Wed, 14 Jul 2004

The Magic Wand of Government

Orson Scott Card is nominally a writer of Science Fiction. In his recent essay covering Optimism, Pessimism, War, and Oil, he gets the economics wrong. He insists that government has a magic wand which it can wave to create the next source of energy beyond oil. He wants government to wave that magic wand.

Orson needs to get a clue. Every time the government waves its magic wand, it's a swing-and-a-miss. Look at canals. Not a one of 'em made money except for the Erie, and it only made money if you assume that the capital that went into it had no better use. Look at railroads. The ones that the government subsidized didn't make money, and the ones that it didn't need to subsidize did.

Orson has several suggestions for what people should do. The major point that he's missing is the time value of oil. He suggests that we should preserve it for the future, because it will be more valuable then. If he was right, then people who have oil in the ground would be happy to leave it there in anticipation of a higher price later. They don't do that, though. Instead, they sell it. They sell it because they expect that oil, like every other commodity, will be cheaper and more available in the future.

Orson might be right. The people who stand to make a lot of money if he's right are doing the exact opposite of what he suggests. I think, therefore, that it's most likely that he's mostly wrong.

Update: Oleg Dulin comments, wondering how future value can be brought into the present. Ordinarily the way that is done is through property rights and futures contracts. If you own something, and you think it will be worth more tomorrow, you won't sell it today. But what if you need money today? If your property rights are secure, then you can sell a futures contract. You agree to sell something in the future for a price greater than the current price, but less than what you actually think it will sell for then. You accept the payment today, and transfer ownership tomorrow.

The problem that Oleg doesn't anticipate is: what if your property rights are not secure? What if you are the corrupt ruler of an oil sheikdom, and are shaking your country down for the oil? You can still sell a futures contract. It currently discounts the price as described above. The discount is increased by the unlikelihood that your country will actually transfer the oil after you have transferred the profits to your Swiss bank account.

Before you get too smug about those corrupt oil sheikdoms, consider that the same mechanism applies in an elective democracy, in spades. When a politician is elected for only four years, he has no guarantee that he will continue to have the same power beyond the election. Elected politicians cannot afford to waste time taking advantage of their power. An oil sheik can reasonably rip off his country for the rest of his natural life, and so can afford to take the long-term view.

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