Greenspan’s Unsure Grasp of Economics

Former Federal Reserve Chairman Alan Greenspan contends that although it may not have been the Bush administration’s motive, “the Iraq war is largely about oil.” According to Greenspan, such an admission is simply “to acknowledge what everyone knows.” To say the Iraq war was about oil is not to say the United States invaded Iraq to control that country’s oil resources – as many critics claim. But Greenspan’s statement demonstrates how much oil colors U.S. policy and decision-making in the region.

Greenspan spouts forth the conventional wisdom:

"If Saddam Hussein had been head of Iraq and there was no oil under those sands, our response to him would not have been as strong as it was in the first gulf war. And the second gulf war is an extension of the first. My view is that Saddam, looking over his 30-year history, very clearly was giving evidence of moving towards controlling the Straits of Hormuz."

Yet such thinking perpetuates the myth of needing to protect the oil supplies of the world, which assumes that oil would not flow freely or cheaply otherwise.

Because the United States depends on imported oil for more than half of the oil it uses, the popular myth is that the United States is dependent on Persian Gulf oil, particularly from Saudi Arabia. True enough, the Saudis are thought to be sitting atop the world’s largest known oil reserves (264 billion barrels or about one-fifth of the world’s total), and Saudi Arabia is the world’s leading oil producer and exporter, and one of the lowest-cost producers of oil. But according to the Department of Energy, only about 11 percent of the oil the United States has imported in the first half of this year is from Saudi Arabia. In fact, so far in 2007, Saudi Arabia is the third largest importer of foreign oil to the United States – eclipsed by Canada and Mexico and just ahead of Venezuela. In fact, nearly half of the oil imported into the United States comes from North and South America. Further underscoring the misconception of U.S. dependence on Middle East oil is the fact that only about 16 percent of U.S.-imported oil has come from the Persian Gulf in 2007.

Even more important than the percentage of oil imported by the United States is the fact the oil is a commodity traded openly on the worldwide market, which means that oil-rich Gulf nations are not in a position to wield oil as a weapon against the United States. With no other meaningful source of revenue, they must sell their oil, and once the oil is sold on the world market, they cannot control where it ends up. As Massachusetts Institute of Technology economist Morris Adelman points out, “The world oil market, like the world ocean, is one great pool. The price is the same at every border. Who exports the oil Americans consume is irrelevant.”

Of course, oil-rich countries could affect the short-term price of oil by cutting back on production. The likely market reaction would be that other countries would increase production. But the myth of oil as a weapon is based on the false assumption of a “fair and reasonable price” for oil. The reality is that the price of oil is determined by supply and demand, not by some perception of what it should cost. Thus, according to Adelman, “Those who want the United States to produce its way out of the ‘problem,’ and those who want Americans to conserve their way out, are both the victims of an illusion. There is no shortage or gap, only a high price.” And even a higher price of oil is not an absolute certainty as other nations might increase their outputs in an effort to increase their revenues. Indeed, even OPEC members cheat by increasing production over their quotas to increase revenues even as the organization is trying to constrain the supply of oil to maximize price.

The possibility of completely cutting off oil supplies is even more far-fetched, says Adelman:

"If the Arabs ever attempted to cut off the United States for political reasons, the non-Arab members of OPEC would simply divert shipments from non-American customers to American. Not for love and not for fun (though they would enjoy spiting the Arabs) but for money. Whereupon the Arabs would ship more to Europe and Asia and the net result would be simply a big confusing costly annoying switch of customers and no harm otherwise. If this is common sense, it is also the lesson of experience. In 1967 a boycott of the United States and also of Great Britain and Germany, whose dependence on imported oil was greater than the United States, failed miserably.”

Thus, the realities of the economics of oil do not justify the U.S. obsession with protecting Middle East oil supplies. Before the first Gulf War, two Nobel laureate economists spanning the political spectrum – Milton Friedman on the Right and James Tobin on the Left – agreed that there was no need to go to war against Hussein to protect oil. The same is true for the Bush administration’s decision to invade Iraq.

SIDEBAR

Alan Greenspan’s belief that getting rid of Saddam Hussein was justified by “making certain that the existing system [of oil markets] continues to work, frankly, until we find other [energy supplies], which ultimately we will” is mystifying. He is essentially arguing for keeping the price of oil low but advocating alternative energy. Yet these two goals are largely incompatible. As long as oil is less expensive than other forms of energy (regardless of the absolute price of oil), there is no economic incentive to invest in less or unprofitable alternative forms of energy. You would think that the former chairman of the Federal Reserve Board would know that.

Read more by Charles V. Peña

Author: Charles V. Peña

Charles V.
Peña is a senior fellow at the Independent
Institute
, a senior fellow with the Coalition
for a Realistic Foreign Policy
, a former senior fellow with the George
Washington University Homeland
Security
Policy Institute
, an adviser to the Straus
Military Reform Project
, and an analyst for MSNBC television.
Peña is the co-author of Exiting
Iraq: Why the U.S. Must End the Military Occupation and Renew
the War Against al-Qaeda
and author of Winning
the Un-War: A New Strategy for the War on Terrorism
.