You Want Me to Criticize Free Markets? Well, Here's One for You...

Most of you know I am a Milton Friedman-style free market fan. I look askance almost immediately in market interference by government, and I believe free market solutions are generally the best solutions to vexing economic problems. But not always.

I am particularly interested in the applicability of free-market principles to the energy market, specifically the oil market. Good story here from the morning paper that describes some of the less salutary effects of the drop in oil prices. I was particularly taken by the story of the oil sands extraction effort in Canada, a capital intensive project that only becomes cost effective with oil at $60-$90 a barrel ($39 yesterday). Impetus to move out smartly in this direction is declining, as it makes less and less "free market" sense to do so.

You can apply this same logic to a number of other initiatives aimed at lessening our dependence on a supply of oil from nations that are at best neutral to the interests of the US, and are at worst, antithetical. Building a nuclear power plant takes a ton of money and time--investments that to the free market--look far less attractive in the days of cheap oil (to which natural gas prices are linked) and coal. Once its built, it provides carbon neutral energy cheaply, but there's a lot to getting a plant built--and free market forces alone won't do it.

Battery technology and hybrid cars present another good example. Sales of hybrids were off the charts with gas at $4 a gallon...but are tanking now. Our auto manufacturers find themselves in a pickle right now in no small measure because they had to take such losses on small, fuel efficient cars in order to raise their CAFE mileage perfomance--because the cars have been so unpopular. What financed the loss? Sales of gas-guzzlers that people were snapping up. When even that stopped, the car makers were left in an untenable position.

What strikes me in all of this is that to some extent, the price of oil drives a lot of buying and investing behavior that could ultimately be ruinous to our economy, and this stems from the indisputable fact that the supply of oil becomes less every day--yet we have absolutely no real idea how much supply there really is! The whole pricing structure of oil is built around a sense of supply based on (educated) geologic guesses, trumped up claims of petro-thugs, and pure magic. Well, not really. It is based on the amount that is being extracted from the ground--which is a quite knowable figure, so knowable that this amount is manipulated by producers on a regular basis to impact their total revenue. World demand is the other component of price.

Our entire economy is dependent on oil, pure and simple. Yet we have no earthly idea how much there is--and rather than move aggressively to wean our economy from a commodity that brings such uncertainty (not to mention such a rogue's gallery of purveyors), we invest for future needs based on a "free market" in oil (this, clearly, is NOT a free market--it is a cartel, which practices monopolistic pricing) that prices this critical asset based on imperfect information (i.e--how much is out there).

Here's where government should step in. First, I'd like to cover two instances in which government action did in fact promote the growth (and "general welfare") of the country. The first is in the movement westward, especially in the construction of railroads. Yes, lots of men got rich on building railroads, but they did so with many examples of aid, support and comfort of the US government. The second was the creation of the interstate highway system in the 50's. While the free market supplied demand that helped spur these improvements, it was GOVERNMENT that supplied the wherewithal to move these initiatives forward...private industry and the free markets needed the government to pay down the risk of these investments so that we all might benefit.

I'm suggesting that this is a legitimate and necessary role for government to play today. Given my supposition that the price of oil comes from a Ouija board, government should be acting to provide loans, loan guarantees and direct investment in technologies and projects that will lessen our dependence on oil (while the price of oil does not--in a free market sense--justify the investment). In other words, government must pay down the risk injected into these decisions by our national reliance on an imperfectly priced supply of oil.

Why? Because it will literally take decades for the country to move in a meaningful way from its dependence on oil, and when the world's oil supply does get to the point where it is generally agreed that "peak oil" has been reached (defined by Wikipedia as that point in which "the maximum rate of global petroleum extraction is reached, after which the rate of production enters terminal decline". Once we get to this point, Katie bar the door on how oil will be priced. If you want to talk about a "competition for resources", think about what would mean--where China, the US, Europe, Russia, Brazil and India--and the whole rest of the world--begin to start stockpiling supplies and locking down long term contracts (whoops, it's already started).

I've complained about a great deal in the President's stimulus package, but I have assiduously avoided criticism of its initiatives on energy. If anything, there aren't enough. When I think of the truly necessary and critical jobs that the US government must do to "provide for the common defense and promote the general welfare", acting as an economic engine to move us from our reliance on oil is at or near the top of the list. I believe this investment would not only be stimulative, it would have lasting beneficial effects for this nation's future.