Since Friday a few news stories have appeared that take a more restrained view of the current gasoline crisis. What distinguishes these stories from earlier accounts is that they are increasingly well-informed about economics in general, the gasoline market in particular, and the contributing (if not dominant) role of federal environmental regulation in causing the sudden price spike and localized supply shortages. The best of these we’ve seen is the May 1 article by Wall Street Journal reporter Jeffrey Ball (subscription may be required).
Ball begins by highlighting a fundamental economic conclusion about most of the week’s legislative proposals (boldfaced for emphasis):
A 25% jump in prices at the pump since December has set off a firestorm in Washington. Politicians are threatening auto makers with tougher federal fuel-economy standards and oil companies with higher taxes on record profits, while warning against price gouging. Auto and oil executives are predicting that a long-term shift toward greater fuel efficiency is under way. But none of these influences is likely to have much effect on gasoline prices or oil consumption in the near term.
In other words, consumers are highly unresponsive to gasoline price changes in the short run. Ball says the short-run price elasticity for gasoline may be as low as 0.1: “That means gas prices have to rise 10% to produce an initial 1% drop in demand.” His observed 25% price rise since January would yield a 2.5% decline in the quantity of gasoline demanded. That means gasoline prices could rise by a lot without reducing demand much in the short run. (For more information about price elasticity, see our 12 April 2006 post.)
If the problem is excess demand for gasoline, Ball notes that there is a simple solution:
The surest way out of the problem, most experts agree, would be to curb consumption of vehicle fuel, particularly in the U.S. For years, economists have argued that the most effective way to moderate U.S. demand would be to hit Americans with significantly higher gasoline taxes. Today’s high prices amount to a market test of that theory.
Of course, no one in Washington has been complaining that gasoline prices are too low. And the stated purpose of almost every policy proposal we’ve read about in the past week, if not the likely effect, is to lower retail gasoline prices. Clear problem definition is essential for clarity in formulating effective public policy, and one thing that’s clear about the recent crisis is that problem definition has been notably opaque.
Ball finds Americans coming up short in their responsiveness to gasoline price increases, but data he reports suggest that he has been looking under the wrong lamp post. Ball reports data showing consumers have been highly responsive to high and rising gasoline prices exactly where we would expect to find them: the new car showroom.
Sales of traditional sport-utility vehicles — the ones built on the guts of pickup trucks, which tend to consume the most gasoline — are falling fast. The decline began in 2003, when gasoline was cheap, but it has accelerated markedly since prices began rising in early 2005. Sales of truck-based SUVs, which fell 4% in 2003 and 3% in 2004, tumbled 13% in 2005 and 7% in the first quarter of this year.
The market for new vehicles is exactly where consumers would be expected to display long-run responses to sustained higher gasoline prices. Buying a new and more fuel-efficient car may be expensive, but reducing vehicle-miles traveled (VMT) is almost certainly much more difficult. Commuting to work dominates annual VMT, so achieving any significant reduction requires carpooling, moving closer to one’s workplace, or changing jobs so that the workplace is closer to home. Americans dislike carpooling, and moving or changing jobs are at best highly disruptive adjustments, and especially so in two-income households. Drivers appear to be acting quite rationally: they are paying more for the same amount of gasoline in the short run, where it’s hard to reduce consumption, but if they are in the market for a new car they are less inclined to buy an SUVs and presumably more inclined to buy a fuel-efficient vehicle such as a hybrid.
According to Ball, Exxon Mobil expects hybrids will account for 30% of the new vehicle market by 2030: “That surge is part of a broader shift toward fuel efficiency that Exxon thinks will cause fuel consumption by North American cars and light trucks to peak around 2020 — and then start to fall.” In other words, high prices in the gasoline market are having exactly the effect one would expect based on elementary economics.
Ball glosses over a more fundamental concern: If the market really is performing as it should in the face of significant external upward pressure on price, what possible benefit could there be in writing a new raft of federal regulations?
“Almost” is not an artful rhetorical dodge. First, Washington Post reporters Rosalind S. Helderman and Michael D. Shear have published an article about a bill passed by the Virginia Senate that would increase gasoline taxes six cents per gallon. Note that the bill’s sponsors” characterize the measure as “a populist effort to make big oil corporations share the cost of improving state roads and transit systems”–in other words, increase the gasoline tax paid by the Commonwealth’s drivers, but deflect criticism by making it appear as if gasoline refiners and sellers had raised their prices. Helderman and Shear say that the Senate has been trying to raise gasoline taxes since January. Second, higher gasoline taxes have been a common element of various policy proposals aimed at combating air pollution, sprawl, traffic congestion and global climate change. These proposals are most transparent about the gasoline tax when gasoline prices are low.