Industrial Policy, Scarcity, and Supply

During the winter there was an energy crisis in Europe. It’s a real shortage, not a smorgasbord—it’s characterized by artificial restrictions on both supply and price. In a recent Foreign Policy magazine article, Brenda Shaffer explains the various ways in which this deficit was created by European policymakers. I want to draw attention to a few worthwhile points he makes and, being incurably pedantic, I also have a small nit to pick.

He notes how European policymakers have an incentive to blame all their energy problems on Putin and his recent invasion of Ukraine, even though Europe’s energy problems are far from a new phenomenon:

Russian President Vladimir Putin’s throttling of gas taps has undoubtedly worsened the situation, but this will already be the third winter of Europe’s energy crisis. In the winter of 2020-2021 and 2021-2022, Europe has already experienced significant increases in electricity and natural gas prices, as well as gas shortages that have led to increased consumption of coal and fuel oil. European policymakers either didn’t take notice or chose not to change course.

What is the reason for the deficit in previous years? In short, industrial policy and central planning. European policymakers decided they could divine the “right” mix of energy sources needed to power an entire continent, and passed laws and regulations trying to shape the market according to their plan:

Europe’s crisis has been two decades in the making. Aiming to engineer a rapid transition from fossil fuels and nuclear power to renewable sources, European policymakers have forced profound changes in energy supply. At the same time, they ignore assumptions for continued demand for oil and natural gas, as well as the need for a reliable baseload fuel source to back up intermittent solar and wind. Many EU member states have reduced domestic production of fossil fuels and restricted imports, with the notable exception of gas from Russia.

Shaffer also noted that Russia is the only available option for natural gas. Europe has many other sources of natural gas, but policymakers have stopped or otherwise restricted imports from these sources, even today:

Europe’s policy of cutting off gas supplies has created shortages that began to drive up prices two winters ago. Believing it will soon be able to do without gas, Europe has also blocked long-term contracts for imports, leaving Europe starved for gas even though it is surrounded by some of the world’s largest gas reserves – not only in Russia, but also in North Africa, Central Asia and other regions. . The EU could easily secure access to reliable gas supplies at affordable prices but now relies on the expensive spot market instead. Even today, as European officials scour the world for new gas volumes, they are refusing to sign long-term contracts with producers.

Despite all this, European policymakers continue to operate in the same mode of central planning that created this mess in the first place:

European leaders are aware that their energy market design is not working. National governments are bailing out or outright nationalizing collapsed utilities. Most are now setting electricity and gas prices for customers. Moreover, Europe’s high carbon price hasn’t stopped utilities from firing up mothballed coal plants and switching from gas to fuel oil for electricity and heat… Instead of focusing on these issues with urgency and laser sharpness—and reversing the wrong decisions of various countries to phase out nuclear— European leaders continue to push new projects that are untested and far from commercially viable.

My main nitpick is Schaffer’s use of the term “scarcity.” In economics, scarcity refers to something more specific than low supply or high prices. It is not entirely true that the “policy of stopping gas supply” itself will create shortages, although it will certainly contribute to price increases. To truly create a deficit, prices must be prevented from rising to their market-clearing levels. And, to his credit, he mentions the use of price controls and how they have this effect:

Today, Europe’s proposed caps on gas and electricity prices, along with new levies on energy producers, would further restrict supply to protect consumers from higher prices that could prompt them to lower their thermostats and turn off the lights.

Here he mentions one of the great virtues of price. Prices not only convey information about the relative supply and demand of goods; They provide an incentive to act on that information. I would have liked it if Shaffer made the connection between price caps and deficits clearer throughout his piece. To an economist, the connection between them may seem too obvious to ignore, but when communicating with the public, it is important to make that connection as clearly and forcefully as possible. However, Schaffer does well to show how European policymakers have engineered the crisis and how they have every incentive to place the blame squarely on Putin without publicly admitting their error or reverse course.

Kevin Corcoran is a Marine Corps veteran and a consultant in healthcare economics and analytics and holds a Bachelor of Science in Economics from George Mason University.

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