In an extraordinary document recently submitted to Congress, the Department of Energy explains how we sh ould deal with the next oil emergency. It says a shortfall of oil should be met by running an economic recession deep enough and long enough to bring our demand for oil into line with the available supply.
You will not find those exact words in the report, of course, but that is its message. What the report literally says is that, in the event of a disruption in oil supplies, we should allow "the market to do the job it does best -- allocating scarce resources efficiently and effectively among competing demands. . . . No action could have a more salutary effect on [our] preparedness and endurance capability . . . than to guarantee that domestic price controls and allocation of oil for civilian purposes will never again be imposed," and ". . . oil supply disruptions must be greeted with a firm and non-accommodative monetary response."
In short, oil prices are to rise until the market clears. That will solve the problem. High priority users are defined as those who will pay for it; low priority users will drop out of the market voluntarily. The price mechanism does not need to be supplemented by other measures. The only mitigation is a willingness to sell some of the Strategic Petroleum Reserve in the event of a disruption. As an economist, I have more respect for the market than most. But doctrinaire reverence for the free market in any circumstance, even an emergency, seems to me foolhardy. The key question is not whether supply and demand will be brought into balance -- they always are -- but how that will be accomplished, and at what cost.
The administration apparently would rely exclusively on price, apart from some stock drawdown. It is important to get oil prices right, and the January decontrol of oil prices should be applauded as providing the right long-run incentives to producers and consumers. But in the short run of an emergency, demand is very insensitive to price alone. Quick substitutes for oil are not available. Consumers will pay more for oil and less for other things. The balance between supply and demand will be brought about by a fall in business profits (except for energy firms), employment and incomes -- a recession.
For a large disturbance, this policy holds out an even starker repetition of the recession of 1974-75, in which the United States alone lost an estimated $250 billion in output in today's prices. The Western world as a whole lost perhaps twice as much. Unemployment went to 9 percent, and teen-age unemployment reached 21 percent.
Most of the debate over oil price control has concerned its distributional aspects -- who gains and who loses, and the merits of the gainers and losers. Unfortunately, that debate has deflected attention from the more important macro-economic effects. Sharply higher oil prices combined with tight money could make virtually all of us -- except the few owners of crude oil -- much bigger losers than the inevitable direct loss that the disruption itself would require.
It would be foolish to rule out, say temporary gasoline rationing with price controls to reduce demand for oil without large price increases at the pump if that would protect us from a major recession. We should not commit ourselves a priori to controls either. They are unquestionably inefficient and administratively messy. But we should look at the total costs and benefits of alternatives, not just the partial costs. In major emergencies, price controls and allocations would be far less disruptive and costly than a depression.
A sufficient drawdown of stocks could avoid both price controls and recession; it is obviously the preferred course, if we have them and if we are willing to let them go. But is disconcerting to recall that during the disruption of 1979, private firms greatly built up their stocks, and then-secretary of energy James Schlesinger was heavily criticized for ceasing purchases for the Strategic Petroleum Reserve to ease pressure on the oil market. We badly need to work out criteria under which SPR sales will be made.
Furthermore, private firms are drawing down their (still high) stocks now, when normally they would be building them up. Who can blame them? They must pay high interest rates and face a period of prosepective oil surplus for the next year or two. They cannot be expected to take into account the overall national interest -- including our national security and the desirability of avoiding a recession in the event of another oil disruption. That is the responsibility of the government. It should not limit itself to the maximum SPR fill rate -- about 450,000 barrels a day -- in buying stocks, but should purchase at a much higher rate and store above ground until the oil can be moved.
In the meantime, given the administration's declared program for dealing with an oil emergency, we should all pray for quietude in the world's leading oil producers.