Tuesday, August 30, 2005

Oil Prices: Why Are Economists Such Optimists?

The Oil Drum has recently presented a fascinating one-sided debate in which many folks mocked economists for not understanding key issues related to Peak Oil . As an economist, who is married to an economist and spends 85% of his academic time with other economists, it was quite good for me to see how smart people think about a key policy issue.

Steve Levitt posted a very reasonable discussion of his optimism that incentives for conservation and production would play a key role in mitigating any future “oil crisis”. The responses posted to Oil Drum boiled down to calling him “na├»ve” and ideologically driven in his faith in free markets.

While no economist can predict what “magic bullet” will allow us to substitute away from oil, is it such a horrible bet to claim that in a world with millions of inventors and billions of venture capital dollars that somebody will come up with a “Google” like idea for re-inventing vehicles to green them?

Why is oil different from other commodities? The Oil Drum is riding high now that oil prices are so high but the Oil Drum is not clear on how it knows that demand elasticities are close to zero and supply elasticities are close to zero. In the very short run maybe this is true but Keynes is wrong --- in the long run we’re not dead—we’ve substituted to something new.

This whole discussion brings me back to Paul Ehrlich. I read something by Prof Ehrlich claiming that the reason his predictions in Population Bomb turned out not to be true was because of his book. Warning people of a coming crisis, stopped the crisis.