letter to the New York Times.

If we cut through the rhetoric, do the facts support the thesis that countries with "affordable" (read: cheap) energy perform better than those with more expensive energy? They do not. The price of crude oil is about the same everywhere in the world, so we can use retail gasoline prices as a proxy for national energy policy. (A chart of retail gasoline prices and related data can be found in the PowerPoint slides that accompany this post.) Retail gasoline prices range from over $5 per gallon in much of Europe to just a few cents a gallon in countries like Iraq, Iran, and Venezuela.

One argument is that higher energy prices would undercut U.S. exports. However, among the world's four biggest exporters, Germany and Japan, the world export leaders in per capita terms, have far higher retail energy prices than the U.S. and China.

Another claim is that high energy prices would deepen the recession and worsen our already serious budget problems. But Norway, a rarity among energy exporters that keeps domestic retail prices purposely high, has experienced a far milder recession than the U.S. or the OECD average. Where the U.S. national debt is high and rising, the Norwegian government has net assets equal to 140 percent of GDP, bankrolled in part with high energy taxes.

The countries that outdo all others in the "affordable energy" sweepstakes are economic basket cases like Iran and Venezuela. They suffer high inflation and unemployment, and their energy policies are paralyzed by fears of social unrest. Iran actually has to import much of its gasoline, a dire threat to national security at a time when the country is threatened with sanctions.

Why does cheap energy undercut an economy? It's simple. For a market economy to function properly, prices should reflect opportunity costs. U.S. gasoline prices, and the prices of many other forms of energy, fall far short of opportunity cost because they do not reflect externalities like climate change, oil spills, smog, and traffic congestion.

Abraham Lincoln had a favorite riddle: "How many legs does a dog have, if you call a tail a leg?" Answer: Four. Calling a tail a leg doesn't make it a leg. By the same logic, calling cheap energy "affordable" does not make it affordable. If we don't pay the true cost of energy at the pump, we have to pay for it through economic distortions, pollution, and threats to national security.

The bottom line: We can't afford "affordable" energy. There Ain't No Such Thing as a Free Lunch!

Click here to download a free set of PowerPoint slides with data, text, and charts related to the myth of affordable energy. Cut-and-paste the slides into your economics lectures, or assign them as independent readings.


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