People's Democracy(Weekly Organ of the Communist Party of India (Marxist)
August 29, 2004
Oil Prices And The World Economy
THE past months have witnessed soaring oil prices in international markets, which have come on top of increases in the previous three years. In the third week of August world trade prices of crude oil nearly touched $50 per barrel before settling somewhat lower. But further increases are not ruled out in the near future.
RAPID INCREASE IN OIL PRICES
While crude oil prices have been rising since March this year, thus far the month of August has seen the most rapid increase, going up from $38 per barrel to around $48 by August 22. The most recent increases have been driven by a number of factors. The most important factor, of course, is the continued resistance of the Iraqi people to the US military occupation. The inability thus far of the US army to contain the armed struggle of the militia of Muqtada al Sadr and others despite using blatant violence even against civilians, along with the growing sabotage of oil facilities and destruction of oil pipelines in Iraq, has reduced exports and led to expectations of uncertain future supplies from that country.
addition, the threats of terrorist attacks in the world’s largest oil
producer, Saudi Arabia, are growing and also have been increasingly realised in
recent months. The nervousness this has created in world markets has not been
neutralised by OPEC’s promises of boosting production. More recently, the
travails of the giant Russian oil company Yukos have also contributed to rising
some of this supply uncertainty would be considered as inevitable and would have
only a marginal effect on markets. At present, however, these factors, as well
as other potential issues such as instability in Venezuela or strikes in Norway,
or indeed any changes in any oil-producing country, can have substantial effects
on prices at the margin and cause sudden price spikes. This is because world
demand for oil rules very high at present. In consequence, current oil
production is extremely close to current capacity, and there is little margin
for major increases in supply in the near future.
World demand for oil has been fuelled not only by growth in the US, but also by strong demand from other countries. China’s imports of crude oil have increased by more than 40 per cent since the beginning of 2004. This is not all for current consumption – rather it reflects stockpiling by the Chinese government, a shift from holding excess dollar reserves to holding oil reserves.
the US government is continuing to add to its Strategic Petroleum Reserve,
rather than depleting it in order to reduce oil prices. The Bush administration
has made it clear it would not intervene to release any of these stocks unless
the oil prices rise to levels of $55-60 per barrel before the November
analysts do predict that the current high levels of OPEC production (which was
29.8 million barrels per day in July, only 0.5 million barrels below total OPEC
crude oil production capacity) are likely to push prices below $40 per barrel by
the last quarter of 2004. Nevertheless, it is unlikely that 2005 will witness a
sharp decline in crude oil prices, simply because world demand is expected to
continue to grow and keep inventories tight. Global oil demand is currently
projected by the US Department of Energy to exceed 2 million barrels per day
this year as well as in 2005.
So if oil prices do continue to rise, what are the implications? Some observers have already sounded the alarm bells. OPEC itself has predicted that the global economic recovery could be in jeopardy in prices remain at current levels (around $40 per barrel) for the next two years. An OPEC report projects that this would reduce growth in Europe and the US by between 0.2 and 0.4 percentage points.
economists have been even more pessimistic. Kim Hak-Su, the Executive Secretary
of UN-ESCAP (the United Nation’s Economic and Social Commission for Asia and
the Pacific) has suggested that oil prices of around $40 per barrel would mean a
0.5 percentage point reduction of growth in the region, and $50 per barrel would
mean a 1 per cent point reduction.
projections usually hinge around the perceived trade-off between growth and
inflation, and are predicated on the assumption that oil prices increases will
lead to more general inflation. Governments attempting to combat inflation will
then embark upon contractionary fiscal and monetary policies, which will bring
down inflation but also imply lower rates of aggregate economic growth.
is correct to assume that governments across the world remain obsessed with
inflation control, because the political economy configurations that have led to
the domination of finance still persist. However, the
prior assumption, that oil price hikes necessarily lead to higher inflation, may
not be so valid any more.
it is true that for a very long period – in fact almost the whole of the
second half of the 20th century – oil prices showed a strong relationship to
aggregate inflation rates in the world economy. Between 1970 and 2000, for
example, world trade prices and oil prices were strongly positively correlated
and in the largest economy, the US, the Consumer Price Index inflation tracked
movements in world oil prices.
there is evidence that such a relationship may be changing. The chart given
below indicates the annual percentage changes in world oil prices and average
inflation rates in industrial and developing countries, especially since 1996.
things stand out quite sharply in this chart. The first is that oil prices were
exceptionally volatile over this period, rising and falling dramatically. The
second is that such fluctuations appear to have had little impact on aggregate
inflation rates in either developed or developing countries. Rather, such
inflation rates have been relatively stable and even fallen slightly compared to
the earlier decade.
what has changed in the world economy to cause such an apparently established
relationship to break down? To begin with, it is worth remembering that even the
currently “high” oil prices are still well below their real levels in the
1970s, when the oil price shocks generated stagflation.
There are other forces, which have reduced the responsiveness of the general price level to energy prices.
first important factor is the reduced dependence of the industrial economies
upon oil imports, at least in quantitative terms. For the group of industrial
countries in the OECD, net oil imports accounted for 2.4 per cent of GDP in
1978, but have since fallen continuously, to amount to only 0.9 per cent of GDP
the second factor may be even more significant. This is a distributional shift,
whereby the burden of adjustment to higher oil prices is essentially borne by
workers across the world and non-oil primary commodity producers in the
developing countries. This means that even though energy is a universal
intermediate good, its price rise does not cause prices of many other
commodities – and especially the money wage - to increase accordingly.
This in turn enables aggregate inflation levels to remain low even though
oil prices may be increasing.
is well-known that the period since the early 1990s has been once of a
substantial decline in the bargaining power of workers vis-à-vis capital in
most of the world, and this has been reflected in declining wage shares of
national income and real wages that are either stagnant or growing well below
productivity increases. This provides a significant amount of slack in terms of
the ability of employers to bear other input cost increases. In addition, this
disempowerment of workers also means that such input cost increases can be
passed on without attracting demands for commensurate increases in money wages
in the current period.
with the working class, the peasantry and other non-oil primary commodity
producers have also been adversely affected and been forced to take on some of
the burden of adjustment. Indeed, even manufacturing producers from developing
countries have been forced in a situation where intense competitive pressure has
ensured that they cannot pass on all their input cost increases.
world trade since the mid 1990s, the prices of other primary commodities have
generally been depressed, falling between 1995 and 1999, and barely increasing
even in years when world oil prices rose sharply. Similarly manufactured goods
prices also have hardly increased, and have also been falling in absolute terms
over much of this period. Only in the period since 2001 is there some evidence
of all three sets of prices moving together.
OIL PRICE HIKES
does this mean that the oil price is no longer an issue of concern for those
interested in the aggregate growth of the world economy? Not at all, in fact,
such a conclusion would not only be unwarranted, it could also be extremely
is clear that the adverse impact of oil prices upon inflation can only be
contained by suppressing and reducing the incomes of workers everywhere and
peasants in the developing world. But there are limits to the extent to which
such incomes can continue to be reduced, since such a process has already been
under way for some years, and it cannot be intensified in most countries without
causing social unrest and political instability.
this particular strategy has its limits. However,
the alternative strategy, of using contractionary monetary policies to bring
down aggregate inflation, would also be extremely unpopular since it would add
to unemployment and material insecurity which are already at high levels.
appears that if governments are to take into account this requirement of popular
legitimacy, they must be prepared to live with higher inflation in the medium
term. How far this is compatible with the domination of international finance
capital is something that remains to be seen.