It should not be difficult to understand that if a firm is prevented from realizing excess profits when the price of its product rises unexpectedly, while it will have to support excess losses when the price drops below expectations, its owners will not incur costs to make sure it has enough productive capacity to profit from a possible future emergency. So why is the government of the European Union imposing an excess-profit tax on European energy producers following the Russian supply cuts? (See “Exxon Sues EU Over Windfall Profit Levy,” Wall Street Journal, December 28, 2022; “Exxon Sues EU in Move to Block New Windfall Tax on Oil Companies,” Financial Times, December 28, 2022.)

Is it because politicians, bureaucrats, and voters are so cognitively impaired that they cannot understand this simple case of incentives? It would be a too simple and ad hoc hypothesis.

The reason instead is that political processes and especially democratic processes are myopic, biased toward the short term and often the very short term. The typical politician may not be in power when the detrimental consequences may be recognized years from now—while, on the other hand, they are strongly pressured to do something now, anything, and especially with somebody else’s money. Government bureaucrats are sure to get their salaries and pensions whatever happens, short of widespread destruction of capital or a revolution. The typical voter has no incentive to spend time and other resources on getting and analyzing information on public policy since his individual vote will not change anything in a collective choice; and even if he made inordinate efforts to understand, he would have to cast his single vote on bundles of complex measures whose intricate and interrelated consequences are typically impossible to forecast.

In the current climate of public opinion, moreover, government rulers don’t really care if oil supply from private companies drops because their incentives have been undermined. The rulers know (or think) that they will be able to recreate new incentives through subsidies or tax preferences, or just boss the companies around through fear of further regulation or expropriation. In fact, the rulers will normally benefit from enhanced state powers and  many of them would anyway prefer private companies to be gradually replaced by state corporations.