Oil Shocks, Price Controls, and War

Welcome everyone to the Marginal Revolution podcast. In our first episode on the 1970s, we dealt with inflation and monetary policy. Uh, today we're gonna be talking about the oil shocks and price controls. Now, to put this in context, remember in 1973, the, uh, price of oil was $3.50 a barrel in July of 1973, and it went to just over $10 in January of 1974. Now, a tripling of the price of oil in such a short time would be a big shock in any time period. But to understand how shocking this truly was, you have to put it into context. The price of oil had been essentially flat for decades. So in 1950, the price of a barrel of oil was $2.50. And in 1973, as I said, $3.50. In real terms, That was a slight decline in the price of oil, and there was hardly a bump in between. This was the so-called golden age of oil, and the price was stable, was so stable, absolutely flat for two reasons. First, the Seven Sisters owned most of the supply and they set posted prices. But more fundamentally, there was lots of spare production. During this time in both the Middle East and the United States. And that spare production was used to keep prices stable, particularly the United States, led by the Texas Railroad Commission. They adjusted production up and down to maintain a steady price. In fact, it's very interesting. Prices were so stable that somewhat surprisingly, prices were not the object of much debate or negotiation. Between the oil companies and the oil countries. So in the 1960s and 1970s, the Shah of Iran was complaining that the oil firms in Iran were producing too little. So he just took the prices given and said, "Well, if I want more revenues, what do we need to do? We need to increase quantity." Right? So the focus during the 1960s and 1970s was all on increasing quantity, and there was very little hint during this time period that the demand for oil might be very inelastic.

I have a question for you, Alex. If I think back on the oil price shock of 1973, 1979, through a long, awkward, stupid process, it did lead to the US becoming more or less energy independent. We're now the world's leading exporter of fossil fuels, I believe. There's plenty of green energy coming online. In economic models, there's solo catch-up growth. So if you screw up in the 1970s, well, maybe in the 1980s you grow a bit faster and make up for the earlier shortfall. Was it on net a good thing that we had those oil price shocks?

So it is true, of course, that oil is a finite resource and that it contributes to global warming. So You know, maybe the price had to go up sooner or later. Why not sooner? Still, the way that it went up was incredibly disruptive. It could have gone up at a much slower pace and without— we'd still have all of the incentives to turn to other fuel sources, but we didn't need to have all of the craziness which we did in the 1970s.

But maybe you need the headlines. So, you know, take COVID. Let's say COVID was done in slow motion so that each year, like, a tenth of the number of people died than the way it worked, we might not have gotten Operation Warp Speed.

I don't think so. So I think the craziness, right, actually worked in a negative direction. So it's often the case that when you have a lot of volatility, a lot of craziness, that people have bad ideas.

Sure.

So I think it's ironic, but You know, at this time the price of oil is going up, '73, '79. Okay. And what else happens? Well, we also get at this time the nuclear disaster in— what was it again?

Three Mile Island.

Yeah, Three Mile Island, of course. Three Mile Island, which is about to be turned back on.

They're talking about turning it back on. Incredible.

Yeah.

Talk about surprises in the world. Yeah. Actually, one of the biggest.

30 years later, they're going to turn it back on. So we had Three Mile Island now. It's ironic because if the price of oil is going up, you should be investing more in nuclear, right? But what happened? Well, instead of thinking about, oh, the price of oil is going up, we need to conserve oil, we need to invest in more energy, more cleaner energy sources like nuclear, what we got was an environmental movement, right, that said, no, we just must consume less. Okay. And so all energy sources were put under pressure. No, nuclear is bad. Oil is bad. Okay. You have to, you know, wear a sweater. Jimmy Carter. Right. So you got a whole period in American history where we lost the enthusiasm and optimism for growth and for progress and for technology. And we really went into a backwards period, in my view.

For significant parts of the 1980s, though, the price of oil is pretty cheap. At times it's dirt cheap. And that's surprising given all the stupid decisions we made on the policy front. Right.

Yes and no. I mean, let's go back a little bit and fill in some of the details, because a lot of people get this wrong. Like, OPEC was not the dominant force back then, which we think about it today. OPEC was created in 1960, but the oil fields were still nominally owned by the oil firms, and OPEC was basically a non-entity.

Well, they keep prices down in the sense that by threatening nationalization, The incentive is to pump a lot today because, you know, the Saudis will take over your shop.

Yeah. So they were worried about— exactly.

So they had a big effect, but in the exact opposite direction.

Yeah. Now, they did try in 1967 during the Six-Day War. Middle Eastern countries tried to limit production and embargo oil, but that embargo was a total flop. Okay. Price of oil didn't rise. Countries could easily work around the embargo. But what happened was that the demand for oil kept rising faster than supply. Which meant that the excess capacity was going away. Right. So in 1967, the US had excess capacity, but by the early 1970s, it was importing millions of barrels of oil a day. And here's Daniel Yergin, his great book on all of this period, Commanding Heights. He says, quote, America's spare capacity had proved to be the single most important element in the energy security margin of the Western world. Not only in every postwar energy crisis, but also in World War II. And now that margin was gone. In fact, US production of oil peaked in 1970 and then fell until the fracking era in the 2010s. So US production peaks, and then we get the 1973, October 1973 Yom Kippur War. So Egypt and Syria launch a surprise attack against Israel, and this really unites the Middle Eastern countries. There's no longer excess capacity in the United States. So Sheikh Ahmed Yamani, in a famous statement— he's the oil minister for the Kingdom of Saudi Arabia, he's a leader of OPEC— and he says on October 16th, so this is 10 days after the war begins, "This is a moment for which I've been waiting for a long time." The moment has come. We are masters of our own commodity. So they raised the price of oil. Okay. Oil production falls by about 9 to 10%. Okay. That doesn't seem on the surface to be a huge amount, but it reveals something which people had not been prepared for: the inelasticity of oil demand. So I would put it this way. I think this is the key, the key idea here. Almost accidentally, the exporting countries had discovered that the demand for oil was more inelastic than anyone had ever realized. And the main lesson they drew— before 1973, the oil exporting countries thought that the only way to increase revenues was to produce more. After 1973, they learned that an even better way to increase revenues was to produce less.

Let's stick with historical periods where marginal increases in oil supply on net are good. You could debate if we're in one of those periods now, but a lot of earlier time, you just needed more oil, right? Sure. When the price goes up to a high level very quickly, it's a different set of incentives for, say, Mexico or Venezuela, or more recently, Guyana, which did a lot more exploration and found a lot more oil, gas. And in those models, there's an irreversible investment, there's an option value to waiting. You're making a big leap and you have relatively poor countries committing a lot of resources. And to get them to do that, is not the very high price actually a better incentive than some sort of slow run-up? Because you want to signal, I mean, you are signaling in the moment, well, the price is going to be this high for some while to come. And thus for getting more oil out of the ground over the next 20, 30 years, the high price was a very good thing because we all know from reading Marginal Revolution, supply is elastic.

Yeah. Yeah. Supply is elastic. Yeah. In the long run, I think that's true.

But even the medium run, because the 1980s, you get a lot more oil coming onto the market.

That's true. There were some things which we did, it took a long time, but we opened up Alaska. That was one thing. Mexico, as you pointed out, opened up. Some of that was already, quote, in the pipeline, as I believe you said.

But we also bankrupt the Soviet Union. So the great achievement of the 20th century, other than winning World War II, bankrupting the Soviet Union, came about through this dynamic. And we're not sure what the counterfactual would've been, but to have it be grown up, they're enriched for a while and then cut 'em off at the knees 'cause their flow— they in a sense became a flow country. What's the inward flow every year? Because they can't conserve resources effectively. Their flow gets cut down and then they're broke and they go away.

I'm a little confused about that. I mean, isn't the usual story that Russia is exporting oil and gasoline and the high price actually maintained the Soviet Union and then later Russia for a longer period of time?

Well, keep in mind, this is the Soviet Union.

Yeah.

So they're doing very well, say, in 1979. But they're not taking that money and sticking it into a sovereign wealth fund. It's eaten up by interest groups, the military establishment, foreign adventurism. So when the low oil prices come later in the '80s, again, they're poof, it's all gone. So you want volatility to bankrupt them. I'm not saying anyone planned this. It just seems to me it worked out really quite well for accidental reasons. But if they had had a sovereign wealth fund, if they're behaving like Norway, which of course they weren't, then they're just still subsisting on the earlier windfall and you don't drive them under whatsoever.

Yeah, I mean, there were a lot of consequences. Some of those consequences were good, but that doesn't mean that on that, the consequences were good.

But it is the second biggest event, second biggest victory of the 20th century, and the volatile oil price essentially caused a big part of it.

Look, I think the Soviet Union was heading towards the dustbin of history regardless. So there were many, many things could have pushed them over, especially I just think all the old guys getting old. You're like when your politicians are really old.

That's never bad for a country. Come on. They're experienced. They speak better.

Now let's talk about some puzzling economics because the price of oil goes up, right? War starts in October of 1973. The US goes into a recession in November of 1973. Unemployment doubles from 4.5% to— 9%. Okay. Now, I think most of our listeners will say, well, what's puzzling about that, right? Price of oil goes up and you go into a recession. You know, that seems like entirely normal. And yet for economists, this is still quite puzzling because even though oil is obviously of relative importance, it's not that big a feature of the economy. And there in fact are pretty sophisticated theorems which say that if you have, this is Hulten's theorem, if you have a shock to a sector of say 10%, something goes up, productivity goes down 10%, price goes up 10%, something like that. And that sector is a relatively large share of the economy, say 5%, then the effect on GDP should just be those two things multiplied together, 10% times 5%, which is just half a percent. On GDP. So why is this wrong?

Those theorems are wrong, right?

Yeah, yeah, yeah.

The Peter Thiel people go crazy when they hear about this stuff.

I agree, those theorems are wrong, but explaining why is actually pretty hard.

Well, take electricity. I don't know what's the share of electricity in GDP, but it's not that large. But if you lost all of electricity, just to give an extreme example, most of GDP would shut down.

Yes, if you lost it. But suppose that just the price goes up. Why don't you just pay Why don't you just pay the higher price and suck it up? Like, why does the— like, the price of oil goes up, you know, by a factor of 3. In terms of the expenditures on oil, that was something like $5 billion worldwide. But the US economy declined by like $38 billion. So why not just suck it up and pay the extra $5 billion and not have a recession?

But we know from real business cycle theory, co-movements are not symmetric. So let's say they cut off the supply of medium fatty tuna for sushi. Well, you could just eat fatty tuna. It's not exactly the same, but it's going to be a very small GDP adjustment. When it's something that's an input into many goods and you have indivisibilities, you're courting much larger risks. It's not just tuna versus medium fatty tuna.

Yeah, yeah.

And I think energy, especially back then, was like that. It's much less like that now, of course.

Yeah, so I mean, I think that's right. The price of oil goes up and then people wonder about, well, the demand for cars. Should we be investing in this car factory? And so they pull back on investment. And so for Keynesian reasons or for real business cycle reasons, you have uncertainty and that means—

And geopolitical uncertainty too, right? Lots of it, yeah. Not just economic uncertainty, you have both.

Yeah, I think that's exactly right. A lot of people forget that the war itself, the Arab-Israeli War, created a lot of uncertainty because the Arab countries were being backed by the Soviet Union.

Yeah, and they almost won.

And they almost won, yeah.

Which means we, as an ally, almost lost.

Exactly.

And that's itself a big revision.

Exactly. So there was a potential nuclear war there, and in fact, the US forces Some people say this shouldn't have happened, but it did happen. They were put on DEFCON 3, which meant that the Strategic Air Command had to be ready within 15 minutes to launch a nuclear strike. So only the Cuban Missile Crisis had a higher level, DEFCON 2 for some services. DEFCON 3 was also put in place following the 9/11 terrorist attacks. But, you know, this was, this was a big geopolitical deal. Lots of uncertainty from the war itself.

Since the 1980s, economists, for a number of reasons, have underrated real shocks as a source of business cycles and downturns. You have the Keynesians who didn't want to talk about it, and then you had the monetarists, Milton Friedman, who wanted to promote their own recipe.

Right.

And people just stopped talking about it. But even 2008, which clearly had a lot to do with a major negative shock to aggregate demand. But the price of oil is quite high. At the time when that's breaking, and it was a major factor behind the downturn. Absolutely. And no one wants to talk about that.

Yeah, yeah, absolutely. It was a very high price of oil. I think the highest price of oil ever was 2007, 2008.

Wow.

In real terms, I think that's true. And yeah, that influences the demand for automobiles, which is a huge part of the economy and so forth. So we got the oil shock, we got the war shock, and of course we got Watergate, right?

Yeah.

So the war is, you know, like October 6th. All right. On October 20th, this is when Nixon fires Archibald Cox, you know, the Saturday Night Massacre, right?

Of course.

So as Daniel Yergin put it, too much seemed to be happening. The media and the public mind were overloaded. Who could imagine such a thing?

We don't have times like that anymore. Of course, it's a good thing.

Yeah.

But it does raise an interesting question because speaking in July of 2024, where it sure seems that a lot's been happening.

Yes.

Unresolved at the moment we're talking, but the economy's still doing fine. And other times we wanna cite uncertainty.

Right.

As a big problem. Like there's very good evidence for that, but then nonetheless, there are these points where uncertainty seems to be high and eh, whatever. Yeah. Life goes on. Like, which are the relevant uncertainties?

You're right.

Makes it very hard to make these theories of volatile shocks more testable.

Right. So let me make the case that a lot of the cost of the '73 and '79 oil shocks were actually not the shocks themselves, but our response to the shocks. So 1973, this was the year that Christmas didn't happen, right? Or at least—

I remember that. It happened for me. To be clear. I got some nice underwear and I think a few baseball cards.

Excellent. At least the Christmas lights didn't happen. So to deal with the crisis, right, Nixon, he prohibited sales of gasoline on Sundays and he banned outdoor Christmas lights. The White House Christmas tree was dimmed. This was also when the— 1974, we got the 55-mile-per-hour speed limit. Okay, which was not repealed until 1995. And yeah, you just look like here was a— there was a letter to the New York Times. People were asking, if I've already booked a flight home for Christmas, is it possible that the flight will be canceled? And New York Times says, yes, you know, you'd better reconsider your flight, your flight home. This is what people were thinking. And of course, then we had, as we always do, like the oil companies They're accused of making obscene profits. They're brought before Congress, political theater. We've seen this many times before, right? Whether it's the pharmaceutical firms or the social media companies, right?

None of them said, Senator, I sell ads, right? We sell ads.

Yeah. And of course, this is going on all over the world. So I think it was in large part the price controls, which preceded, which preceded, this is important, both the inflation and the oil shocks. It was the price controls which really generated a lot of the costs of the crises.

I have a political economy question for you, which I've wondered about for quite a while. Price controls were fairly common in US policymaking in the post-World War II era. And after these episodes, they more or less went away. You get a lot more regulation or maybe quantity restrictions or other kinds of constraints on what can happen. Prices tend to be freed up. Is that just people started listening to smart economists, or is there some political economy reason? Like, why were price controls ever something that made political economy sense to begin with?

You know, Nixon imposes price controls— this is August 15th, 1971. He puts a price freeze on all prices and wages in the United States.

And they think it will dampen down expectations.

They think it'll dampen down expectations and will cut inflation, which was then increasing. I'm amazed that they could get away with this.

Inflation was what, 4% then?

Yeah, something like that. Maybe a little bit higher. But didn't anyone say this was completely unconstitutional? I mean, states have power.

My father said that. Yeah. Yeah.

I mean, states are prohibited from passing laws impairing the obligation of contracts. And this is that, you know, but I think Lochner was correctly decided. So I'm on the outs on that one. But the point is the public loved it, right? Public loved it. They were totally supportive of Nixon.

At first, but I think it wore on people when they realized they would not be getting their expected raises.

Sure, sure. But it worked politically. And, you know, maybe it wouldn't— maybe I think there would be more pushback today. And of course, this is also the time, you know, I mean, a little bit later, but Milton Friedman gets Free to Choose on PBS. Can you imagine that? Like this right-wing conservative guy gets a television show on PBS?

Yes.

I mean, that seems like it wouldn't happen today. It'd have to be on Twitter today.

Well, YouTube. Yeah. Yeah.

It would be on X.

Right.

Yeah. But you're right. The public eventually, they come to understand.

Rent control was much more popular back then also.

Yeah.

There's still some rent control today, but it's not the hot button issue it had been, though the Biden people have talked about bringing it back in a significant way. Yeah.

So maybe people learn. Here's the New York Times. This is, I think, a really interesting quote. New York Times: From the Rocky Mountains to the Atlantic, schools and factories are threatened daily with midwinter closedowns for lack of heating oil. As emergency stocks become available, trucking lines find themselves so short of diesel fuel that they may not be able to deliver what there is. Now, what's important to understand about this quote is that it's from January 21st, 1973. So the Yom Kippur War didn't start until October of 1973. So the shortages started before the war, before the reduction in the supply of oil, before the big increase in the price of oil. Right? So I think it's important to understand the shortages were there before they were caused by the price controls.

I'm just thinking of a hypothesis. Tell me if you think this is right. I'm not sure, but maybe in a more egalitarian society, the deadweight loss of price controls is lower. So take rent control. If you put rent control on Manhattan today in a major way— still, it's there in a small way— you'd have crazy things happen like, oh, this 80-year-old guy is in an apartment and like a Jane Street trader shouldn't be living there. And that's a big loss of value. But if everyone's earning more or less at the same level, those disparities are much smaller. And maybe the deadweight loss from rent control is lower. Is that possible? Does that work out?

I mean, even in the rent control in the 1970s, I think it was Nora Ephron, the screenwriter, right? And she had this huge apartment, right? And I think that's where actually, I think she was a screenwriter of When Harry Met Sally.

That's correct.

Yes.

Great movie.

Yeah, great movie. And there's a line in that movie of Or maybe, I think it's in that movie, but where he's waiting for people to die and looking in the obituaries, right?

That's right.

To find an apartment, right? So even back then, people like Nora Ephron had big apartments and they were not moving out. She understood price controls.

But the value of time for the searchers is just lower.

Yeah. I'm not sure it could go either way, right? So maybe you could say that, well, with more inequality, then you're going to have higher taxes and you're going to have more redistribution because it doesn't affect most people. It just affects people at the top.

Or it could be the— argue it the other way with higher inequality. Well, the wealthy people can just buy things. They just don't have to rent because they have so much money and they just bypass any system of rent control as long as they can buy. Right.

Yeah, that's certainly— you see that in countries like India, right? Which you and I know quite well, is that the rich buy themselves out of the public disasters, right? They buy themselves out of the poor public sector so they have their own personal security, they have their own electrical generating system, right? The public goods don't work. So maybe you get more of that in the United States as well. I'm not sure.

Yeah.

So the price controls were creating a lot of this allocation, in fact, misallocation. So you had— it's amazing, right? One of the things which people get wrong about price controls is they know they create shortages. But the surprising thing is they also create these surpluses. In fact, what they do is they create a lot of misallocation. So in the winters of '73 and '74, you had parts of the United States which were dying literally for not having heating oil. At the same time, you had lots of heating oil in other parts of the United States. So why wasn't the heating oil going from where it was of low value to where it was of high value, where people really needed it? And the answer, of course, is because of price controls, right? A signal is— what is the signal, Tyler Cowen?

It's something, a good thing in that book.

A price is a signal wrapped up in a sentence. You got it. Right. Right. Without the price controls, the people who really need the oil, they're able to signal their need and they're able to incentivize people to deliver oil to them by raising the price. So you get a smooth allocation of oil across the United States. With the price control, there's no longer incentive to ship the oil from where it is not needed to where it is needed. And the complaints to politicians, they just don't signal and incentivize the same way that prices do.

And even apart from price controls, as you know, there are longstanding state-level or regional-level barriers to trading energy, which often persist. So you can drive to different states in the US and the price of gas can be fairly different. Right. So while shipping gas per se, the law aside, is not that expensive, but the differentials continue. And that's because of this crazy quilt patchwork of federalistic energy regulation. Yeah.

And it got crazier and crazier over time. So people weren't incredibly— they weren't completely stupid. They recognized that having a low price of oil would discourage the search for more oil and the production of more oil. So they created a system where old oil was under a price control, but new oil, that didn't have a price control. And then they created almost a buy one, get one free. So you produce— one barrel of new oil, okay? And then you get to have one barrel of old oil or some portion or a quarter barrel of the old oil, something like that without a price control, right? So you had now two different prices for the same goods, one for old oil, one for new oil. And then of course, it's also obvious that you can only put a price control on domestic prices. You know, you can't tell the foreign suppliers, "We're gonna put a price control on you." So when we were importing oil, which we needed to do, Then you take the imported oil, which is bought at the high price, and now the refiner has got to turn that oil into gasoline, which is produced at the controlled price. So they're buying high, selling low. That doesn't make sense, right? They can't do that. So they created another system where you had a different price for export for oil, which was imported. And in fact, what they did is they made The refiners who use domestic oil, they made them subsidize the refiners who use the imported oil. So you had old oil, new oil, imported oil, exported oil, all with different prices. And the system just became more Kafkaesque over time.

The deadweight loss I remember best was a very simple one, and that was just waiting in the car with my mother to buy gasoline, very long lines. And this would happen, say, once a week.

Right.

And there was just no simple way around it.

Right, right. Absolutely. Yeah. And often you're running your car in line, you know, waiting for the gasoline.

Correct.

Yeah, yeah, yeah, yeah.

And then that year, The Grinch Stole Christmas, I was living in northern New Jersey, which at that time was quite a Catholic part of the country. So that lights were not out was a big deal. It wasn't a small thing. If you did this in Northern Virginia now, I don't think people would barely notice. But you would have these elaborate getups. Maybe a lot of it was wasteful signaling, but nonetheless, people would go to great lengths. And there were whole classes of people who would drive around to look at the lights because the displays were so ornamented and interesting.

Right, right, right.

And that was just gone all of a sudden. Yeah.

So price controls in general were lifted in 1974, but not for oil. Those price controls continued. And then, of course, we had Jimmy Carter comes to power in '77. And instead of lifting the price controls on oil, he starts the moral equivalent of war. You remember this?

Of course I do. Yeah.

Meow.

I watched that talk on TV.

Yeah.

Yeah.

Put on a sweater. Okay. Meow, however, didn't mean expanding supply. It meant reducing consumption. This is when the Department of Energy is created, and there's a whole host of new regulations on the energy sector. And then we have the second crisis in 1979 as a result of the Iranian Revolution. And that in itself is an interesting, ironic case of good things leading to bad things and so forth, because one of the causes of the Iranian Revolution was the huge success of the Shah. Right? So the higher price of oil in the 1970s, the early 1970s, that just sent billions of dollars from the West to the Middle East. So in 1970, the oil rents were about 12% of Iran's GDP. In 1974, they hit 47.4%. Of GDP. So this was an incredible windfall for the Shahs, essentially free money. So now think about it, how is free money bad? Well, US GDP is about $25 trillion. Imagine if the government suddenly got $8 to $10 trillion of free money. And suppose this happens under the administration of, say, the very liberal President Alexandria Ocasio-Cortez, right? So President AOC, Then begins spending. She's got trillions of dollars. So she begins spending on so-called modernization. Maybe she builds a spaceport, bullet trains, but also things like the Green New Deal, lab-grown meat, right? Okay. Abortion rights, free university education, free daycare, radical arts programs. This $8 trillion is whipping its way through the economy. It's incredibly disruptive. And that's what happened in Iran. So Iran, you see all these pictures, right? Look at the women in 1973. They're wearing miniskirts in Tehran, right? And they're going to all of these, there's all this new art, okay? And all of this new building, right? Well, that was great if you were in on it, but if you weren't in on it and you were conservative and maybe you're living in the country and you see your country is being revolutionized overnight. My mother was actually, my parents were in Iran a little bit earlier than this. But my mother says this is the most fastest growing forward progressive moving, the most exciting country she'd ever been in because things were changing so rapidly. I almost ended up growing up in Iran, but fortunately—

The original revolution would have been a different blog.

Yes, it would have. Yeah. So you had all this cultural change and then you had the backlash in '79.

And you know, they bought a lot of paintings by de Kooning and Warhol and some of the other top painters, which turned out to be great investments in fact. But it's an embarrassment to the current regime that they have this stuff. I think some of it they tried to sell. I'm not sure how far they got, but a lot of it I believe is still there. Wow. And even to sell it is a kind of admission, like what, you know?

They had this fantastic party in Persepolis, like this is one of the greatest parties of all time. Everyone who's anyone from the world comes to Persepolis and they have this giant party. And yeah, I think it upset a lot of people. So in fact, the Shah, his regime begins to tumble when the oil workers go on strike, cutting Iran's oil production to zero, to zero on Christmas Day, 1978, zero production of oil in Iran. This actually led to the ironic situation where a US oil tanker tries to deliver, you know, oil to Iran, right? Of course, you know, as you think, that never makes it, but they try to deliver the oil. Ayatollah Khomeini comes in December 1979. You would have thought that production would have picked up. But of course, this is when Iraq invades— Iraq attacks Iran in 1980. The price of oil, which had been pretty stable at around $15 $20 a barrel in late 1978, goes up to $40 a barrel. So we get our second big price shock.

Are price controls ever better than a carbon tax? So we know the economics of a carbon tax, but we know voters don't like it. And most places have not done much with the carbon tax. Price controls voters, maybe stupidly, but sometimes like more for the wrong reasons But what if what it does is discourage supply? You know, should Greg Mankiw change the Pigou Club to be for price controls?

Well, of course, the price control in one way is going in the wrong direction, right? The carbon tax is raising the price. The price control is reducing the price.

But at the margin, the price is getting more— not literally, but the true price.

Yeah, yeah. The true price is going up because you have, because you have a shortage. That's true. But certainly you're sending mixed signals, right? I mean, on the one hand you're saying if you can get oil, it's very cheap, so you use too much of it, but maybe you can't get it and that tells you you should try and buy an electric car. But I mean, it's a very sort of convoluted system, right? A carbon tax is sending the right signal, prices going up, and it sends it equally to everyone, right? I mean, the shortage does not does not fall on everyone equally, but an increase in price caused by, say, a carbon tax falls on everyone equally. So you get a much broader and I think more consistent movement in the right direction.

So let's say it's 1980, all of this is happening, and you're energy czar. There was an energy czar in those times. What is it you would do?

Well, I would've done what Reagan did.

Okay, you decontrol the price, but what else would you have done? Anything?

He decontrols the price on inauguration day. January 29th, 1981, his first lunch, okay, in between the parades and all of that, he decontrols the price of oil, gasoline, oil, and propane. Prices rose slightly, but the shortages ended immediately. So I take that as incredibly important and profound because it's a little bit of a stretch, I admit, but Today, as we pointed out, 2024, the US is one of the biggest producers of oil in the world. And imagine telling that to someone in the 1970s. It's mostly due to the fracking revolution. It's only a slight exaggeration to say that the resurgence of American production would not have happened without Reagan's decontrol of oil prices.

Sure.

So in that sense, I think that was exactly the right thing to do.

But at what point in that history would you start thinking, well, now's the time to discourage oil?

I mean, I'm not a denier of climate change by any means whatsoever. So I think that there is definitely a case for raising the price of carbon, if only as an insurance policy, right? So we would like to use less carbon to avoid a kind of a runaway collapse, like if the methane in the northern Canadian tundra is suddenly released, the temperatures could go up very quickly. So as an insurance policy, I would like to see a higher price of oil. And I think a carbon tax would be the right way of doing that.

But I wouldn't do this in 1950, right? Or not in 1920. Sure. And when's the time? When we actually should have done it? Do we know anything about that?

So I guess, I mean, the earlier you start to do it, the less you have to do.

Yeah, I know. So maybe 1950 is the right answer, but that's what I want to know.

Yeah, yeah, yeah.

It seems there's a lot less substitution.

Yeah. So I mean, I guess the key issue then is what are the substitutes? So before the environmental movement of the 1970s, nuclear would have been the substitute. And if we'd raised the price of oil, you know, more consistently and gone nuclear, but taking away that substitute at exactly the time the price of oil is going up was, of course, absolutely disastrous. But I can see an alternative timeline in which nuclear became, as people had expected, —became the United States using as much nuclear as, say, France does today.

But it's still only stationary power, right, nuclear, even if you let it flower.

Well, there's batteries, so, you know, you can— and we might have—

The batteries then are quite poor. The batteries then— Say you're running a factory or people are trucking goods across country, which drove a lot of growth in the '50s. Correct. Correct.

The batteries are pretty poor. But again, it's hard to say, you know, what technological developments would have happened earlier. If prices had been different. I mean, we could have, and we may still use hydrogen. So nuclear and hydrogen really go very well together because you can use the electricity produced by the nuclear power plant in the off hours to split water into hydrogen and oxygen, and then you can use hydrogen as a transportation fuel source. So I, again, I mean, There's a lot of alternative histories, and I'm not sure which one would have happened.

You might have had electric cars much earlier. Yeah, you might have. Yeah, because a lot of the early talk for cars was about electric cars and trucks.

Sure. They were competitive with gasoline at the very beginning. Yeah. Now, I don't think— there is this conspiracy theory that we could have had them in the 1910s and 1920s were it not for— I forget how the conspiracy theory runs. I don't think that's true. I think the technology was not ready, but we could have had them earlier than today. I think that much is true. Yeah. Yeah. And surprising we don't have more, you know, like we could have done electric trains and things of that nature.

Yeah. And many places did.

In fact, many places did. Yeah. Yeah. Yeah. Okay. Let's talk about one more thing, which is related to this, and that is, you know, maybe governments have gotten smarter, right? So in 2022, uh, Russia cut off, uh, natural gas, uh, shipments to, uh, Germany. In retaliation for the Western sanctions imposed on Russia for its invasion of the Ukraine. And then the pipelines were blown up, right? I remember we argued about that.

Blown up, that's the voice. Yeah.

And a lot of people, including German politicians, predicted that Germany would have to ration gas, that people would freeze to death, that the economy would go into a deep recession. And in the end, the German economy adapted to a much lower supply of natural gas by using less and finding substitutes. The spot price of gas, you know, rose by a factor of more than 8 at peak. But instead of price controls and rationing, the German government let the price rise. But they did protect German consumers with a lump sum transfer based upon the past use of natural gas. And that meant everybody had an incentive to listen to the signal of the higher price of natural gas. And in the end, the German economy, you know, rode out this massive decline in the quantity of natural gas. And to me, this is a sign that maybe economists at least have learned some lessons.

I was shocked that went as well as it did. You may recall, I think it was Deutsche Bank forecast a major recession for Germany. I'm not sure they had a recession at all, but if they did, it was just like a marginal recession. Uh, and yeah, they nailed it. So I think one thing we don't understand is when politics evolves, so much of it obviously gets a lot worse, but a whole bunch of other parts in fact get better. Just like Department of Motor Vehicles at the state level in the US, most states it's much better. And we have plenty of theories for why things would get worse. Yes. And plenty of theories for why things might get better, but we're very poor at explaining this weird mix of worse and better that we seem to experience. Yeah, I agree. Because Germany has screwed up so many other decisions. Sure. German trains are no longer on time or even close to it as a regular matter. Yes.

I was in Germany quite recently and the train pulled up and we went to get on and the doors never opened. And people on the other side were like banging on the doors as the train left the station. They weren't able to get out. So that was my, I had to revise my Bayesian priors on German efficiency. Yes. Yeah, I agree. And in the United States right now, we're talking about rent controls. I don't think that's gonna happen, but it seems that, you know, you and I have spoken of the great forgetting. That's right. So many of these lessons which we've been talking about in the 1970s, You can say the 1970s led to Milton Friedman, right? And Milton Friedman became a much more important spokesperson, representative of free to choose and so forth. But Milton Friedman has been dead for some time. Okay. People forget. People forget. People forget Milton Friedman and they forget what caused Milton Friedman to come into being, which is all of the mistakes which we made in the 1970s.

One of my takeaways is simply the 1970s was a great time to learn economics. The lessons were very visible.

Yes. Yeah. So I would put it the following way. I think Milton Friedman was not the smartest economist ever. Maybe that's Ken Arrow. But Milton Friedman was right on the most number of things. And the reason he was right on the greatest number of things was that he was lucky enough to be born, to come to fruition at a time where we were doing everything wrong. That's right. Right. So, you know, live in interesting times, I suppose.

Maybe you and I then. But I think growing up in the 1970s for me was a big part of my wanting to become an economist. Right. It seemed obviously important. And it was. In the 1980s, depends which years of the '80s, but, you know, later on, it's like, well, you take prosperity for granted. You just see things are getting better. Yeah. I think it produced a very different kind of economist.

Yes. Yes. And having seen, you know, the decline in inflation and we're going to talk about crime in another podcast, having seen the decline in crime, people just forget. They forget. And of course there's new people, right? That's right. People, they never learned the lessons in the first place. Right. You know, they never saw the 1970s. And so I think that's one of the reasons why we're doing these podcasts.

I agree.

Thank you, Tyler Cowen.

Thank you, Alex.