Greg RehmkeI wrote earlier (April 1) to argue that the increase in oil prices over the last few years was providing a vast stimulation both to further oil exploration and development, and to expand effective (i.e. private sector) research and development of alternative energy and electric cars.

I asked then how far oil prices would fall as new energy supplies came on-stream and Americans purchased smaller cars and reduced their driving. Of course oil prices continued up since that April 1 post ("How Low Will Oil Prices Go? "). My frustration then was with the media's continued calls for government to intervene, and reporter's lack of understanding or appreciation of markets. New York Times reporters seem always surprised when automobile use declines in response to higher gas prices. And reporters usually claim oil prices have fallen only because world economies are in recession or teetering on the edge. (For many reporters, recession fears will end only when a democrat is again confidently pushing and pulling the levers of executive power.)

I was in error, in April, in assuming that consumers around the world were paying higher prices for oil, as they were in the US. If $3 and $4 a gallon oil was significantly reducing driving in the very rich US, it should have had a larger impact in poor countries. But of course governments in China, India, Indonesia, Russia and elsewhere have even less faith in markets. Price controls and subsidies there insulated their population from higher oil prices. Distorting or blocking price signals prevents recalculation of transportation resources. Transporters keep driving older inefficient (and heavily-polluting) vehicles instead of trading up to cleaner, higher mileage vehicles. Subsidized gas and heavy taxes on new cars are a source of air pollution in Cairo that is 10 to 100 times acceptable standards. Removing taxes on new cars and allowing fuel prices to rise would help clean the air at minimal net cost. (And if state governments in the US would suspend sales taxes on new and used cars, consumers at all income levels would quickly trade up to cleaner, more fuel-efficient cars.)

Without price signals, industries in poor countries can't tell which are creating wealth and which are actually reducing the value of inputs. To claim that industry and transportation in developing countries are too poor to adjust to higher prices is to ignore reality. People and governments in these countries are too poor to burn oil and dollars wastefully though gasoline subsidies. Market reforms and economic progress over the last ten years in India and China provide exactly the flexibility needed to adjust to higher oil prices. If Chinese bureaucrats had not been so fixated on stockpiling diesel for the Olympics, and keeping prices fixed to avoid protests while in the world spotlight, the recent oil and diesel run-up would not have been so severe.

Economic progress over the last ten years has been the fastest for the most people in the history of the world, thanks mostly to expanded economic freedom and investment in India and China. And what's past is prelude: the pace and scope of world economic progress will accelerate and expand over the next ten years. Technology has cleared the path, and international information and investment flows will widen it.

I have mentioned before Michael Cox’s metaphor of four men dropped in a jungle, but only one has a machete. Who gets out first? The surprise answer is that they all emerge at about the same time. The man with the machete clears the path, and the others, once they find it, sprint along to catch up. Everyday people in England, Western Europe, the U.S. and Japan, cleared the path with thousands of agricultural, banking, and industrial innovations over the last few centuries. And now everyday people in China, India and Eastern Europe are putting in long days both to deploy long-available world technologies in their once isolated lands, and to create valuable goods and services for businesses and consumers in already-wealthy countries.

This a good thing. Billions in India and China are earning money (and saving much of it) producing goods and services for others. Both parties in all voluntary trades benefit. Astonishingly, this progress is being achieved against hostile, incompetent, and corrupt governance impeding investors, workers, and entrepreneurs in China, India, Europe, and South American (and, of course, in the U.S.).

A recent Book Forum at the Cato Institute featured the 2008 book “India: The Emerging Giant.” Both the author, Arvind Panagariya, and Cato commentator Swaminathan Aiyar, emphasized that India’s progress was in the face of India’s trademark government corruption, incompetence, and deeply interventionist regulations. Both speakers emphasized the good news for developing countries in the information age: if India can achieve sustained 7, 8 and 9% economic growth with its current government, well, any other poor country can too. More good news: the recent Indian government shake-up may bring more market reforms and partial privatization of Indian electricity, airlines, and other state-owned enterprises.

India prospers through expanded international trade and investment only as it creates wealth for its trading and investment partners. This means wealth is also created on the other side of those trades in the United States, Europe, China, and Japan. Over the coming years hundreds of millions more in India, as in China, will train and work hard to provide goods and services to Americans and Europeans and will purchase high-quality goods and services produced in America and Europe. And trade doesn't just expand. It deepens and grows more complex. Call center and software consulting teams intertwine advanced and entry-level services across continents, for example, and evolve unexpected divisions of labor and comparative advantages.

Indian government universities graduate 30,000 Indian engineers each year, but private colleges in India are graduating 400,000 engineers a year and expanding rapidly. “From 1990 to 2003 the number of engineering colleges alone [in India] rose from 337 to more than 1,200 (of which almost 1,000 are in the private sector)” –WENR

Informal private schools are also expanding rapidly across India, providing inexpensive and high quality private education for poor children—by far the largest work force in the world (one of ever four new workers in the world over the coming years will be in India). James Tooley’s research found over 300 “informal” unregulated private schools in just one slum area in part of the Old City in Hyderabad.

My first draft of this essay was written on July 15, and the day's headlines claimed a “plunge” of oil prices to $139 a barrel. This seemed a joke. A real plunge would take oil below $100 a barrel, which is still way high. Decades of federal government regulations restricting oil exploration and drilling, restricting the building of new refineries and new coal-fired and nuclear energy, have long restricted energy supplies in the US. And governments around the world mismanage monopoly oil exploration and development.

Price controls keep gasoline subsidized in many countries, so price increases don’t slow demand. Governments eventually allow prices to rise slightly and then have widespread protests. Government interventions overseas have turned citizens there into energy cripples, dependent upon the state, just as interventions in retirement savings here has turned most Americans into financial cripples, dependent on bankrupt Social Security and Medicare.

Government mismanagement of production in Mexico, Nigeria, Iran, Iraq, Venezuela, Libya and Russia limit incentives to boost oil production. People respond to incentives, and if those in government and with monopoly oil companies don’t benefit from expanded exploration, drilling, and production, they will instead focus their attention on activities that provide tangible personal gains.

Speculating on oil, food, and other commodity prices on the side has been one particularly enriching activity enjoyed by government officials in China, India, Indonesia, Africa, and South America. Just as Congressmen and Fannie Mae executives have taken advantage of “special” loans and donations, so local government officials around the world have tried their hand speculating with the commodity purchases they control. Chinese officials put in charge of making sure their district has enough iron and copper ore, diesel fuel, and rice, have purchased extra quantities to warehouse against possible shortages (they say) and price increases (they hope). Teapot Dome scandals may be waiting to be uncovered around the world. If governments are responsible for providing rice to “their” people, you can count on eventual rice shortages, along with ongoing spoilage, theft, and corruption. (See “Rice Hoarding Pressures Supplies" from May WSJ).

We can expect these public/private speculators to be wiped out as commodity prices crash on further fears that financial institutions and economies are faltering, and as new oil and natural gas supplies come to market. The silver lining in this financial cloud: governments faced with massive losses might be willing to strip government agencies of the power to play with commodity and finance fire. Maybe the U.S. government will give up backstopping home-loans as it faces absorbing a few trillion dollars in bad debts.

The great, great news is that people around the world will prosper, along with their financial institutions, as energy, food, and commodities move to more open markets directed by transparent and private firms. As governments get out of the way, supply-side and demand-side innovation and entrepreneurship will quickly boost production and drive commodity prices down, as free-markets have over the last few thousand years.


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