Thanks to the comments from many of you, I think I now have a better idea about why
economists have a hard time communicating with others about the issue of peak oil. But I’m not
quite sure what to do about it.
Let me again thank those of you who contributed to
href="http://www.econbrowser.com/archives/2005/07/further_discuss.html"> a lively discussion
about how economists may think differently from some of you about the question of peak oil.
I initiated this discussion by trying to lay out what economists would expect a transition from
increasing global annual oil production to decreasing global annual oil production to look like.
Specifically, I pointed out the opportunities for anybody to make huge profits if production or
price was expected to change precipitously, arguing that the natural consequences of individuals
trying to earn these profits would be to help direct an orderly and planned transition.
A great number of you responded with detailed critiques and examples of where market
valuations were imperfect or reflected erroneous forecasts. In one of the most sophisticated
and informed arguments along these lines,
Jeffrey Miller called attention to href="http://www.nber.org/~confer/2003/bff03/pollet.pdf">this study by Stefano DellaVigna and
Joshua Pollet. These researchers examined the extent to which the number of babies born in
year t – n might help to predict the stock returns in particular age-sensitive industries such
as children’s books and toys in year t. If you could successfully predict those stock returns
based on information available years in advance, that would be an indication that markets are
not fully efficiently incorporating all available information– the stock price should have
risen in year t – n, not in year t, for reasons similar to those I gave in my original post as
to why oil prices would rise before production peaked. DellaVigna and Pollet found
statistically significant evidence that you could predict the stock price changes for some
particular industries from such demographic factors.
I do not want to get sidetracked here, but I would be remiss if I did not call attention to
some of the difficulties in drawing too strong a conclusion from such evidence. Over the years
there have been many hundreds of related empirical inquiries into whether stock prices
efficiently incorporate this or that piece of information. Most have found that they do, and
for those studies that reached the contrary conclusion, the relationship that they reported was
often found not to hold up in the data that became available after the paper was published.
Notwithstanding, I see this as a side issue, because I am perfectly prepared to concede, as any
reasonable person must, that markets are imperfect, and that they can and do make mistakes all
the time. Indeed, as I suggested in my original post (and as the DellaVigna and Pollet study
attests), more than half the published papers in economics study market imperfection in one form
or another, and certainly participants in our little discussion have brought up any of a number
of other good examples, such as the market valuation of dot-com stocks, Google, corporate
expensing of employee stock options, and the failure of markets to anticipate the run-up in oil
prices since 2001.
I can agree with you on all of that, at least up to a point. But here’s where I get stuck.
What I see many of you then in effect concluding is something along the lines of the
If markets are not perfect, then we should put no faith in them.
This strikes me as a very inappropriate conclusion to draw from that kind of evidence. If you
reflect back on my href="http://www.econbrowser.com/archives/2005/07/how_to_talk_to.html">original argument, it
had a qualitative as well as a quantitative dimension. If someone makes a calculation along the
lines I described using too high or too low an interest rate, or too high or too low a future
price, then sure, the specific quantity of current production would be different from the one I
talk about. But the qualitative conclusion that I was drawing– that any move in that
direction would produce some smoothing of the price and quantity available to the market over
time– is still very much going to be there.
More to the point, I argued that these profit opportunities would be available not just to
the Saudis, not just to the oil companies, but literally to anybody in the world. I don’t see
how any view of market imperfection or stories you might tell about this or that group could
lead you to dismiss the power of an incentive of that kind. Perhaps some of you maintain that
the potential contribution of those who are not themselves oil producers is inconsequential,
reasoning like FT that
Playing this game in the longer term means you’re fighting those with underground reserves.
Fancy taking on Saudi Arabia or Iran with your storage tanks in Rotterdam?
But the point is, under the scenario I described, you’re not fighting Saudi Arabia, you’re
taking their money. Every barrel you buy low and sell high is money from their bank account
into yours– the bigger they are, the more money you can make.
You count on the effectiveness of market incentives every day, supposing correctly that they
can be trusted to ensure that most of the items you seek will be at the grocery store when you
arrive, and that the oil companies will continue to move into more and more difficult terrain to
try to extract oil from the ground. So why would you believe that profit incentives won’t make
any difference for how peak oil plays out? Because that’s a much more important issue, and the
societal changes are more profound? If that’s your reasoning, I would suggest that you have
things exactly backwards. The more important the issue, the more profound the societal changes,
the greater is the profit to be had for those who recognize and respond to those incentives, and
the more confidence you should have that many, many people will try to do so.
I submit to you that the opportunity to take the wealth of Saudi Arabia and deliver it into
your own back pocket is a powerful incentive indeed, one that– and I mean this very, very
literally– can move mountains. That the peak oil community would dismiss such incentives as
being of no practical consequence, and insist instead that greater change in the world is likely
to be instigated as a result of their own earnest exhortations, continues to be a source of the
greatest bafflement to me.