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Efficient and Inefficient Rationing

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Natural gas deliveries to Europe from Russian state corporation Gasprom have already been reduced and further reductions are expected as winter approaches. It is a way for the Russian government to pressure European governments into dampening their political and military support for Ukraine. The European Union government is advancing a rationing plan to face the reduced supplies (“Brussels Asks EU States to Slash Gas Use by 15% Starting Next Month,” Financial Times, July 20, 2022):

Brussels has asked EU countries to cut their gas use by 15 per cent and set out emergency plans ahead of winter when it anticipates severe disruption to gas supplies from Russia.

If supply drops by 15%, the use of gas (by consumers and intermediate users) must also decrease by 15%. The question is who will bear the burden of this reduction, that is, how demand will be rationed. Some economists don’t like to use the term “ration” when the process is done through market prices; it does, however, emphasize that everything in our finite world has to be rationed one way or another. But we may use the term “allocate” as a synonym.

There exist basically two ways to ration something: through market prices or by diktat from some political authority—politicians or government bureaucrats in our societies. (I neglect traditional or religious rules like in primitive societies.) Political allocation can only be arbitrary, whether it is egalitarian or not, and even if it hides behind a formal rule of law. It is arbitrary for two reasons: first, the authorities are likely to favor themselves or their most useful political clienteles; second, even if the authorities are composed of perfect altruists, they don’t have the information of time and place that is dispersed among the minds of all the participants in the economy (see F.A. Hayek, “The Use of Knowledge in Society,” American Economic Review, 1945).

Automatic allocation by market prices is preferable because each user is thereby incited to take into account the value of gas (our illustrative case) for other users. The individuals who will finally get the gas or what is made with it (say, home heating or metal objects made with gas-produced electricity) are those who are willing to pay the most for it. If you are among those, you pay for the gas more than the value of which you are depriving others.

It is true that some users may be willing to pay more because they have higher incomes, wealth, or financing capabilities. But this is not necessarily the case: when you buy a car and the steel and aluminum that goes into it, you outbid billionaires who would otherwise have ordered bigger private yachts; if no car were produced, their yachts would cost less. Mutatis mutandis when you buy a Cohiba. In a sense, the allocation of gas will remain efficient if political authorities give tradeable ration coupons or equivalent cash subsidies to some users who could not otherwise “afford” the stuff. A consumer will buy a thousand cubic feet of gas for (say) $12 only if it is worth more than what he can otherwise get for $12. (There will be of course a transfer from general taxpayers to gas consumers and some consequent deadweight loss, and this fact should not be ignored.)

The EU plan seems to recognize the efficiency of some price allocation in the case of industrial users of gas. If I understand the plan correctly, after some EU allocation of the reduced supply among member countries, industrial buyers could obtain their gas through national auctions or, what amounts to the same in an opportunity-cost sense, by bidding down the subsidy they could receive from the government (presumably for having to sell the gas at lower prices than they paid for it):

Market-based measures can mitigate the risks to society and the economy. For example, Member States could launch auction or tender systems to incentivise energy reduction by industry.

And, from another EU document:

One recommended measure consists of national or joint auctions or tender systems by which Member States incentivise a reduction of consumption by large consumers (mostly industries). Those industries best placed to reduce demand would voluntarily offer to do so. Depending on design, they could receive financial compensation in return.

Although some measure of rationing by market price is envisioned for industrial users, the allocation to household consumers and other “protected customers” will remain purely political. Since it is the government who will decide who are these “protected customers ” (households, hospitals, non-large consumers, and other politically preferred clienteles) to benefit from protected supplies and capped prices, political factors will determine resource allocation. Along these lines, mandates for temperature or hourly thresholds would still be possible. So-called “public” places (venues and businesses open to the public) can be subject to forced consumption cuts.

As usual, much dirigisme and economic planner’s conceit mars the EU plan. The more you read it, the more you realize that.

Although less inefficient than if no market mechanism at all is used, the system will still be inefficient. Consider an individual consumer who would prefer to consume a bit less gas to heat his home (he has warm duvets for the night) in order to keep some money for patronizing well-heated restaurants, bars, theaters, or concert halls. On a free market, it is easily done: he consumes less gas—by buying less or by selling his ration coupons—and uses the money to spend on these other activities he considers more important. In a government allocation system like the one envisioned by the EU government for “protected costomers,” our individual consumers’ more expensive gas consumption at home is subsidized and he may not choose to apply these subsidies to his preferred consumption activities instead.

Besides being arbitrary, the “prioritization” of—that is, discrimination in—subsidies and interventions is very opaque. The rationally ignorant voter will have no idea that the rationing system reduces the supply, and jacks up the prices, of some goods he would prefer to buy instead of subsidized heating.

Rationing gas among all users should be done through market prices. If there must political tampering with market allocation to protect poorer households, it should be done by tradeable ration coupons or simply and preferably by cash subsidies.  Unfortunately, this is not how politics work under a mostly unlimited democracy (“totalitarian democracy,” as Bertrand de Jouvenel would have said) where politicians must satisfy the most vocal clients and organized interests, while pretending to run the economy “from a societal perspective” (whatever that means). Expect a mess, generated jointly by the governments of Russia, the EU, and individual EU countries.

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