Oil dilemma caused by ‘unrealistic’ past prices —economist

Press, 9 May 1980, Page 2

Oil dilemma caused by ‘unrealistic’ past prices —economist

Decades of unrealistically low oil prices are to blame for the “agonising” adjustments by the Western world to present increases, according to a visiting American economist. To Professor Vernon Smith, soaring oil prices were not a matter of “Arabs versus the rest of the world” but the result of incorrect incentives for development of oil fields in the past.

“For many decades oil prices were much too low from the point of view of the basic scarcity of the resource,” he said yesterday. Professor Smith, professor of economics at the University of Arizona, was in Christchurch to address the Canterbury branch of the Economic Society of Australia and New Zealand.

He put a case for the freemarket economy in which pricing systems, free from government intervention, regulated the use of resources and the production and distribution of goods.

One of the functions of government was to create a framework of property rights, said Professor Smith. However, there had been no property right on oil while it was in the ground. The resource had been exploited under the “rule of capture” by which companies were compelled to compete with one another in

drawing off oil from common underground reserves.

Professor Smith said that companies could only claim a right to the oil once it was above ground. A scramble to raise oil and sell it as quickly as possible had created a flooded market and unrealistically low prices. "Incentives to conserve on the part of the producer were not there; incentives got all fouled up,” he said. Companies extracting oil in the United States had later recognised the common pool nature of oil and had agreed among themselves over the rate of extraction.

However, from the 1950 s until the early 1970 s so much oil had been on ’ the world market that domestic producers in the United States had sought protection against imports. “The people who decide how much to produce now own the oil in the ground, and the incentives are much different,” 1 said Professor Smith.

Had there been property rights on untapped oil from the outset, the pricing system would have ensured a gradual rise in prices linked with scarcity and demand, he said.

Oil priced at $25 or $3O a barrel was “far more realistic” now than $3 a barrel. Governments tended to act in response to demands from

different sections of the economy, Professor Smith said. Interference, for example minimum wage laws or price controls, produced incentives which were contrary to “maximising what we get out of resources.”

This in turn, was not in the long-term interests of the consumer, the producer, or the wage earner.

Professor Smith described pricing as a “remarkable piece of machinery for coordinating activity.” “The world’s work gets done day to day through the pricing system setting priorities, and responding to those priorities.” He said that price was the mechanism by which resources were allocated among uses of different priorities. This was an economist’s view of pricing and the one which governments should adopt. Another view, held by producers and consumers, emphasised the visible effects of price fluctuations.

Professor Smith said that it was natural for consumers to resist price rises and producers to resist price reductions. However, in the interests of everyone it was better that governments considered the pricing system as a whole, rather than reacting to the pressures from groups of affect :d participants.