The Energy Crisis and the Coronavirus Crisis

By David Montgomery

EDITOR’S NOTE: This article was last revised on January 14, and policy responses as well as stock market reactions continue to become more extreme.  Despite the need for reassurance and the feeling that something is being done, not all responses are useful.  Some like a temporary payroll tax cut including self-employed and small business loans are on point and useful, others such as permanent mandates for sick leave are broader than necessary, and efforts to sneak in abortion funding and such are outrageous.   The appearance of charts extrapolating exponential growth of cases is very disturbing.  There are far too few cases in the US at this point to establish an exponential trend, and the number of cases is already leveling off in South Korea and China. That is a very hopeful sign, and should create some optimism that draconian measures now in place for social distancing will work as well here.  The cost of those measures in lost GDP is about $1 trillion (due to forecasted growth in 2020 falling from +2.5% to -2.5% on a $22 trillion economy). They had better be worth it.  WDM

There is a remarkable similarity between policy responses to the Arab oil embargo of the 1970s and the way responses to the Chinese coronavirus are developing. Both events were handled by Republican administrations with weak commitments to basic economic principles at their highest levels, that had to cooperate with Democratic majorities in Congress with their own ideas about how to manage markets.

The oil embargo had a very small direct effect on the U.S. economy, and the direct effects of the coronavirus are not likely to be larger. The economic damage resulting from the Arab oil embargo was almost entirely self-inflicted, due to panic and poorly designed policies. Any economic damage from the coronavirus is also much more likely to arise from panic and policy errors than from the disease itself.

The Oil Embargo of 1973 was an attempt by Arab oil exporters, principally Saudi Arabia, to deprive the U.S. and other allies of Israel of crude oil supplies. In that strategic objective, it was a total failure, as oil shipments were quickly rearranged on the world oil market to go to all the places where there was demand. World oil prices did rise dramatically, but no one went without supplies. Nevertheless, between 1973 and 1974, US GDP declined by about 2 percent and gasoline lines were pervasive and never forgotten.

The immediate response to the oil embargo in Washington was to pass the Emergency Petroleum Allocation Act (EPAA) which expanded price controls on crude oil and refined products (gasoline, diesel and home heating oil) and created a program to allocate those supplies “fairly” across states based on their past consumption. The result was natural. Price controls prevented price signals from reaching oil companies to increase drilling and crude oil production and removed economic incentives to reduce travel and oil consumption. The allocation program made things worse, as states with growing population and income like California became short on supplies and other states had unused allocations because demand was no longer there. The result was panic, with hoarding of gasoline, more frequent trips to the pump to keep tanks full, and long gas lines. These were finally managed in the worst locations by further rationing by means of odd-even day eligibility to purchase gasoline.

To compound the error, the highest priority of economic policymakers at the time was to control inflation. As a result, the Federal Reserve moved in exactly the wrong direction, by tightening the money supply, resulting in further economic contraction and skyrocketing interest rates. Economists and policymakers realized in hindsight that this was the wrong way to address a global supply shock, and policy since then has been to accommodate inflationary pressures from supply shocks.

Estimates of the direct damage done by the oil embargo, what it would have been in the absence of these policy mistakes, put it at no more than 0.2% of GDP in 1974, less than 10% of the total, immediate economic losses.

Over the longer term, the oil embargo stimulated aspirations for “Energy Independence” that led to a growing bureaucracy, increasingly complex regulation of oil and gas production that only began to be relieved in the 1980s, energy efficiency standards and renewable fuel mandates that still impose costs today, and massively increased spending on (usually failed) demonstration projects for new technologies.

We can already see similar patterns in the case of the novel coronavirus. The direct economic costs of increased illness are a reduction in hours worked and diversion of resources to increased medical care. These magnitudes are difficult to predict, but if the spread of the coronavirus in the U.S. is no worse than the peak that appears to have been reached in Wuhan, costs of the coronavirus will be a small fraction of the costs that influenza imposes every year. The U.S. had had 9 to 45 million cases of influenza per year since 2010, with annual death toll of 12,000 to 61,000 – say 1.5 in 1000. The variation in influenza morbidity and mortality does not even show up in GDP.

As of March 12, China had a total of 80,981 reported cases of coronavirus and 3173 deaths, about the same as the previous week. The US had 1215 cases and 36 deaths. The expert consensus is that the mortality rate in the U.S. from coronavirus will be between 0.1% and 1%, so that a conservative estimate might be 1000 deaths if the U.S. reaches 100,000 total cases. This is less than 10% of the average death toll from influenza. Even if we reached 1 million coronavirus cases, the death toll would likely be far lower than the high end of the range of deaths from influenza. I predict that if precautions against coronavirus make commonplace the recommended habits of hand-washing, staying home with respiratory symptoms, and avoiding touching our faces, the reduced death toll from influenza is likely to far exceed deaths from coronavirus itself.

In addition to these direct effects of the coronavirus, the only real supply shock to be expected is some interruption of supply chains from China. Taking these factors into account, reputable forecasts before the stock market panic were that in first quarter of 2020 growth would slow by about 0.2 percentage points, recovering by the summer.

The Federal Reserve has clearly learned its lesson from the 1970s, and its recent rate reduction will not exacerbate the direct costs of supply chain interruptions even if it cannot reduce them. Moreover, U.S. businesses have become more flexible in their operations, and had ample time during fears of a U.S.-China trade war to work out how to source supply chains from different locations.

The much greater threat to the economy would be an overreaction to the limited risks of illness as news media in search of viewers and politicians looking for cheap shots create panic and force policymakers to appear to be doing something. Instead of giving accurate information on comparative risks, or at least unedited coverage of statements from responsible officials, media are reporting each single new case as if it is a nuclear warhead in the hands of terrorists.

It is never easy to deal with the claim that “we don’t know how much worse it might get” or references to naïve models that predict millions of cases. Dr. Fauci from NIAID admonished congressmen that they should not accept extreme scenarios as forecasts of likely outcomes. He warned that “the press tends to report on the higher end of ranges” even though they are just exercises to see how large a number a model can produce. Such reports only heighten anxiety and push politicians to take ever more extreme measures – such as the police-state prohibition on gatherings of more than 250 people by the governor of Maryland, a state with 18 known cases in a population of 6 million.

Nationwide, we are seeing a rash of cancellations: sports seasons, public events and performances that have considerable economic value, closings of schools and universities, bans on gatherings and even church services, dramatic reductions in domestic as well as foreign travel, quarantine of infected individuals, recommended seclusion of older people, and on and on. All this despite health risks that still appear to be less than from catching the flu – for which many fail even to claim immunizations. These possibly excessive social distancing measures and event cancellations are affecting spending on restaurants and bars, recreational, leisure and hospitality services and travel. Employees in these industries will lose jobs and incomes, further reducing spending.

Even this has not yet clearly dampened consumer spending, because spending has increased for other items, sometimes to ridiculous degrees. Panic buying has emptied store shelves just as it caused gasoline lines in the 1970s. There is no shortage, just a movement from retailer inventories to household hoarding. Those shelves will be refilled quickly, and the surge in buying will end when households run out of room to store their panic purchases. Even sales of autos and household appliances appear to be increasing, likely an acceleration of purchases out of concern that supply chain disruptions may affect cost or availability in the future. By the end of the year, these gyrations in sales will even out. All it takes to avoid permanent economic loss is patience and common sense.

The disturbing developments that resemble those of the oil embargo include both short and long term responses. While policies adopted thus far to restrict entry into the US and to quarantine exposed individuals seem to be both limited and effective, calls for the President to make plans for much more extensive quarantines could very well worsen panic, incentivize even more costly private and local activity to avoid risks, and take a bigger bite out of economic performance.

On the broader policy front, the coronavirus may be used to rationalize further trade restrictions, with Tucker Carlson already saying that “[t]o protect against coronavirus and other threats, US must become less dependent on China.” Shades of Project Independence. In terms of bureaucracy, former public health officials from the Obama administration are lamenting the disestablishment of agencies tasked with addressing biological threats across the board and using this particular outbreak to recycle their proposals.

Executives of businesses such as airlines that are suffering from the coronavirus are already flocking to the Oval Office for relief. There has been a continuing, bipartisan willingness to give in to such pleas, with the same consequences in each case: temporary aid that becomes permanent, restored profits to the complainers that must be paid for by taxpayers or downstream users of their products and services, and a growing general dependence on government largesse as a substitute for creative business strategies to weather hard times.

The President’s proposal for a temporary cut in payroll taxes makes more sense than specific bailouts, as most economists agree that social security and unemployment taxes are a serious disincentive to hiring, especially for low-paying jobs – but if Congress delays and the coronavirus scare ends in a month or two, the tax cuts may take effect just when they are no longer needed. The old story of fiscal policy as a countercyclical tool.

One of the other things that we should have learned from energy policy over the years is that any law that Congress passes on a near unanimous bipartisan vote is almost certainly full of bad ideas. The $8.3 billion coronavirus bill signed last week by the President, up from the $2.5 billion requested, is a case in point: it includes $1.25 billion for use in other countries, $500 million in Medicare telehealth funding, and funding to stockpile masks and gloves with no plans for how to distribute them where they would be useful. An additional bill introduced in the House during the week of March 9 includes more provisions only remotely related to coronavirus – such as forcing businesses permanently to provide more paid sick leave (for stalking as well as illness), adding a sick leave program to Social Security, and extending unemployment and welfare payments in ways that create incentives to remain out of work.

Many of the errors of energy policy are here — starting programs with payoffs far too distant to help the crisis, buying into stockpiles during a period of shortage, and putting together a package to buy votes rather than do a specific task.

To sum up: the available evidence is that direct economic harm from the coronavirus is likely to be limited to short term supply chain disruptions and that public health effects are unlikely to be as large as avoidable influenza morbidity and mortality. Losses now appearing in hospitality, entertainment and travel industries are being driven by excessive public and private reactions to fears of mass contagion. Policy responses to the Arab oil embargo of 1973, an event with similarly small direct effects, turned the embargo into a driver of economic under-performance for a number of years. Panic, largely induced by those policies, made things worse.

Similar types of responses are being contemplated today. Though the economy is in much better shape than it was on the eve of the 1973 events, trust in government and performance of the media are far lower. Even if the erosion of trust is incurable, the Administration should resist pressure for micro- and macro-economic interventions that make things worse. It should continue to disseminate consistent information from authoritative sources that keeps risks in perspective and remove barriers to rapid development of vaccines or antivirals. Recognizing, of course, that waste also arises from pushing faster than the available science resources can handle. Another lesson of energy policy.

In addition to activities disclosed in previous issues, David arrived in Washington shortly after the Arab Oil Embargo and was commissioned by the Senate Finance Committee to write the first definite analysis of the economic impacts of oil price and allocation regulations. He has continued to work on energy security issues, broadening out into climate change and risk management, ever since.