Gas Prices and Global Consumption

Cheap gas makes people use too much of it — that’s the takeaway from a study in this month’s American Economic Review. In “The Economic Cost of Global Fuel Subsidies,” Lucas Davis, a associate professor at Berkeley’s Haas Business School, uses World Bank data to show that countries with consumer fuel subsides have higher fuel consumption.

Crude and refined oil are traded internationally, so their wholesale prices are similar everywhere. What causes such a great variation in price — from $0.08 a gallon in Venezuela to $9.61 in Turkey — are taxes and subsidies. Mr. Davis determined countries’ subsidies by calculating the difference between domestic consumer prices and international spot prices, and factoring in distribution, transport and retail costs. Basically, if what people pay at the pump is less than the cost of the fuel and its related costs, he considers the fuel subsidized. Without factoring in external costs to the environment, Mr. Davis estimates the opportunity cost of gasoline everywhere to be roughly $3.57 per gallon.

Using this rationale, he determined that 24 countries subsided gas and 35 subsidized diesel in 2012, totaling $110 billion in fuel subsidies world-wide. Compared to countries without fuel subsidies, these countries generally use more fuel than necessary. According to the report, “subsidies create deadweight loss by enabling transactions for which the buyer’s willingness-to-pay is below the opportunity cost.”

In other words:”When you price gas at seven cents a gallon, people figure out a lot of ways to use a lot of it,” Mr. Davis said. For example, Saudi Arabia, where gas is 60 cents per gallon,”uses massive amounts of fuel whenever it produces anything,” he said. “It’s wasteful production.”

Mr. Davis said artificially low fuel prices can also be bad for the economy.

“If the government of Venezuela gave cash to its people, they’d consume a lot more of everything,” Mr. Davis said. “Free gas means people drive a lot more but are poor in other ways — it leads to a terrible allocation of goods in the economy.”

The U.S. is a bit of an outlier in this theory. U.S. subsidies are on the production end, which Mr. Davis said only amounts to “cents” worth of savings on the consumer end. Because Americans pay more than the opportunity cost for fuel at the pump, Mr. Davis doesn’t consider its fuel to be subsidized — but that doesn’t stop Americans from using lots of fuel.

There are a number of reasons Americans consume so much gas. First of all, even without consumer subsidies, fuel doesn’t make up a huge share of U.S. income and it is lightly taxed compared to other OECD countries (An average of $0.49 a gallon in the U.S compared to $4.00 in Germany and the Netherlands). Mr. Davis said U.S. taxes don’t reflect the huge external costs of excess driving — roadwork, traffic congestion, accidents, and carbon dioxide emissions — which he approximates should be about double what Americans pay in taxes per gallon.

The U.S. also has a historical car culture that has influenced the layout of the cities. “Drive around L.A.,” he said, “It’s very different from driving around Paris.”

About The Numbers

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