The Security Trap

CHICAGO – Even as the world becomes more integrated, the word “security” crops up again and again, as in “food security” or “energy security.” Typically, this means a country creating and controlling production facilities no matter what the cost. Thus, Arab countries grow water-hungry grain in the desert, and China acquires part ownership of oil companies in Sudan. Are these economically sensible actions? If not, what should the world do to reduce the need for them?

Let’s start with ownership of foreign resources. One might think that a country that owns foreign oil can use the profits from sales to insulate its economy from high world oil prices. But this makes no economic sense. The world market prices oil according to its opportunity cost. Rather than subsidizing the price in the domestic oil market (and thus giving domestic manufacturers and consumers an incentive to use too much oil), it would make far better sense to let the domestic price rise to the international price and distribute the windfall profits from foreign oil assets to the population.

The key point is that fundamental economic decisions should not be affected by the ownership of additional foreign oil assets. But, because of political pressure exerted by small, powerful interest groups, windfall profits will inevitably be spent at home in unwise subsidies. As a result, the acquiring country will, if anything, make suboptimal economic decisions.

Could the purchase of foreign resources lead to smoother national income? A purchase will always look beneficial if one looks backward after the resource price has risen. But if the price of oil falls, citizens suffer a loss of income and wealth (relative to having invested the money elsewhere). Assuming the foreign oil assets are priced fairly at the time of purchase, the country benefits only when the purchase helps smooth its income; however, purchases may increase income volatility even for a country that relies heavily on oil.