Rove's Math is faulty again

One of the M.O.'s of George W. Bush's political and business careers is the ability and willingness to create an 'after me, the deluge' so don't replace me situations. Fear, Uncertainty and Doubt is created so that although Bush and his associates have created a bad situation, the FUD keeps people from being willing to switch to other management for the fear of the higher associated costs of cleaning up after Bush. This was best captured by the Economist [h/t Unqualified Offerings]

In 2000 he beat an incumbent vice-president after eight years of peace and prosperity: the wry slogan among his inner circle was: “Things have never been better. Vote for change.” Four years later, with the economy stalled and Iraq in flames, he won again. This time, the backstage slogan was: “Things have never been worse. Stay the course.”

And we are getting the same playbook in Iraq. It is a clusterf*ck, the state has been delegitimatized to a ridiculous Nth Degree, the US is funding both the insurgency, and the counterinsurgency efforts (usually the same people), Iran's President was welcomed with flowers and chocalate while President Bush, Sec. State Rice and Sec. Def Gates have to make nighttime unnanounced visits and the success that is being trumpeted is returning to violence levels of 2005 when Iraq had already become a failed state. Oh yeah, two major US allies (Turks and Iraqi Kurds) are setting themselves up for a multi-division slug-fest once the ground dries out in the spring.

And yet, Bush allies are arguing that doing more of what Bush is doing with the same management team is the course with the lowest cost of action. Karl Rove is arguing that pulling out of Iraq would send oil to $200 a barrel. This after seeing the price of oil triple in the past five years, and ignoring either a static or dynamic analysis of the situation.

If we were to give up Iraq with the third largest oil reserves in the world to the control of an Al Qaida regime or to the control of Iran, don’t you think $200 a barrel oil would have a cost to the American economy?

This is wrong on several levels. First, Al-Quaida as the right's talking points like to trumpet this week, is not that strong in Iraq. It never has been until it was a convienent bogeyman. Instead the primary combatants shooting at the US in Iraq have been native-born Iraqis, Sunni Arab nationalists/revanchists/Ba'athists, [at least one, usually two, sometimes all three], Sadr's Mahdi Army which is overwhelmingly urban Shi'ites, and criminal/smuggling operations. The foreign fighters have been at times extremely useful idiots, but always idiots in the eyes of the Sunni Arabs. Al-Queada can't take over the central government; their best objective is hollowing out the central government.

Secondly, the economics don't work out. Iraq is exported in 2007 an average of 1.6 million barrels per day. More recently Iraqi oil exports were roughly 1.9 million barrels per day out of total production of about 2.4 million barrels. Global oil and oil near substitute production in January 2008 was 87.2 million barrels. Iraq produces 2.7% of global crude in January 2008.

If we were to assume for the argument that complete US withdrawal would lead to a complete shutdown of Iraqi oil production and exports and thus lead to a doubling in spot prices, this implies an elasticity of demand of less than .03 in the short run. Elasticity of demand is an economic concept that estimates how much prices would change in response to a percentage change in supply. For instance an elasticity of demand of 1.0 would have prices increase 1% for every 1% of a good that is no longer available. An elasticity of demand of .5 would have prices increase by 2% for every 1% of supply removed from the market etc.

The best short run estimates of the elasticity of demand for crude oil range from .10 to .16. Over the longer run, these elasticities increase, but in the short run using the lowest accepted estimate, removing all Iraqi oil from market would lead to a price increase of 27% +/- a bit, and using the .16, removing all Iraqi oil from market would lead to a price increase of 17% +/- a bit.

And these estimates assume all Iraqi oil comes off the market when we have proven history that there is a good deal of capacity for limited Iraqi production no matter how many people are being shot and pipelines being blown up.

And this is just the simple static counter-argument against Rove. If one wants to get a little more complex and attribute at least a portion of the nominal dollar price increases in oil over the past five or six years to a weakening US dollar, and low US interest rates, we can construct an interesting counterfactual. Right now the entire Iraq expenditure is being placed on the US credit card. Iraq is costing in cash terms about $200 billion per year right now. Removing a significant amount of that cost from our ongoing and recurring expenses will reduce US debt loads, and marginally reduce the downward pressure on the dollar. A strong US dollar means US consumers pay less per gallon/barrel than in a scenario with a weaker US dollar.

This part of the argument that Joseph Stiglitz has been making recently. The Federal Reserve failed in 2003/2004 to counteract the massive fiscal stiumulas of war spending by tightening monetary policy. This led to a bubble, and the subsequent credit crunch.

The war has fed into the weakness of the wider economy, he said, adding, "To cover that up, the Fed and the regulators flooded the economy with liquidity - giving cheap money to anybody this side of a life support system."

He said there was a direct correlation between the extent of the current crisis in financial markets and the cost of the conflict.

So in this counterfactual, the US dollar is a little stronger and oil is a little cheaper. Rove is factually wrong, but he is throwing out a marker of blame against anyone advocating that they want to clean up George W. Bush's failures. Par for the course.