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April 26, 2013

Earth Day and Capitalism

April 26, 2013
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On Monday millions of people around the world celebrated Earth Day. Although there are always exceptions, it’s safe to say that the vast majority of these people are in favor of more government regulations to (allegedly) protect nature and the environment from the unchecked greed of a pure capitalist system.

In this post I’ll explain that this thinking is backwards: A true laissez-faire economy based on private property offers incentives for wise stewardship of natural resources. History shows that the most mismanaged habitats and ecological disasters in history went hand-in-hand with strong government.

Capitalist Myopia?

One of the standard arguments for government intervention in the arena of exhaustible resources is that private market transactions allegedly lack the capacity for a long-term perspective. For example, proponents of government subsidies to renewable energy sources will often argue that the planet only has x years left of oil, making it imperative for humanity to wean itself of its “addiction” to fossil fuels, or for the US to end its “dependence on foreign oil.”

In the first place, it is a bit odd to deal with the problem of oil running out in 50 years, by forcing humanity to stop using oil much sooner. But more fundamentally, the argument overlooks the fact that modern capitalism has an entire network of markets devoted to the future availability of commodities. Indeed, it’s surprising that the interventionists missed them, when they have the word “future” in their very name: They’re called futures markets.

Elsewhere I have spelled out in detail the operation of futures markets, and how the prices of futures contracts (for various dates) interact with the spot price of oil, in order to “regulate” the rate at which oil is consumed today, versus held off the market for future use.

Even if we took the “finite resource” logic at face value, and imagined all of the world’s oil were in one giant pool being drawn down over time, the operation of markets would produce very long-term thinking. For example, if people were consuming so much oil from the pool that it would run out in a few years, then speculators would buy and sell various financial instruments, causing the delivery price of a future barrel of oil to rise much higher than the current spot price. This would give producers an incentive to slow down current production rates, leaving more oil in the pool for future years. The higher spot prices in turn would give an incentive to consumers to switch away to activities involving less use of petroleum products. In other words, the profit motive would guide everyone’s behavior in the exact way that the interventionists want, with far more precision and feedback mechanisms than top-down rules.

Yet in reality, it is very misleading to think of the world’s supply of oil as one giant, known pool, which we are constantly reducing. When people cite statistics saying, “We only have a few decades of oil left,” they are referring to reserves that have been discovered. There are still plenty of oil deposits that we haven’t yet discovered, and which therefore don’t show up in the standard statistics.

Simply put, it’s not efficient to go find every last drop of oil on planet Earth. Instead, the efficient thing is exactly what private business does—it spends significant amounts on exploration and discovery, but only to provide a very comfortable margin. As “known reserves” are whittled down, people go out and find more oil. This is the same process that every household uses with regard to food in the pantry. Nobody looks at the number of soup cans in the kitchen, does some quick arithmetic, and then exclaims: “We need to start eating renewables, like the grass on the front lawn. If we don’t make the switch, at this rate, we’ll run out of chicken noodles next Tuesday!”

Government Officials Focus on the Moment

Ironically, it is governments that suffer from myopic incentives. Unlike private owners, government officials are only temporary custodians of the natural resources under their control. They don’t have the same incentives to preserve the long-run value of such assets, but instead will have a tendency to dole out favors to their cronies while in power.

For example, take the problems of “overlogging” and “overfishing.” The culprit here is government-owned forests and bodies of water. You never hear of a farmer slaughtering all of his pigs because the price of pork is high; no, private owners know that to maintain a lifetime flow of revenue, they need to hold back current production and allow natural, reproducing resources (whether pigs, trees, or salmon) to flourish.

In contrast, look at the incentives facing a government official in charge of setting the price on, say, logging on state-controlled forest land. He may not be in charge past the next election, and doesn’t personally own the real estate under his control. Therefore, he has no personal financial interest in maximizing the long-run market value of the forest land, the way private owners would. Instead, he has the incentive to cut a sweetheart deal to a logging company, which will extract more timber in the present than might be optimal. Moreover, the general lack of markets and private property in other assets on the state-controlled lands, causes environmentalists to decry “capitalism” (and seek tighter regulations) when in fact the mismanagement is due to government control in the first place.

When it comes to mineral deposits, the situation is usually reversed: Rather than develop coal, oil, and natural gas resources at the economically appropriate rate (which would maximize the market value of the expected stream of revenues from the deposits), government officials will restrict current output in order to cater to environmental groups. This is a very costly decision—which forfeits many billions in potential federal revenue and keeps gasoline prices higher—that does not translate into personal financial hardship for the individuals making such leasing decisions, because they wouldn’t be the ones to personally pocket the extra revenues from a better policy.

Where Are the True Ecological Disasters?

Critics of unfettered capitalism like to point to the Three Mile Island “disaster,” which dovetailed with the apocalyptic movie The China Syndrome and scared a generation of people about the dangers of nuclear energy. Yet despite the uproar, it is difficult to document many actual victims of the accident. (One nuclear physicist quipped that his heart attack from the stress of dealing with Jane Fonda and other activists made him the only demonstrable victim of Three Mile Island.) If even one person developed cancer unnecessarily, that is one person too many, of course, but people die in accidents all the time. The Three Mile Island accident hardly offers a lesson on the free market and energy production, the way interventionists like to frame things.

In contrast, the former Soviet Union really was an environmental disaster. As a Boston Globe correspondent wrote in 1990:

MOSCOW – In the minds of millions, the environmental disaster that is the Soviet Union is summed up in one word: Chernobyl.

The world’s worst nuclear disaster ever, the 1986 power-plant explosion that spread radiation as far as the United States, has taken at least 250 lives, forced the evacuation of 115,000 people and cost $12.8 billion in cleanup and lost energy. The catastrophe continues to unfold in leukemia cases now being diagnosed.

But horrific as it was, Chernobyl was in some ways an environmental sideshow for the U.S.S.R.

The country today is facing not just one environmental crisis, but a series of overlapping threats that have developed over 50 years. Its outdated and inefficient heavy industries are environmentally as well as financially costly. An estimated 50 million Soviet citizens are living in cities and towns beset by serious air pollution.

“Forget Chernobyl for a moment,” said Yury Shcherbak, a medical doctor, member of the Supreme Soviet and chairman of the republic’s activist Greens.

“Imagine that there’s a state in the United States that has 3 percent of the country’s land mass but 25 percent of its industrial capacity – nearly all of its heavy industry, such as coal and steel, inefficient and highly polluting. Imagine that it exports energy but keeps the pollution for itself. And finally imagine that 60 percent of the land had been overplowed and is eroding.”

Add to that the world’s worst nuclear accident, Shcherbak concludes, and you’ll get a picture of the state of the Ukraine.

Conclusion

Contrary to most of today’s environmental activists, free-market capitalism has incentives for the preservation of the long-term value of natural resources. Both theory and history show that overriding private property rights in favor of government authority, will actually make nature less secure. After all, the same greedy impulses that infect private businessmen, will also be present in government officials. The crucial difference is that market prices show private owners the costs of their actions.

It’s true that proponents of government intervention can use sophisticated arguments concerning “negative externalities” to challenge the efficacy of market prices. (I have written elsewhere on the problems with this logic in the case of carbon taxes.) Even so, it’s important for the public to learn the general presumption in favor of private property, rather than government edict, as an important component of safeguarding natural resources and environmental quality.


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