More Hours of Work are Required to Buy a Gallon of Gasoline

Gasoline prices this Memorial Day weekend are about $3.67 per gallon, about 12 cents less than last year and down about 27 cents from their peak in April.  Gasoline prices were higher, on average, in 2011 than any other year and 2012 looks to be about the same.  The nominal price of gas peaked in 2008 but fell rapidly as the recession hit the U.S. economy and ended the year at under $1.70 per gallon.  Although there are some news reports that households will drive more and travel further for vacations in the summer of 2012, any increase in travel will occur despite historically high gasoline prices.

One way to measure the relative change in the price of gasoline over time is to compare the price of a gallon of gas to the wage rate of a typical worker with a given set of skills.  The following chart calculates the number of gallons of gasoline that the median high school graduate could afford to purchase with their gross (pre-tax) earnings when working full-time.  In 1998 the median high school graduate could afford over 463 gallons of gasoline with their gross weekly full-time earnings.  By 2011 the median high school graduate could afford less than 182 gallons of gasoline with their gross full-time paycheck.

The typical blue collar worker had to work 2.5 times as many hours to fill their car’s gas tank in 2011 compared to 1998.  The situation looks no better for working class families in 2012.  The price of gasoline increased by 9.5% from the first quarter of 2011 to the first quarter of 2012.  This rate of increase was more than three times as large as the increase in the median weekly earnings of high school graduates.

The outcome of the Presidential election will depend on consumer confidence and the perceived state of the economy in swing states in November.  Working class families are likely to be encouraged by the decline in the unemployment rate and private sector job creation over the past 18 months.  But optimism about the recovery will be muted by the fact that weekly earnings for blue collar workers have increased very modestly while the price of gasoline has more than doubled since the depths of the recession in early 2009.

If Presidents Can’t Lower Gasoline Prices, Can They Be Blamed For Stagnant Wages?

Many pundits have opined that there is little President Obama can do to lower gasoline prices.  Richard Thaler, of the University of Chicago’s Booth School of Business, explained in the Sunday New York Times that this is because the U.S. is a “price-taker” in the world market for petroleum products.  The U.S. has a limited influence on world prices because we control only about 2% of the world’s oil reserves and consume about 20% of the world’s oil, according to Thaler.  He also cited a University of Chicago panel of leading economists who unanimously agreed that changes in U.S. gasoline prices are “predominantly due to market factors rather than U.S. federal economic or energy policies.”

The U.S. is also a “price-taker” in the market for unskilled labor.  There are about 50 million Americans with a high school diploma or less in our labor force.  The world’s adult population exceeds four billion and most are relatively unskilled workers.  U.S. demand for and supply of unskilled labor is small relative to the rest of the world.  Thus changes in the wages of less educated and less skilled workers are also “predominantly due to market factors” rather than U.S. federal economic or labor policies.  Working class wages have stagnated relative to the salaries of college educated employees over the past few decades primarily because of shifts in labor supply and demand and not the policies of Presidents and Congresses, whether Democratic or Republican.

Does this mean that federal policy has no impact on gasoline prices or the wages of working class Americans?  Obviously not, but as Professor Thaler noted some policies are more efficient than others in achieving “societal goals.”  For example Thaler, an informal advisor to President Obama, described the Obama administration’s decision to increase the corporate average fuel economy standards for automakers to 54.5 miles per gallon by 2025 as “not the best way” of reducing oil consumption.  Similarly, minimum wage laws are “not the best way” of raising the standard of living of young, inexperienced and relatively unskilled workers.

Thaler’s discussion of oil prices illustrated why one can’t evaluate policies or assess the welfare of consumers or producers by merely observing price fluctuations.  In one section of the op-ed he wrote:

Presumably, no one would call President George W. Bush unfriendly to the oil industry.  Yet the price of gasoline rose steadily during most of his administration. In February 2001, just after Mr. Bush took office, the average price of regular gasoline was $1.45 a gallon. By June 2008, that price had risen to $4.05. Still think presidents and oil-friendly policies can determine oil prices?

Many readers are probably confused by this passage.  Doesn’t the oil industry want higher gasoline prices?  Wouldn’t a President friendly to the oil industry be pleased that gasoline was $4.05 per gallon?

The price of any good or service, including wages and interest rates, can rise or fall for many different reasons.  Corn producers prefer higher corn prices if they result from demand increases but not if they are caused by a drought.  Energy policy should distinguish between high oil prices caused by high GDP growth in the U.S., Europe and Asia, a moratorium on oil exploration, uncertainty in the Middle East or the declining value of the U.S. dollar.  A price change alone tells us little about what caused the change and which policies might be effective at mitigating the impact of the change.

Increasing gasoline prices and a widening wage differential between more educated and less educated workers are determined largely by shifts in supply and demand.  Without understanding the market forces that caused these changes one can’t be sure whether they are a cause for concern.  If the policy goals are to mitigate the impact of these price changes the least effective and efficient government policies are direct price controls, such as the minimum wage.  Price controls treat a symptom of a problem but do not address the underlying forces of supply and demand that caused the problem.

Commentators and pundits who are quick to note that presidents  have little control over gasoline prices, should also make it clear that the decline in the pay of less educated workers relative to college graduates has much more to do with world supply and demand for unskilled labor and much less to do with presidential politics.