Cheaper oil is good for the economy — it's basically the equivalent of a tax cut. Unless it's bad for the economy, which can be the case if falling prices spur deflation and hurt countries and companies that depend on oil exports. Whether the impact is good, bad, or a little of both, will depend on how long prices stay low.
If cheap oil is the result of a drop in demand (from an ailing Chinese economy, for example), prices will rise when the economy picks up. If lower prices stem from increased supply (from the shale boom, say), then cheap oil is here for at least a while. Two things are certain: There's still a finite amount of oil in the world, and the economy needs oil to function. That suggests oil prices will increase someday, although no one is sure whether that will happen as soon as the spring or as far off as the 2050s.
Unless something really is different this time. Those are dangerous words, and it's always safer to assume that history does, in fact, repeat itself. There is a chance, though, that the drop in oil prices could inspire a change in energy policy, in which case there may be lasting consequences.
Many economists support increased taxes on oil, largely because oil is necessary and scarce, and excessive use of fossil fuels harms the environment. Among rich countries, America's fuel taxes are the lowest. Many developed countries, often oil-producing ones, actually subsidize fuel. But burning through oil today poses costs in the future, and low taxes and subsidies also diminish the incentives to discover greener, more sustainable alternatives.
Lower oil prices give governments the chance to increase fuel taxes (or cut subsidies) without incurring immediate harm to the economy. Indonesia, Malaysia, and India are cutting their fuel subsidies. The World Bank is encouraging other countries to do the same. It argues that fuel subsidies create distortions that mainly benefit middle-income households and the money is better spent on infrastructure projects. Larry Summers called on America to use this moment to increase carbon taxes. Congress is considering the first fuel tax increase since 1993.
The risk is that we still don't know how long oil prices will last and what exactly is driving the drop. Oil prices in particular bounce around on the whims of the market. Increasing taxes would mean that even if this is a temporary blip, today's oil market will set the tone for years to come. Suppose, for example, China cuts its oil subsidy. When oil prices rise again, Chinese consumers will face higher prices. In response, they ought to use less oil, which would leave more for everyone else. It also would give a comparative advantage to residents of countries that don't increase taxes.
Higher fuel taxes (or cutting subsidies) makes economic sense, and this is the politically opportune time, if there ever was one, to achieve this. But setting long-term policy in response to volatile oil prices can create unintended consequences. Five years from now, some countries will face much lower prices. Others will be paying more. That may alter global trade and development ways we can't predict today.
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