Thursday, November 03, 2005

Another Doomster Who Misunderstands Economics 101

Eric Sprott, CEO, and Sasha Solunac an analyst, are at Toronto-based Sprott Asset Management Inc. They have posted a piece in Financial Post (Canada) on oil prices and the latest in ‘peak oil’ hysteria (‘its going to happen someday and will be awful; not if, but when, etc.,’). Now I am not going to get dragged into discussing ‘peak oil’ and its assorted consequences. My interest is in their dragging Adam Smith into their rant, er, sorry, problematic conclusions.

“Mr. Foster [author of two editorials criticising peak oil alarmists] apparently relies on blind faith in "free markets" and "human ingenuity" to avert an energy crisis. Furthermore, according to Mr. Foster, any attempt by governments, through energy policy or otherwise, to do anything about the looming crisis is wrong. He likens such actions to those of "old Soviet planners" and attempts to turn the peak-oil problem into a left-versus-right ideological debate. Unfortunately, we believe that laissez faire in this instance is tantamount to a head-in-the-sand approach that accelerates the problem rather than alleviating it.”

The use of laissez faire tells us where they are going, and they go there.

“Don't get us wrong. We are proponents of free markets a la Adam Smith. However, and unfortunately, oil is not a widget that can be produced freely depending on supply/demand signals.”

Sorry, Eric Sprott and Sasha Solunac, but ‘producing freely’ is not the role of supply and demand. Indeed, the process by which supply or demand, speaking loosely, adjust to each other is not instantaneous – they do not have a capacity for an infinite velocity in their adjustments – their effects lag rather than act immediately and it is in those lags that they take effect.

“Therefore, to ignore the fact of peak oil and "let the markets decide" is naive at best and disastrous at worst. Human history is replete with examples of mismanagement of resources when left in the hands of the free markets. One example that immediately comes to mind is the Newfoundland cod fishery.”

Excuse me, Eric Sprott and Sasha Solunac, but there was never a market in Newfoundland cod fishery; nobody held property rights in the cod and that was the problem. It is called the ‘Tragedy of the Commons’ and was discussed in the 18th century by David Hume, and since by many others.

Cod fishing when the cod is treated as a free good is bound to lead to over fishing. It is not a contradiction with supply and demand, nor is relevant to the operation of the price mechanism on a private good like oil. Quite the reverse, if oil prices are unconstrained, the price mechanism would be the most efficient and effective way to reduce the quanity of oil demanded in line with the fall in supply from anything like ‘peak oil’, and with least disruption (which is not the same as no disruption).

“Sorry Adam Smith, but individuals acting for their own benefit do not always produce an outcome that is best for the whole. In this case, laissez faire failed and we are now without the cod that was once considered boundlessly abundant.”

Sorry Eric Sprott and Sasha Solunac but Adam Smith never said that “individuals acting for their own benefit do not always produce an outcome that is best for the whole.”

You have misread or misheard what Smith actually said. He was well aware that individuals pursuing their self interest do not necessarily, or always, produce the best outcome – consider his strictures against ‘merchants and manufacturers’ who create monopolies, restrict supplies, raise prices and reduce the real incomes of wage earners. You make your case only by exaggerating his policies. Incidentally, he never used the words laissez faire.

The absence of property rights in cod caused it to be over exploited. With property rights established, cod would become an economic good – excess demand at zero price – and with a price on its extraction, the quantity demanded would be brought into line, with a lagged adjustment for the owners to police their property rights in the cod, and it would remain renewable. If cod became scarcer in a season, the price would rise and fewer extractions would be made as people switched to consume alternatives. It has nothing to do with so-called laissez faire. In fact the exact opposite. Higher prices for economic goods like oil curtail the effective quantity demanded!

Eric Sprott and Sasha Solunac could take up the bet with John Tierney of the New York Times if they are so sure that economists have got ‘peak oil wrong. Mr Tierney has bet that oil prices (or any commodity) will be the same or lower in real terms in 2010 as they are today (see the archive article on this blog under August, from the options on the right column). He is as confident as Julian Simon was in the great oil price hike in the 70s; Simon took a $1,000 dollar bet that they would be the same or lower and won. Tierney is so confident that he is right that he will take any amount of bets to the contrary. And Tierney has also extended his bet challenge to anybody:

‘If you think the price of oil or some other natural resource is going to soar, show me the money.’”Now, why don’t the doomsters, panic merchants, scare mongers and environmentalists rush their bets to Tierney – he can be found on email: Tierney(at) – but somehow I do not think he will be kept busy covering his bets.”

Meanwhile, if peak oil is reached tomorrow, next month, next year or next decade, and if politicans allow the price to adjust as supply falls, the quanity demanded will eventually fall as consumers ration their purchases, starting with the poorest, and begin to switch to alternatives, which producers have strong profit incentives to search for and make available, and even more consumers switch (rich and poor alike) as the options became available.Politicans – and doomsters – can inhibit the adjustment by imposing price controls, planning and prohibitions.

Read the full article:
National Post (‘a better read’)


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