The not-so-Golden State (?)
I wrote another letter to The Economist, but unfortunately the article I wrote about requires a subscription to read. I linked it anyway; all (both?) of my readers already subscribe to The Economist, right?
SIR – “The not-so-Golden State” (May 27) frets about growing poverty and inequality in California, and yet a big part of the answer to the “problem” is right in the article: “With unskilled immigrants pouring in from Latin America…the gap between rich and poor is growing faster in California than anywhere else in America.” But when poor Latin Americans move to California and get richer, both poverty and inequality obviously decrease. Perhaps California appears to have a problem only because the analysis is tied arbitrarily to political borders.
Michael Hartl
Orange, California
Oil Depletion and the Law of Diminishing Returns
Most people—including, lamentably, both most scientists and most politicians—don’t have a good understanding of economics, and as a result there is much confusion on the subject of oil depletion—sometimes called (in rather alarmist fashion) “peak oil”. My own thinking on the subject was sparked by David Goodstein, a physics professor at Caltech (where I got my physics Ph.D.). Goodstein is a principal exponent of the view that oil production will peak very soon (within one or two decades), and has expressed his view clearly in lectures and in his book, Out of Gas: The End of the Age of Oil. Goodstein is a clear thinker and an accomplished scientist, and he makes a compelling case; I am inclined to believe his claim that, at least when considering conventional sources and proven reserves, we are “running out of oil”. And yet, unlike him, I am not particularly worried. How can this be?
The answer begins with (a variation on) the law of diminishing returns, which says that people tend to exploit the best sources of a material first, so that over time the quality of these sources tends to decrease. (This formulation of diminishing returns is slightly different from the definition you might find in an economics textbook, but the two are closely related.) For example, copper miners first seek out the richest and most accessible ores, and switch to inferior ores only when the best sources have been exhausted. The law of diminishing returns might seem obvious, and it should. Unfortunately, commentators often fail to mention by far the most interesting aspect of this law: despite the law of diminishing returns, the price of material goods tends to decrease over time! Virtually all resources are cheaper now than they were in antiquity, for example. The reason for this is simple, yet profound: the productivity of human labor tends to increase fast enough to overcome diminishing returns. The result is that, despite diminishing returns, human beings are materially much better off now than our ancestors were, simply because we are so much more productive. It is worth reflecting on how remarkable this is, and how contrary it is to our naive intuition.
The second part of the answer lies with free markets and the price system. In a free market, as a material resource becomes depleted, its price rises (for a fixed quantity demanded). The increasing price provides an incentive to search out new sources of the material, to develop new technology to extract the resource in a new way, or to find a substitute for the resource. There is, of course, no guarantee that these new sources will be found, that the requisite technology will be developed, or that a suitable substitute will be found, but the historical evidence is unambiguous: humanity has never “run out” of any resource (or failed to find a suitable substitute) when free markets have been allowed to operate. Quite the opposite—since price is fundamentally a measure of scarcity, and prices (in inflation-adjusted dollars) of material goods have decreased over time, we are forced to conclude that we have more now of virtually everything.
Consider now the case of oil. When oil production peaks, its supply will begin to decrease; as a result, for a fixed (or growing) quantity demanded, the price will increase. As the price climbs ever higher, the incentive to exploit currently marginal oil sources (such as tar sands) will increase; sources unprofitable at $40/barrel might be highly profitable at $100/barrel. (As an aside, please understand and reject the nonsensical pseudo-thermodynamic arguments against tar sands and the like. For example, the so-called energy return on energy invested [EROEI], which supposedly makes tar sands unviable, is not fixed by physical law, but rather is a function of the technology used in extraction. Some sources of oil today, including many deep-sea deposits, had an EROEI less than one using the technology of twenty years ago, making their extraction uneconomical at the time. It is perfectly possible for a resource with an EROEI less than one now to have an EROEI greater than one in the future.) If, as has happened historically, improved technology more than compensates for the inferior quality of new oil sources, then the price of oil will eventually drop below the price that originally provided the incentive to develop the technology.
Of course, in a physical sense there must be a finite amount of oil, so if we continue to consume oil we must “run out” eventually. Luckily, oil is not the only source of energy; whether or not we run out of oil is irrelevant if we can find substitutes for its uses. Unfortunately, current “alternative” energy sources are not price-competitive with petroleum; fortunately, as scarcity forces the price of oil up they will become so. Moreover, the incentive to invest in, say, solar energy will be much higher if oil is trading at $100/barrel than it is at $40/barrel. As a result, if history is any guide, when oil is sufficiently expensive these incentives will lead to some major breakthrough in one or more alternative sources of energy, and ultimately the price of energy will actually decrease, as it has for centuries.
(I should note that petroleum has costs not reflected in its current price, most notably the cost of pollution and the taxes spent on military efforts to maintain stability in the oil-rich Middle East. It would probably be a step forward to include these costs in the price of oil somehow, such as a special tax on gasoline. Alternative sources still wouldn’t be price-competitive, but the cross-over point would certainly come sooner.)
Improvements in the productivity of labor, as the result of specialization and improving technology, have always allowed humanity to overcome the law of diminishing returns. It is possible that oil will be the exception; perhaps no one will figure out how to make tar sands a viable resource, or perhaps a “major breakthrough” in alternative energy won’t occur. Given the historical evidence, though, the onus is on those who think oil is different from other resources to prove their case. Moreover, for those who are optimistic enough to think that disaster might be averted somehow, the onus is on them to show that their preferred solution is better than the one provided by free markets and the price system.
When allowed to interact in free markets, human beings have shown a remarkable ability to overcome all manner of challenges, including the supposed depletion of natural resources. I am therefore sanguine about our prospects of thriving, even as we run out of oil.
On immigration
Immigration is a hot topic these days, so I thought I’d put in my 2¢. My solution to the immigration problem is (like many of my beliefs) politically untenable; but this blog is about intellectually honesty, not pragmatism, so here it is: open borders. There are many who argue against open borders because the ensuing flood of immigrants would overwhelm welfare programs, government-sponsored health care, the school system, and many other public services. These arguments are perfectly correct, except they are weak arguments against immigration; they are, however, strong arguments against public services.
Let’s take one of the main services people are worried about in this context: public schools. If schools were provided by private companies in the same way that, say, restaurants are, immigrants would represent additional potential customers, and their presence would be welcomed. Education companies and restaurants alike would rightly see immigrants as a new market. The reason that immigrants place a burden on the school system is that public education ignores the underlying economic reality that education is a scarce good. That is, education costs more to provide for many people than it does to provide for a few. The so-called burden derives not from a problem with immigrants, but rather from a defect in the way we provide educational services.
And so it goes for the other supposed reasons that open borders wouldn’t work. More people means more workers, more consumers, and more productivity generally. And that doesn’t go just for highly skilled workers; people in general are an economic positive, even if they are unskilled. To the extent that the “system” can’t handle new people, that’s an indication that the system itself is broken. And to the extent that immigration puts pressure on this broken system, that pressure (as computer hackers would say) is not a bug—it’s a feature. (Amazingly, I’m not the only one who thinks this way.)
Crushing Competition
Larry Lessig is a great thinker, but even he makes mistakes from time to time. The most recent installment of his Wired Magazine column is a case in point:
In “Crushing Competition” (issue 14.05), the usually razor-sharp Lawrence Lessig mistakes the revocation of a subsidy for the fostering of competition, and thus makes a correct point midst a dense fog of confusion. Byzantine tax regulations are a free lunch for accountants, and their simplification is analogous to closing an oil industry tax loophole or ending soybean subsidies. The state of California is thus right to make its tax forms simpler—but not for the reasons Lessig cites.
Instead, Lessig argues from broken analogies that any competition, even from government, is good. But government is uniquely able to crush its rivals with regulation and subsidize money-losing operations indefinitely through taxation. For example, private emergency services and private schools—two cases Lessig mentions—face ruinous competition from deeply entrenched, subsidized government services. Far from being “outrages”, attempts to cut (the taxes which provide) public funding for such services are laudable efforts to introduce to these industries the very competition Lessig so rightly celebrates.
Michael Hartl
Orange, California
Linguistic narcissism?
I have a hypothesis that some brilliant writers are afflicted by a kind of linguistic narcissism: their writing is so beautiful that they manage to convince themselves of bad ideas. Stephen Jay Gould, for example, wrote persuasively in favor of the Marxist view of human biology. Malcolm Gladwell’s Blink, crackling with wit and anecdote, advances the thesis that people are surprisingly good at making snap decisions on precious little information—except when they’re not.
Today I read the obituary of John Kenneth Galbraith, an economist known for his “witty and acid-penned” writing and critiques of consumerism and corporations. The brilliance of his writings may have blinded, not only his readers, but also Galbraith himself, to the flaws in his thinking.
To take one example, Galbraith once said that “I am struck by our superb capacity to manufacture consumer gadgetry, including electronic games, versus our capacity to produce schools.” His apparent astonishment is an indictment of “our” society’s priorities, but a simple rephrasing might ameliorate his confusion: “I am not struck by the superb capacity of private companies to manufacture consumer gadgetry, versus the capacity of governments to produce schools.”
My hypothesis could be wrong, of course; bad ideas might have nothing to do with verbal fluency. There are, after all, plenty of excellent writers whose principal ideas are not obviously wrong. But I suspect that some people’s capacity for self-deception is enhanced by their falling in love with their own (literary) voice.
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