from Energy, Security, and Climate and Energy Security and Climate Change Program

Do Oil Imports Matter?

October 12, 2011

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Bill Nordhaus has an interesting essay on energy in the New York Review of Books. He reserves his most forceful arguments for attacking the idea that “foreign oil” matters:

“Virtually no important oil issue involves US dependency on foreign oil. Whether we consider pollution, macroeconomic impacts, price volatility, supply interruptions, or Middle East politics, our vulnerability depends upon the global market. It does not depend upon the fraction of our consumption that is imported.”

This worldview is conventional wisdom among most economists whose work doesn’t focus narrowly on oil. Their instinct is understandable given the tendency of many politicians to grossly overstate the benefits of domestic oil production. Ultimately, though, it’s wrong.

Take a look at Saudi Arabia. Does Saudi vulnerability to oil markets look like U.S. vulnerability? Of course not. Is that because the Saudi economy is less oil intensive than the U.S. one? No. It’s because when oil prices rise, Saudi Arabia has a big way to benefit.

I’m not saying, of course, that the United States can (or should want to) become Saudi Arabia, or even Norway for that matter. But there is a continuum, and it’s wrong to claim that domestic production doesn’t matter at all.

Let’s break things down along the same lines that Nordhaus does:

Pollution. Nordhaus is correct that this doesn’t depend on import levels.

Macroeconomic impacts. Import levels matter, though perhaps not as much as many assume. Over the long run, everything else being equal, lower imports are generally good for the economy. This is not because it’s inherently bad to “ship money overseas” – after all, trade is usually beneficial. But trade for the sake of trade is not. If, for example, you’re importing something because of ill-conceived regulation at home, that’s a bad thing; also, to the extent that oil is overpriced, importing oil is bad for the U.S. terms of trade.

In the short run, Norhaus is closer to being correct. There’s a very strong case to be made that, even if the United States produced all the oil it consumed, the short run macroeconomic distortions from oil price shocks would significantly outweigh the gains from greater producer revenues. That said, those gains in producer revenues wouldn’t be zero: they would help blunt the macroeconomic impact, even if wouldn’t eliminate it.

Price volatility. Nordhaus is mostly right: the United States is exposed to the same price volatility no matter where it buys its oil from. But there are two caveats. First, to the extent that the United States underdevelops its domestic supplies, the world oil market may find itself relying more on supplies from more volatile parts of the world. (Of course, many will argue that U.S. politics and regulations make its oil supply unreliable too.) Second, price volatility doesn’t really matter in an of itself – what matters is the economic impact. On that count, see the previous point.

Middle East politics. Score one for Nordhaus: the United States is going to be entangled in the region for a long time, regardless of what its oil policies are. That said, the less vulnerable the United States becomes to oil market disruptions, the more freedom of action it will enjoy in the region.

It’s easy to overstate the importance of oil imports. But that doesn’t make them unimportant. If U.S. oil policy could do only one thing, it would be wise to focus solely on reducing consumption, and to ignore the production side. In practice, there’s no reason why it can’t address both.

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