Something Must Be Done. This Is Something.🍋

The politics of fuel shocks so often outruns the economics

Imagine, for a moment, you’re a government on an island on the other side of the planet from Iran. Due to circumstances beyond your control, the price of oil is climbing swiftly, and future supplies could be limited. Consumers, media and industry are screaming that Something Must Be Done! But what? Let’s look at how some governments have responded.

Retail price caps help … or do they?

I’ll start with a small island — Tasmania.¹ It has passed a law to allow it to set a maximum retail price of fuel. Tasmania has no oil of its own, so it is completely reliant on imports. Let’s say the cost of imported fuel corresponds to a retail price of A$5.00 per litre. The Tasmanian Government, in its wisdom, decides that’s too high, and imposes a price cap of A$4.00. What happens? Well, no distributor or retailer wants to lose money selling petrol. So, they are likely to withhold what stocks they have, hoping for a change of heart (or at least of the price cap) from government. Shortages can be expected.

Frenchmans Cap, Wild Rivers National Park, Tasmania Dave Heatley

What’s worse for Tasmania is that no ship is likely to deliver fuel to the island if the owners of the fuel expect to lose money. Nor can the Tasmanian Government compel them to deliver, as the state’s jurisdiction ends three nautical miles offshore. So expect shortfalls in deliveries of oil to the state. Even the possibility that a shipment may be subject to retail price caps may encourage tankers to dock at a more supplier-friendly island.

Under these circumstances, price ceilings make shortages more likely. Any economist can tell you that shortages are worse than high prices. At least people have the option to buy at the high price, and will do so if their purpose is sufficiently valuable to them. They have no corresponding option if nothing’s for sale.²

Free public transport sounds nice, but …

In response to rising fuel prices, Tasmania’s Liberal government³ has announced three months of free public transport. Demonstrating that such policies cross political divides, Victoria’s Labour government has announced that public transport will be free in April.

Koala, Kennett River, Victoria Dave Heatley

Over in South Australia, the Liberal Party, the Greens, the Business Chamber, and the Rail, Tram and Bus Union have all called for free public transport amid high fuel prices. The state Treasurer of the recently re-elected Labor Government, Tom Koutsantonis, responded:

"Yes, it would be lovely to give everyone free public transport and free car parking and a puppy".

Koutsantonis further said that it was not responsible budget-wise to offer free public transport, even if it would be popular.

To date, the governments of other Australian states have declined to introduce free public transport.

Back to the economics. If fuel is expensive, then those who can will be likely to substitute public transport (PT) for private vehicle transport. This reduces overall fuel demand and makes shortages less likely. It only works, however, up to the point where PT services become congested.⁴

Importantly, this substitution will happen with current PT pricing. But what happens if you zero-price PT services at the same time? Well, other people will use PT (or make more use of it) who aren’t substituting away from private vehicle transport. These “non-substituters” will also contribute to congestion. A “free” PT service with zero empty seats isn’t really that useful, hence lowering the price of PT will send at least some potential substituters back to private vehicles. Relative to leaving PT prices unchanged, free PT could plausibly increase fuel use and make shortages more likely.

Tax cuts are always popular

The logic of taxes is straightforward. Higher taxes discourage consumption, and lower taxes encourage it. So, the Australian labour government’s decision to halve fuel excise for three months to lower the retail price of petrol and diesel will, of itself, increase fuel consumption. And that, perversely, will make fuel shortages more likely; the same fuel shortages the Government claims it is trying to prevent.

A sting in the tail

So far, New Zealand has sensibly avoided policies like these. I remain hopeful that it will continue to do so.

I’ll leave the last word to economist Chris Richardson:

“I entirely understand why the [Australian] government is doing this because the punters are seeing that they are being helped. Chances are they’re not actually being helped, it just looks like they’re being helped.

“Families will understand that, they’ll love it, but they perhaps won’t recognise that it comes with a sting in the tail. And that sting in the tail will be the same as last time: that it keeps inflation higher for longer than it otherwise would have been.”

By Dave Heatley

Sub-alpine vegetation, Tasmania Dave Heatley

1. Disclaimer: I grew up in Tasmania, have lived in Victoria, and have family in South Australia.

2. In response to a fuel shortage, including one to which their own policies contributed, governments can choose to implement non-price rationing. The typical forms are queuing, which replaces willingness-to-pay with willingness-to-wait, and rules-based allocation, in which a human or algorithm decides who is more important or worthy. Queuing can be undermined by secondary markets (e.g. someone with a high opportunity cost of time paying someone with a lower opportunity cost to queue for them), and it’s tricky to design rule-based allocations that are fair.

3. In Australian politics, Liberal is right of centre, and Labour is left of centre.

4. Over time, public transport agencies can expand services to meet extra demand. However, there is limited scope for this to happen in a one-to-three month timeframe, as it takes time to increase the numbers of trains, buses, drivers etc.