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At a Price? Oil and the Economic Future

The oil price is often regarded as a sort of thermometer to measure the health of the world economy. It surged in the financial crisis, and the dramatic fall to under USD 30 a barrel (from almost USD 150 in June 2008) is now being interpreted as a sign of a new impending meltdown.

It is worth thinking about how the lines of causation work. Expensive oil produces increased costs for most rich industrial economies, and so a surge of oil prices will slow economic growth. Spikes in the oil price were associated with global recessions in the1973-74 and 1979-80 (the oil price shocks), but also in 2000 and 2008. A slowing of economic growth might be expected – other things being equal – to lead to a price decline. That is roughly the story of today’s situation. Oil prices plummeted in the immediate aftermath of the September 2008 Lehman shock, but then recovered substantially, as the vigour of emerging market growth stopped a repetition of the interwar Great Depression. Today, the weakness in all major emerging markets – with the possible exception of India – is depressing the demand for oil. It is not surprising that petroleum problems are now regarded as proof of global economic fragility.

Today’s decline is also produced by another logic, a rather long term response to debates about energy use and their climatic consequences. Since the use of hydrocarbons as fuel contributes to CO2 emissions, and thus to the global warming effect, policy makers are engaging in more serious action to curb that use in a longer term. But in what the German economist Hans Werner Sinn calls the “Green Paradox,” the likelihood of future restrictions creates powerful incentives for oil and other carbon energy producers to sell now, rather than later. That logic is evident above all in the Saudi response to the oil price weakness. The effect is that the prices are driven down further, and present day consumers are given greater incentives to consume, to buy ‘gas’ guzzlers and then drive them around for fun.

For most of the industrial world, even the oil producing United States, low oil prices are unambiguously good news in the short term. The chance decline of oil prices is one of the major forces that is stabilizing the fragile Eurozone. Worries – in both Europe and the United States – that falling commodity prices are producing bad (i.e. 1930s style) deflation are overdone.

But there is another aspect to the price decline. Low oil prices change the geopolitical calculus. They weaken in particular the often authoritarian regimes that control oil production. There is a substantial political science literature that links poor governance with dependence on natural resources – the so-called resource curse. Nigeria, Venezuela, Saudi Arabia, Russia, Iran and Iraq are all problematical politically in their own quite different ways, but in each case abundant petroleum resources have poisoned the political system. Politics in those fuel exporters is a deadly competitive game about who can capture the spoils from oil production, and as the prices fall the bandits quarrel more among themselves.

Each of these oil producers concocts a narrative to explain why the bad things are occurring. Mostly these stories involve quite familiar elements drawn from the history of fighting about oil. Venezuela’s President Nicolás Maduro Moros takes up the old slogans of Latin American left populism and blames the United States. Russian officials similarly see analogies between the late 1980s, when falling oil prices undermined the fragile Soviet Union, and today’s experience, and see the hand of Washington at work in both episodes. They regard shale gas and fracking as instruments of American power. It is thus quite predictable that corrupt political elites elsewhere will revive the language of economic populism in the face of their predicament.

The richer countries have gained a windfall from oil price developments; but they need to reckon also that the fallout will be increased geopolitical instability. There is more of a security challenge, and less of an economic challenge. But security challenges are costly. They also demand some degree of policy coordination. Individual countries – perhaps even those as large and as powerful as the United States, but certainly mid-sized European countries cannot deal with them on their own.


Professor Harold James

Harold James is the Claude and Lore Kelly Professor in European Studies and a Professor of History and International Affairs at Princeton University, specialising in modern German, economic and financial history. He was was appointed an International Monetary Fund Historian in 2016. His publications include Making a Modern Central Bank:The Bank of England 1979-2003 (2020), The Euro and the Battle of Economic Ideas (with Markus K. Brunnermeier and Jean-Pierre Landau, Princeton University Press, 2016) and Making the European Monetary Union (Harvard University Press, 2012), while his Politeia publications include Crisis Managed: Monetary and Fiscal Frameworks for the Future (2011).

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