Exogenous Effects of Oil Price Thesis

  • Length: 10 pages
  • Sources: 7
  • Subject: Economics
  • Type: Thesis
  • Paper: #93809198

Excerpt from Thesis :

This invariably means reducing the profit margin for the producers, which economists feel has long-term implications. That is the lack of smooth inflationary shock transmission leads not only to reduction in production output but also contributes to reduction in future investments. Thus, inflationary shocks due to oil price hikes are more long lasting in China. [Tang et.al, 2009]

Sub-Saharan Countries

The impact of Oil price explosion is nowhere as pronounced as in sub-Saharan Africa and in particular the oil importing countries. Among the lower economies those that are oil intense such as the sub-Saharan countries are bound to suffer more -- as much as 3% of their GDP. Oil dependence has not change much with only 6% reduction between 1990 and 2005. This is because these countries have a total dependency on oil as their major source of energy compared with other developing countries in Asia. For instance, India and China use coal as their principal source of energy (50% and 70% respectively). Besides few oil exporting countries most other nations in Africa are entirely dependent on oil such that some of these countries lost as much as 3.5% of their GDP for few years during the recent Oil price hike. Seventeen countries in the continent are totally dependent on Oil or biomass for their energy demands. Sub-Saharan African countries are very vulnerable to Oil price fluctuations as most of these countries spend as much as 14% of their GDP for oil imports. Statistics show that compared to the 1990 Oil price hike Africa is adversely affected during 2003. The fact that sub-Saharan African countries have the lowest per capita income and highest external debts makes it difficult for the economy to absorb the Oil price shocks. Also while Asian (Philippines and Thailand increased production) and South American countries such as Brazil (reduced oil imports by 50%) have increased local production there are no similar possibilities for the sub-Saharan African countries (excluding the few oil exporting countries) in the immediate future which makes their situation very bleak and vulnerable to oil price changes. Statistics from 1990 to 2003 show that 10 out of the 37 oil importing countries experienced a GDP per capital fall of around 10% while for five countries it was 20%. Rwanda, Burundi, Central African Republic and Malawi experienced a doubling of the debt ratio during this period. [Robert Bacon, 2005]

Macroeconomic Effects of Oil Price Hikes (A comparison)

Comparing the oil price shocks in the 1970's with the recent years and their respective impact from a global economic standpoint would help us better understand the macroeconomic effects of Oil shocks. Understanding the differences between the periods would help us better prepare for future episodes of stagflation. Firstly the Yom Kippur war in 1973 and the ensuing oil embargo of the OPEC nations and next the 1979 Iranian revolution both resulted in severe recession. Blanchard et.al conducted an extensive comparative study of these varied periods of economic downturns and by using statistical multivariate and bivariate VAR analysis tools using GDP, CPI and other variables such as prices and quantities, arrived at some conclusions. Inferring from the statistical data and graphs it was clear that the impact of Oil price hikes in the context of unemployment, price hikes, wages and overall productivity were milder in the recent years than in the 1970's. One of the reasons ascribed to this is the declining wage rigidities particularly since the 1990's. The absence of wage adjustment or slower wage adjustment in the 1970's could have led to the loss in productivity and increased inflation. Secondly, improvements in monetary policies in the recent years have helped to reduce the inflationary impact of Oil price changes. Today's banks are more committed to maintaining low levels of inflation. Also, the OIL GDP share is significantly reduced today when compared to the early periods. Last but not least, many nations today have built strategic oil reserves to offset any sudden and short-term supply limitations. So overall, the world is better prepared now than it was in the earlier period to tackle the repercussions of oil price fluctuations. [Blanchard (2007)]

Conclusion

Oil price directly influences the economic development of all the countries of the world. The destabilizing effects of Oil price hikes in the trade balance of both developed and developing oil-importing economies is very clear. As discussed above, both for the OECD countries as well as the non-OECD countries oil price hikes tend to slow down the economy. Even for the OPEC nations, the initial gains in their national revenues will be offset by the depressive effects of inflation in the oil importing countries. Oil importing developing nations would bear the brunt of the oil price hike more compared to developed countries as their higher oil intensive economies and higher import costs would stretch their already overstretched resources. Though, on a comparative level, we are much better prepared now than the 1970's, Oil price still remains an important macrovariable that governs the global economy. Today's governments are better prepared to control inflation while maintaining low interest rates. Still the frequent upswing in oil prices is a big problem for most nations, including the OECD nations that have large and growing budget deficits driven by surging oil import bills. In developing economies such as India where government offers subsidies, fiscal imbalances due to Oil subsidies will be further amplified. Sub-Saharan African countries having the lowest per capita income and highest external debts are the worst prepared to absorb the Oil price shocks. Over the next decade energy diversification would be the key strategic focus for countries that are struggling to manage the ever-increasing demands with the limited sources and striving to reduce their dependence on oil.

Bibliography

1) Jad Mouawad, 2009, 'Rising Fear of a Future Oil Shock', retrieved Nov 18th 2009, from, http://www.nytimes.com/2009/03/27/business/energy-environment/27oil.html

2) Tom Doggett, (2009), 'U.S. Sees OPEC 2010 Oil Export Earnings at $750 Billion', retrieved Nov 18th 2009, from, http://www.reuters.com/article/reutersComService_3_MOLT/idUSTRE5AA4HD20091111

3) Christopher Johnson, (2009), 'OPEC Oil, Gas income tops 1 Trillion, Reserves Up', retrieved Nov 18th 2009, from, http://www.reuters.com/article/GCA-Oil/idUSTRE5673L920090708

4) OECD, 'Unemployment in OECD Countries to approach 10% in 2010, says OECD', retrieved Nov 19th 2009, from, http://www.oecd.org/document/57/0,3343,en_2649_33927_43136377_1_1_1_1,00.html

5) Tang, Weiqi & Wu (2009), 'Oil Price Shocks and their Short- and Long-Term Effects on the Chinese Economy', MPRA, no 14703, Retrieved Nov 19th 2009, from http://mpra.ub.uni-muenchen.de/14703/1/MPRA_paper_14703.pdf

6) Robert Bacon & Adib Mattar, (2005), 'The Vulnerability of…

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