Hawaiian Officials Duel Adam Smith
In Plan to Regulate Gasoline Prices

NEW YORK -- Economists rarely agree on rules of thumb, yet Hawaiian lawmakers chose to defy an important one when they reached back to 1970s economics in approving a plan to regulate gasoline prices.

The rule of thumb they defied is that economies work best when markets decide the price of a good. Market forces, economists argue, create a comfortable balance between supply and demand. Make the price too low, and the people supplying a product or service might stop producing it, fearing they won't make a decent profit. Make the price too high, and you'll choke off demand. When supply and demand determine the price, the thinking goes, a balance is reached.

It is one of the underpinnings to Adam Smith's invisible hand theory, which held that the selfish acts of individuals led to greater good for society.

For decades, Hawaiians have been driven mad as they watched their own gasoline prices consistently hover above prices elsewhere in the U.S. Convinced that local producers were gouging them and frustrated by the government's inability to exact much compensation in the courts, lawmakers decided to put an end to it by agreeing to set gasoline prices locally according to prices on the West Coast of the U.S.

Yet already, standard economic arguments are being lined up against the move, which won't go into effect until 2004. "The local gas-station owners are likely to be squeezed," says Paul Brewbaker, chief economist with the Bank of Hawaii. He says he's also worried that oil refiners -- there are only two in the state -- might cut back supply. "I'm just amazed," he says.

Meanwhile, University of Hawaii economist Christopher Grandy argues the state plan would simply replace Hawaii's energy problems with those of the West Coast, where gasoline prices actually have risen much more quickly in recent months. "This is not a recipe for lowering gasoline prices to consumers," he says.

Hawaiians might be excused if they've lost a bit of patience with conventional economics. They feel like they've been hit by an invisible fist for the past decade. While the U.S. economy roared to life during the 1990s, Hawaii bounced like an island-hopper from one economic disaster to another. A Japanese-led investment-and-tourism boom collapsed during the early 1990s; a falling yen exacerbated the decline. Hurricane Iniki devastated the resort island of Kauai in 1992.

Since 1992, employment in Hawaii has gone from 543,000 to 549,000, a 1% increase -- almost entirely in government jobs -- during a period when national employment climbed by 21%. During the same period, the number of hotel rooms in the state actually contracted, while nationwide, the room count jumped by 26%, according to Smith Travel Research. "Hawaii has gone through a pretty horrible decade, basically," says Carl Bonham, a University of Hawaii forecaster.

Mr. Bonham expects a very moderate recovery in 2002, with visitor arrivals up 3% after falling 9% last year, and with inflation-adjusted incomes in the state edging up just 0.5%. Employment, he says, will be driven entirely by government hiring.

He's doubtful that gasoline-price controls will speed things along much. As in most arguments about price controls, the debate about Hawaiian gasoline centers around competition. In a fully competitive market, suppliers battle one another for business and the price falls to a clearing level that keeps customers happy. In a noncompetitive market, however, supply is constrained and some consumers complain that they pay an unfair price.

In the case of Hawaii, the state filed a lawsuit in 1998, accusing divisions of ChevronTexaco, Royal Dutch/Shell Group's Shell Oil, Unocal and Tosco, owned by Phillips Petroleum Co., of allocating market share among themselves and fixing gas prices. Yet opponents of controls say there is a simpler reason for the high prices. Hawaii is a remote, isolated place that doesn't invite much competition. Furthermore, transport of gasoline products is expensive. Remoteness, not price-fixing, is the cause, these opponents say.

Indeed, Hawaii isn't the only remote collection of islands to find itself in this debate. In late 2000, lawmakers in the Philippines made an effort to nationalize oil imports because they had become fed up with the high gasoline prices that island nation was forced to pay. Gasoline stations there are frequent targets of vandalism when petroleum prices are rising.

But efforts to control prices from the top often end in disaster. In the late 1970s, for example, when U.S. oil companies were accused of gouging American consumers, price controls resulted in hourlong lineups of cars twisting through suburban neighborhoods because of resulting supply shortages. Soviet-era price controls also led to widespread shortages in Eastern Europe.

This is not to say that economists never prescribe them. During last year's energy shock in California, for instance, several respected energy economists urged President Bush to clamp down on California's wholesale-electricity sector. They argued that the simple rules of economics didn't apply in that market, in which a few powerful producers were suspected of withholding supply during periods of peak demand and driving wholesale prices up.

One of the leaders of that push, Frank Wolak, a Stanford University economist, says gasoline is a different market, and as a result, different rules apply. One big distinction: Gasoline is part of a global industry where the competitive forces are intense. Electricity producers don't sell into a world or national market or in many cases, even a state-level market. "A price cap on gasoline when oil prices are high makes very little sense," he says.

Write to Jon Hilsenrath at jon.hilsenrath@wsj.com¹

Updated May 6, 2002