Are We Doomed for Another Oil Shock?

May 12, 2006 | by | Topic: Economics & Political SystemsPrint Print

Guest Commentary

Like most people, I feel the sting when it costs $55 to fill up the family minivan. As a result, I’ve been driving around town more often in our Civic, which gets twice the gas mileage. I suspect many of you are wrestling with similar choices.

As someone who studies and teaches economics, I have had other, more troubling thoughts concerning the current price spikes: As gas prices have inched higher, I began to wonder if we would experience a repeat of the cost-push stagflation of the 1970s. None of us wants to relive the nightmare of those oil shocks.

To my surprise, the data suggests the opposite. The economy is growing, unemployment is low, and inflation is tame. By any measure, these numbers are superb. How can it be that this economy is holding up so well when the last time we faced a significant spike in oil prices in the 1970s, the U.S. economy suffered through two painful recessions?

Before explaining why this price episode is markedly different, let us go back in time.

As a teen, I witnessed the oil embargo from the backseat of my parents’ station wagon. Gas lines were long, and gas was in short supply. Everyone had to plan ahead to get gasoline, and rationing meant that travel was restricted and people stayed closer to home. This put a damper on economic activity and contributed to the already low downturn. In the 1970s, supply was short.

Today, demand is high. This is a big distinction. People can get gasoline today, but it costs more. Consider why this matters:

A demand-driven price change works differently than a supply-driven change. The higher prices are a result of increased domestic and international demand for gasoline. Price increases do not stop people from driving; the gas is still there, but the increases do cause people to spend more on gasoline. Think of this as the circle of life: When I fill up, I get the gas I want and the station gets the dollars it wants. Those dollars do not disappear — they are circulated throughout the economy. Gas-station owners take the dollars they receive and buy stuff that they want, which, in turn, becomes someone else’s income. This pattern repeats itself until these exchanges eventually peter out. In short, a demand-driven price increase alters how we spend our incomes but not how much we spend.

Am I happy about higher gas prices? No. Gasoline is taking up a larger share of my monthly expenditures; however, this has not stopped me from continuing to spend. And apparently I am not alone. Worldwide economic growth, most notably in the United States, China and India, has led to significant increases in the demand for energy. So everyone is partly to blame for higher gas prices.

And since politicians do not want to get caught in the uproar over prices, both sides of the political aisle are pointing fingers and trying to insulate themselves from the wrath of angry consumers. The frenzy among lawmakers led the U.S. House to pass a bill to make oil price gouging a federal crime. The vote was 389-34, in spite of the fact that price gouging associated with gasoline sales has been almost non-existent. Intervention in the market is not the answer.

What is the answer? The market. The U.S. economy is now larger, more diverse, and flexible than it has ever been. In the past 30 years, the economy has doubled in size, created tens of millions of new jobs, and re-centered itself for the information age. Ideas can be brought to the market more quickly, and the Internet has spurred new forms of commerce. All of this has reduced our dependence on oil. Furthermore, innovations have created more fuel-efficient vehicles and hybrids, making the typical automobile today twice as efficient as the gas-guzzlers of the 1970s, so we don’t need as much gas to get where we need to go.

Compared with our counterparts in Europe, who pay $7 per gallon, gasoline is still cheap and plentiful here. By the time this is no longer true, the market’s invisible forces will have perfected alternatives to power the transition to another source of energy.

This is the good news. Unfortunately, the bad news is that this message is lost on the media and on Capitol Hill. That means that fingers will keep on pointing.

Dirk Mateer

Dirk Mateer

Dr. Dirk Mateer is a Senior Lecturer and Director of Undergraduate Studies in Economics at Penn State University and a contributing scholar with The Center for Vision & Values at Grove City College.

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