Wednesday, May 03, 2006

High petrol prices are not such a bad thing

The teeth-gnashing and hand-wringing about high petrol prices hasn’t been quite as intense here as it has in the US lately, nor the inevitable calls for the government to ‘do something’ about the problem. Still, it’s been annoying.

So it’s refreshing to see a Ross Gittins column in today’s Sydney Morning Herald putting forward an economic reality-check:

In a market system, a rise in the price of such a commodity prompts a change in behaviour. It increases supply by encouraging exploration for new sources, makes formerly uneconomic oilfields profitable and encourages the development of substitute fuels. At the same time, it reduces demand by encouraging consumers to use petrol more economically and search for cheaper substitutes. Put this reduction in demand together with the increase in supply and you see that a rise in prices should lead to a fall in prices. So allowing retail petrol prices to move in response to market forces is the best way to minimise the long-term rise in prices likely to come from the developing world's increasing demand for oil.

There's evidence that motorists really are changing their behaviour in response to the higher prices of the past year or two. Despite the continuing growth in our economy, the quantity of petrol sold in Australia last year fell by 8 per cent. In the purchasing of new cars there's a marked swing away from four-wheel-drives and other gas-guzzlers and towards smaller cars. There are even signs of a modest switch back to travel by train and bus.

The column also makes the climate change / petrol price link:

With the evidence of global warming getting stronger, we need to be limiting our use of petrol and other fossil fuels in the interests of the environment. So, if anything, the tax on petrol needs to be higher, not lower. The recent report on international tax comparisons showed that, in the December quarter of last year, we had the third-lowest level of taxation on unleaded petrol among the 30 members of the Organisation for Economic Co-operation and Development - 49 cents a litre compared with the average of $1.15 a litre. That gap is likely to continue widening because of John Howard's decision to abandon the annual indexation of the excise on petrol in 2001.
The column then takes a pot shot at 'politicians and greenies':

It really is remarkable, the way we can have our regular bouts of indignation over the price of petrol without anyone thinking it relevant to mention greenhouse gases. Politicians and greenies who profess to be terribly concerned about our failure to sign the Kyoto Protocol keep their mouths firmly buttoned.
Are you kidding? People make the link all the time - any time anyone mentions a carbon tax, they're talking about higher fuel prices to reduce greenhouse emissions. What politicians and green groups don’t do is say explicitly "High petrol prices are good and they should be higher" because that would leave them open to easy pot shots from their opponents ("This shows how out of touch X is. Families are hurting and all X can say is that it’s a good thing") and they’re not that stupid. What they do say is things like we need to remove subsidies on motor vehicles, we need to provide better public transport options, we need better town planning, we need to promote the development of alternative fuels, etc.

Of course it’s easier for journalists and bloggers to be less circumspect and I think that if Gittins looked at the discussions at Grist, the Oil Drum, Environmental Economics blog or pretty much any link from this blog, he’d see that people’s mouths are anything but buttoned on the fuel price and climate change issue.


Bill Perkins said...

Outstanding post. I read of a study that calculated the true cost of gasoline, if the environmental impact is factored in, to be $11/gallon(US). I, and so many others, are all for higher gas prices, particularly if it occurs because of a government tax which is then used to subsidize the development of alternative energy sources. We just need national leaders, in the US and Australia, with the vision and leadership to make this happen.

hc said...

I am sure you are right that high prices send out the right signal to users and to suppliers.

But I don't think we should be masochistic about it - low prices give lots of consumer surplus and the ability to drive a car yields pleasure and convenience.

The point is to levy a tax which captures the externalities.

By the way a big externality for the US is the defense cost involved in acting as policeman in the Middle East. Developing alternative fuel sources - or alternative sources of supply would reduce this cost.

Where did you get the $11US figure from Bill? This would correspond to a very hefty carbon tax.

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