Sunday, November 9, 2008

Picking Winners

People generally do not have faith that private markets will adequately provide for our future energy needs. Except for libertarians and economists, people believe that government must employ the services of experts, and use taxes and subsidies to "pick" which energy sources are best for the future.

An example is OK State's patron saint T. Boone Pickens, who has spent millions of dollars in television advertising to convince the public that wind energy and compressed natural gas are indeed the "winners" we should pick. Yet government must pick this winner, must force the public to adopt these sources through taxes on energy sources the market favors, and subsidies on wind and gas, which the market disfavors.

Experts such as Pickens may know much, but their knowledge is miniscule compared to the knowledge possessed by the market. Markets will reward the true winners with fortunes and punish the true losers swiftly. Markets brought us Google and Amazon. I wonder what the internet would be like if only government could decide what would be posted?

Remember the Great Leap Forward? China's communist leaders developed specific plans for modernizing China. Rather than relying on markets and the people who work in agriculture daily, the government forced farmers and food processors to produce food in a way the government thought was best. An example is forcing households into collective cooperatives, where they were forced to share their tools and draft animals. Intended to boost harvests, it instead produced famines. A more absurd example was when China's leader, Mao, decided steel should be produced in peoples' backyards rather than large factories.

A story you probably have not heard took place in Japan. In the 1970's and 80's the Japanese widely thought that for an industry to become successful, it needed the backing of the government to "boost" the best firms ahead of the inferior firms. The Japanese government decided they needed to shave off a few automobile firms by picking two "winners". The winners would then be subsidized by the government, allowed to grow larger, and this would allow them to capture economies of scale and produce at a lower cost.

The two winners that were picked where Toyota and Nissan. The losing companies were urged to produce something other than cars. One of those losers begged the government simply to be allowed to produce cars, even though he wouldn't receive those subsidies. He had a particular form of engine that he thought was superior. This form of engine was not deemed a "winner" by the Japanese government, but the market did. I am talking about the automobile manufacturer named Honda. They are the best cars in the market. I have two Hondas in my garage.

Speaking of Honda, I seriously doubt any government would pick a car design like the oddly shaped Honda Element as a design that would be a winner in the marketplace. Yet of the two Hondas in my garage, one is an Element.

The great economist Hayek coined a term "The Fatal Conceit." It describes the condition where someone like T Boone Pickens or Al Gore believes so fervently in their knowledge, they wish to force their beliefs about energy onto society at large. Yet there are many other people knowledgeable about energy. Individuals in the oil industry have superior knowledge about the oil reserves left. Individuals making advanced car batteries have superior knowledge about what batteries will look like in five or ten years. Firms building windmills in Western OK have superior knowledge about the cost of wind power and how that cost will change in future years. All of these individuals and firms are making bets about how world energy consumption will change and how their competitors will perform. Those with the most knowledge and the most confident about their knowledge will raise the most investment money, and will have more power to shape the future of energy. Yet no one is dictator, no one is immune to failure.

The best energy policy is one which aggregates all of these individuals' knowledge in a way that allows feedback to the individuals on how their beliefs compare to others. The best energy policy switfly punishes energy sources that perform poorly and bestows fortunes on those who perform well. The only policy that performs these two activities well is markets unfettered by government policy. The best energy policy is one that simply allows markets to make decisions, based on who makes money and who doesn't. The market knows more than T Boone Pickens and Al Gore, and the market is quick to admit when it is wrong. That is why anyone who wants to make sure their children have lights to read by and cars to drive should give more reverance to the efficiency of the market than the self-annointed saviors such as Pickens and Gore.

Just look at ethanol. Government received a mandate from groups who believed government should pursue an alternative form of domestic energy. Politicians used this mandate to deliver money to powerful constituents - corn farmers. Virtually everyone who knows anything about ethanol will attest that it is a horrible program with huge costs and virtually no benefit. Worst of all, because it is a government program, it is almost impossible to end it.

I admire T. Boone Pickens' concern for the future, and greatly appreciate his support of my magnificent university. Pickens has donated millions promoting his plan and donating to OK State to make the world a better place. Yet, in my opinion, if he really wanted to ensure a more pleasant future, he would use all his money in an effort to make more money by investing in the energy source that he thinks the market will choose. If he is wrong, he only loses his money. If he is right, he may save the world.

Additional References:
Cato Daily Podcast, Pickin on Pickens, July 22, 2008
Cato Daily Podcast, Big Visions for Energy and The Fatal Conceit, August 5, 2008
EconTalk Podcast, Private vs. Public Risk-Taking, 10/3/06

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