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Boom and Bust in the U.S. Oil Market

Most Americans have at least one positive prospect in 2015: cheap gasoline. For many years, opponents of the oil industry have warned that we are on the verge of resource depletion and skyrocketing fuel costs unless we switch to renewable energy sources immediately. Had they perceived the lessons of history, they would have seen that technology—often led by the pressures of necessity, competition, and profit—has a way of silencing naysayers by making it possible to do more with less.  The development of fracking technology has led to precisely the opposite of their predictions.

We now find ourselves in the middle of an oil boom, especially in my home state of Texas, which claims responsibility for a large portion of the economic recovery. Texas added almost twice as many jobs since December 2007 as every other state combined. Since June 2009, a whopping 40 percent of all job growth in the U.S. is attributable to Texas. Moreover, this incredible job growth has been experienced at all pay levels. One more figure: of the top 10 most improved cities in America, 8 are in Texas.

But prudence suggests such soaring statistics may signal that a bust is just around the corner. Whether this is good news or bad depends on where you stand in the equation.

The nature of innovation is such that whoever discovers a cheaper or better way to accomplish something can gain huge rewards in the short term, before the market has time to adjust. Eventually, high profits attract competitors, who increase the supply of goods and offer lower prices, ultimately drying up those profit margins. In other words, any monopoly on technology eventually dissipates, and mass accessibility to better products becomes the norm. This, in a nutshell, is how free markets continuously elevate the standard of living for everyone in society.

A boom in oil production has nearly halved the price in recent months, and profits are tapering quickly. Cheap gasoline will amount to hundreds of billions more dollars in the pockets of most Americans whose livelihoods are not dependent on oil—that’s the good news. But for those who are in any way connected to the industry, cutbacks, layoffs, and fewer opportunities are at the doorstep.

“Economic protections are like medications that treat symptoms while worsening the disease.”

Scenarios like this tend to bring about sweeping moral arguments for protectionist policies—bailouts, price floors, price ceilings, tax credits, subsidies, and all sorts of other mechanisms for propping up a struggling industry and “saving middle-class jobs.” Many of our national laws are built on the premise that you, the consumer, should pay extra—both at the register and through taxes—to ensure that someone in another state is able to keep their job. We find it in agriculture, renewable energy, manufacturing, and any other industry that might help a politician get elected.

Do not count on the usual public figureheads on the left to amass in favor of bailing out the oil and gas industry during this downturn. But those on the right would be wise to remain conservative on the issue as well.

Economic protections are like medications that treat symptoms while worsening the disease. (It is important to note a key difference in temporary emergency protection to sustain normal businesses after a natural disaster, versus protections that seek to achieve a certain flow of resources and prevent fundamental changes in the economy.)

One does not need a PhD in economics to understand the root cause of a recession. A recession is quite simply a misallocation of resources; too much has been invested in things that provide too few returns. This is true for any size company, community, or family that is experiencing financial problems. The struggle for economists is to perceive this misallocation before anyone else does, which is difficult for even a small community, and impossible for a whole nation.

The only way for a struggling economy to become stronger is to allocate its resources more efficiently and this can only be evaluated when the mechanism of prices is allowed to paint an accurate picture (watch a video on the role of prices at LearnLiberty.com). Economic protections by government intervention distort this picture and cause investments to remain misallocated.

If a price ceiling keeps rental rates too low, not enough houses will be built to meet demand. If minimum wages push labor costs too high, not enough people will be hired and unemployment will increase. If subsidies prop up profits among corn farmers, too much corn will be produced. Overinvestment happens naturally in a market, but buyers and sellers respond by altering their plans and buying patterns, so the market corrects. But if protectionist policies prevent this flexibility, the result is one of two outcomes: 1) the correction never happens and we never realize how much is wasted, 2) the correction does eventually occur and great losses dominate the news headlines.

There will be short-term winners and losers in the current oil market, but as long as such fluctuations are allowed, we are all winners in the long-term. It is true that a struggling industry can have ripple effects across the economy, which makes price fixing or government funding a tempting proposition. But we must also recognize that protectionism has ripple effects as well, and they can be far more devastating

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