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This little story out of Puerto Rico is quite mind gargling in the stupidity of what they did. It is, on a smaller scale, exactly the biggest problem that the Venezuelan economy faces today. They decided to dispense with markets and prices in the allocation of one of the vital accoutrements of a modern economy: energy. And this is just never going to work well. There’s a reason we use markets and prices as methods of resource allocation. That being that there’s no other manner that makes even a modicum of economic sense.
What Puerto Rico actually did is make electricity free for municipal uses, a dunderheaded decision with entirely predictable consequences:
The free power dates from 1941, when the utility was established by Rexford Tugwell, a member of Franklin D. Roosevelt’s brain trust and the last American governor of Puerto Rico to be appointed by the president of the United States. He contended that for electricity to benefit the people, it had to be owned by the people, and he created Prepa by nationalizing the handful of private electric companies then on the island.
The private companies had paid local property taxes, but publicly owned Prepa did not. Free electricity was intended to make up for the lost tax revenue. The value of the free power was supposed to match the forgone taxes, and if cities took more, they were supposed to pay for it. But the rates are driven by oil prices, which since the 1970s have lost any connection they might have had to property values, and the power authority simply stopped trying to collect what cities owed. In 2014 a consulting firm found the cities had received $420 million worth of free electricity that they should have paid for.
The results of this?
Today, Aguadilla has 19 city-owned restaurants and a city-owned hotel, a water park billed as biggest in the Caribbean, a minor-league baseball stadium bathed in floodlights, and a waterfront studded with dancing fountains and glimmering streetlights.
Most striking is the ice-skating rink. Unusual in a region where the temperature rarely drops below 70 degrees, the rink is complete with a disco ball and laser lights.
An ice skating rink? Powered by oil generated electricity? Oil which the power company has to pay for but the city does not pay for the electricity?
Yes, I think we can see why the place is bust, can’t we?
Which brings us to the Venezuelan example. So, for an oil producing nation… Why shouldn’t gasoline be cheap? Then the price was fixed, then there was inflation, with the result now that it costs more to run the gasoline station itself than the total revenue from selling the gasoline. In fact, the state-owned gasoline distributor doesn’t even collect money for the gasoline from the gas station; wholesale deliveries are free. But of course the crude oil from which the gasoline was made has to be pumped up; that costs money. And given the vast thirst for gasoline at such prices (a full tank is these days a handful of U.S. cents at the black market exchange rate) local refining capacity isn’t enough to process it. So, Venezuela exports crude, pays the world market price to have it converted into gasoline, and then imports that–only to give the gasoline away. One reasonable estimate (including opportunity costs, as any reasonable estimate would, for they could sell the crude at the world price instead and run buses or whatever) says that this costs the Venezuelan state some $50 billion a year–enough money to entirely sort out all of their economic problems, in fact. Well, that and hiring a few politicians who have the first glimpse of the subject of economics perhaps (the current economy minister denies the very existence of inflation. He’s a sociologist).
This is why we use markets; this is why we use prices to guide resource allocation. And this is why we do not use barter, nor quid pro quos, to do the same. Because relative values change, prices are guides to those changes in relative values and thus we want to change allocations as values change.
Puerto Rico is bust in part because it violated such simple rules; Venezuela is so because it in much larger part did the same. We need to make sure that we don’t make the same mistake. It might well be that we don’t like the initial allocation of resources as a result of purely market forces. That’s fine, we can change them. But we need to change them by taxing one group of people in order to provide others with the wherewithal to purchase those resources at the market rate. Section 8 vouchers are a better way of gaining housing for the poor than rent controls. Food stamps are better than price fixing and rationing as in Venezuela. Taxation and market prices for electricity are better than charging for neither. Students should pay for their college degrees, not see them as some free gift.
Or, as I often say around here, we can do all sorts of things with the economy but whatever we do, let’s not mess with markets.