The Impact of Rising Oil Prices on the World Economy

Important peacetime changes in society are normally too slow and gradual to be discernible while they occur. When seen in this perspective, developments in the oil markets since 1973 have been less than normal. One is tempted to say that in 1973 the world economy witnessed a further round of eating the apple from the tree of knowledge and that we are still digesting. Although the economics (and neighboring) professions have had eight years for reflection and research, the process of identifying and assessing the impact of rising energy prices on the world economy is likely to go on for some time to come. Needless to say, such an analysis is complicated by the fact that the rising trend of energy prices has brought about changes in important mechanisms in the world economy (including the process of economic policy-making).

This paper reports on an energy conservation scenario computed by the United Nations World Model. Energy prices are assumed to rise as they did in the base runs but shifts in fuel mix and energy-saving are assumed to be achieved through increased labor and capital costs. Results suggest that vigorous energy conservation would substantially decrease, but not eliminate, the payments stresses in the reference case. Regional effects vary greatly. Payments-constrained regions could develop somewhat faster despite additional requirements for investment goods. Developed economies would achieve improved trade balances through higher investment and some consumption sacrifice.

The sharp decline in economic growth since 1973 presents a problem comparable in scientific interest and social importance to the problem of unemployment in the Great Depression of the 1930s. Conventional methods of economic analysis have been tried and have been found to be inadequate. This paper outlines a new framework for understanding the slowdown in economic growth. We find that the fall in U.S. economic growth since 1973 has been due to the dramatic decline in productivity growth. Within the new framework we identify higher energy prices as an important determinant of the productivity slowdown.

Energy price decontrol in the United States is analyzed in terms of its energy and economic effects. It is found that decontrol stimulates some increase in oil and gas supply together with a substantial reduction in demand. Decontrol affects real economic performance through several mechanisms; adjustments related to energy supply expansion and international trade tend to increase productivity while adjustments related to energy demand reduction lower productivity. Quantitative analysis of decontrol, using an energy-economy simulation model, shows that real economic growth is likely to be increased as a result of decontrol with the international trade effect being the dominant mechanism underlying these gains.

This article reviews the main short-terni macroeconomic consequences following a rise in the price of OPEC oil. Output is postulated to be reduced to the extent that the recipients of increased oil revenues (either OPEC or domestic oil producers) increase savings, and to the extent to which domestic real income is redistributed. Using the INTERLINK model of the world economy, this proposition is tested for Denmark, Finland, Norway and Sweden. Under the assumptions of unchanged exchange rates and policies (including no domestic responding of Norway’s incremental revenues), the hypothetical results suggest that consequent to the 1979/80 oil price rises, Finland’s output loss is much smaller than the other three OPEC-dependent countries because its terms of trade loss is largely offset by increased exports to the USSR.

An empirical measure of OPEC respending is developed in this paper and used to compare the situation in 1979/80 with that in 1973/74. A world trade model system is used to simulate the impact of an increase in the price of oil on the industrial countries, under various assumptions about OPEC respending. The simulation results suggest that the degree of respending is crucial for the impact of the oil price increase on the industrial economies and that Europe is more sensitive to variations in OPEC respending than the USA.

The MARKAL model used in the International Energy Agency (IEA) Energy Systems Analysis Project is surveyed in this paper. MARKAL is a multiperiod, multi-objective linear programming model that represents a nation’s energy system. It includes new and conventional technologies, applies various policy and physical constraints and optimizes in accordance with some specific criteria (usually cost minimization). The cost-minimizing principle as a basis for a cooperative international strategy is also discussed. The trade-offs between system costs and oil imports for Sweden are outlined. Some results concerning the structural change in supply and demand technologies associated with these trade-offs are also reported.

The starting point for this article is the notion of a possible trade-off between static efficiency and ex post flexibility of input proportions. It is found that under reasonable assumptions, plants designed for a single input price constellation can be made more efficient than those designed for a variety of input price constallations. In order to obtain an estimate of the economic significance of flexible input proportions ex post, a simulation model of the general equilibrium type is used to analyze the impact of unexpected oil price increases. The results indicate that, compared to a case with rigid technology, the social cost of an oil price increase is significantly lower when the technology is flexible. However, other rigidities, e.g. on the labor market, seem to be more significant than technological rigidities in this context.

The effects of an increased oil price are analyzed in a two-sector economy with immobile labor combined with a “wage leadership” assumption. Starting with a full employment equilibrium, an increased oil price will generally lead to unemployment in one of the sectors. This unemployment may be eliminated by an appropriate change in fiscal policy. If unemployment occurs in the sector which produces nontradeables, taxes should be reduced whereas taxes should be increased if unemployment occurs in the sector which produces tradeables. If an increased oil price leads to an international excess supply of tradeable goods, the direction of the tax change necessary to eliminate unemployment is unambiguous even when the sector in which there is unemployment is known.

This paper examines the optimal production of a resource such as oil when its price is determined exogenously (e.g. by a cartel such as OPEC), and is subject to stochastic fluctuations away from an expected growth path. We first examine the dependence of production on extraction cost, and show that the conventional exponential decline curve is indeed optimal if marginal cost is constant with respect to the rate of extraction but is a hyperbolic function of the reserve level. We next show that uncertainty about future price affects the optimal production rate in two ways. First, if marginal cost is a convex (concave) function of the rate of production, stochastic fluctuations in price raise (lower) average cost over time, so that there is an incentive to speed up (slow down) production. Second, the “option” value of the reserve, i.e. the ability to withhold production indefinitely and never incur the cost of extraction, provides an incentive to slow down the rate of production.

This article presents a non-technical survey of some recent theoretical analyses of the pricing of exhaustible natural resources and the incentives for developing resource substitutes under oligopoly, and looks in perspective at what appear to be the central considerations. Among the main conclusions that are presented are those that bear on the pace of R & D activity, the phenomenon of sleeping patents, oligopolistic pricing before and after the resource-substituting invention, the timing of innovation, and the transition from one resource base to another. It concludes with an analysis of a national R & D policy for a resource-importing country.

This paper compares the rate of extraction of a natural resource under alternative market structures when there is uncertainty about the date of discovery of a substitute (or about the date of discovery of a new deposit). The analysis shows that imperfectly competitive market structures are excessively conservationist: for any value of the initial stock of the natural resource, the price is higher than in competitive equilibrium (and therefore higher than the socially optimal level). But markets with limited competition may have a higher price than markets with pure monopoly (the same monopolist controlling the natural resource and its substitute). In particular, we find that the highest prices are associated with (Nash quantity setting) duopolists; the next highest prices occur in markets in which the monopolist controls the resource but the substitute is competitively produced; the pure monopolist sets his price lower than this, while the market in which a monopolist controls the substitute but the resource is competitvely owned is still lower.

Possible interpretations of the concept of scarcity in extractive resource markets are presented and then related to traditional economic ideas of efficient patterns of resource use. Sources of inefficiency in resource markets are then considered, with the main emphasis being on disequilibrium. Various simple models of disequilibrium suggest that resource markets are more stable if traders’ expectations are based on quantity rather than price information, so that the provision of such information increases efficiency.