Conventional wisdom, firmly anchored in the experience of the oil shocks of the 1970s, has it that high oil prices are not good for the global economy. And a look at the global economy now, with consumer confidence weakening sharply in the face of high gasoline prices, confirms it.
But two economists at the International Monetary Fund have published a research paper challenging the traditional view, arguing that high oil prices are not a big economic drag. The new analysis, “Oil Shocks in a Global Perspective: Are they Really that Bad?”, is particularly relevant as global economic growth starts to falter, with some policymakers blaming the impact of high oil prices for the slowdown.
Oil prices have so far this year averaged more than $100 a barrel. If Brent crude, the global benchmark, remains around its current level of $110 a barrel for the rest of the year, 2011 would set the highest ever annual average price, above the $98 a barrel in 2008, when Brent prices rose to an all-time high of nearly $150 a barrel.
Tobias N. Rasmussen and Agustín Roitman, the two economists at the IMF in Washington, argue in their analysis that although oil prices have “a negative effect on oil-importing countries”, the impact is not as large as previously thought. They say a 25 per cent increase in oil prices “will cause a loss of real GDP in oil-importing countries of less than 0.5 per cent, spread over two to three years”.
“One likely explanation for this relatively modest impact is that part of the greater revenue accruing to oil exporters will be recycled in the form of imports or other international flows, thus contributing to keep-up demand in oil-importing economies.”
Other economists believe the analysis could be extended to other commodities, including copper and iron ore. They believe high prices are a drag for consumers but are boosting economic growth in countries from Chile (in the case of copper) to Australia (for iron ore), helping to sustain global economic growth.
The new analysis is at odds with the view of other economists, notably James Hamilton, who, in his seminal “Oil and the Macroeconomy Since World War II”, published in 1983, linked episodes of high oil prices with economic recessions in the US. The new research is, however, more in line with some other papers, particularly the research by Olivier Blanchard and Jordi Gali, “The Macroeconomic Effects of Oil Price Shocks: Why are the 2000s so Different to the 1970s?”.
It is also in line with the thinking in Saudi Arabia, the world’s largest crude oil exporter, which has argued over the last few years that economists have been exaggerating the impact of oil prices. Ali Naimi, Saudi Arabia’s oil minister and the de facto leader of the Opec oil producers’ cartel, said earlier this year that the global economy could weather oil prices at nearly $100. And natural resources ministers in other commodity-producing countries have also argued that high prices have boosted their economies, thus compensating at the global scale the impact of higher costs in economic growth in consuming nations.
The different impact of higher oil – and some other commodities prices – today and in the past is due largely to the different nature of the most recent price shock.
While in the mid-1970s, early 1980s and 1990-91 high oil prices were the result of large supply disruptions, including the Arab oil embargo, the Iranian revolution and the Gulf war, the rally in oil prices of the last decade is mostly due to strong economic growth propelling oil demand. High oil prices are, therefore, the mirror of high economic growth. The same applies for other commodities.
Nonetheless, some analysts note that supply-side factors are also playing a role, particularly in agricultural commodities, due to export restrictions, mandatory minimum prices introduced by governments and lower crops resulting from bad weather. Oil prices have also been lifted by a supply disruption in Libya this year. And in metals and minerals, floods in Australia and strikes in Latin America have curtailed supply, helping to lift prices in spite of slow demand growth.
Mr Rasmussen and Mr Roitman acknowledge the difference between the current demand-driven cycle and previous episodes, warning that “the finding that the negative impact of higher oil prices has generally been quite small does not mean that the effect can be ignored”.
They add: “Our results do not rule out more adverse effects from a future shock that is driven largely by lower oil supply than the more demand-driven increases in oil prices that have been the norm in the last two decades.”
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