The question of crude: Europe’s going to party like it’s 1979
It’s a cautionary tale, but the moral of the story isn’t that governments should always let prices rise as high as needed to balance demand with supply. Sometimes there are good social reasons not to let markets rip, even if government intervention comes at a cost
You probably have to be a senior citizen to remember the gasoline shortages of 1979. I am, and I do. I also remember how demoralising they were. Then as now, outside a few big cities, America was a highly car-dependent nation, and waiting in long lines, not knowing whether you would be able to fill up, was deeply disconcerting.
What caused those shortages? The precipitating event was the Iranian revolution, which sent world oil prices soaring. But an oil price surge in itself needn’t mean gasoline shortages; it could — as we’ve seen recently — just mean higher prices at the pump.
The problem was that policymakers weren’t willing to see that global price hike fully passed on to U.S. consumers, given that only about 40 percent of the oil we consumed was imported. So they tried to limit the hit with various controls on prices and distribution; we needn’t go into the details. The point is that as every economics textbook will tell you, price controls often (not always) lead to an excess of demand over supply, and that was where the lines and shortages came from.
It’s a cautionary tale, but the moral of the story isn’t that governments should always let prices rise as high as needed to balance demand with supply. When politicians don’t do what Econ 101 says they should, it’s not necessarily because they’re stupid (although sometimes they are); it’s not even necessarily because they’re cynical (although that happens too). Sometimes there are good social reasons not to let markets rip, even if government intervention comes at a cost.
Which is why we’re probably about to see a number of countries intervening heavily in energy markets over the next few months.
America, where plunging gasoline prices have temporarily brought inflation down to zero, won’t be one of those countries. But Russia has drastically curtailed shipments of natural gas to Europe, and European households are facing a huge inflationary shock as a result.
You might wonder why Russia’s de facto embargo matters so much. After all, Russia isn’t the only provider of European natural gas, and gas is only one of Europe’s energy sources. Consider, for example, British electricity generation. Gas accounts for only roughly 35 percent of Britain’s electricity, and currently none of it comes from Russia:
Yet British home energy bills are skyrocketing. Why?
Part of the answer is that, as I wrote last Friday, markets in natural gas are basically defined as regions served by particular pipeline networks; and even though it doesn’t import gas directly from Russia, Britain is part of the European gas market. Russia’s stealth embargo has sent prices in that market soaring. Even so, isn’t gas just part of the British picture? Yes, but as the textbooks tell us, a good’s price normally reflects not its average cost of production but its marginal cost — the cost of the last, most expensive unit. In Britain right now, the marginal kilowatt-hour is produced with gas. So it’s up, up and away — unless the government steps in. Which it will.
Just letting things rip isn’t an option, not in a democracy anyway. Without government intervention, energy prices would rise so much that millions of families would be financially ruined. Something has to give. In Britain specifically, the policy picture is especially murky because Liz Truss, the most likely successor to Boris Johnson, is refusing to announce her energy policy until she takes office. At this point it sounds as if the preferred policy is likely to involve financial aid to families rather than the price caps France and Spain, among others, have imposed. That is, keep consumers paying sky-high prices for each additional unit of energy they consume, but give them a check to help them afford what they were already consuming.
In practice, however, this probably won’t be enough, because families’ needs will differ so much. Even among people with similar incomes, some will live in houses with good insulation and low energy bills, others in drafty, energy-guzzling buildings. In the long run, policy should encourage everyone to upgrade their personal energy efficiency, but in the long run we are all, well, not dead, but quite possibly impoverished in the face of this gigantic price shock So my guess is that actual policy will be a hodgepodge. There will be financial aid to help pay energy bills, paid for in part with excess profits taxes on domestic energy companies. But there will also be price caps and probably some form of rationing.
Overall, European energy policy in 2022-23 is likely to bear a family resemblance to U.S. policy in 1979-80 — not because policymakers are stupid, but because the need to limit extreme hardship will force some awkward compromises. And that won’t be the worst thing in the world, so long as it’s a temporary state of affairs. Rationing and, maybe, occasional energy shortages will be inconvenient and deeply annoying; but Europe will cope if they last for months rather than years. It would be a different story if we were looking at a permanent regime of price controls, à la Venezuela, but that isn’t likely. Even if the war in Ukraine goes on, Europe will both develop more sophisticated systems of energy allocation and gradually wean itself off its dependence on Russian gas. Until then, we’re getting a lesson in the limits of Econ 101. Sometimes you just can’t do what the textbook says you should.