David R. Henderson  

My Review of Hubbard and Navarro

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From "Good on Taxes, Bad on Trade," my review of Glenn Hubbard's and Peter Navarro's book, Seeds of Destruction in the latest Policy Review:

The strongest chapter, by far, is the one titled, "Why You Can't Stimulate Your Way to Prosperity." This case against using increases in government spending as a countercyclical policy to end a recession is a nice blend of economic and political analysis. Hubbard and Navarro point out what has long been an argument against such policies: the often long lag between when a law increases spending and when the spending actually occurs. But they go further and draw on some more-recent research by Harvard economists Alberto Alesina and Silvia Ardagna that has justifiably received much attention. Alesina and Ardagna, examining fiscal stimulus in 21 countries, found that the most successful ones relied "almost entirely on cuts in business and income taxes" and that the least successful relied on increased government spending.

They write: "Oil's brake on net exports is an obvious problem." No, it's not. As international-trade economists have understood since Adam Smith, it's better to buy cheaply from people in another country than expensively from high-cost producers in our own country. Incidentally, they write that Adam Smith and David Ricardo were contemporaries. No, they weren't. When Adam Smith died in 1790 at age 67, Ricardo was eighteen years old.

Another problem, state Hubbard and Navarro, is that America's heavy oil dependence makes our economy far more vulnerable to slower growth and recessions triggered by sudden price increases. But because oil is traded in a world market, we are vulnerable to price increases whether we import all or none of our oil. So whether we produce all or none of the oil we use, an oil price increase hurts our consumers the same amount. To be sure, if we imported less oil and produced more domestically, a price increase would help our producers. But how would we put ourselves in the position of having more production? By guaranteeing a higher price to domestic producers. By insisting on higher-cost domestic production, we would avoid the possibility of more-expensive oil when prices spike for the certainty of more-expensive oil all the time.


What Hubbard and Navarro do not recognize is that their very proposal would give increased market power to OPEC, making world prices higher than otherwise. There is a scholarly literature on this in the Energy Journal, to which I have contributed, but about which they seem unaware. A price floor on oil sold to the United States, a country that uses about one quarter of the world's oil, would make U.S. consumers artificially insensitive to any world price of oil below the price floor.

Currently, OPEC has to trade off the higher revenue per barrel of a price increase with the reduced number of barrels sold. But OPEC officials would quickly figure out that if they reduced the price of oil below the U.S. price floor, there would be no such tradeoff in the U.S. market. No matter how low OPEC cut the price below the floor, the increase in barrels demanded from the United States would be zero because the U.S. government would not allow its consumers to buy at that price. If, for example, the price floor were set at Hubbard's and Navarro's hypothetical $100 per barrel, and OPEC considered cutting the price from $100 to $40, it would not sell a single barrel more in a market that accounts for one quarter of the world market. The good news is that U.S. consumers don't use all the oil in the world. If they did, then OPEC would set the price at that price floor. The bad news is that because we do consume so much oil, OPEC would be less likely to cut price. Thus, ironically, the authors' proposal would transfer wealth from world oil consumers to those same countries that they regard as our enemies.


For my articles in Energy Journal, see this and this.



COMMENTS (3 to date)
Maxwell writes:
Another problem, state Hubbard and Navarro, is that America's heavy oil dependence makes our economy far more vulnerable to slower growth and recessions triggered by sudden price increases. But because oil is traded in a world market, we are vulnerable to price increases whether we import all or none of our oil.

It's unclear from your block quotes above, but do H&N make any reference to lowering restrictions on other forms of energy (ie nuclear) in the United States? Surely that would make the US less vulnerable to fluctuations in oil prices, no?

Hyena writes:

That was my thought as well. Are they talking about substituting foreign oil for domestic oil or for less oil dependence overall?

Jan writes:

Hubbard and Navarro are right about oil. You are wrong.

And then you compound your error by repeating a mediocre undergraduate's understanding of the economics of trade.


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