Trade linkages and macroeconomic effects of the price of oil

Abstract

In this paper we assess the impact of oil price shocks on oil-producer and oil-consuming economies. VAR models for different countries are linked together via a trade matrix, as in Abeysinghe (2001). As expected, we find that oil producers (here, Russia and Canada) benefit from oil price shocks. For example, a large oil shock leading to a price increase of 50% boosts Russian GDP by about 6%. However, oil producers are hurt by indirect effects of positive oil price shocks, as economic activity in their exporter countries suffers. For oil consumers, the effects are more diverse. In some countries, output falls in response to an oil price shock, while other countries seem to be relatively immune to oil price changes. Finally, indirect effects are also detected for oil-consumer countries. Those countries, which trade more with oil producers, gain indirect benefits via higher demand from oil-producing countries. In general, the largest negative total effects from positive oil price shocks are found for Japan, China, the USA, Finland and Switzerland, while other countries in our sample seem to have fared quite well during recent positive oil price shocks. The indirect effects are negative for Russia, Finland, Germany and Netherlands.

Introduction

In this paper we study how changes in the price of a country's key export good affects its economy when it trades with other countries that are net importers of that good. More specifically, we look at how GDP growth of an energy-exporting country reacts to changes in energy prices. The direct effect is expected to be positive, as the country gets more export revenues, but there are also indirect effects that are ex ante expected to be negative. For energy importers, a jump in energy prices constitutes a negative supply shock, which slows their economic growth. This in turn reduces the (energy and other) exports of the energy exporter. Therefore, the gain in growth for the energy exporter is not as large as one could assume at first glance. On the other hand, energy importers can gain some benefits from higher energy prices if they are able to export more to the energy-producing country.

Energy — and more specifically oil — is one of the most important raw materials in the modern economy. Oil products are widely utilised e.g. in transportation and power generation, and oil is also used in the manufacturing of chemical products. Therefore, the price of oil is one of the key prices in the international economy, even more so because it is widely used as reference value for other energy resources.

At least since the first oil crises in 1973 the macroeconomic effects of energy prices have been studied extensively. For example, Hamilton (1983) concludes that almost all recessions in the USA have been preceded by a large increase in the price of oil. Also, there is some evidence that the effect of oil prices on economic growth may be non-linear (Hamilton, 2000). Negative growth effects of large oil price increases are more substantial (in absolute size) than the positive effects of similarly-sized oil price decreases. However, in recent years a growing body of research has indicated that the macroeconomic importance of oil prices may be waning. But these results of course usually relate to countries which are net importers of oil and other energy products. On the other side of the equation, energy exporters can be expected to benefit from higher energy prices. Their terms of trade improve, and higher export revenues can be used for more of both consumption and investment.¹ For example, Rautava (2004) shows that in Russia higher oil prices lead to faster GDP growth.

Our research question is somewhat different. We are interested in how oil price shocks affect growth in different countries, but we also assess the interplay of such shocks across countries. Foreign trade is the key channel of transmission. We are especially interested in how the positive growth effects of higher oil prices for an oil-producing country are altered if one takes into account that economic growth in most other countries slows. If demand in net importers of energy decreases, oil exporters are not able to export as much as before to these countries, ceteris paribus. This will then have a negative effect on their economic growth (Of course, the problem may be less acute for energy-only exporters.) While we expect the net effect of higher oil prices to be positive for energy exporters, it is of interest to see how the situation changes when trade linkages are taken explicitly into account. And, on the other hand, when an oil exporter experiences an economic boom because of higher oil prices, other countries are able to export more to it.

To study this question, we utilise the methodology first formulated by Abeysinghe, 1998, Abeysinghe, 2001. Abeysinghe (2001) measures the direct and indirect effects of oil prices on GDP growth of 12 economies (ASEAN4 and NIE4 countries, China, Japan, USA, and the rest of OECD as one country) using a model that includes the oil price as an exogenous variable. It is found that, because of the indirect effect transmitted through a trade matrix, even net oil exporters like Indonesia and Malaysia cannot escape the negative influence of a high oil price. Positive direct and negative indirect effects offset each other for these two oil producers, so that the net effect is nil.

We estimate a model in which countries' growth rates depend not only on oil price changes but also on other countries' growth rates via a bilateral export matrix. The idea is that higher growth in one country boosts other countries' exports to that country, which in turn spurs economic activity in the other countries. We are then able to derive impulse responses for oil price shocks.

To study the question at hand we utilise quarterly data from a large oil exporter, Russia, as well as from its most important trading partners² between the first quarter of 1995 and the third quarter of 2006. Russia is one of the most important oil exporters in the world, and in 2004–2006 it was the second largest oil producer, after Saudi Arabia.³ It is also a large economy that influences other countries' growth rates via its demand for their exports. Currently, energy products account for some 60% of Russia's exports, and therefore the country's other exports are likely to suffer if high energy prices reduce demand in its major trading partners. While it would be very interesting to study our question also for other major oil producers, data issues force us to concentrate on Russia. While the available data for Russia is not very long, it is impossible to get something similar for major OPEC countries, for example. In our sample Canada is the other exporter of oil and other energy products, but its energy exports amounted to only about 15% of its total exports between 1995 and 2008.

Our main results can be summarised as follows. Oil price increases have a clear and positive effect on the oil exporter's GDP growth. However, the large positive direct effect is tempered somewhat by a negative indirect (albeit small) effect, as Russia⁴ is less able to export to the countries adversely affected by the oil price shock. For most oil-importing countries, the net effect of higher oil prices is negative. Of the countries considered, the largest negative direct effects of a positive oil price shock are found for Japan, China, the USA, Finland and Switzerland. According to our results, many European countries would be relatively unharmed by the recent positive oil price shocks. Moreover, to our knowledge no one has tried to distinguish between the direct and indirect effects of an oil price shock for our sample of countries.

The study is structured as follows. In the following section we present a selective literature survey. The third section presents the estimation methodology in more detail, and the fourth section describes the data in more detail. The fifth section presents our results and the sixth adds some conclusions.