Econ 101: Counting on the Government
Why does everyone expect the president and Congress to ‘fix’ gas prices?

By Gary Wolfram, Ph.D.
Business & Media Institute Adviser
May 3, 2006

     On April 29, 1996, in response to political polls, President Bill Clinton ordered the Energy and Justice Departments to investigate why gasoline prices had reached $1.27 per gallon. Ten years later, we find that once again politicians feel they must defend themselves from charges that they have failed to keep gasoline prices low enough to keep their constituents happy.

     Once again, they are calling for investigations into “price gouging” by the oil companies. Anyone who has a sense of how market economies work knows why the price of gasoline rises — demand is exceeding supply at the current price. The interesting question is not why gasoline prices are rising, but rather why the average adult thinks government should control the price and set it below the existing market price.

     In an earlier Econ 101 commentary, I pointed out the irony that those who would most benefit from the new French labor law were the ones rising up in protest over it. Americans have the same fundamental problems – they don’t understand the way the market works, including the role of profit and consumer-driven allocation of resources. When you add the readiness of government officials to seize power, it can lead to public policy that often makes the situation worse. It also results in public cynicism as politicians fail to accomplish what they claim they can.

     Politicians decry the “obscene” profits of the oil companies and call for increased taxes to allow the government to capture some of these profits. This would simply make matters worse. It is profit that attracts resources into the production of gasoline, adding to refining capacity, discovering new sources of oil, and other endeavors that increase the supply of oil. When the government threatens to tax profit, especially in a business as risky as oil and gasoline production, it will result in higher, not lower prices.

     The oil market has become inordinately risky as of late, mostly due to unstable foreign governments. Nigeria is in a crisis; there is tension between the United States and Venezuela; Iran is threatening to produce nuclear weapons; Iraq’s oil production is under threat from terrorists; and Bolivia has just sent troops into the oil fields. The only way to attract investors to this industry is to compensate for large risk with the possibility of large profits. A “windfall profits” tax would reduce the supply of oil and gasoline and drive prices higher.

     On the other hand, if the government were to set a maximum price on gasoline, it would immediately create shortages. This would recreate the 1973 disaster of long gasoline lines, government rationing, disruption of our transportation network, and general economic chaos. The lower the price set by the government, the worse the situation would be, as people hurried to snatch it up.

     Why do consumers call upon government to do such silly things? They don’t understand the role of profit. But they also don’t understand that consumers, not producers, control the economy. Oil companies cannot require consumers to buy gasoline. If your neighborhood Marathon station charged $5 per gallon, the first thing you would do would be to see if the ExxonMobil station down the road was cheaper. Marathon cannot set its price too far above its competitors, because the consumer will buy from another company.

     If all companies were selling gasoline at $5 per gallon, you would probably start riding your bike to work. If consumers buy cars with less horsepower or ride the bus, then the price of gasoline will fall. But Americans aren’t the only ones in the market – if millions of Chinese start buying cars, then the price of gasoline will rise.

     Our own government has added plenty to the price of gasoline. It requires specialty blends of gasoline for different regions of the country to meet pollution standards. The new government mandate for ethanol use along with a 54-cent ethanol tariff to exclude Brazilian ethanol will help politicians in the Iowa caucuses, but is another factor in rising gasoline prices. Government regulations make it difficult to add new refining capacity and to shift energy demand to nuclear power. The central and western Gulf of Mexico provides about a quarter of America’s domestic oil, in part because so many other possible sites are off limits. This creates additional risk from hurricanes to both oil production and refining.

     Politicians should heed the words written by French political philosopher Frederic Bastiat more than 150 years ago. He understood what happens when the idea that government is the solution to our problems prevails: “Good fortune and bad fortune, wealth and destitution, equality and inequality, virtue and vice — all depend upon political administration … There is not a grievance in the nation for which the government does not voluntarily make itself responsible. Is it not surprising, then, that every failure increases the threat of another revolution in France?”

     Politicians attempting to fix blame for high gasoline prices and busily finding “solutions” that make matters worse are evidence that we have reached the situation that Bastiat described. We need a revolution of ideas that will educate the American people and enable them to see their government’s capabilities more clearly.