Industrial Policy in oil and gas exploration in US

The Bush administration in the US led an aggressive push to both deregulate oil and gas exploration drilling activities and unlock newer reserves in an effort to limit America's energy dependence on external sources. A task force, led by Vice President Richard Cheney and comprising of top oil executives was established to push policies that promoted the aforementioned objective.

The NYT has an excellent story that illustrates how proactive policies, some of them controversial for various reasons, including allegations of cronyism, played a critical role in ushering in a boom in oil and gas exploration in the US. 

The task force’s work helped produce the Energy Policy Act of 2005, which set rules that contributed to the current surge. It prohibited the Environmental Protection Agency from regulating fracking under the Safe Drinking Water Act, eliminating a potential impediment to wide use of the technique. The legislation also offered the industry billions of dollars in new tax breaks to help independent producers recoup some drilling costs even when a well came up dry.

Separately, the Interior Department was granted the power to issue drilling permits on millions of acres of federal lands without extensive environmental impact studies for individual projects, addressing industry complaints about the glacial pace of approvals. That new power has been used at least 8,400 times, mostly in Wyoming, Utah and New Mexico, representing a quarter of all permits issued on federal land in the last six federal fiscal years.

The Bush administration also opened large swaths of the Gulf of Mexico and the waters off Alaska to exploration, granting lease deals that required companies to pay only a tiny share of their profits to the government.

All these measures encouraged oil companies to start investing in new exploration technologies to access the more difficult oil and gas sources, especially deep drilling for oil through high-pressure hydraulic fracking and horizontal drilling to unlock gas reserves beneath shale rock formations. Once the oil prices started rising in 2005 and 2006, these newer technologies suddenly became attractive and a boom ensued in deep drilling and unlocking shale gas reserves. Deep drilling and fracking opened up large new oil fields, including off-shore fields. Similarly, horizontal drilling and high-pressure fracking opened up massive reserves of gas underneath layers of shale rocks.

There is another distinguishing feature of this aggressive industrial policy push which is of great relevance for countries like India. Deep drilling in West Texas desert and off-shore locations in the Gulf of Mexico and Alaska coast, raised considerable opposition on environmental grounds. There have been valid concerns about the adverse impact of hydraulic fracking on gound water sources and surface run-off pollution of nearby water bodies. However, the federal government has not strayed away from its policy focus,

How the country made this turnabout is a story of industry-friendly policies started by President Bush and largely continued by President Obama — many over the objections of environmental advocates — as well as technological advances that have allowed the extraction of oil and gas once considered too difficult and too expensive to reach... Some areas of intense drilling activity, including northeastern Utah and central Wyoming, have experienced air quality problems. The drilling technique called hydraulic fracturing, or fracking, which uses highly pressurized water, sand and chemical lubricants that help force more oil and gas from rock formations, has also been blamed for wastewater problems. Wildlife experts also warn that expanded drilling is threatening habitats of rare or endangered species.

 In the US, the consequences of this aggressive industrial policy push has been  hugely beneficial,

Not only has the United States reduced oil imports from members of the Organization of the Petroleum Exporting Countries by more than 20 percent in the last three years, it has become a net exporter of refined petroleum products like gasoline for the first time since the Truman presidency. The natural gas industry, which less than a decade ago feared running out of domestic gas, is suddenly dealing with a glut so vast that import facilities are applying for licenses to export gas to Europe and Asia. 

National oil production, which declined steadily to 4.95 million barrels a day in 2008 from 9.6 million in 1970, has risen over the last four years to nearly 5.7 million barrels a day. The Energy Department projects that daily output could reach nearly seven million barrels by 2020. Some experts think it could eventually hit 10 million barrels — which would put the United States in the same league as Saudi Arabia.

In fact, this boom in oil and gas exploration is providing a much needed boost to the national economy itself.

The newfound wealth is spreading beyond the fields. In nearby towns, petroleum companies are buying so many pickup trucks that dealers are leasing parking lots the size of city blocks to stock their inventory. Housing is in such short supply that drillers are importing contractors from Houston and hotels are leased out before they are even built. 

The contrast with the flip-flops and prevarication that characterises the central government policy on mining and environmental concerns in India could not have been more stark. The source of one of the biggest infrastructure bottlenecks, the relatively slow electricity generation capacity addition, can be traced to the failure to open up new coal mines in the face of environmental opposition. The consequent impact on the national economy has been devastating.

India's WTO challenge

Here is my op-ed with Srikar on the need to align national economic policies with our WTO commitments.

Industrial Policy in the US

Faced with a jobs crisis, the Obama administration is proposing a wide-ranging package of policies to revive the manufacturing sector in the US economy. This interest in reviving manufacturing comes on the back of a three-decade long decline of jobs in American manufacturing - US manufacturers produced roughly the same amount of goods in 2010 as they did a decade before, but they did so with six million fewer employees on their payrolls.

The Times summarizes the proposals which include using taxes, tariffs, and other policies to favor domestic manufacturers over their foreign competitors,

The administration has put together a far-ranging set of proposals: cutting taxes for manufacturers that produce goods in the United States, taking away tax breaks for businesses that move jobs offshore, doubling a tax deduction for makers of high-tech goods, providing support to businesses investing in areas where factories are closing, expanding worker training programs and creating a new task force to better enforce trade rules and intellectual property rights. Closing a loophole that allows companies to shift profits abroad would pay for the tax credits.

This is classic industrial policy. However, instead of directly picking winners, the government is putting in place a framework which would enable the most competitive firms in particular sectors to flourish and develop strength. The ultimate objective of the policy is to increase local job creation and boost economic activity in manufacturing sector.

The big challenge for governments pursuing industrial policy are three-fold. One, which industries (within manufacturing) to favor with industrial policy? Two, what should be the type and extent of industrial policy instruments deployed to support each industry? Three, the need for sunset provisions so that the concessions and preferential policies are not permanently baked in.

It is a very real danger for governments to be misled into either supporting inefficient and flagging industries or deploying the wrong set of instruments (eg, like ones that discourage foreign technology transfers) under pressure of lobbying from industry interest groups. This is all the more a problem in democracies since these industry groups are more often massive contributors to the political parties. The difficulty faced by the Government of India in withdrawing the tax concessions granted to IT firms operating within the software technology parks established by the government is a classic example of the problems with exiting such policies.

Corruption and growth

Tim Harford points to this insightful joke which captures the difference between the roving bandit and the stationary bandit, about which I had blogged earlier.

"A bureaucrat from Sani Abacha’s Nigeria visits a bureaucrat in Suharto’s Indonesia and is impressed that his Indonesian counterpart lives in a nice house and drives a Mercedes. "Do you see that road? Ten per cent," the Indonesian explains.

A couple of years later the visit is reciprocated. Suharto’s man finds the Nigerian civil servant in a palace with a pair of Ferraris. "Do you see that road?" says the Nigerian, gesturing at virgin rainforest. "One hundred per cent.""

He explores the challenge of reconciling the incentives of the inevitable corruption among politicians and bureaucrats with those of promoting national economic growth. He points to the success as countries like South Korea, which despite close and corrupt nexus between businessmen and the ruling elite, managed to escape being grid-locked in corruption and stagnation by focusing on export-driven growth. This focus on export markets and the need to be competitive ensured that corruption did not compromise on productivity and quality.

Similarly, the spectacular Chinese economic growth story conceals rampant corruption involving close relationship of politicians, bureaucrats and businessmen. However, certain systemic incentives sought to mitigate the adverse consequences of such corruption and align incentives of all sides towards promoting growth. The export driven growth model, which underpinned the success of town and village enterprises (TVEs), and the informal economic performance based promotions of local party apparatchiks contributed in no small measure to China's success.

In all these models, the ruling establishment, wilfully or otherwise, succeeded in putting in place mechanisms that incentivized economic growth and more critically linked the flow of corruption benefits itself to this growth. In other words, these systems ensured that corruption was sub-ordinated to the achievement of the broader macroeconomic and growth objectives. As the economic growth increased, all stakeholders realized the benefit of nurturing the goose that lays the golden egg, a virtuous cycle of growth and corruption got entrenched. I have two observations about this.

1. Is it possible to replicate this model in countries like India? I am inclined to believe that there are a few ingredients that served to sustain this model, which may be missing in countries like India. The most important ingredient is literacy. I believe that high-levels of literacy exposed all stakeholders to the benefits of sustainable economic growth. Most often, as is evident in the lower level corruption in countries like India, where illiteracy is widespread, the extent of corruption is not dis-similar to Abacha's Nigeria. Though I am not aware of any empirical validation, I believe that there could be a positive correlation between stationary bandits and literacy, and vice-versa between roving bandits and literacy.

Another factor that could possibly come in the way of the formation of such mutually-beneficial coalitions in India may be democracy itself. Does the inevitable lack of discipline of democratic politics erode the stability of such coalitions? Does the lack of continuity in multi-party democracies hamper the establishment of a stable elite?

2. An important point about state-driven industrial policy that is often missed in standard debates about its pros and cons is its role in building and sustaining such coalitions. Supporters point to its role in effective allocation of resources in developing economies. However, they overlook its equally important role in sustaining the careful equilibrium among a set of stationary bandits.

The industrial policies followed by countries like South Korea and China have for long been accused of having engendered a system of crony capitalism. However, the redeeming feature of this capitalism, appears to have been that these capitalists were interested in first expanding the pie and then nibbling the expanded pie!

In other words, East Asian industrial policy not only allocated resources efficiently, but also did so in a manner that reconciled the apparently contradicting need to appease the rent-seeking inclinations of the ruling elites and maintain economic growth.

Deindustrialization and American Hegemony

Manufacturing jobs have declined precipitously in the United States since the late 1960s. As the graph below shows they fell from 28% of total employment to 10% last year. The decline is continuous, and, one should add, precedes NAFTA and other Free Trade Agreements, (FTAs) which are often associated with the process of deindustrialization in the US. That the topic is old should be highlighted by the fact that the classic on the subject is Barry Bluestone and Bennett Harrison’s book published in 1982.

However, if one looks at the absolute number of manufacturing jobs, rather than their share in total employment, a slightly different picture emerges. First, manufacturing employment grows up to 1979 (peaking at around 19 million jobs). In other words, the fall in the manufacturing employment share from the 1960s to 1979 is fundamentally the result of a rate of employment growth in the manufacturing sector lower than in the economy as a whole. From 1980 manufacturing employment basically starts falling slightly up to 1994, and from 1994 to 2000 it grows only a trifle, fluctuating around 17 million jobs. Interestingly enough, 1994 is the year of the implementation of NAFTA. The whole period from 1980 to 2000 is a period in which the share of manufacturing employment falls, not just because employment grows faster in other sectors, but also because it stagnates.

However, after 2001 (the year China entered into the World Trade Organization, WTO) manufacturing jobs collapse, with only 11.5 million jobs in 2010. This may suggest that, in part, one may have to revise Bob Rowthorn’s view that North-South trade has no role to play in deindustrialization. But clearly the process that starts in 1979 is of a different nature. One view is that it represents a natural result of economic maturity, and that faster growth in manufacturing implies more workers absorbed in the services sector.

I would suggest, but not elaborate too much here, that deindustrialization in the United States, and I mean the post-1979 phenomenon, is part of a strategy of accumulation, which was based on lower wages and higher interest rates, with demand pushed by increasing the debt leverage of the private sector (as suggested in another post). The weakening of the unions (and FTAs have played a role in this), and the move of manufacturing jobs abroad (mostly to Asia), and, as a result, deindustrialization, are part of the pattern of accumulation since the 1980s. However, this should not be read as a general weakness of the United States industrial sector.

As noted by Fred Block, the United States has a shadow industrial policy machine, that has allowed certain sectors to be weakened, but has promoted vigorously other sectors deemed strategic.  For him:

“The rise of the computer industry in the U.S. was, at every stage, orchestrated by major government initiatives and even to this day large federal investments are being made to keep the U.S. computer industry ahead of foreign competitors. Nor is the computer industry atypical. Virtually all U.S. industries have become heavily dependent on scientific and technological advances that are financed primarily by the federal government's support of university and government laboratory researchers.”

Block argues that there is a hidden developmental State in the US. In that sense, deindustrialization has not been a sign of the weakness of the US, or of the demise of its hegemonic power, as some on the left would argue. On the contrary, is part of the renewed American Hegemony, which has been maintained at the cost of certain sectors, and, in particular, of its working class.

More on innovations and the role of governments

This is revisiting an old debate, thanks to the excellent Chris Dillow. Daron Acemoglu re-examines the classic claim that producers capture only a tiny fraction of the full benefits of any innovative activity and research and development activity should therefore be catalyzed by governments.

Analysing the incentives that drive investments in innovative activities by private firms and the direction (or areas) of those investments when the market is dominated by a particular technology or strategy, he writes,

"This paper... shows that equilibrium technological progress may exhibit too little diversity (too much conformity), in particular, foregoing socially beneficial investments in 'alternative' technologies that will be used at some point in the future. The presence of future innovations that will replace current innovations imply that social benefits from innovation are not fully internalized. As a consequence, the market favors technologies that generate current gains relative to those that will bear fruit in the future; current innovations in research lines that will be profitable in the future are discouraged because current innovations are typically followed by further innovations before they can be profitably marketed...

The recognition that there will be further innovations (in the prevailing technology or strategy) will discourage research in areas that will generate new products or technologies for the future relative to improving currently used products, processes, or technologies. Consequently, in equilibrium, too much research will be devoted to currently successful product and technology lines...

A social planner would choose a more diverse research portfolio and would induce a higher growth rate than the equilibrium allocation. The diversity of researchers is a partial (imperfect) remedy against the misallocation induced by the market. Researchers with different interests, competences or ideas may choose non-profit maximizing and thus more diverse research portfolios, indirectly contributing to economic growth."

In this context, Chris Dillow points to three reasons why this finding assumes even greater significance. He writes,

"1. If there is a danger of catastrophic climate change, then there is a need for new green technologies. But the danger that producers won’t get the fruits of such innovations - as they’ll be usurped by future better innovations - can lead to under-investment in them.
2. Capital spending and productivity growth have been weak for years. This might be a symptom of a decline in useful innovations. Maybe capitalism has picked the low-hanging fruit.
3. Many innovations (pdf here) since the 1980s have had the effect of increasing inequality. They’ve benefited capitalists and/or bosses at the expense of workers."