Peak oil: Sharks in a barrel?

Steven Steven Levitt on Peak Oil

What most of these doomsday scenarios have gotten wrong is the fundamental idea of economics: people respond to incentives. If the price of a good goes up, people demand less of it, the companies that make it figure out how to make more of it, and everyone tries to figure out how to produce substitutes for it. Add to that the march of technological innovation (like the green revolution, birth control, etc.). The end result: markets figure out how to deal with problems of supply and demand.

Okay, I read freakonomics. Even got the CD to torture my kids on the drive to the beach. So, I like Levitt, and some of the clarifying counterintuitions he provides to things like gun control, and yeah, shark attacks. But comparing Peak Oil, and the massive, broad economic ripple effects it would entail to a media circus like shark attack! News at 11! strikes me as goofy. It also reminds me of something which leaves me queasy with the dark science: its passionate, religious regard for the self-righting nature of markets, versus its abstract, antiseptic disregard for things like adjustment costs--you know, the footnotes acknowledging the millions squished by the advent of things like the better mousetrap or fax machines or....

Or highly opaque, high entry-barrier industries like Oil. Quoted above, Levitt takes Peter Maass to task for this past weekend's lengthy NYT article on peak oil. Yeah, Levitt tells us not to worry, substitutes will be a-comin and a new day will dawn. It reminds me of the mythical feather and cannonball falling together in a vacuum. Great, now show me an economic, political or equivalent real-world vacuum. His answer to all things myst0-economical is that "people respond to incentives." Marvy. 20-20 hindsight that does little, in usuable terms, to explain the existence of BzzAgents or similar gift- or social-economy mysteries of a new era.

As a non-pro, I'd say that large masses of individuals do not 'respond to incentives,' the markets reflect an aggregate response, in which many in the mass were laggards to realizing the "obvious" until it rolled over them.

I suppose, to follow this leisurely rolling equilibrium theme, tectonic plates too, just like people, respond to "incentives." Incentives such as magma pressure, geo-magnetism, subduction and such draw them along and make them bumpy like an economist's forecast, but some sick twist of fate means I'm not around to appreciate the change of view, or the appreciation in land value. But that's just me. So maybe my question is: Do incentives pace adjustments?

Luckily, Max Sawicky, Real Economist!(tm), marches in to ease my "adjustment cost" anuerysm:

Steve Levitt gets freaky:

"I don't know much about world oil reserves. I'm not even necessarily arguing with their facts about how much the output from existing oil fields is going to decline, or that world demand for oil is increasing."

We then get a textbook rehash of the principle that when scarcity grows, prices go up, people buy less of the scarce good, and substitutes come online. Investment flows to alternatives, which get less expensive in consequence.

So don't worry about the world's dependence on finite fossil fuel resources. Who needs expertise in resource economics? Markets solve all problems. The universe is a convex set whose boundary is smooth and everywhere differentiable, may God strike me dead.

The principles make perfect sense, but they are completely beside the point. They typify the incompleteness and intellectual arrogance that pollutes academic economic discourse.

Do markets really solve all problems? Most problems? Nothing ever goes wrong? I guess it depends on how you define "wrong." For instance, Amartya Sen wrote a book about poverty and famines which describes how markets solved the problems of people having no money to buy food: they die of starvation, the ultimate steady state.

If oil runs out, sure there will be substitutes. How fast will these come online, if they do? How much will they cost? What will be the costs of adjustment? Will that be fun? Who knows? Markets solve problems. Solutions do not exclude freezing in the dark, a new kind of equilbrium.

Booyah! I feel better, if not too much smarter. Never fear. Responding to Leavitt's critique, the boys from The Oil Drum invite us over, and they have a go. One of my fave comments, from Step Back...

Most (not all) economists are scientists to the extent that they carry a mental model of how the world works in their heads.

They claim that observations within the real world validate their model.

This is the point, however; where I see their "invisible hand" playing dirty tricks. It covers up the fantasy third, all seeing eye on top of the foreheads of econmists and pretends that well documented failures of "the market" never happened. In other words, see no evil and the evil does not exist.

By contrast, for a true scientist, even a single lab experiment that proves the model to be in error, trumps the model. Not so in the wonderful world of economics. Every failure can be erased through "rationalization". The tulips never happened. Easter Island never happened. The dot.com bust never happened. Economists proclaiming how the internet will single handidly carry the world in to the next paradise, that did not happen either. It is an infallible science because all its fallibles are conveniently marked down in price and ultimately erased with the faded memories of each new, gullible generation. (Yes you 20 year olds out there, who have no real life memory of the 1973 oil shock. It happened. People shot each other at gas stations. Anything it takes, is done to get the fluid of our addiction.)

Let's start with the most fundamental feature of micro-economics: a willing, able, and knowledgeable seller (S) meets with a willing, able, and knowledgeable buyer (B) in a pool of similarly situated actors, S2, B2, S3, B3, etc.

The buyer (B) and seller (s) negotiate, each in his own interest (using the aid of the invisible hand covering up the invisible 3rd eye), and they ultimately settle on a fair "price".

This microscopic act is repeated many times. Zoom the microscope back to a macroscopic view of the Petri dish, and suddenly you are face to face with this fuzzy wuzzy thing called "the market". With all the germ like actors digging away down there (S1 thru Sn AND B1 thru Bs), each in their own best interest, a magical force takes hold of the Petri dish and miraculously the Petri dish is levitated to a higher plane of consciousness, of intelligent design consciousness. We call this magical force that lifts the Petri dish, "the invisible hand". We call its intelligently created consciousness, "the wisdom of the markets".

No one sees the "invisible hand". But just like the Emperor's clothes, trust us, it's there. And if you can not see it, surely you are neither as wise nor as patriotic as the degree carrying professors that do see it. Ditto for "the wisdom of the markets".

OK. So remember we said it all starts with:
(1) a willing, able, and knowledgeable seller (S), and
(2) a willing, able, and knowledgeable buyer (B)

Well what if one of those 6 assumptions is not true?
What if the seller is not able to provide the oil?
What if the buyer (Joe Public) has no knowledge of the impending Peak Oil (PO) situation?

Does the seller of an SUV tell the buyer about PO? Duh, NO.
Does the buyer buy the SUV? Duh, Yeh.
Are the markets wise?

We just report ... YOU decide. [emphasis his/hers]

Transparency. About true supplies, and true intent. And about human behaviour, which is seldom transparent; and about sloth, which is ever present. Yes, the markets, like those sharks and those tectonic plates will go their own way. Just don't get in the way. Or learn to jump high, and hover.