The Becker-Posner Blog

Are the Incentives of College Administrators Well Aligned with Social Welfare? Posner

A promising field of economics called organization economics studies the organization of activity within complex entities such as for-profit corporations, government agencies, and not-for-profit private corporations. Colleges and universities (which I’ll discuss interchangeably, calling both types of institution of higher education “university” because universities are generally larger and more influential) straddle these divides—there are public universities, private not-for-profit universities, and private for-profit universities. I’ll focus on the second—private not-for-profit universities. Public universities don’t seem much different from private not-for-profit ones, in part because in recent years many public universities have made sustained and successful efforts at raising money from alumni and foundations, lessening their dependence on state funding and as a result achieving considerable, in some cases virtually complete, autonomy. As for the for-profit universities, they presumably can be modeled as typical for-profit service corporations. That leaves the not-for-profit university, which plays a much larger role in American higher education than in higher education in other countries. Most of the wealthiest and most prestigious American universities are private. 

The differences between for-profit and not-for-profit institutions are not profound; we observe this in their coexistence in a number of fields, such as health care and education. The major difference is that for-profit institutions are financed in part by equity investment, in which the investors are compensated by ownership of any residual of revenue over cost—i.e., profit—while not-for-profit institutions are forbidden to distribute the residual to investors. They borrow, just like for-profit institutions, but the remainder of their capital consists of donations rather than of equity investment; the university’s endowment correspondents to the equity in a for-profit corporation. The residual goes in part to university administrators in the form of enhanced salary or bonuses and in part (usually in larger part) to expanding or improving the institution. 

Not-for-profits are more risk-averse than for-profits because their administrators cannot capture as much of the upside of risky investing as equity investors, and corporate executives, whose compensation is usually tied in one way or another to the corporation’s profitability, can. But competition forces even not-for-profits to take some risks, as we learned when the financial crisis that began in 2008 revealed the degree to which university endowments had been invested in high-rolling hedge and private equity funds. Competition for students and faculty forces university administrators to seek to maximize revenue and minimize cost. Competition is a pervasive socioeconomic phenomenon; it is not limited to businesses. 

The competitive pressures on universities can and often do result in a misalignment between private and social goals. From the standpoint of society as a whole, the goals of higher education are to enlarge general (as distinct from firm-specific) human capital by imparting valuable intellectual skills to young people of intelligence and ambition, and to produce research that generates mainly external benefits and so is underproduced by for-profit entities. And to a large extent, certainly, the universities work toward those goals, and with considerable success. But from the personal standpoint of a private university’s trustees and administrators, another goal is to maximize revenue (net of cost) and hence tuition income, donations, research grants, and income from consulting and patents—the grant money and income from consulting and especially patents being shared between faculty and university. The consequences of these endeavors include a high level of expenditures on student amenities (to attract rich kids), on intercollegiate sports (to stimulate alumni donations), and on faculty “stars” who can attract research grants and impress parents and alumni. Other consequences include light teaching loads for faculty stars as a form of untaxed compensation, student pandering (beyond provision of amenities) and so grade inflation, reduction in required courses, and proliferation of extracurricular activities—all being aspects of treating students as “consumers” to be pampered in partial compensation for high tuition and student debt and to encourage future donations. Still other consequences of endeavors to maximize revenue include recruitment of student athletes who may have no intellectual interests or promise, “legacy” admissions (discrimination in favor of student applicants who are children of alumni, especially wealthy alumni), and encouraging applied research (because it is patentable, as basic research is not). False advertising of job opportunities for graduates of graduate schools and professional schools (such as law) is also a not uncommon university marketing tool. 

From an overall social standpoint, therefore, there is a great deal of waste in the American university sector (as there is in most institutions), but it is not obvious to me what if anything should be done about it. I note, however, that there is a good deal of government subsidization of private universities, in the form of research grants but, more important, of below-market student loans. Government grants for basic research are defensible because, by definition, basic research generates only external benefits. Subsidizing tuition by means of below-market student loans makes less sense. If the loans, not being subsidized, were more costly, tuition would be lower; and promising students would still receive scholarships and low-cost loans, financed by the universities themselves, because universities want to have good students (along with student athletes, legacies, and “diversity” admits), to build reputation and attract good faculty. Many students who receive subsidized loans to enable them to go to college, but would not be subsidized by a university, would be better off not going to college. College is not for everyone.

 

 

 

 

 

Are the Incentives of Colleges Aligned With Social Welfare? Becker

The over 4,000 American private and public colleges and universities compete fiercely for students, faculty, and grants, and constitute the most competitive system of higher education in the world that provides both high quality and low quality programs. American universities are a magnet for postgraduate, and increasingly also for undergraduate, students from other countries. These two facts suggest that American universities (like Posner I use the word university to stand also for colleges) are doing a very good job of catering to the interests of students the world over. More generally, American universities are pretty successful in producing higher education that contributes effectively to social welfare, given the public policies that impinge on their behavior.

American public, private non-profit, and increasingly for-profit institutions of higher education compete hard for students and faculty. As a result, they offer a variety of courses, programs, and qualities of colleges and universities that range from a bare minimum program at many public community colleges to elite education at universities like Harvard, Stanford, and Chicago. These programs cater to students of varying qualities and with different interests. Students vote with their feet by choosing some institutions and programs over others, and by traveling long distances from other countries to attend American universities. This “voting” has made American universities responsive to the interests of students, which on the whole is a very good thing since these interests reflect changing job prospects and other changes in society.

In addition, American universities conduct much of the basic research conducted in the US, with support from the federal government and private gifts. That many young and older scientists and scholars from abroad compete to spend significant time at American universities is a good indication of the leading edge quality of this research. Perhaps they do not do “enough” basic research, but they do much more than universities elsewhere, and they would do even more if the federal government increased its support of university research.

American universities have been criticized because many of them engage in high-level competitive sports that involve heavy recruitment of student athletes. Since students and alumni like rooting for their school’s teams, these are perfectly appropriate activities for universities, aside from a couple of major problems. One is the exemption that the Supreme Court has granted to the obvious cartel-like behavior of the NCAA that uses its power to severely restrict compensation to student athletes, especially those in football and basketball. Universities should be forced to pay competitive prices for these athletes, not the much lower cartelized prices that the NCAA enforces. A much higher cost of star football and basketball players would induce some universities to tone down their emphasis on these sports, but many universities would still compete in these and other sports.

I agree with Posner that the federally financed student loan program needs significant modifications. More market-based interest rates on these loans are desirable, but in addition students under various circumstances should be allowed to borrow more than the current maximum limits on these loans. Especially students who attend expensive private universities may want to borrow more than they can at present, but most of them also receive high enough earnings later on to finance the interest repayment burden on these loans. It is no harder for most families to carry $100, 000 or more in student loans than it is for them to repay mortgage loans of comparable size.

However, students who are fettered with loans that they cannot repay should be able to discharge all or part of their loans through personal bankruptcy. To be sure, unlike mortgages, student loans do not have collateral that can be taken over by lenders in case of defaults on the loans. This is not so different than home ownership in the many states that do not allow the individuals declaring personal bankruptcy to be sued, although lenders can foreclose their homes. Despite the absence of collateral, workers who cannot repay their student loans should have the option of reducing the burden through discharging some of the loans through personal bankruptcy, the way other debt can be dischargeable through bankruptcy. To limit the abuse of this privilege, universities (including the for-profits) that make many student loans that end up being in arrears or discharged through bankruptcy should have their ability to make further loans severely constrained. This is already done to some extent, but tightening these constraints would force schools to be more careful in who they qualify for loans and the amounts they qualify for.

Having taught for almost all my adult life at American universities I am well aware of their many limitations. These include faculty who cater to students by easy grading and telling jokes, faculty who engage in vicious battles over trivial issues, faculty and administrators who are afraid to take stands against political correctness and the latest education fads, alumni and other donors who are cultivated for large gifts that really do not help a university’s mission, and so forth. Nevertheless, on the whole, American universities do an excellent job of providing up to date and diversified education for students of varying abilities and interests. Many of their “failures” are the result of bad incentives provided by federal and state support and regulation of university programs. Students the world over have voted for decades with their feet in favor of American universities against what is available in other countries.

Concern About The Decline in Manufacturing in the United States? Becker

 

Manufacturing employment as a fraction of total employment has been declining for the past half century in the United States and the great majority of other developed countries. A 1968 book about developments in the American economy by Victor Fuchs was already entitled The Service Economy. Although the absolute number of jobs in American manufacturing was rather constant at about 17 million from 1969 to 2002, manufacturing’s share of jobs continued to decline from about 28% in 1962 to only 9% in 2011.

Concern about manufacturing jobs has become magnified as a result of the sharp drop in the absolute number of jobs since 2002. Much of this decline occurred prior to the start of the Great Recession in 2008, but many more manufacturing jobs disappeared rapidly during the recession. Employment in manufacturing has already picked up some from its trough as the American economy experiences modest economic growth, and this employment will pick up more when growth accelerates.

Still, if past trends continue, the share of American jobs in manufacturing will probably be lower in the future than it was even as late as 2007.  New and exciting technologies, like 3D printing, may bring back some manufacturing output to the United States since labor costs will be a lower fraction of the total cost of manufactured products based on these new technologies. However, these technologies are unlikely to offer many jobs since they are generally labor-saving, not labor-using, but the jobs will require skilled and better paid workers.

Commentators have always lamented a sizable fall in jobs in any large sector of an economy.  A prominent example is the huge decline in farm employment during the twentieth century in all developed countries. In 1900, about 40% of American jobs were in agriculture. This fraction continued to drop during that century, despite a host of special subsidies and tax breaks to the farm sector. Only 2.5% of the American labor force has worked on farms during the past couple of decades. The enormous advances in farm productivity are a major reason behind the disappearance of farm jobs. With about 2% of the labor force currently on farm, the US manages not only to provide the vast majority of food consumed by 300 million Americans, but American farmers have enough production left over to export large quantities to the rest of the world.

Big productivity gains in manufacturing are also a major cause behind the decrease in manufacturing employment in the US. Higher productivity lowered prices of manufactured goods relative to prices of services. Yet employment in manufacturing fell because the lower manufacturing prices did not stimulate a large enough increase in the demand for manufactured goods to offset the productivity increases of the manufacturing workforce.

A second obvious force reducing jobs in American manufacturing has been the growth in China’s economy and its exports of a large variety of cheap manufactured goods (which are a great boon to American and other consumers).  Since China did not become a major player in world markets until after 1990, exports from China cannot explain the downward trend in manufacturing employment prior to that year, but Chinese exports were important in the declining trends in manufacturing during the past 20 years. Finally, the recession cut jobs in all sectors of the American economy, but especially in factories and construction.

President Obama, in his State of the Union address, advocated special tax breaks and support for the manufacturing sector. I do not see any more convincing case for subsidies to manufacturing than there was for the special treatment of agriculture during the long decline in farm employment. Most of the arguments made in support of privileges for manufacturing could be made for services and other sectors of the economy.  For example, although certain manufacturing industries have had high rates of productivity advance, so too has mining, such as through the development of fracking techniques. The most important technological advance of the past several decades has been the computer and the Internet, for these gave birth to email, word processing, apps, online sales, and social networks like Facebook and Twitter.

Instead of singling out manufacturing for special privileges, the government should get behind certain general policies. High on the list would be raising the rate of growth of the American economy, for this will tend to create jobs in most sectors of the economy. More government support may be justified for basic research in science and other areas that would also benefit all sectors, not just manufacturing. Local and state governments, along perhaps with the federal governments, could try to reduce the dismally high dropout rates from American high schools. Dropouts have trouble finding good jobs even in the best of times, and they suffer the most during recessions.

Many other steps can be taken to help the American economy, especially by limiting the growth of entitlements and the federal budget. None of the steps to improve the economy involve favoring manufacturing employment and the manufacturing sector. The call by many for special treatment of manufacturing jobs is basically misguided.

Decline of U.S. Manufacturing—Posner

 The only secure ground for the government’s subsidizing a producer is that the goods or services that he sells are likely to confer external benefits, which is to say benefits that, because they are not paid for by the buyers, do not contribute to covering the producer’s costs. The total social benefits, private as well as public, that his production creates may exceed his costs, but he will not produce if the private benefits (the payment he receives from customers) do not cover those costs. 

Some manufactured products, vaccines for example, confer external benefits: when most of the population is vaccinated against some disease, the risk to the rest of the population may be so slight that they stop buying the vaccine: they are benefiting from it but not paying for it. Another example is intellectual property that, in the absence of patent or copyright protection, could easily be copied: the original producer of the intellectual property would be conferring benefits on the copiers for which he would not be paid. 

External benefits are actually rather pervasive in manufacturing as in other sectors of the economy. For example, consumers who value a product much more than its market value derive an external benefit, because (by definition) the manufacturer does not capture this “consumer surplus [value].” But there is no reason to think that manufacturing confers greater external benefits than other sectors. 

There is a general anxiety about becoming dependent on foreign nations for products that are vital to our nation. That is a legitimate concern when one is talking about products that are essential for national security or economic welfare, such as military aircraft; and obviously our military production is heavily and justifiably paid for largely by the government, although some is paid for by foreign buyers. The foreign “products” that might be thought essential to our security and welfare are not manufactured goods at all, but commodities such as oil and rare earth metals. The United States is still the world’s largest manufacturing country, accounting for a fifth of total world industrial output. 

Becker points to the analogy of agriculture. Employment in agriculture has plummeted, leading to anxieties spurred by agricultural companies about the decline of the “family farm” and the loss of the imagined virtues of the independent farmer, to combat which agriculture continues to be heavily subsidized. The subsidies are widely recognized to be a pure social waste, and the same would be true of subsidizing manufacturing. Like manufacturing, American agriculture is thriving with its historically small labor force. 

The decline in agricultural employment is a product of technological advance, and likewise the decline in manufacturing employment. Subsidizing manufacturing will no more increase employment in manufacturing than subsidizing agriculture has prevented the precipitous decline of agricultural employment, for a manufacturing subsidy will be used to speed the automation of manufacturing tasks and so accelerate the decline of manufacturing employment--unless the subsidy is conditioned on increased employment, which would would mean diverting workers from more to less productive work. We would not be better off if 40 percent of the labor force were in farming rather than 2.5 percent, or if 28 percent of the labor force were in manufacturing rather than 9 percent. 

Some concern has been expressed that we need to boost manufacturing in order to reduce our trade imbalance, because many manufactured goods are exported. But a recent article in the New York Times (April 10) points out that the United States is the world’s largest exporter of services—and would be larger still if we took steps, such as loosening visa restrictions that impede international provisions of services and making the same efforts to pry open foreign markets to American services as we do to pry open foreign markets to American goods. 

The politicians know all these things. The push to promote manufacturing is political in origin and may (one hopes will) be abandoned after the election. Its political appeal is related partly to the fact that unions still have a foothold in manufacturing, and partly to the fact that America’s prowess in manufacturing (think of the vast output of munitions in World War II) is associated in the public mind with the epoch of greatest American world power. 

I have no objection to efforts to negotiate with foreign countries trade agreements that facilitate U.S. exports (they also of course facilitate imports—and that’s fine too). Such efforts are the centerpiece of the Administration’s program of stimulating employment in manufacturing. But the efforts should be extended to services. I can think of no rational basis for putting manufacturing ahead of services.

Notice

We had expected to blog yesterday (Sunday) on the question whether to subsidize U.S. manufacturing. We have run into a delay, but hope to post soon.

Unlimited Campaign Spending—A Good Thing? Posner

The Supreme Court’s 2010 decision in Citizens United v. Federal Election Commission held that Congress cannot limit expenditures in political campaigns as long as the spender, who might be an individual or an organization, including a corporation or union, is not affiliated with or acting in concert with the candidate or political party. The Court held that such “independent” expenditures are not campaign donations, which can be regulated; they are pure expressions of the political preferences of the donors. 

Some of the expenditures are made directly by donors to buy political advertising, but most (84 percent of the roughly $100 million in such “independent” expenditures already made in the current presidential primary campaign) are given by the donors to political action committees (called “super PACs”), which channel the expenditures into political ads or other methods of influencing political opinion. This is sensible intermediation since the donors are unlikely to be knowledgeable about creating or buying or placing ads. 

The Supreme Court allows donations to political campaigns to be regulated (and limited) because of fear that donations unlimited in amount corrupt the political process, because the candidate recipient knows that a donor of a large amount of money expects something in return, usually favorable consideration of a policy that would benefit the donor, and hence a large donation is likely to be a tacit bribe. But the Court, rather naively as it seems to most observers, reasoned in the Citizens United case that the risk of corruption would be slight if the donor was not contributing to a candidate or a political party, but merely expressing his political preferences through an independent organization such as a super PAC—an organization neither controlled by nor even coordinating with a candidate or political party. 

The criticisms of the Court’s reasoning are several. First, the notion of “coordination” is vague, and tacit coordination with a candidate or a party seems to occupy the same never-never land as tacit collusion in antitrust law. It can be quite effective yet is hard to condemn as actual coordination. Allies of the candidate or members of the party can run the super PAC, and without even talking to the candidate or to party officials can figure out what kind of political advertising will be helpful to the candidate. Most super PAC advertising has been negative—that is, has attacked opponents of the candidate whom the super PAC favors—because positive advertising would be difficult without explicit coordination; the reason is that candidates tend to be vague and protean about what they favor, in order to maintain their freedom of action and reaction, so a super PAC could operate at cross-purposes with its favored candidate if it advertised in support of a program that it thought the candidate would favor. In addition, negative political advertising is usually more effective than positive. 

It thus is difficult to see what practical difference there is between super PAC donations and direct campaign donations, from a corruption standpoint. A super PAC is a valuable weapon for a campaign, as the heavy expenditures of Restore Our Future, the large super PAC that supports Romey and has attacked his opponents, proves; the donors to it are known; and it is unclear why they should expect less quid pro quo from their favored candidate if he’s successful than a direct donor to the candidate’s campaign would be. 

So the real question is whether campaign donations, in whatever guise, should be limited. There are two arguments. The first and less is that, as with brand advertising, advertising pro and con competing politicians tends to be offsetting; the argument is that if the contestants’ spending is limited, this will not affect the outcome of the contest but merely reduce its cost. But the argument is weak because it fails to account for the need of a new entrant to spend more heavily than incumbents in order to offset the cumulative effect of earlier expenditures. Even if the producer of some famous brand stopped advertising altogether, it would be years before consumers began to forget about the brand and stop buying it, but a new entrant would have no existing body of consumer good will to fall back on. 

The stronger argument for limiting campaign donations is the corruption argument, which I have just suggested is as strong against the super PACs as it is against direct campaign donations. But again there is the concern with new entrants. If a candidate’s name is Bush or Clinton or Kennedy (and he or she is related to a former President who bore one of those names), the candidate enters a political campaign with an information advantage by virtue of belonging to a well known political dynasty extending over two or more generations (hence like an established brand). An unknown may need to spend more than one of those dynasts to pull even. Yet it hardly seems feasible to fix a limit on contributions and then raise it for new entrants. 

That said, I think the emergence of new media in the Internet era make the corruption argument stronger than the new-entrant argument. The reason is that the Internet greatly reduces the expense of disseminating information, whether about a candidate or anything else. The number of over the air radio and television stations is limited and likewise the number of newspapers and magazines, but nowadays most people are getting their information, including political information, from social media, blogs, tweets, and other modes of communication, effectively infinite in number, accessible costly over cell phones, laptops, and other electronic devices. These technologies for creating, disseminating, and receiving information at very low cost should enable any candidate with a persuasive message to reach a large audience of potential voters, and should thus favor new entrants in political as in other markets—provided they are not allowed to be drowned by enormous expenditures by super PACs. 

We saw the effect of the new information technologies at work in the 2008 Democratic primary season, when the relatively unknown Barack Obama defeated the much better known Hillary Clinton, and we have seen it again and more dramatically (consistent with the rapid expansion and adoption of these technologies) in the current  Republican primary campaign. Michelle Bachman, Herman Cain, Rick Perry, Ron Paul, and Rick Santorum, none of whom was nationally prominent (Santorum had once been, but after his one-sided defeat for reelection to the Senate in 2006 had lapsed into obscurity), were able to compete effectively with the better-known candidates (Romney and Gingrich), and lost because of lack of support rather than lack of campaign funds. True, Santorum and Gingrich were both bolstered by super PACs, but they were hammered by Restore Our Future, thus providing a good example of offsetting “arms race” political expenditures. 

But could it be that the more that is spent on political campaigns, the more informed the voting public becomes? This suggestion is hard to take seriously. Political candidates seem to have a very condescending view of the American electorate; almost no information is conveyed by political advertising. Debates and other campaign appearances provide voters with insights into the character and intelligence of candidates, but positive political advertising is largely a mode of hagiography, and negative of defamation.

Restrictions on Campaign Contributions- A Good Thing? Becker

Posner is clearly correct that the analytical differences between “super Pacs” and direct campaign contributions to candidates are not large enough to justify disparate treatments. Yet, because they should be treated the same way does not necessarily imply that spending by super Pacs should also be sharply controlled. I believe that it is very likely  preferable to apply the reasoning in Citizens United v. Federal Election Commission to direct contributions than to extend the limits on direct contribution to super Pacs.

I agree with Posner that candidates with political positions attractive to rich individuals may obtain considerable funds that give these candidates political advantages in appealing to voters. Such political contributions may well also affect the policies supported by candidates and elected officials. This is the corruption issue raised by Posner and by much of the literature that supports sharply limiting campaign contributions.

Sharp restrictions on campaign contributions would make more sense if monetary contributions were the only major force that shapes who wins elections and the policies goverment officials support.Yet that is very far from the situation that prevails in American politics, and in the politics of most other democratic nations. One reason for this is that interest groups can often avoid the intent of restrictions on campaign contributions through other ways to influence political outcomes. For example, many industries hire lobbyists and spend other monies to try to persuade legislators, regulators, and others in important political positions to subsidize their industries, or to reduce the taxes on their industries, or to gain other advantages.

It is not only business that is active in these ways since, for example, unions of government employees use political clout to obtain generous pensions and health plans for their members. The tight budgets that are currently being imposed on many national and regional governments-such as the Greek government and state and local governments of the United States- have induced government unions to fight hard to keep their pension and health benefits, and to limit any reductions in these benefits. Similarly, unions of public school teachers have spent considerable money and time to defeat efforts to introduce school vouchers and many other changes in public school systems.

Candidates who galvanize enthusiasm with their oratory and political positions induce many supporters to spend considerable time working to elect these candidates and to promote policies the candidates favor. Time spent by supporters is often as effective and “corrupting” as money spent influencing political outcomes and policies. This is probably especially true in the age of the Internet and other methods of mass communication. Supporters of a particular candidate may spend a lot of time on political issues through blogs, Facebook and other social networks, and through other forms of mass communication. Radio, television, and Internet stars, such as Rush Limbaugh, Bill Moyers, and Matt Drudge, not only affect the views of followers, but also how active they are in supporting conservative or liberal policies.

These reflections lead me to question whether it is wise to control one form of interest group politics; namely, direct and indirect monetary contributions to political campaigns, in an environment where other types of interest group politics are important and are only weakly controlled. I am not denying monetary contributions have a significant effect on who wins elections and the policies that are implemented. The empirical political literature shows rather conclusively that political contributions are influential, although frequently not decisive. However, it is known as well that other interest groups sometimes also have decisive influences over political outcomes through lobbying and many other ways. When other methods of influencing candidates are mainly uncontrolled, it is dubious whether sharp controls over monetary campaign contributions are merited, no matter whether these contributions are indirect or direct.

Fracking and Self-Sufficiency in Gas and Oil-Becker

More or less every American president starting with Dwight Eisenhower, and prioritized by Richard Nixon, called for American self-sufficiency in energy sources. In fact, America is now about self-sufficient in natural gas, and America’s oil imports have declined as a fraction of its total oil consumption from a peak of 60% in 2005 to about 50% in 2011. Part of the decline is due to the Great Recession’s effects on US output and automobile use. Another part is due to rising prices of oil that reduced oil imports, but increased spending on these imports. A third and growing part is due to increased domestic production of oil and especially gas that is likely to continue to grow rapidly during the next decade. The main reason for the expansion in domestic gas and oil production is a technique called “hydraulic fracking”. Texas wildcatter George Mitchell was the most important person responsible for the development of the fracking method to extract gas from shale formations in the 1980s. This method uses large quantities of water under high pressure with added chemicals to crack open rocks and extract the gas, and sometimes oil, hidden in these rocks. The cost of using fracking for natural gas extraction has become so competitive that most US natural gas production comes from fracking. As a result, the price of natural gas has fallen from a peak of about $10.80 per million BTUs to $2.20 currently. Instead of building terminals that could import liquefied natural gas, energy companies are now trying to export more natural gas. US natural gas inventories are so bloated there is a possibility that the price temporarily could be forced down toward $0, or even to a negative level. Traditionally, a barrel of oil has sold for about 11 times the price of a million BTUs of natural gas. During the past few years, rising prices of oil and declining natural gas prices have raised that ratio to almost 50.No wonder there has been a rush to substitute gas for oil in electric power generation and in other activities. Environmentalists have criticized the use of fracking techniques, and have pushed for bans or serious restrictions on their use. These critics claim that the techniques use too much water that could be used for other purposes, that it contaminates drinking water in areas surrounding fracking activities, and that it pollutes the air in surrounding neighborhoods. I am not in a position to authoritatively evaluate these environmental claims. However, the chairman of Chesapeake Energy, a major fracking company, recently argued in a Wall Street Journal interview that fracking does not use so much water, and that in any case the company in most of its operations now recycles 90% to 100% of the water it does use. Furthermore, the EPA just dropped its claim that a different energy company contaminated drinking water in Texas. This is the third time in recent months that the EPA backtracked on claims that link fracking to pollution of surrounding water supplies. The size of the effects of fracking on air pollution is still an open question as the debate continues over this and other environmental effects of fracking. Some political leaders have proposed a very bad idea:to restrict American output of oil and gas to use by American industry and consumers. If such laws were enacted and yet the US continued to import oil from abroad-which will be the case for the foreseeable future- restricting US production of oil to American use would have no effect on the domestic price of oil. The reason is that the global oil price would then determine domestic prices since no one would buy domestic oil if it were more expensive than imported oil, and no one would use imported oil if it carried a higher price than domestically produced oil. On the other hand, suppose domestic production was so large that oil imports were unnecessary and exports of oil were prevented. Then domestic oil (along with natural gas) would sell below the world prices for these fuels. This would be bad for the domestic oil and gas industry because it would be forfeiting profits from selling some of its production abroad. Moreover, the relatively low domestic prices of these fuels would encourage greater domestic use that would lead to more pollution, although cleaner gas or oil would be substituted for dirtier coal in the production of electric power and in other uses. Fracking has made the US self-sufficient in gas, and it is leading to reduced imports of oil. If this progress continues, before too long US consumption of oil as well as natural gas would not be drastically affected even by an entire breakdown of imports from the Middle East. The early progress in fracking techniques was very much aided by federal support and the work of engineers in the Energy Department. However, fracking was made into a profitable technique mainly through the ingenuity of people like George Mitchell in search of financial gains from finding ways to expand domestic production of gas and oil.

Energy Self-Sufficiency—Posner

The policy of trying to achieve economic self-sufficiency, thus eliminating the need for foreign trade, is called “autarchy” and is associated with warlike regimes, such as Nazi Germany, since war may cut off a nation from foreign markets in products essential to a nation’s war machine. Germany made long strides toward energy self-sufficiency, essential to its blitzkrieg tactics, by manufacturing oil from coal; Germany had coal reserves in abundance, but no oil reserves. The only source of oil, besides its coal, that it could count on was the Romanian oil fields, and their output was too limited to supply the German military’s fuel needs. 

Autarchy is a very costly policy for a nation to pursue, because, to the extent the policy succeeds, the nation loses the opportunity to substitute foreign products for inferior or more costly domestic output. A nation that has no exports will have nothing to trade for superior or cheaper foreign products. 

Nevertheless it can be sensible to be concerned about the reliability of foreign sources of commodities that are important to a nation’s power or welfare. Most of the world’s oil resources are owned either by unstable countries, ranging from Nigeria and the Sudan to Iraq and Iran, or by unfriendly countries such as Russia, or by countries that are both unstable and unfriendly, such as Venezuela, or by potentially vulnerable countries, such as Kuwait and the other Persian Gulf sheikdoms, and Saudi Arabia. 

Anxiety about the supply of oil, coupled with increased demand by rising countries such as China, have driven oil prices very high. That is actually a good thing because it both limits demand and stimulates exploration and development, including development of substitute energy sources. High oil prices have stimulated increased  U.S. production of oil, although it has left us far from self-sufficient—we still import about half of all the oil that we consume. And this despite the fact that for reasons that Becker explains, such as substitution of very cheap natural gas (very cheap because of increased supply attributable to hydraulic fracturing [“fracking”]) for oil in power plants, the economic downturn, and the high price of gasoline as a direct consequence of high oil prices, domestic demand for oil has declined. 

Should we worry about our continued if slightly diminished dependence on foreign oil? Probably not. Advances in technology, which include fracking, which is used to increase production of oil as well as gas, and deepwater drilling, should offset supply interruptions caused by foreign oil nations’ instability or hostility or vulnerability. Moreover, there are substitutes for oil and oil products as fuel and power sources, and the higher oil prices are, the faster those substitutes will come to market. Among attractive substitutes is simply less commuting—more working from home or living closer to work—and therefore less highway congestion, a negative externality. High gasoline prices, by reducing demand, have the same beneficial environmental effects as high gasoline taxes, which many economists recommend. 

High gasoline prices may be a social boon, but they are a political problem. The contenders for the Republican presidential nomination are blaming those prices on Obama. They want the Administration to authorize more deepwater drilling and take other measures to increase domestic production. But unless those measures led to a significant increase in the world supply of oil, which is hardly likely, since the United States has only 2 percent of the world’s oil reserves, oil prices and therefore gasoline prices would be unaffected because, as Becker explains, those prices are set at the intersection of global demand and supply. 

Moreover, there is a difference between authorizing new drilling and expanding supply. If the authorization leads to new production sufficient to reduce oil prices significantly, further increases in production are discouraged. Lower prices make it more difficult to cover the costs of increased production, especially since those costs may rise as oil companies are forced to explore for and develop oil in less favorable terrain, as older fields become exhausted. 

If we do wish to lessen our dependence on foreign oil, the best instrument is probably a tariff. A tariff would increase the price of imported oil, and therefore encourage more domestic production. Moreover, it would weaken oil exporters, by reducing their output (the United States is a huge market for foreign oil—it consumes about 20 percent of the world’s oil, and half of that comes from abroad). It could actually lead to a reduction in oil prices. If a product has a positively shaped supply curve, meaning that the cost of production rises with output, then a reduction in output reduces the cost of production and therefore, given competition, the price.