Although I worry more than Becker does about the environmental consequences of the production and consumption of oil, and although I want oil prices to remain high--indeed to continue rising--I largely agree with his analysis of the rival proposals for dealing with the present "crisis": allowing more drilling for oil on the outer continental shelf and in Alaska versus imposing an excess profits tax on the oil companies. I agree with him that the former is a good idea and the latter a bad one. But I will qualify my agreement by suggesting policy adjustments to minimize the adverse effects of allowing more drilling or of imposing an excess profits tax.

Expanded drilling in U.S. territory (including our territorial waters) will reduce both U.S. dependence on foreign oil and the wealth of foreign oil-producing countries, many of which are hostile or potentially hostile to the United States. These are important benefits. But there are also significant costs. Any increase in the production of oil from the seabed and from the fragile Alaskan tundra will create environmental damage, both directly, because of the environmental damage caused by the drilling itself (such as, in the case of offshore drilling, the dumping into the ocean of "drill cuttings"—the solids that are brought to the surface in drilling an oil well), and indirectly, as a consequence of increased production of oil, because of oil spills by tankers, traffic congestion and highway wear and tear, and, most ominously, increased carbon emissions from the burning of oil as a fuel. Becker notes correctly that the less oil we produce, the more that foreign nations will produce. But given the high price of oil, increasing out oil production will increase total world production rather than just substitute for foreign production. So there will be more tanker spills and more carbon emissions if offshore and Alaska drilling is allowed, since the supply of oil will be greater.

The problems created by an increased supply of oil can be minimized by an increase in the federal gasoline tax (better still would be imposing a tax on carbon emissions, since such a tax would create an incentive to reduce the amount of emissions per unit of gasoline consumed) calibrated to prevent gasoline prices from declining as a consequence of increased production of oil and hence increased supply. Already the shock of $4 a gallon gasoline has caused a modest decline in U.S. consumption of oil, yet $4 is little more than half the retail price of a gallon of gasoline in most European countries. Distances are shorter in Europe, and so U.S. gasoline prices would not have to double in order to make substantial inroads into our oil consumption. But they should not be allowed to fall as a result of increased world supply due to offshore and Alaska drilling.

A gasoline or carbon-emissions tax must not be confused with a tax on the profits of oil companies, which, because of the uncertainties involved in exploring for oil, will, as Becker points out, reduce the incentive to find and exploit new domestic oil fields. (In contrast, a heavy tax on gasoline will increase the incentive to find energy substitutes for oil.) In addition, imposing excess profits taxes sends a bad signal to the business community: that success will be penalized. And there is a danger that the proceeds of the tax would be used to subsidize the purchase of gasoline in order to reduce gasoline prices. The demand would rise without stimulating domestic production, so we would have the worst of all possible worlds: high consumption of oil and increased dependence on foreign production. But in the unhappy event that an excess profits tax is imposed, at least it should be limited to profits from existing oil fields, to minimize the dampening effect on the incentive to develop new fields.

Because the environmental risks of offshore and Alaska drilling are greater than those of drilling for oil on land in the lower 48 states, an environmental excise tax should be placed on the oil produced from offshore and Alaska wells. It is not enough to rely on the tort system to provide sanctions for oil spills. Many of the environmental effects of drilling for oil are individually too small to invite tort suits, yet the cumulative effects can be very large. That is true with respect to effects on fisheries and on the frequency of tanker spills. The more oil that is transported by sea, the more spills there will be, but it will rarely if ever be possible to ascribe a particular spill to a particular producer of the oil that was spilled. An environmental tax is therefore necessary to induce the oil companies to internalize the environmental costs that their activities impose.

Source: http://www.becker-posner-blog.com/archives/2008/06/oil_prices_offs.html

                                 
Increases in energy prices sharply accelerated during the past year, as the price of oil more than doubled, and gasoline prices in United States rose by 25 percent. Responding to these price increases, Senator McCain and President Bush have called for an end to the 27-year old federal moratorium on offshore drilling for oil and gas in US waters, while Senator Obama supports a continuation of the ban. McCain has also indicated that he is reconsidering his opposition to drilling in the Artic region of Alaska. In another response to the energy price boom, Obama has proposed an excess profits tax on oil companies, while McCain has come out against such a tax. What does economic analysis contribute to an evaluation of these proposals?

Supporters of a continuation of the moratorium worry that offshore drilling and oil leakages will kill many fish, and damage beaches and other coastal areas. These are potential risks, but whether to continue the moratorium involves a balancing of the advantages of drilling against environmental and other risks. These risks have not been affected by the rise in energy prices, but the benefits from drilling clearly have increased. Additional oil (and gas) from offshore drilling would lower US spending on imported oil, and thereby reduce the transfer of wealth from Americans to other oil and gas producers. Larger domestic energy supplies would also improve energy security in the event of a disruption in the supplies of oil and gas from major producers located in places like the Middle East and Nigeria that have had terrorist attacks on oil production facilities.

Even if offshore drilling started tomorrow, it would take several years before actual production began since construction of platforms in deep water and installation of equipment take time. The value of ending the moratorium now would depend not on energy prices and risks of disruption this year or the next, but on the situation beginning in several years and extending over the following decade. Some oil specialists are predicting a rise in the price of oil to $200 a barrel during the next few years. I have argued previously why such a large price increase is unlikely (see my post on May 11); indeed, oil may very well retreat from its present level of over $130 a barrel. Still, as long as world GDP continues to grow over the next decade at a sizable pace-which is likely- the price of oil will remain far above what it was in the 1990's.

This means that the financial and other benefits from offshore drilling are likely to greatly exceed the benefits at the time the moratorium was imposed, for oil was then much cheaper even in inflation-adjusted terms. The increasing share of imports in the oil consumed by the United States, and the rise in oil prices, explain why the value of imported oil rose more than five fold since the 1980s. This is why cost-benefit calculations of whether to end the moratorium and allow offshore drilling have shifted in the direction of allowing drilling. Although the risks of offshore drilling are much harder to quantify than the benefits, I believe the shift in the benefit-cost ratio has been large enough so that the time has come to allow drilling. Norway and Great Britain, to take two examples, have allowed drilling in the North Sea for many years without suffering major environmental damage. To be sure, in the end oil companies are the ones who have to decide whether the gains from drilling are worth the risks, including lawsuits if there are damaging oil spills, but these companies seem eager to start drilling offshore.

The proposed excess profits tax on the earnings of oil companies would discourage the search for additional oil, and hence would have the opposite effects on this search from a relaxation of the moratorium on offshore drilling. An excess profits tax that is expected to persist for many years discourages further exploration for oil simply because much of the profits on new oil production would be taxed away. In 1980, President Jimmy Carter introduced a windfall tax on oil companies to prevent them from profiting a lot from the high price of oil due to the Iran-Iraq war. An evaluation by the Congressional Research Service, a think tank that provides reports to Congress, concluded that the tax significantly reduced domestic oil production and raised oil imports. Disillusionment with the tax led to its abandonment in 1987. Yet the lessons from this fiasco have been forgotten, for since the post-Katrina rise in gasoline prices in 2005, members of Congress have made regular attempts to introduce legislation with a sizable excess profits tax on oil companies.

Even those Americans who worry a lot about global warming and other global pollution form the use of oil should be reluctant to discourage oil production offshore or elsewhere by American oil companies. Lower production by American companies would cause a rise in the world price of oil. Moreover, increased production by other countries would tend to offset reduced production by the United States, so that the effect on global warming and global pollution is likely to be modest. However, the increase in wealth transferred from the United States to the Middle East, Russia, Venezuela, and other oil-producing countries could be substantial.

Source: http://www.becker-posner-blog.com/archives/2008/06/energy_prices_o.html

                                 
The run-up in the world price of oil during the past several years, and especially the rapid climb during the last few weeks to over $120 per barrel, has fueled predictions that the price will reach $200 a barrel in the rather near future. Such predictions are not based on much analysis, and mainly just extrapolate this sharp upward trend in oil prices into the future. The price of oil in "real" terms (i.e., relative to general prices) will not reach $200 in this time frame without either terrorist or other attacks that destroy major oil-producing facilities, or huge taxes on oil consumption. I try to explain why in the following.

The two previous sharp increases in the world price of oil, in 1973-4 and 1980-81, were due to supply disruptions. The first one was the result of the formation of OPEC that led to output restrictions by members of this cartel, while the later one was due to the Iran-Iraq war that curtailed petroleum production in these two countries. Although the world price of petroleum rose by a lot in all three episodes, worldwide oil production went down in the two earlier ones, while production has risen during the current price boom. The present boom in oil prices has been mainly driven by increases in demand from the rapidly growing developing nations, especially China, India, and Brazil, although output growth in the US and European have added to world demand, and speculation on potential future price increases also contributed to the increased price of oil. To be sure, supply problems in Nigeria, Venezuela, Russia, and other major oil-producing states have contributed to accelerations in the oil price increases at times during the current boom.

Note the contrast between the major causes of the current explosions in oil and food prices. Although the sharply rising prices of different commodities are often lumped together, increases in the prices of corn and other foods have in larger part come from the supply side rather than from demand. The main supply culprits in the market for foods have been the diversion of corn acreage to the production of ethanol, and the increased cost of fertilizers and chemicals used in food production due to the rise in the price of oil (see my discussion of rising food prices on April 13 and 17).

The rapid growth of world oil prices during 1973-74 and 1980-81 contributed in a significant way to the world recessions during those years. Yet even though world oil prices in real terms are now above the prices in 1981, the previous peak in oil prices, and despite the sharp run-up in prices during the past couple of years, the world economy has not (yet ! ) been pushed into recession. One reason for the difference is that unlike the previous episodes, the current price rises have slowed rather than eliminated the boom in world output. Another difference from the previous episodes is that the share of oil and other energy inputs in GDP is down by a lot in the developed world since 1980, especially in Japan and Europe, but also in the US.

Of course, even with energy's smaller role in the production of output, any rise in oil prices to over $200 a barrel in the next few years would have serious disruptive effects on the world economy. To many persons who have commented on this prospect, such a high oil price seems plausible, given the expected continuation of the rapid growth in the GDP of China, India, Brazil, and other major developing countries. For the evidence is rather strong that the short run response of both the supply of and the demand for oil to price increases is rather small. The small elasticity of both the supply and demand for oil explains why the moderate reductions in world oil supply during the earlier price spikes, and the moderate increase in world demand during the current price boom, produced such large increases in price.

However, the long run response to price increases of both the demand and supply for oil and other energy inputs is considerable. For example, given enough time to adjust, families react to much higher gasoline prices by purchasing cars, such as hybrids and compacts, that use less gasoline per mile driven. They also substitute trains and other public transportation for driving to work and for leisure purposes. High energy prices, and hence the opportunity for large profits, induce entrepreneurs to work more aggressively to find fuel-efficient technologies, including the use of batteries as a replacement for the internal combustion engine.

Clearly, given high enough oil prices, many ways are available to increase the supply of petroleum, Explorations for additional supplies will be extended deeper into oceans and other remote places because the high cost of extracting oil from these sources would be offset by the high energy prices. Usable petroleum is also already being extracted from oil sands and oil shale, and high and rising oil prices will speed up and extend this process. The reserves of tar sands in Canada and Venezuela are huge; indeed, Canada is getting much of its oil production from this source. Oil shale is also abundant in several places, including the United States, and while extraction of petroleum from shale is expensive and complicated, the high prices have induced some countries to start doing this.

Rising prices of oil and other energy inputs will eventually be controlled by new technologies that greatly economize on the use of these inputs. Increased supplies of oil and other energy sources that become profitable to exploit only with prolonged high prices will also push these prices back.

Why We Should Be Rooting for $200 per Barrel of Oil--Posner

As Becker explains, we cannot predict the future price of oil. But it is unlikely to rise in the foreseeable future to $200 a barrel, especially if we think in inflation-adjusted terms. Oil prices in real terms have fluctuated a great deal. In December 2007 dollars the price of oil was below $20 in 1946, above $100 in 1979, and only about $10 a recently as 1998. High prices affect both demand and supply; the recent price peaks have already reduced demand for gasoline in the United States and increased efforts to discover and exploit new oil fields. The United States has large untapped oil reserves both offshore and in Alaska, and there are many other untapped reserves elsewhere in the world. Supply is responding to the high price of oil and will respond more. If Iraq ever stabilizes, its output of oil will increase. Were the world price of oil to rise to a level close to $200, both demand and (with a lag) supply would respond. Oil trapped in sand and shale--a potentially very large supply--would become economical. In the longer run, very high oil prices will further stimulate the development of alternative fuels.

Major political or natural catastrophes could of course alter the picture. Middle eastern oil supplies are vulnerable to the ever-present threat of war in that region, and the oil industries of Venezuela, Nigeria, and possibly even Saudi Arabia are vulnerable to political unrest, civil war, or terrorism.

I would like to see the price of oil rise to $200, despite the worldwide recession that would probably result, provided that it rises as a result of heavy taxes on oil or (better) carbon emissions. The taxes would jump start the development of clean fuels, and the financial impact on consumers could be buffered by returning a portion of the tax revenues in the form of income tax credits. That would not reduce the effect of the taxes on the demand for oil or the incentives to develop alternative fuels, because the marginal cost (the production and distribution cost plus the tax) of oil to consumers would not be affected. Higher oil prices are necessary to check global warming, reduce traffic congestion, and reduce dependence on foreign oil, so much of which is produced by countries that are either unstable or hostile to the United States. Heavy taxes on oil would reduce not only the amount of oil we import but also the revenue per barrel of the oil exporting nations, so there would be a double negative effect on those countries' oil revenues: they would sell less oil and earn less per unit sold. The reason for the latter effect is the upward-sloping supply curve for oil. Suppose the first million barrels of oil can be produced at a cost of $1 per barrel and the second million at $2 per barrel. If total demand is one million barrels, the suppliers break even: they have revenues of $1 million and costs of $1 million. If total demand is two million barrels, the suppliers have revenues of $4 million (because the price of all barrels is determined by the price that the marginal purchaser is willing to pay) but costs of only $3 million ($1 million for the first million barrels, $2 million of the second). The lower the price of oil received by the oil producers (that is, the price net of tax), the lower their net income.

Unfortunately I cannot see a confluence of political forces that would make heavy taxes on oil feasible. We seem to be experiencing a democratic failure, in which long-term problems simply cannot be addressed.

Source: http://www.becker-posner-blog.com/archives/2008/05/the_rise_in_the.html
         http://www.becker-posner-blog.com/archives/2008/05/why_we_should_b.html

                                 
Medicare is the federal system that covers hospitalization, physician care, drugs, and a limited amount of nursing home care for men and women over age 65. President Lyndon Johnson started it in 1965 in a modest financial way when the elderly were a small fraction of the adult population, and when drugs and surgeries to treat diseases of old age were far fewer and less complex. This program has grown in the 42 years since then into a major entitlement, with spending of almost $400 billion, which is more than 3 percent of American GDP. Of even greater concern is the projected growth in this program during the next several decades.

If past growth in Medicare is a reasonable guide to future growth, and assuming that real GDP grows at an annual rate of two and one half percent, Medicare spending as a share of GDP will double by 2020, and increase some 3-4 times by 2050 to 10 percent or more of GDP. Dollar spending on Medicare patients would increase to over a trillion dollars by 2020. Less than half of the projected increase would be due to the further aging of the population, while the majority is the result of the expected continuing growth in spending on hospitalizations, surgeries, and drugs for the elderly of given ages.

Much of the increased spending would occur even with the most efficient health delivery system since senior citizens along with younger adults put a high value on living longer in reasonably good health. The value placed on longer life and good health generally rises as incomes grow; indeed, economic analysis and past experience indicates that the willingness to pay for better health will increase in the future at least as rapidly as incomes do.

Still, there is no doubt that while the American health care delivery system has many strengths, including an encouragement to medical innovation, medical costs for the elderly could be significantly reduced with no reduction in quantity and quality if various inefficiencies in the system were corrected. Numerous proposals have been advanced to make the Medicare delivery system more efficient. Former Secretary of State and of the Treasury George Shultz, along with Professor John Shoven, in an important forthcoming book, Putting our House in Order, review several of these proposed reforms and advance their own thoughtful reforms for social security as well as Medicare and Medicaid. We discussed various reforms of American spending on medical care in our blog posts on January 13 of this year, and I will not repeat them now.

Instead, I discuss why drugs should have an important role in inefficient as well as efficient medical delivery systems. Medicare only started to cover spending on drugs in 2003, and the coverage had various defects. These include a deductible that is much too low, and a "doughnut" where there is no coverage at all for additional spending in the middle ranges of drug spending (see my discussion on Feb. 13, 2005 of these and other defects of drug coverage, with suggestions for how to make that coverage more effective). It is no surprise that spending on drugs by the elderly were not part of Medicare at the beginning since drugs were a minor part of their total medical spending in 1965. However, discoveries since then have led to various blockbuster drugs, and many less revolutionary advances in medications. These include drugs to lower blood pressure and cholesterol, to treat Parkinson's disease and other disorders of the nervous system, to help thin the blood, to overcome erectile dysfunction, to fight Aids, and to reduce testosterone to combat the spread of prostate cancer. The share of their total medical care that seniors spend on drugs has moved steadily upwards during the past 40 years, and now is more than 12 percent, and before long might approach 20 percent.

Drugs should be part of an effective health delivery system not only because of the continual introduction of new drugs, including a growing importance of genetic based drugs, but also because drugs have a very attractive cost structure, especially for the growing elderly population. As the number of persons over age 65 increases during the next several decades, it would be useful to have a health delivery system in which costs do not rise as rapidly as the number of persons treated. Surgeries do not have this property since their cost tends to increase in proportion to the number of surgeries performed since each one takes a more or less fixed number of surgeons and supporting personnel. Hospitals also have few economies of scale with respect to the number of in-patients treated once a relatively small efficient bed size is reached.

Drugs have a totally different cost structure. They typically have very high fixed costs of research and development and low marginal costs of adding additional users. To develop a new drug to treat depression, or Alzheimer's, or another serious medical problem, usually requires hundreds of millions of dollars in the form of spending on research and various stages of clinical trial development, including many failures before a successful treatment is developed. Once a valuable drug is developed, however, the cost of producing each pill is usually small, certainly a tiny fraction of its fixed costs of development. This means that additional users can be added with relatively little increase in total costs, and a decline in average cost per user.

This property of the cost of producing drugs has two extremely important implications for Medicare costs. The first is that drugs are an efficient way to treat diseases and disorders that hit a large number of men and women since then the fixed costs can be spread over a larger number of users. This makes them particularly valuable to the elderly who are a growing share of the population in the United States and all other developed countries, and in many developing countries as well, including China. Moreover, the U.S. and world populations are also increasing, which increases the demand for all drugs, including those that help treat older persons.

Drugs are also valuable in inefficient delivery systems that have trouble choking off medical treatments that would not pass a benefit-cost calculation. This would characterize systems with highly subsidized medical care, with excessively low deductibles, or with rules that cannot deny treatments to the very elderly and those close to dying who would benefit only a little from receiving treatment. Surgery, hospitalization, and close physician supervision are expensive ways to treat seniors who do not benefit much from this care since the cost of these procedures tend to rise in proportion to the number treated. On the other hand, while treating seniors with drugs sometimes also may not add much in the way of benefits, the additional cost per user would be much smaller than the average cost per user. This property of the cost of using drugs makes them particularly useful in the American medical system since that system errs on the side of generosity toward the elderly and others compared to the health care systems in most developed countries.

This advantage of drugs in inefficient health delivery systems does not argue against the need for major reforms of Medicare to make it more efficient. It recognizes, however, the value of second-best solutions in a political environment where reforms of health care are likely to come slowly because they run up against many powerful vested interests.

Source: http://www.becker-posner-blog.com/archives/2008/03/drugs_and_the_c.html

                                 

The shooting recently of 10 innocent persons at a retail store and a university in Illinois has highlighted once again the issue of gun control in the United States. Five customers and employees were murdered at a Lane Bryant clothing store in a robbery attempt that got out of hand, while a former student killed other students at Northern Illinois University, and then killed himself. The question raised by these shootings once again is how to control the use of guns?

I will take for granted in this discussion that effective gun control laws are desirable, and mainly consider how to make them effective. So I bypass the lively controversy among economists over whether gun control laws are desirable-for two strong and opposite conclusions drawn from limited empirical evidence, see Mark Duggan ("More Guns, More Crime", ,Journal of Political Economy, 2001), and John Lott ("More Guns, Less Crime", University of Chicago Press, 2000). Effective gun control laws that prevent guns from getting into the hands of mentally unstable individuals and criminals are surely desirable, but present laws do not achieve that.

The main issues in gun control legislation are 1) many people, mainly men, want to own guns for self protection because they live in bad neighborhoods, or because they fear that criminals may invade their homes, or because they just like guns. In addition, shopkeepers want guns to protect themselves if attempts are made to rob them, and criminals want guns in order to commit crimes more successfully. 2) The number of guns in the United States is huge, probably well over 100 million. Many were purchased legally, but probably most were obtained in the active black market in guns. Individuals who want to own guns but are prevented from acquiring them legally will often buy them illegally. Clearly, the black market in guns is strong, even though many law-abiding persons do not know how to go about getting guns illegally. Sellers of guns underground are generally criminals since they can function more effectively than honest sellers in illegal markets where contracts and other attributes of legal transactions are difficult, if not impossible, to enforce except by the use of force.

A close analogy is with drugs. That drugs like cocaine are illegal shifts the market for drugs underground. The higher price in the underground market offsets the risk of punishment to traffickers, which attracts sellers who are willing to bear the many sizable risks in this market, including imprisonment. These traffickers engage in violence against competitors and others, and they corrupt police and other officials to protect the considerable profit they make when they can avoid being apprehended.

One criticism of many state gun control laws is that they are too lax in allowing some persons to purchase guns legally who should not be eligible to buy guns. For example, the killer of the 5 students had a history of mental illness, yet he only recently had been able to legally buy a pistol and a shotgun. He made these and some prior legal purchases of guns in Illinois, even though this state has a rather stringent gun control law that requires a background check for a criminal record, registration by gun owners, and a cooling off period before purchases can take place. If gun laws were greatly tightened, individuals who badly want to have guns but cannot obtain them legally would try to turn to the underground economy, just as those who badly want to consume drugs get their drugs underground. Pretty much all men who want guns for criminal purposes now obtain their guns illegally in the underground economy. That economy would become still more important if gun law were tightened.

Still, several steps can be taken to have much more effective gun control. The first would be to impose a high tax on legal gun transactions, which would greatly raise the price of guns purchased legally. Like the tax on gasoline, cigarettes, and some other goods, a gun tax should be several hundred percent of the untaxed price to discourage purchases of guns by those with less strong demands. Individuals who strongly want guns for legitimate purposes might still prefer to get them legally, if they can, since they would then avoid the various punishments and other risks of buying guns illegally. For this reason, gun control laws should allow persons with legitimate needs for guns to buy them legally at the very high prices caused by the high gun tax.

The second step is to punish substantially traffickers in the illegal gun market to discourage individuals who could get guns legally from buying them in the underground market. A sizable punishment to illegal suppliers would raise the price of guns in the illegal market in order to compensate sellers for the risks of punishment. One criticism of present gun laws is that sellers of guns in the underground economy are not punished enough when they are caught. (Unfortunately, higher gun prices in the illegal market would attract sellers who would be good at avoiding apprehension since the profits could then be huge for sellers who can avoid punishment.)

Since a high tax on gun sales and substantial punishments to illegal seller of guns would greatly raise the price of guns in both the legal and illegal markets, the demand for guns would be reduced in both markets. The magnitude of the fall in the number of guns purchased would depend on how responsive purchases are to higher gun prices-this response is what economists call the elasticity of demand. I have come across little evidence on this elasticity for guns. Yet one would expect that the demand for guns by individuals is likely to be significantly higher when other persons have more guns, partly because of the desire to protect themselves, and partly because of the culture this creates to own guns. As a result, the overall response of purchases to high gun prices might be quite large. For under these conditions, a higher gun price lowers the demand for guns by some individuals, and that in turn reduces gun demand by others. These “social interaction” effects on gun demand would tend to greatly raise the overall price response of the demand for guns.

The illegal market would cater mainly to persons with criminal and other questionable backgrounds that could not readily buy guns legally. Of course, even with active enforcement against sellers in the underground gun market, some individuals will be able to buy guns illegally. Hence the third prong of the desirable approach to gun control would be to add a large extra sentence, larger than is common in many states, to the prison sentence of criminals who used guns to commit crimes. Such greater punishment for using guns to commit crimes would encourage criminals to shift away from guns toward knives and other less lethal weapons.

Source: http://www.becker-posner-blog.com/archives/2008/02/can_gun_control.htm