The domestic consequences of Trump’s war
Beyond the current shock
It has taken a war to convince the world that it needs to abandon fossil fuels.
Wars do strange things to commodity prices.
In the 1950s, while the Korean War raged, the United States built up massive quantities of wool to provide military uniforms, sending wool prices soaring at a time when Australia was the only significant wool-growing country. “A pound a pound” was the common way the boom was described in Australia, using the currency and weights of the day. For two years fortunes flowed into hardscrabble farms, and the less prudent spent as if they had been promoted into the ranks of the squattocracy.
Once a font of £s
But it all ended with the 1953 truce. Farmers hoped higher prices would return: after all, war or no war, people need to be clothed. But they don’t have to be clothed in wool, and new fabrics were becoming available: in1954 the patent on nylon expired, allowing many new entrants into the clothing market.
It’s a lesson with relevance today.
One short-term certainty is that oil and gas prices will rise, and that most countries will find it hard to deal with these rises. Like the wool farmers in the 1950s, oil bosses from Moscow to Houston are finding it hard to hide their joy.
This jump in prices, and likely longer-term development, are covered in a 9-minute podcast hosted by the The Economist, in which Alice Fulwood interviews their global energy and innovation editor, Vijay Vaitheeswaran. The title of the podcast – Big Oil’s Iran windfall won’t last – hints at where the discussion is going.
They’re not suggesting that the prices of oil and gas will simply come back to pre-war levels. They may stay elevated for a short time, as known but expensive reserves are exploited. Rather it’s that the already-established global trend away from fossil fuel will accelerate, “not because of the green imperative, but because of the security imperative”, says Vaitheeswaran.
So far Australia’s LNG producers have held back from taking advantage of the war-induced boom. Maybe it’s because they feel that, in view of stubbornly high electricity prices, they could lose their social licence. (The marginal-cost pricing model used in the National Electricity Market makes our electricity price highly sensitive to the gas price.) Ian Verrender mentions this possibility in his post Why gas giants have suddenly gone to ground over Iran. He points out that this restraint may not be entirely due to long-sightedness or social responsibility: a malfunction at one of our gas terminals, shutting down half of its export capacity, may have something to do with it.
We let a chance go by, but perhaps we had no option
Cutting government charges on gasoline and diesel makes political sense, and short-term economic sense because of our obsession with the CPI, but it is bad policy for the long term.
The price cuts explained
Commenting on the government’s decision to halve excise, and to suspend the Heavy Vehicle Road User Charge, a reader of the roundups has written:
There is no silly idea that will not be adopted if all the focus groups are strongly in favour of it. …. Just when people might have been considering changing their driving style, looking for alternatives to driving etc, the government releases the pressure of price signals.
The Heavy Vehicle Road User Charge, a levy on diesel fuel, is specifically designed to recover the costs of road maintenance and repairs. Excise on diesel and gasoline is not so closely hypothecated to roads (strict hypothecation was abolished in 1992), but there are enough interest groups keeping an eye on government to make sure that it goes to roads.
The cost of cutting diesel charges
Some of the cost of the government’s decision to bail out road users will therefore be manifest in more road fatalities, more road injuries, and more damage to roads and to vehicles of all types.
The main cost of these and other bail-outs to subsidize the price of fossil fuels is that they kick down the road the need to have prices of fossil fuels that reflect their true costs, not just in road use, but also their contribution to global warming: “externalities” to use the language of economists.
We have missed the opportunity to raise prices to realistic levels while blaming Trump, Netanyahu, and whatever clerical misogynist currently carries the title “Supreme Leader” in Iran for the price rises.
Our reader is in economically respectable company. One of the lead editorials in The Economist is titled The case against energy bail-outs. The Economist has a thick paywall, but its message is clear: if some good is to come out of this terrible war it should be a realistic price of gasoline, gas and other derivatives of fossil fuels. In simple Economics 1 terms the authors write:
High prices and fat profits tell consumers to economise on energy while encouraging producers to find and sell more. And as the energy crisis of 2022 showed, interfering with these signals can hurt some of the world’s poorest people.
It is arithmetically impossible for every government to shield its consumers from the energy shortage. So long as the Strait of Hormuz remains closed, the world has lost 15 percent of its oil supply; add in damage to Qatar’s facilities, and the global supply of LNG is down by about a fifth. No amount of subsidy can bring this back. Global energy consumption must fall.
To put it even more briefly, forcing a price cut for something that has just become more scarce doesn’t make sense. If the price has risen, and there are many market players, that higher price should stimulate a supply response.
And as explained in the next section, it makes even less sense when that price doesn’t cover the cost of production.
Australia’s muddled energy policy
Writing in The Conversation, Hussein Dia of Swinburne University of Technology endorses those views and goes further: Cutting fuel excise is a sugar hit – we need a plan to slash dependence on imports. He offers practical short-term measures, such as more reliance on public transport – in line with the Prime Minister’s address to the nation.
But his main point is about the lack of coherence in our energy and transport policies. He writes:
Even as Australia’s power grid runs more and more on renewables, policymakers continue to approve more and more investment in fossil fuels. With one foot in each camp, it’s hard to have a coordinated strategy to shift rapidly to forms of transport that don’t rely on long fuel supply chains.
Policy discussions around reducing incentives for EVs and introducing distance-based road user charges for EV drivers risk sending mixed signals to consumers and industry.
A credible transition to a new technology requires a clear sequence: first, give incentives and support, and move to pricing reform only once the adoption trend is established.
As is often pointed out in these roundups, we have some of the world’s cheapest road transport fuels. Politically that arises from the idea that we live in a country with huge distances, when in fact almost all of us live along a compact coastal strip.
Should have thought abouyt l/100 km before buying it
Transport is one sector where we are pitifully slow in reducing our CO2 emissions. One reason is our failure to have a carbon price applying to fossil fuels – not even a de facto carbon price as we have applied to other sectors, with measures such as the Capacity Investment Scheme for the electricity sector, and the Renewable Energy Certificate Market for large corporations.
When we fill up our vehicles there are only two government charges, when by the principles of efficient resource allocation, there should be three.
The first charge is the GST, paid by consumers at the pump, and by corporations in the final selling prices of their products.
The second, as explained above, is a pair of charges – excise and the Heavy Vehicle Road User Charge – paying for roads.
But absent is the charge we really need, a carbon price, which takes into account the externalities of fossil fuel use.
Contrary to the case put by some calling for tax reform, farmers, firms involved in mining and construction and other non-road fuel users should be exempt from excise and other road charges. But we should have that third layer, a carbon price, without any exemptions.
That’s not a particularly complex system of charges, but our public debate about fuel prices reveals a degree of confusion. If we called excise a “road user charge” it would surely be more easily accepted: research in many jurisdictions covering different areas of government activity reveals that people are much more accepting of “user charges” than “taxes”. That’s because people like the assurance that what they pay the government in taxes funds something they want. And the word “excise” is confusing to almost everybody.
Standing in the way of such clear language are the Commonwealth Treasury, who have a visceral hatred of hypothecation because it deprives them of power to allocate spending, and the Coalition, who regard all government expenditure as waste. They would be satisfied with a third-world network of public roads, supplemented by the occasional tollway owned by their corporate mates.
The government’s weak excuses for poor policy
“Halving the fuel excise is smart politics, but flawed policy” is how three researchers from Victoria University’s Centre of Policy Studies describe the government’s bail-out in a Conversation contribution.
The government seems to have two excuses for its move on fuel prices.
One is that it has been pushed by the group of parliamentarians known as “the opposition”. In view of the economic incompetence of that group it’s a poor excuse. When Angus Taylor, Dan Tehan or Tim Wilson put forward an idea it’s unlikely to rest on sound economic foundations.
The other excuse, with a little more validity, is that fuel prices feed directly into the CPI, and that the Reserve Bank considers any rise in the CPI to be “inflation”, requiring a response in the form of contractionary monetary policy.
It is understandable that self-sustaining inflation requires a strong monetary or fiscal response. That’s the way to deal with price rises generated in a feedback loop where prices rise with wages, which rise with prices, which rise with wages, and so on – the type famously experienced in the Weimar Republic 100 years ago and the occasional banana republic in present times.
But a rise in prices resulting from a previously underpriced commodity being brought up to an economically efficient price is quite different. That’s structural change brought about by a more efficient alignment of prices. The price rises are once-off, and are not going to boost aggregate demand: in fact in this case because fuels are imported, and because the price rises are associated with economic uncertainty, demand will be weakened.
When an economy is going through significant structural change there will almost certainly be a rise in indicators such as the CPI. For many the adjustment will be hard, and they have a defensible case for compensation, but that compensation should be a cash payment, or assistance to adjust, not a subsidy to shield them from the change. If there is some macroeconomic need to suppress demand, then this could be achieved through fiscal policy. Gas exporters and wealthy undertaxed superannuants could be called on to fund such assistance.
The Reserve Bank board would do well to take an extended break to reflect on how Australia coped in times past. In the 1950s we underwent massive structural change, while enjoying rising incomes, and keeping unemployment down around one percent, and while the annual rise in the CPI averaged 5 to 6 percent. Australians couldn’t have been too upset: they went on electing the Menzies government.