Comments on the American Economic Association Conference
Douglas B. ReynoldsProfessor, EconomicsUniversity of Alaska, FairbanksDBReynolds@Alaska.Edu
If you did not go to the American Economic Association’s (AEA) conference in San Francisco this year, here is some of what you missed. Presenters at the main sessions were well known economists, but that doesn’t mean they all had a good grounding in energy economics. Indeed, one economist I talked to thought it was strange that I was an energy economist. I'm sure most economists do not believe that, although, when I went to the conference session entitled “U.S. economy where do we go from here?” nothing was mentioned about oil and energy, which was strange. It could be that many economists believe that oil supplies will grow indefinitely now that shale oil is here, or it could be that they believe technology will overcome oil scarcity. Nevertheless, let me inject here some energy economic reasoning into their discussion.
First of all, just to be clear on the oil scarcity issue, when considering the supply of oil, it is not true that even though there is shale oil source rock around the world, that all of that source rock is equally exploitable. For example Poland, due to energy security reasons surrounding its relationship with Russia, has been trying to extract oil and gas for several years now from its shale source rock but has had limited success—Economist (2014). The shale rock in Poland has clay that is embedded with the shale which makes any fissures clog up. Nevertheless, it could be argued that because the price of oil has been down to $26 per barrel then that implies there are plenty of new oil supplies, although, the price of oil could be signaling that oil demand and the world economy are slowing or in decline again. On the technology side of things, the major automobile producers have yet to make an electric vehicle that can compete successfully with internal combustion vehicles other than the very expensive Tesla cars. Therefore, oil supply scarcity could soon enough rear its ugly head.
U.S. Economic Growth
Going back to the AEA session on U.S. growth, which was the signature session of the AEA conference, the panelists spoke about what can be done to induce more robust economic growth in America. Indeed, the moderator and others showed some very disturbing statistics about the U.S. economy. For example, though headline U.S. unemployment is down, the labor force participation rate is lower than it should be considering current demographics. Wages are low, and wage growth in the low income brackets is in decline or going negative. Wealth is uneven. There is much inequality of wealth and incomes, creating a deep divide between the rich and poor which tends to cause lower consumer spending since the rich put more of their income into savings. Other OECD developed countries have had even worse conditions than the U.S. In addition, the recovery in growth after the financial crisis of 2008 has been a much more subdued rebound than what has happened after other recent historic recessions.
No one mentioned oil as being a part of the reason that world growth has been slow these last few years. Yet, oil prices average around $100 per barrel from 2009 to 2014 which could be a large part of why growth has been slow during that time span. Also any growth inducing policy after the last recession could just as easily have pushed oil prices even higher by causing an increase in oil demand. That being said, the speakers each had their prescriptions for how to fix the economy, none of which took oil into account.
U.S. Debt Problems
One of the speakers at the U.S. growth panel, Martin Feldstein of Harvard University, mentioned how the U.S. debt could be a problem in the future. He talked about how, if the U.S. continues high deficit spending, then that could cause the national debt to grow and eventually rise well above GDP. The problem then becomes that the growth in the national debt will force the government to borrow more just to pay the interest on the debt which in turn will crowd out private investment. Alternatively, the large national debt could cause problems with foreign exchange repayments. However, what was not mentioned was that oil could exacerbate the debt problem.
Recall, during the 1970s when the first oil shock occurred, there was a wage-price spiral that increased general inflation which increased nominal and even real interest rates. The higher interest rates forced the U.S. and many other countries to pay high debt servicing payments on each of their national debts and incur even more borrowing. As the debt level goes up above 100% of GDP, and assuming oil prices will go up again inducing inflation, then there will be a severe rise in interest payments. Then debt servicing will consume an ever larger percent of GDP but without creating infrastructure, providing government services, or taking care of entitlements. In other words, in terms of a famous Alaskan boondoggle, it will be a lot of government spending (on interest payment “bridges”) to nowhere.
Policies To Induce Growth
The speakers were mostly concerned with getting the economy rolling again. John Taylor of Stanford and Joseph Stiglitz of Columbia suggested instituting government policy reforms to help the economy grow more robustly such as instituting a flat tax (with less loop-holes but at a lower base rate), reducing and simplifying regulations, freeing up international trade, and reforming entitlements. All of these sounded like good prescriptions to make an economy more efficient and more robust. Another suggestion was using a balanced budget multiplier tax where, for example, an increase in gasoline taxes could be instituted in order to pay for rebuilding the country’s infrastructure. That would be deficit neutral, since both taxes and spending would increase simultaneously at the same rate, but the tax would create a boost to the economy both in terms of creating more efficiency in transportation and in providing the construction workers with spending money that would stimulate the economy.
However, what was so interesting about Taylor’s presentation was how the five year moving average of productivity growth had changed over the years, ostensibly, according to Taylor, due to policy adjustments. He suggested that policy reform in the past produced high productivity growth, where as policy inaction and growing policy complexity tended to produce low productivity growth. However upon close inspection of the productivity statistics, it looks more like the price of oil was a bigger factor in causing productivity growth changes than policy reform. When oil prices were high in the 1970s, Taylor's productivity growth statistics show a decline. When oil prices declined in the 1980s, the productivity statistics slowly started to improve. Then in the early 2000s, as oil prices rose again, sure enough, productivity starts to decline again. The productivity growth was the worst over the five or so years right after the great recession of 2008 exactly when oil prices were $100 per barrel. I will let one of the many econometricians call up Taylor for the data and find the statistical relationship with oil prices using the appropriate multiple vectors of tests. The eye test is sufficient for myself. I think it comes down to a famous (American) football quote slightly augmented to our purpose in regards to economic growth: “oil isn’t everything, it is the only thing.”
Actually, if institutional economics has anything to say about it all, it looks more like oil prices themselves induced policy reform rather than the politicians inducing the policy reforms. So when oil prices rose, one reaction was policy reform. For example when oil prices rose in the 1970s voters first voted out of office Gerald Ford and when oil prices rose further, they voted out of office Jimmy Carter. In the mean time voters searched for a candidate who said he had a plan to change the economy. So, they voted in Ronald Reagan who instituted policy reforms. Thus the voters induced by high oil prices voted for policy reform candidates. However, many policy reforms were actually well under way under the Carter administration before Reagan came into office such as the natural gas pipeline reforms. So even though Reagan often gets much of the credit for all of the reforms in the 1980s, clearly others were involved. I will let the political scientists argue over that one. They can also argue whether or not it was oil prices or something else that helped to push through the new health care reform (Obama Care).
There was much discussion in this AEA session over what the Federal Reserve could or could not do to further growth prospects without causing inflation, or in general what any growth inducing policy could do to reduce unemployment (or alternatively to increase the labor force participation rate) without causing inflation. Stanley Fischer, a member of the Federal Reserve Board (the Fed), suggested that real interest rates are close to zero while inflation is low and that therefore any Federal Reserve stabilization policy is difficult to undertake. Asset purchases and other policies that helped reduce the depth of the last recession did help, but those policies if pursued indefinitely can cause other problems with the financial markets, most notably moral hazard. If the Fed raises its inflation target to induce growth, then that can cause volatility in inflation and the normal set of social costs due to inflation, such as shoe leather costs, menu costs and contract costs, will increase. No one has seen those inflation costs in a while but they are real as Fischer implied.
On that note, there was also a presentation by Oliver Blanchard on inflation expectations. He noted that inflation expectations are very anchored, such that at this point in time not many people expect any inflation and this gives the federal reserve and other policy makers a lot of leeway to use tools like quantitative easing to help restore the economy. Since the economy has a solid anchoring of inflation expectations then any stimulative policy should be able to push aggregate demand outward and not cause inflation. Indeed, he explained how the pressure on the Fed will be intense to conduct such stimulative policies, but that the danger of inflation still lurks.
Current inflation expectations anchoring, though, could soon enough be put to the test once world peak oil is reached. The lesson we need to learn is from that of the fall of the Soviet Union. Anyone who has studied the Soviet fall closely can see that the Union of Soviet Socialist Republics (U.S.S.R.) also had a very good grounding of inflationary expectations because it was a planned market economy where prices hardly ever changed. That inflation expectations anchoring was based on years, and even decades, of stable prices, albeit with unstable quantities (shortages). However, all of the grounding of inflation expectations was lost in a matter of months when the ruble was devalued and allowed to float in 1989, which happened to be one year after the Soviet Union reached its peak in oil production. Thus the fall of the Soviet Union was not due to inefficiency as much as it was due to oil scarcity, as I explain in my upcoming book on the subject. The Soviets actually had one of the best inflation expectations anchoring you could ever imagine and yet within not many months there was hyper-inflation.
The Hyper-Inflation Hypothesis
Going back to Taylor for a moment, he acknowledged that even if we engage in policy reform, we could be at a point where we have used up the “low hanging fruit” of technological development and therefore productivity growth may naturally be on a downward trend (read: we can no longer use oil to create productivity growth, but must use other energy natural resources, which are much less productive than oil and where electricity is a technology and not an energy natural resource). If that is the case, then the lesson of the former Soviet Union (FSU) is clear. A decline in productivity can cause real wages and real costs to increase. If nominal wages and nominal costs are slow to change, but productivity declines substantially, then in order for a government to pay for all of its obligations, such as health care, it will have to print money and you will soon enough get hyper-inflation along with a recession (stagflation).
None of the economists in the panel talked about hyper-inflation, but in reality it was the best thing that ever happened to the FSU. It reduced real wages creating all kinds of stimulative reform, entitlement reform and health care reform. Hyper-inflation destroyed barriers to entry and created a balanced budget due to increased real taxes from the printing of money and the creation of inflation. Real debts were reduced. Thus, when a political system is stuck and cannot compromise to get solutions, as the U.S. congress seems to be, and when different sectors of the economy are not able to react to the reduced or negative productivity growth that oil‘s scarcity can cause, then one solution that no one wants to talk about is hyper-inflation. It can, by itself, create the reform that Taylor and Stiglitz say is so necessary. It will reduce the real national debt that Feldstein is concerned about. And once the next round of oil price shocks occur, I am sure hyper-inflation will happen.
The AEA conference was fabulous with lots of sessions on every aspect of economics including some USAEE sessions. However, I believe economists need to be more aware of the role energy plays in the economy as it can help induce or inhibit economic growth. Furthermore, energy economists and other economists need to study more closely the fall of the Soviet Union as it will shed light on how our own economic future will play out. Hyper-inflation may turn out to be a good thing in the long run which will induce policy reform and help increase the well being of the economy. The Roman Empire (Tainter and Patzek 2011), the FSU and possibly even the ancient Anasazi (Stuart 2000) all used hyper-inflation to help overcome economic decline, as it can help remove structural impediments to economic growth during a severe recession. Many economists might say we’re not like Rome, we’re not like the FSU, and we are certainly not like the ancient Anasazi, but we are like those great empires in that they all, like us, depend on energy of a certain type and quality. Once that energy becomes scarce, then those economies that depended on each of their specific types of energy went into decline. Then hyper-inflation almost inevitably erupts.
American Economic Association (2016), Program Of The Allied Social Science Associations January 3-5, 2016, San Francisco, Ca, January 3, 2016, 10:15 am, “The United States Economy: Where To From Here?” Presiding: Dominick Salvatore (Fordham University); “U.S. Macro Policy in the Future,” Olivier J. Blanchard (Peterson Institute for International Economics); “Dealing with Long Term Deficits,” Martin Feldstein, (Harvard University); “Central Banking: What’s Next?” Stanley Fischer (Federal Reserve Board); “How to Restore Equitable and Sustainable Economic Growth in the United States,” Joseph Eugene Stiglitz (Columbia University); “Can We Restart the Recovery All Over Again?” John B. Taylor (Stanford University); Discussants: Dominick Salvatore (Fordham University), https://www.aeaweb.org/webcasts/2016/Economy.php .
Economist, (2014). “Polish Fracking: Shale fail,” November 14, 2014.
Stuart, David E. (2000). Anasazi America: Seventeen Centuries on the Road from Center Place, University of New Mexico Press, Albuquerque.
Tainter, Joseph A. Tadeusz W. Patzek, (2011). Drilling Down: The Gulf Oil Debacle and Our Energy Dilemma, Copernicus.