Friday, June 27, 2008

Like Paul Krugman, I am somewhat surprised that Republicans don't believe in the efficient markets hypothesis. However, I think I have a better explanation.

In today's op-ed the fact

Somewhat surprisingly, Republicans have been at least as willing as Democrats to denounce evil speculators. But it turns out that conservative faith in free markets somehow evaporates when it comes to oil. For example, National Review has been publishing articles blaming speculators for high oil prices for years, ever since the price passed $50 a barrel.

And it was John McCain, not Barack Obama, who recently said this: “While a few reckless speculators are counting their paper profits, most Americans are coming up on the short end — using more and more of their hard-earned paychecks to buy gas.”

On his blog, a hypothesis

I think that conservative belief that the market is always right is colliding with another, even more deeply held belief — that there are no limits, except for those imposed by tree-huggers.The idea that oil might really be getting hard to find, in spite of the magic of capitalism, is just unacceptable; so they insist that it’s all craziness in the futures markets.

Now I like the snark of how the magic of capitalism makes oil as in (with apologies to William Shakespeare)

Conservative: Capitalism can call oil from the vasty deeps.

Krugman: Ay and so can I or any man, but does it come ?

But I have a very slightly different way to put it (not worth a blog post but I've typed so far).

(with apologies to David Manning who writes somewhat less well than William Shakespeare)

"the intelligence and facts [are] being fixed around the policy."

There are hard core fresh water economists, many of whom are conservatives, who have consistent views about how the world works and draw policy implications. Most conservatives, however, start with the policy implications and work backwards to the view about how the world works.

If the market for oil were perfectly efficient (perfectly competitive even) then the US government could use its market power to the benefit of US citizens.

A gas tax in the USA with revenues redistributed to the citizens would, in this case, have a second order dead weight cost (assuming no global warming and that the money isn't used to pay for highways as it is) and cause a first order transfer from oil exporting countries to oil importing countries. Such a policy is anathema to Republicans so conservatives have to come up with an argument for why it wouldn't work. If they have to abandon the efficient markets hypothesis they will.

The claim that, if markets are efficient, then the best policy for the citizens of a given polity is laissez faire is correct only if 1) the polity is a closed economy, or 2) a tiny open economy which has no effect on world prices or 3)if world supply curves are horizontal or, finally (I think) 4) there will be retaliation for begger other countries policies.

I'm not sure prof. Krugman wants to talk about that so much as people might think that it applies to other goods as well. Such benefits from tariffs don't appear in standard trade theory for reason 3) with CRS production functions relative prices of goods depend on prices of factors and not on demand for specific goods since supply curves are horizontal (any quantity for the right price none for less) if production functions are CRS. Then factor mobility and I don't remember what ...

Anyway aside from psychoanalyzing psychopaths Krugman and I agree and, of course, he puts it better

Most of the adjustment to higher oil prices will take place through private initiative, but the government can help the private sector in a variety of ways, such as helping develop alternative-energy technologies and new methods of conservation and expanding the availability of public transit.

But we won’t have even the beginnings of a rational energy policy if we listen to people who assure us that we can just wish high oil prices away.

It's about the policy response.

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