Dispelling the myth of the oil price shock

18 August 2011

US politicians are angry about Opec and gasoline prices, but there is new evidence that oil price increases do not seriously damage the world economy

Still toying with the idea of running in the 2012 US presidential race, Donald Trump once more piled into oil producers group Opec about high American gasoline prices in an interview with Fox News in August. Oil should be $30 a barrel and not $100, he said. The only reason why it is not is because Opec conspires against the US and should be broken up.

Not only will sharply lower oil prices be bad for oil-exporting nations, it will do little to help the world economy generally and the developing world in particular

Economics will be the big issue in next year’s elections and opinion polls this summer suggest it will end President Obama’s presidency with a landslide for any credible Republican Party contender. Opec is an irresistible target for everyone hoping to tap US voters’ anger about joblessness, still accounting for 9 per cent of the US labour force. But it is also conventional wisdom among economists that oil price rises are bad, not only for the US, but for the world.

A new report released by the IMF in August falsifies this argument. Using a global dataset covering the years since 1970, IMF economists Tobias Rasmussen and Agustin Roitman indeed demonstrate that oil price rises hurt the US economy, but America is the exception. For the rest of the world, the story is different.

“…We find no evidence of a widespread contemporaneous effect (from oil price rises) on economic output across oil-importing countries, but rather value and volume increases in both imports and exports,” say the authors. “These findings suggest that the higher import demand in oil-exporting economies resulting from oil price increases has an important and immediate offsetting effect on economic activity in the rest of the world, and that the adverse consequences are mostly relatively mild and occurring with a lag.”

So what is happening everywhere except in the US is that the increased income enjoyed by oil-exporting nations usually leads to higher imports from those countries. The US is the exception. Its main problem is that it imports too much petroleum and exports too little to oil-exporting nations. These are policy issues for Washington and not for Opec. The US has got it wrong, not oil-exporters.

The IMF report suggests that the charge that Opec and oil-exporting nations have damaged the global economy by “artificially” increasing prices is wrong. Far from impoverishing the world, Opec nations have used the proceeds from the higher price of what remains their main source of hard currency to promote development at home and stimulate exports overseas. The beneficiaries have often been low-income nations in the Indian subcontinent and the Far East that have provided labour to work in Opec countries.

The oil-producers group was founded in 1960 to secure a fair price for oil-exporting countries. It was also inspired by a desire to promote economic development in the Middle East, Africa, Latin America and Asia. Underpinning Opec’s purpose was the conclusion that the US and Western Europe were unequally enjoying too much of the world’s economic output. Opec did indeed succeed in raising oil prices, but it is far more than a market-fixing cartel. It’s been – through its domestic and international investment programmes – one of the most important engines of growth for five decades in some of the world’s poorest countries.

The evidence also suggests that those calling for oil prices to fall are motivated by narrow self-interest. Not only will sharply lower oil prices be bad for oil-exporting nations, it will do little to help the world economy generally and the developing world in particular. The era of low prices after the 1986 oil slump had no general economic merit. Its main achievement was to provide motorists in the US and other advanced economies with cheap gasoline. That point has been made before. The IMF report provides facts to substantiate it.

Oil Shocks in a Global Perspective: Are they Really that Bad? An IMF Working Paper published on www.imf.org on 1 August 2011.

A MEED Subscription...

Subscribe or upgrade your current MEED.com package to support your strategic planning with the MENA region’s best source of business information. Proceed to our online shop below to find out more about the features in each package.

Get Notifications