Man Without Qualities

Thursday, April 11, 2002

Ask the Expert!

Paul Krugman’s new column says we are at risk of a new “oil shock.” It is not on the surface a very partisan piece of writing – and that is precisely the reason the Man Without Qualities believes the column demonstrates the pathologies that make reliance on Mr. Krugman dangerous, regardless of the political orientation of the reader. The column illustrates Mr. Krugman’s apparent growing if concealed concern with conspiracies, a reluctance to acknowledge even in non-political contexts historical facts embarrassing to his political beliefs, and a tendency to ignore rather than address the economic observation of others. The problems seem to run much deeper than those of an academic who turns his hand to partisan argument in the context of a newspaper column when the need arises in that context.

In the course of describing why he believes “an oil crisis can happen so easily”, Mr. Krugman says:

“Economists have never reached a consensus about what happened in 1979, but my interpretation is that it was similar to the recent California electricity crisis. In both cases the key was the combination of a tight market and demand that wasn't very responsive to price. Under those circumstances, individual producers — power companies in California, oil-producing countries in 1979 — have a lot of market power. That is, it is in each producer's interest to cut back production to drive prices higher. The result is a price surge, even though there is no real capacity shortage.”

If there is a topic remotely approaching the scale of “what happened in 1979” with respect to which “economists have reached a consensus,” the Man Without Qualities is unaware of it. Indeed, some of Mr. Krugman's colleagues at the Princeton economics department still appear to be defending what they called their “quasi-experiment” that purported to show employment going up when the price of labor is raised by minimum wage laws, despite what appeared to be fairly persuasive discrediting –albeit perhaps not in “peer review” journals.

But whatever it is that is denying the economists their consensus with respect to “what happened in 1979,” it is likely that a lot of them would believe that an explanation of “what happened in 1979” should begin with OPEC's decision in summer of 1979 to increase crude oil prices by 40 percent. Mr. Krugman notes that “the 1979 oil crisis wasn't the result of a deliberate embargo.” But it did involve collusive efforts to raise prices, efforts that were considerably aided when on November 4, 1979 religious revolutionaries in Iran overthrew the Shah and cut off its oil.

Conspiracies increasingly seem to peer from between the staves of Mr. Krugman’s writings, as though such preoccupations may drive his thinking more than he acknowledges. (He has previously written, "A bizarre thing happened to me over the past week: Conservative newspapers and columnists made a concerted effort to portray me as a guilty party ...") Collusion is important for his argument here because without collusion it is almost never “in each producer's interest to cut back production to drive prices higher,” tight market or not, and the 1979 OPEC collusion was open and notorious. It therefore weakens his reasoning considerably for Mr. Krugman to opine that the 1979 oil crisis “was similar to the recent California electricity crisis” without even addressing the issue of collusion in the California case. He appears to be saying that he thinks the California energy crisis included an OPEC style agreement among the energy producers – but the matter is oddly left open. It is common knowledge that some people controversially alleged collusion among California energy suppliers – allegations still passed around although apparently never substantiated. So Mr. Krugman couldn’t persuasively argue that he didn’t implicitly raised the issue in connection with both the events of 1979 and those in California. The reader may wish to evaluate Mr. Krugman’s photograph now appearing in the Times.

Moreover, Mr. Krugman states “the 1979 oil crisis wasn't the result of a deliberate embargo,” but he does not acknowledge that Jimmy Carter placed an embargo on importing Iranian oil into the United States – a dubious economic decision. The self-imposition of an oil embargo by a Democratic President whose handling of that particular crisis is generally viewed as poor may be painful or embarrassing for Mr. Krugman, but it does seem to be material to the issues he raises.

Mr. Krugman says that “it would not take much worsening in the political situation to produce markets so tight that the logic of market power kicks in and countries decide that, quite aside from politics, their financial interest lies in reducing, not increasing, their output.” But others have noted that “OPEC itself learned during the 1980s that permitting oil prices to overshoot on the upside also generates tremendous microeconomic adjustments, which can set the stage for a price collapse.” That argument is deserving of at least mention if one is going to bring up the issue of how oil producing countries perceive their own “financial interests.”

The danger to the US arises, Mr. Krugman says, because “we made ourselves crisis-proof for a while, then became complacent. After the oil crises of the 1970's, Western economies sharply increased their energy efficiency. … The result was the marginalization of the danger zone … But rapidly growing oil consumption in the S.U.V. era was met, inevitably, by increased Persian Gulf production. So oil prices are once again hostage to Middle Eastern politics.”

But Mr. Krugman ignores profound statistics that do not support his “S.U.V. era” argument. According to the Department of Energy, per capita oil consumption in the United States has not increased in “the S.U.V. era.” In fact, aggregate oil consumption has increased at about the rate of population growth. A major (and ignored) difference between the national energy positions in 1979 and today lies in the fact that the amount of energy required to create each dollar of American wealth has dropped dramatically and continuously in each year since 1972. And the US industrial sector has become far more efficient at energy consumption. In 1998, for example, US oil imports were equal to 0.6% of GDP compared to 1.9% in 1978.

I do not believe Mr. Krugman omits to treat the above factors in this column because he is partisan or dishonest or because of space considerations. The column is not very partisan (although Mr. Krugman's disapproving reference to the "S.U.V. era" does suggest criticism of the Bush Administration's CAFE decisions), and there is no apparent reason for Mr. Krugman to be dishonest. Nor would it be necessary to fully argue each such factor and consume that space. Acknowledging their existence would have been enough to indicate his awareness. It seems that Mr. Krugman simply did not have these things in his mind when he wrote the column. It appears not to have been deliberate.

Mr. Krugman also says that in the event of an “oil shock” the Fed would likely not raise interest rates as it did in 1979, and that much appears to be correct. But it is not because, as he puts it, “[t]oday, after a decade of price stability, fears of inflation are much more muted.” That makes it sound as if the Fed has been led into the same mere complaisance that Mr. Krugman elsewhere ascribes to the nation generally in energy matters. In fact, US core inflation rate has been suppressed by productivity growth – and other observers have noted that “the Fed would be far more alarmed about oil prices if it saw compelling evidence that the growth rate of productivity was slackening.” Mr. Krugman’s thinking in this area again seems dangerously incomplete. He restricts himself to observing that “the Fed can't respond with another big round of interest rate cuts: since it has already reduced rates from 6.5 to 1.75 percent, it doesn't have much ammunition left.”

Mr. Krugman’s gloomy, fragmented and dangerously incomplete thinking is not just reflected in this column. In the book, Public Intellectuals: A Study of Decline, Richard Posner refers to a striking example of Mr. Krugman's work product:

"In a book published in 1990 [The Age of Diminished Expectations] he had offered as 'the most likely forecast for the U.S. domestic economy in the 1990s.... fairly slow growth, modestly rising incomes for most Americans, generally good employment performance, [and] a gradual accumulation of inflation' to 7 percent. He predicted that by 2000 the United States would 'have sunk to the number three economic power in the world,' after Europe and Japan, and that the world economy would be less unified than it had been in the 1980s. He published a ‘revised and updated' edition four years later, but retained these predictions."

Mr. Krugman's book cannot be dismissed as a partisan frolic by a serious academic. Something serious is going on here.

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