Oil prices show uncertainty and fragility

According to the UNCTAD Secretary-General in launching the Trade and Development Report, the rising oil price and the reactions to it is illustrative of the uncertainties prevailing in the world economy and of the need for better coordination and international cooperation that takes account of the problems of the developing countries.

by Chakravarthi Raghavan

Geneva, 19 Sep 2000 -- The rising oil price and the reactions to it, unpredicted and unexpected by economists, is illustrative of the uncertainties and the unexpected in the world economy, and the need for better coordination and international cooperation that takes account of the problems of the developing world, the Secretary-General of UNCTAD, Mr. Rubens Ricupero said on 19 September in launching the flagship of his organization, the Trade and Development Report 2000 (TDR).

Like military planners fighting the last war, economists and policy makers had been preparing for a soft vs hard landing of the US economy, speculating about the consequences of a hike in interest rates, of the stock-exchanges and many other elements and factors.

But no one had envisaged the sudden spurt in oil prices and its effects. When the prices rose, doubling in a period of 20 months - after the collapse of the oil prices in 1998 - no one had been prepared This illustrated his point that in macro-economics, the principle of uncertainty is still there.

Until now, before the oil-price rise and subsequent crisis, there was all talk about the new economy and growth at 3-4 percent levels.

“There has been an element of hubris and arrogance in all this,” said Ricupero. “The increase in productivity, and the technological changes etc, economists were telling us, meant that there could never be another oil shock (as in the 1970s).”

But everyone forgot that the transport sector, whether for private transport, or movement of goods etc, was entirely dependent on petroleum and its products and there was no substitute.

And even in countries like Brazil, where they had set up an alcohol programme, for use in cars, and which was also environmentally friendly since there was no need for any lead additive, the collapse of oil prices had meant that the alcohol programme had to be dismantled because the government could not afford to provide subsidies.

“The oil price rises are here and perhaps the single large effect of it is that the era of cheap energy is over, at least for the time being,” Ricupero said.

But now that the prices have gone up, there is a multiplication of appeals and exhortations to the producers to be restrained.

But while the overall effect of the price rise on the industrial economies may be less than in the 1970s, it will have a serious negative effect on the oil-importing developing countries, and particularly the least developed among them, Ricupero underscored.

In 1998, the OECD countries had benefited to the extent of about $60 billion by the collapse of the oil prices. They have also been benefitting from the collapse of commodity prices and markets. But now that oil prices have risen, it has begun to hurt the industrial world and there is political reaction.

Responding to questions, the UNCTAD economists said that no simulations had so far been done on the effects of the price rise on the indebted developing countries, since the necessary data was not there.

The other simulations done had been on the basis of an averaging of the oil price over this year or next, and not on the basis of the price quotations, spot and forward, on the London or other markets. Various organizations had done simulations, and they were not easily comparable.

UNCTAD’s own simulations, done in cooperation with Japan’s Soko University, suggest that because of the time-lag for the price rise to work itself into the economy, the immediate impact of the price rise was marginal in 2000, except for the Philippines and Thailand, which may have a 0.3 percentage point reduction in growth.

Over the long term, if the prices hold, the impact would be more significant in the five years starting in 2010, and will be felt more in the developing than developed regions.

In the immediate future, i.e in 2000-2005, the impact is greatest in the Middle East - plus one percentage point - but also for Indonesia, the Philippines and Thailand - where there may be a negative 0.3 to 0.4 of a percentage point.

For the Middle East oil exporters, the longer term impact of higher oil prices on growth is expected to be negative, because sustaining higher prices will need reductions in oil output.

The UNCTAD economists however said the simulations had not factored in a number of elements of contrasts in the situation of the 1970s and now in regard to the oil-price rise.

Among those not taken into account were:

*        the major oil exporters, and more those in the Gulf region, were no longer capital surplus countries, but even indebted ones, and hence any oil earnings flowing to them would quickly be absorbed by imports or in repayments to their creditors;

*        part of the price rises at the pump were due to the fact that in Europe, during a period of low prices, the governments had hiked up the taxes on oil products, and used the increased revenues to finance governments, even as they reduced direct taxes on corporations and those on higher-income brackets - a case of diversion of incomes from the bottom to the top.

Any political agitation by truckers and others could result in forcing governments to reduce consumption taxes, but would not have any transfer of resources to the oil exporters.

*        in the US, the oil refineries were running to near capacity, and even if there were a sudden increase in oil supply, even say, by another million barrels a day, the pump prices won’t come down because of refinery capacities; it would take 2-3 years to increase capacity.

An UNCTAD senior economist, Mr.Richard Kozul-Wright, said that some of the elements, and more political factors of how governments in the North would react, had not and could not be used for simulations.

However, it was clear that the industrialized countries were much more inflation conscious and their reactions therefore would be to prevent any inflation.

Also, to the extent as in France, there is a fiscal response, even a temporary reduction in taxes, it would help to bring the point home that both monetary and fiscal policies were needed for macro-economic coordination.

Ricupero earlier said that as a result of a low level of cooperation and coordination among major industrial countries, and relative to the needs of developing countries, the vulnerability and the fragility of the global economy had in fact increased.

When there was this phenomenon of oil crisis and price rises affecting citizens in the industrial world, there were calls and exhortations for self-restraint on the part of producers etc.

But unfortunately, no such concerns were voiced or heard when the phenomenon was in reverse, as when commodity prices collapsed in 1998, and developing countries were hit by, and are still vulnerable to volatility.

“Once it was over (the financial crisis and volatility), people have forgotten all about the new financial architecture, and we are back to business as usual.”-SUNS4743

The above article first appeared in the South-North Development Monitor (SUNS) of which Chakravarthi Raghavan is the Chief Editor.

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