It has been said that necessity is the mother of all inventions. That is certainly true with regards to the introduction of fuel-efficient vehicles in the 1970s. There are several factors that ushered in an era of engines with greater fuel efficiency but one of the most important was the then record-breaking crude oil prices caused by events in the Middle East.
By the 1980s in contrast, there was an oil glut but improvements gained in the previous decade stayed in spite of the downward trend in global crude oil prices. The same trend was again seen in the 2000s. Crude oil prices went up and then down but I fear that we might have missed the wave for fuel efficiency improvement, no thanks in part to intervention by the state in many parts of the world.
In one way or another, many economists have never really doubted that global crude oil prices would come down even when oil prices were going through the roof not too long ago. The rationale behind the idea is closely related to the mainstream growth model which stresses the importance of technology in improving output based on the same input in a status quo scenario. In other words, when prices increase sufficiently high, there is an incentive to look for new and better ways to solve old problems.
The availability of substitutes further strengthens the idea as consumers switch from consuming crude oil to other resources.
And then there is the gospel of economics. With all else being equal, quantity demanded goes down given higher prices.
Therefore, the fall of crude oil prices was never a question of if; there was only a question of when. Some people laughed at this, just as the executives at Shell in the early 1980s laughed. They probably did not even smile when the oil glut set in soon and lasted for about two decades.
In 1980, the famed Simon-Ehrlich wager was entered between entomologist Paul Ehrlich and economist Julian Simon. The wager was made to settle a dispute on whether commodities prices would on average be higher in the future while discounting for inflation.
Ehrlich hypothesized that humanity would face a severe shortage of resources in the long run. Simon believed otherwise. With prices as a signal of scarcity, Ehrlich bet the prices of five commodities would increase in 10 years’ time; Simon bet in the other direction. It was a battle between Malthusian and mainstream economic ideas.
Ehrlich’s hypothesis is not at all insensible but prices of commodities are hardly the best indicators to prove his case. Technology improved in those 10 years. Lesser materials were required for the same activities. Moreover, the availability of substitutes moderated and even prevented the predicted prices increase. In the end, Ehrlich lost the bet.
We are witnessing the same trend at the moment. Global prices of crude oil as well as various commodities have gone up and down. However, the factors which played a part in bringing the prices down may differ from the previous 1970s episode. Instead of technological improvement, based on various newspaper reports, lesser economic activities seem to be the culprit.
Prices of crude oil began the relentless upward march around 2003 only to fall dramatically in the middle of year 2008. People did respond to the situation while prices were high. There is proof that people were switching to smaller vehicles. In Malaysia in September 2008, for instance, sales of compact cars experienced an increase amid dearer retail fuel prices. Electric vehicles meanwhile saw themselves being moved from the fringes of society to almost mainstream in developed economies such as the United States
Despite all that, there is not enough convincing evidence which asserts there is an overall widespread improvement in fuel efficiency. In many ways, these changes are merely transient in nature unlike technological improvements. These changes are transient because they probably would revert once prices go down again. These are cyclical rather than structural changes.
Structural changes unlike cyclical ones have lasting effects. Within the context of fuel efficiency, the changes come in the form of technological improvements which cut across the board.
Because of this, global crude oil prices may return to record-breaking levels once the economy recovers from its flu.
The period of expensive crude oil was an opportunity to improve fuel efficiency of vehicles but unfortunately, the creative destruction associated with free market did not happen as widespread as it had in the 1970s. Then, the introduction of more fuel-efficient Japanese vehicles in the US almost brought the Big Three — General Motors, Chrysler and Ford — to their knees. Vehicles with bad fuel economy were made obsolete and rejected. While the Detroit-based manufacturers are again in trouble, it is not very clear if the main cause is the creative destruction we saw in the 1970s.
The structural changes probably failed to occur due to the fact that almost half of the world population enjoyed fuel subsidies until only recently. The subsidies shielded the consumers from the effect of high global crude oil prices. The disconnection between individuals and the free market prices effectively removed the demand for greater fuel efficiency and conservation in general.
Just as high crude oil prices forced countries to reduce or abandon subsidies, the economic downturn set in to bring fuel prices down. Even when we finally got the chance to meet reality, the impetus for structural improvement in the economy was robbed from us in the nick of time.
The quest for greater fuel efficiency can be grounded on many reasons but for me, the greater reason revolves around the need to reduce carbon emissions in order to mitigate the effects of climate change. Climate change is perhaps the largest tragedy of the commons we have ever seen. It is not at all comforting that a lot of these emissions occur in developing countries with fuel subsidies.
Carbon emissions is one of the reasons why I oppose fuel subsidies. In addressing the tragedy of the commons, technological improvements in fuel efficiency or even downright new sources of energy are crucial. We had the chance to undergo a period of creative destruction but that opportunity has come and gone, for now.
The next time the opportunity knocks on our doors, we must seize it.
A version of this article was first published in The Malaysian Insider.