Subsidizing gasoline is such a multidimensionally bad idea, the study of all the different ways in which it’s counterproductive could take up the bulk of a very productive economist’s career. Over the years we’ve written about many of the angles: from air quality and congestion to the effects on urban development patterns, the state’s finances, and even the macroeconomy. So you might think we have it covered. Alas, no.
Setting aside the environmental and other knock-on effects, there are two broad ways you can go about when you go to put a dollar figure on the cost of a crazy policy like giving away gas.
One strategy is to estimate the difference between the international spot market price and the domestic price, and come up with a figure for the opportunity cost of the subsidy. That’s the approach we’ve usually favored on Caracas Chronicles, and it yields some eye-popping figures. Davis concurs – the figure is massive.
However, even these monster numbers miss a lot of the economic value destroyed by the gas subsidy. The opportunity cost of the subsidy is simply a transfer of money from PDVSA to Venezuelan gas buyers.
As inefficient as it may be, it doesn’t get at the crux of the issue. The real issue is deadweight loss: value that’s not transferred from someone to someone else but is destroyed outright by the transaction.
Deadweight loss arises when you fiddle with prices in such ways that people who don’t really value something very much end up consuming ahead of people who value it much more. As Davis says,
“Subsidies create “deadweight loss” by enabling transactions for which the buyer’s willingness-to-pay is below the foregone revenue from selling oil. In other words, it costs the government more to provide the subsidy than the value the subsidy creates for gasoline consumers. In Venezuela right now there is someone driving around who values gasoline at only $.50 cents per gallon. Gasoline can be sold in international markets for about $3.00, so each time this person uses a gallon of gasoline the world becomes worse off by $2.50.”
I realize this may not be intuitive for many people, so I’ll take a stab at breaking it down.
Suppose you have the last Coca Cola in the desert. In front of you are two people: one of whom has just quaffed a nice, soothing 1.5 l bottle of gatorade, and another who hasn’t had a drop to drink in 2 days. Both of them have $5 in their pocket. But it just so happens that the one who just drank the gatorade is sitting on the Venezuelan side of an imaginary line (a.k.a., a border) where CocaCola is price-controlled at $0.01 per bottle, while the dead-thirsty guy is on the Colombian side of the same border. The Colombian would gladly hand over the full $5 for that coke, whereas the Venezuelan isn’t really thirsty and wouldn’t pay more than $0.03 for it. Deadweight loss is the destruction of value that occurs when you insist on shoving the last CocaCola in the desert down the Venezuelan’s throat, because Socialism.
The problem is waste. The Venezuelan doesn’t really value the Coke. Maybe he starts spilling it all over the place, or just lets it sit there going flat. But even if he does drink it and gets his “full” 3 cents of enjoyment from it, the Colombian who would’ve obtained $5.00 worth of value from it goes thirsty. The gap between the $5 in value the transaction could’ve generated and the 3 cents it actually did generate isn’t actually transferred to anyone – it’s welfare that’s destroyed. Analytically, that’s the real welfare loss, that is where the waste occurs, and that is what Lucas Davis tries to measure.
His numbers? Welfare losses in 2012 are about US$ 10 billion, or close to $400 per capita.
That may not sound like a whole lot, but when you consider yearly per capita oil revenues on an insanely good year such as 2012 were about US$4,000, it’s pretty staggering. Basically, 10% of our oil income – not our profits, mind you, but our income – is disappearing. It’s not that it’s being given away, it’s not that someone is benefitting, it’s simply vanishing in a puff of logic.
They don’t call it a deadweight loss for nothin’.
This, by the way, is before you consider other economic costs. For example, increased fuel consumption creates more carbon dioxide pollution, more smog, more traffic accidents, etc. While he doesn’t break those numbers down by country, Davis says it is roughly 75% of the deadweight loss. In that regard, adding up economic costs means we’d be looking at roughly $17 billion in total economic costs for Venezuela. And that’s not even taking into account the whole fuel-for-cocaine angle …