Low-Energy Fridays: Conflict in Iran raises energy prices, but how should that inform policy?

Low-Energy Fridays: Conflict in Iran raises energy prices, but how should that inform policy?

By Philip Rossetti

Stop me if you’ve heard this headline before: “Military Action in the Middle East; Gasoline Prices Soaring.” It’s effectively a law of the universe that conflict in the oil-rich Middle East disrupts energy markets and causes prices to rise. Of course, this applies to the current conflict in Iran. Critics of the Trump administration’s actions point to rising energy prices amid the conflict; however, an overreliance on price signals to guide foreign policy can lead to perverse policy positions that are at odds with broader objectives.

The economic consequences of armed conflict are often misunderstood, with perceptions that miscalculate true costs or benefits. The “broken window fallacy” is a key economic concept that helps clarify the effects of destruction and counter misperceptions.

The fallacy is explained by a parable, which goes like this: A child is playing outside his father’s store and accidentally breaks the store window with a rock. The father comes outside angrily shouting at the child, making a scene and causing a crowd to gather. Some people in the crowd get to thinking the child has done a service to the country by making more work for window repairmen, who will then spend that money elsewhere in the economy. An economist corrects them, explaining that because the money the shopkeeper must spend on repairs would have been spent elsewhere—and more productively—the child has robbed his father of the opportunity to invest that money in production. On net, the destruction of the window has reduced productivity and weakened the economy due to the lost opportunity for spending (“opportunity cost”).

The parable of the broken window shows that destruction does not benefit the economy. People often look to the immediate direct effects of an action and erroneously conclude that these events create benefits (or costs) without considering broader foregone opportunities. For example, there’s a persistent myth that the Great Depression ended because of World War II—as if spending money on bullets and bombs and building tanks is an optimal allocation of resources.

War is economically harmful because it directs resources away from productive uses and toward destructive ones. Contemporary evaluations of the New Deal and related World War II policies have found that they extended economic hardship rather than shortening it.

Even still, it is important for both policy educators and policymakers to appreciate that foreign policy decisions cannot be reducible to economic optimization. A superpower that folds to foreign policy pressure because of any economic harm—or increase in gasoline prices—is one that can be easily compelled to acquiesce to any foreign demand. Leveraging influence against commodity prices to pressure foreign governments is a common strategy. It was used against the United States during the 1973 Yom Kippur War, when Arab members of the Organization of the Petroleum Exporting Countries (OPEC) initiated an embargo against the United States over its support of Israel. While President Jimmy Carter didn’t succumb to the pressure from heightened gasoline prices (which had roughly quadrupled), he did help end the conflict by negotiating the Camp David Accords.

Similarly, Russia has recently used its role as an energy supplier to Europe in an attempt to diminish support for Ukraine. It was nearly successful, as some major European economies were initially reluctant to offer aid. China often responds to rising tensions by restricting the export of critical minerals to other nations.

For reasons of national security or social justice, it may be prudent for a nation to accept an economic hardship in pursuit of an alternative good. In fact, this is the rationale for many trade restrictions, such as the United States’ restriction on the import of solar panels made using forced labor. To avoid such restriction implicitly supports the upstream harm the government claims to oppose.

Ultimately, a strategy is definable as the application of scarce resources to achieve a desired outcome. Part of strategy formation is recognizing that no application of resources is costless and that an accurate understanding of the totality of a strategy’s costs (both direct expenditures and indirect economic impacts) is essential. While it is prudent and wise to note the negative economic harm that accompanies any conflict, it is also important to examine all issues in their entirety rather than reflexively evaluating foreign policy based on prices at the pump. Such an attitude could lead one to support military interventions in oil rich regions, or conversely, to dismiss the injustices committed by oil-rich nations like Russia.

When Russia invaded Ukraine, I noted that foreign policy would be at cross-purposes if the United States supported Ukraine while simultaneously importing oil from Russia, which would have created a source of hard currency for Russia to maintain its war effort. The United States did indeed stop importing Russian oil soon after that piece was published; however, the exercise illustrates challenges that arise when energy policy intersects with foreign policy.  

To be clear, I’m not offering an opinion on the current conflict with Iran. There are substantive arguments both for and against these military actions, and humility demands that I acknowledge I don’t have all the information about Iran’s nuclear weapons progress or relevant threat assessments. And if history is any guide, public attitudes with respect to military operations tend to change over time as perceptions of success or failure evolve. But overall, it’s important for experts to avoid arguments that could be seen as hypocritical or are divorced from broader national security objectives. Critiques of military intervention in Iran because of oil prices would be equally valid if used to argue against military aid for Ukraine or sanctioning Russia.

Ultimately, foreign policy debates focused on national security must be supported by national security-specific arguments. Energy prices are extremely important, but they cannot be the primary directive all foreign policy is based upon.