Wealth and the Rising Cost of Globalism

James Howard Kunstler has eloquently argued in The Long Emergency that cheap oil makes globalism possible.  Transporting goods across the globe costs energy, and, when energy costs enough, local production becomes more economical than global. For now and the near future, however, it still costs not only less money, but even less energy to manufacture goods in China and ship them to the U.S. than to use U.S. workers. Expanded global trade is, in a roundabout way, as much a logical response to rising energy costs as it is a result of cheap energy, and it should  (and probably will) continue until a lot of problems get fixed.

An employed Chinese laborer in the manufacturing sector, who makes perhaps $3000 per year, together with an unemployed American consume far less energy than an employed American and unemployed Chinese. Leave aside the staggering wage and standard of living differentials.  The energy cost of transporting from overseas all of the clothes, food, steel and cement that an average U.S. household consumes in a year, presently under $100, is less than it costs the U.S. wage earner to drive to and from work.

Fossil fuel is being squandered, of course. The squandering is exacerbated by trying to avoid unemployment at all costs. Protectionism would increase U.S. energy consumption, aggravating unemployment in the long run. It is simply too costly to keep the U.S. labor force fully employed doing what they did during the last century. It is less costly to modestly feed, clothe and shelter the unemployed. The whole point of employment is to create wealth. If society has to burn its wealth to prop up employment, that’s bad, no matter how sanctified our work ethic.

A subsidized enterprise destroys wealth if it would be unprofitable without the subsidy. Cheap access to a precious, limited resource is a subsidy. It destroys the wealth not only of future generations, which everyone claims to be so concerned about, but of the present one as well, because individual entrepreneurs profit at the expense of the society as a whole. The principle is illustrated by the following toy model:

Suppose oil costs $100 a barrel when 100 consumers each buy a barrel per week. Suppose a 101st consumer comes along, able and willing to pay slightly more per barrel, and the market price immediately goes up to $101 per barrel as a result of the increase in demand. How much does the 101st barrel per week really cost? You could be forgiven for thinking that it costs society $101 per week, but you would be wrong. It costs $201 per week – $101 per week to the 101st consumer, and another $100 per week that the resulting price increase costs the first 100 consumers.

Now suppose a barrel of oil can be used to manufacture $110 worth of goods (to be more precise, $110 above the other manufacturing costs). It can then be assumed that, in a society with a work ethic and a free market, someone will be willing to buy the oil at $101 (always per week), produce and sell the goods for $110, thus making a $9 profit.

The problem: While the individual was profiting the $9, the society as a whole took a $91 loss, having given up $201 for goods that were worth only $110.  Has the 101st individual profited because she has created true wealth or because of a hidden subsidy at the expense of the society? I assert the latter; she has received public wealth for less than its true worth.

Yes, I’ve oversimplified, I’ve neglected the lowered cost of goods manufactured from oil that an increased supply would cause, but the principle is nevertheless a valid one. When unrestrained demand drives up the unit cost of a finite resource indefinitely, the default ceiling on that cost becomes the point of zero profit to the individual, and this may be well beyond the point of zero profit for the society as a whole.

The wild fluctuations in the price of gas in 2008 were triggered, accompanied, and followed by relatively small changes in demand – less than 10% in either direction. This suggests that most Americans willing to pay $2 for a gallon were also willing to pay $4. To this majority, the gasoline is worth at least $4 per gallon. This is hardly surprising. If a typical U.S. worker can save an hour of commuting time by consuming a gallon of gas, and his wages are far more than $4 per hour, then it pays to drive to work himself, even at $4 per gallon. (A Chinese worker who makes less than $2 per hour should probably not drive even if gas costs $2 per gallon.)

If fuel sells for much less than most people value it,  and those same people were the collective owners of the fuel back when it was still underground, then the oil company that drilled for it and sold it must have received it from the public for less than its true worth. That’s a subsidy. When government representatives undersell public resources to their friends in the private sector, no doubt in exchange for favors, it is but one more mechanism by which government confiscates your wealth.

If we are not selfless enough to bequeath our publicly owned fossil fuel to future generations, let us at least be smart enough to sell it to them, or to anyone else for nearly as much as the next generation will eventually be willing to pay. With the revenues, maybe we can retire and enjoy life, and leave the job market open to young people. If there are no buyers at the price I am asking, then I want my share left safely where it is, beneath the Earth’s surface, until I decide to cash it in.

David Eichler

June 12, 2009

The Daily Reckoning