Oil Prices & Global Economy Term Paper

Excerpt from Term Paper :

The implications of this vulnerability to volatile oil prices is simple; 'high crude prices must encourage European governments to make investments in energy sources other than oil' (Wielaard, 2005, p.1).

The negative economic impact of rising oil prices is typically more severe for developing countries than for OECD (Birol, 2004, p.2). This is currently the case as high oil prices 'are badly affecting many developing countries' (Schlein, 2005, p. 1). The U.N. Conference on Trade and Development (UNCTAD) recently stated that 'the high cost of oil is placing a heavy burden on poorer nations that spend around five-percent of their gross domestic product on oil. This, compared with the two-to-four percent that wealthier nations pay' (Schlein, 2005, p.1).

There are several reasons why oil-importing developing countries struggle more over high oil prices than their developed counterparts. Energy dependency and intensity is greater in developing nations than developed ones; this is due to a high level of industrialization and urbanization. Furthermore, energy is used less efficiently in these nations than in developed ones. 'On average, oil-importing developing countries use more than twice as much oil to produce a unit of economic output as do OECD countries' (Birol, 2004, p.2). The amount of debt a developing country carries also profoundly affects its ability to effectively manage rising oil prices. Lastly, developing countries are not able to promptly switch to alternative fuels in order to relieve the burden of escalating oil prices. Essentially, all of the energy resources and mechanisms that developed countries have in place are lacking in developing nations, thereby crippling their ability to surmount oil shocks. In light of the stress high oil prices put on developing countries, the UNCTAD advises them 'to use recent windfall gains from higher commodity earnings as an opportunity to step up investment in infrastructure and manufacturing capacity' (Schlein, 2005, p.2), which are deemed crucial for continued development.

Adverse effects are readily evident in developing nations' economies. There is already a slowdown in China's economy, largely due to domestic policy that renders energy artificially cheap. 'Petrochemicals are a critical raw material across the spectrum of manufacturing, so costlier oil would have an immediate inflationary impact' (Wehrfritz, 2005, p.23). India is in a similar predicament. Currently, it 'relies on imports for 70% of its crude, and unless the global price falls, the cost that subsidies impose on Indian oil companies is forecast to hit $9.15 billion this year' (Wehrfritz, 2005, p.23). The cost of subsidized oil 'is expected to reach $14 billion, or 2.4% of GDP this year' (Wehrfritz, 2005, p.24). In South Korea, higher energy prices may take the nation into a recession (Wehrfritz, 2005, p.24).

Considering the recent increases in oil prices and its varying consequences on individual nations, it is not surprising that the global economy has reflected such changes. In April, IMF stated 'world growth would slip to 4.3% from last year's 5.1%' (MSNBC, 2005, p.1). More recently, however, the UNCTAD found 'the world economy grew by almost four percent last year, the best performance since 2000. But, this is expected to drop to three percent in 2005' (Schlein, 2005, p. 2). Furthermore, 'according to the IMF's model, an increase of $10 a barrel in oil prices should knock three-fifths of a percentage point off the world's output in the following year' (The Economist, 2005, p. 57). Others view the situation more severely: 'the OECD has compared the soaring cost of oil to the price spikes that shook the world economy in the 1970s and warned that today's high energy costs could derail global growth' (Ellson, 2005, p.1).

While developing and developed oil-importing countries are coping to various degrees of success with rising oil prices, oil-exporting nations are naturally experiencing an economic boom. For example, in Malaysia, Grewal (2005) states that 'the economy is expected to remain steadfast, given that [it] is a net oil exporter and high oil prices translate into stronger Government budgetary positions' (p.2). Projected 2005 OPEC net oil export revenues are $429 billion (in constant $2,005) while those of 2006 are expected to be $439 billion (EIA, 2005, p. 4). This transfer of income is predicted to continue and per Huber & Mills (2005), 'at current prices, the world is going to send some $30 trillion to Persian Gulf states over the course of the next several decades' (p.58).

Speculations abound about the short-, medium-, and long-term effects that recently escalating prices will have on the global economy. There is an acute awareness that oil dependency -- especially on imported oil, plays a significant role in national, regional, and global economic well-being. The ways in which each country manages their domestic situation will undoubtedly produce global ramifications. However, based on the existing data, it appears as those a global economic downturn is inevitable, with a disproportionate share of the burden falling on those nations that are not taking steps to buffer potential damage to their economic structures. It seems that the poorer developing oil-importing countries are most vulnerable to such a global economic slump.

In conclusion, global dependence on oil proves a precarious situation in times of rising oil prices. In the past, oil shocks contributed to global economic uncertainty, with varying periods of recovery. The size, speed, and longevity of the oil price hikes; an economy's level of oil dependency; and fiscal and monetary policy responses determine the degree to which oil shocks will affect a nation's economic growth. The currently escalating oil prices are creating distinct effects on developed and developing nations. The former appear to be better able to absorb the oil prices than the latter. This is largely due to developed countries' pre-existing cushioning mechanisms and their ability to quickly respond to changes in the oil market. Developing nations that are in dire need of such systems are consequently more vulnerable to volatile oil prices. This is the case in countries such as China, India, and South Korea. Despite current high demand for highly priced oil, there is little doubt that many economies, if any, can maintain at this level. It is this reason that many experts foresee a global economic slowdown in the near future.


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