WHAT is black, sticky, comes in large tubs and causes depressions?

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Many economists play down the impact of the oil price but the fact is that when it rises sharply, economies always start to slow down about 18 months later, writes Andrew Oswald

Oil price puts skids under growth

WHAT is black, sticky, comes in large tubs and causes depressions? No, not Marmite. Here is a string of numbers as a clue: 1974, 1979, 1991, 2000.

The answer is oil - and, more precisely, large rises in the price of oil. Our planet is sliding into recession because the price of oil trebled between January 1999 and September 2000. British unemployment will soon be rising, and is likely to peak in the winter of 2002-03.

Although some economists refuse to pay attention to the oil-price explanation for business cycles, this theory fits the facts better than any other. And it has matched them repeatedly over the decades.

A good bumper sticker for Washington would be: "You weren't paying attention, Mr Greenspan. Every world slowdown has been preceded by a hike in energy costs". Four oil-price explosions have produced four world slowdowns.

This time, America and Germany fell off a cliff simultaneously, right in the middle of last summer. Other nations showed symptoms a few months later. Once output splutters, jobs soon suffer.

American and German unemployment turned up early this year. Judging from historical patterns, it is likely that the American jobless total will rise until the middle of next year - tracking the movement in energy prices, as it has so many times in the past.

The world economy will be the next to go down. Australian, Canadian and French unemployment rates have all recently started rising. Japan continues to encounter its particular version of the perfect storm.

Britain is one of the few economies where the jobless number is still declining (just). That is because of the large increase in public spending that was fortuitously announced last year and the New Deal.

But the good news is not likely to last. I believe the winter months will bring intensifying gloom about the British job market.

Explanations are not hard to find. Oil, fundamental to our way of life, is a kind of black magic. Most people are probably not aware how much it shapes their lives. Oil is the single biggest source of energy for the economy.

It powers our aircraft and ships and virtually all transport; it heats our homes and cools our offices; it fuels the deliveries made to factories across a modern economy; it allows us to get to work in the morning; it is a key ingredient in plastics, chemicals, clothing, fertilisers and much more. We live on a planet that turns because of energy and especially because of black gold.

For good reasons, George Bush has energy on his mind. But he and his policymakers need to throw out the common myths about oil and the global economy.

Myth 1: we are less dependent on oil these days

The world depends more on oil than at any time in history. We went through 20m barrels a day in 1960, and 60m barrels in 1980. World consumption now exceeds 75m barrels every 24 hours. Remarkably, one seventh of the globe's oil production goes direct to the right feet of American drivers. That is not sustainable.

Yes, efficiency has risen and we produce more gross domestic product per unit of oil. But this oft- repeated fact misses the point. Western society throws away the advantage of greater energy efficiency by consuming far more goods than our parents and grandparents did.

The transport sector is the single largest consumer of energy in European countries. This reliance on oil for moving goods and people left the British stationary during September 2000's fuel-tax protests. There could have been no better demonstration of oil's power: without it, modern society grinds to a halt.

Myth 2: oil-price shocks now have minor effects on growth and jobs

Since the second world war, whenever the price of crude oil has trebled, the world economy has trembled. We are going through exactly that again. Unfortunately, Alan Greenspan wrongly increased American interest rates last year, just as the seeds of the oil-led slowdown were being sown. That made things worse.

Although most stockbrokers' mathematical models do not allow for it, the oil price is a key determinant of what will happen to an economy. When raw materials become more expensive, costs rise. Then profits drop, firms begin to go out of busines and people lose their jobs. Oil has a monopoly in transport. No substance is more important to an economy. These days, people use petrol in huge quantities just to see their friends.

Myth 3: oil shocks do not matter much because there are lots of other energy sources

The price of oil shapes all other energy prices, including those of natural gas and coal. The price of natural gas has risen more than 50% this year. Over time, these prices look like smoother versions of the graph for the price of petroleum. Oil prices also govern electricity prices, even though many nations burn little oil in power stations. The ramifications of oil-price shocks spread far beyond the use of oil itself. Opec effectively sets all energy prices.

Myth 4: last year's oil-price rises have done no real harm

From statistical work done with my colleagues Alan Carruth and Mark Hooker, we know that the lag from an oil-price movement to an output or unemployment movement is about 18 months. The price of oil started to rise from its minimum around January 1999. Sure enough, 18 months later the economies on both sides of the Atlantic started to slow strongly, and most euroland and American output figures now make increasingly dire reading.

Problems are no longer round the corner. They are here.

Myth 5: there are plenty of substitutes for oil if needed

There may be in the future, but not yet. And one worrying fact is kept quiet by all concerned. There is no substitute for aviation oil. One day we may drive solar-powered cars, but they cannot take goods and people to America or Asia. This one is so far insurmountable

Myth 6: the world has nothing to worry about in the long run and America can continue to have cheap petrol

American petrol is half the price of American milk. Yet it is harder to increase the world flow of oil cheaply than many - including President Bush - accept. American domestic oil production peaked, forever, in the 1970s. Despite what some political analysts believe, the evidence shows that the rate of oil discovery is comparatively unresponsive to movements in oil prices.

Moreover, there is a wild card in the pack - China. The average American consumes 25 times as much oil as the average Chinese. Yet China has five times the population of the United States, and though it has few vehicles now, it is industrialising rapidly.

Just do the mathematics: when car ownership becomes more common in China, world demand for oil will soar. A demand-supply balance will be sustainable only with high prices.

We have never before seen a trebling of oil prices in peacetime - without a Middle East war. This is worrying. It is a portent of extraordinarily expensive energy to come in our grandchildren's lifetimes. The world economy will feel the pain.

So, if you want to understand world business cycles, keep an eye on the price of oil. Remember how crucial it is to modern economies. Do not be lulled into a false security by the fact that we produce our own oil. Oil-price shocks cause severe slowdowns but, because of the lag, there is time to prepare for them.

Let us hope we do not need a fifth occasion before this message finally sinks in. Yes, it's recession. Yes, it's the oil price. Again.

Andrew Oswald is professor of economics at Warwick University


-- Martin Thompson (mthom1927@aol.com), September 03, 2001


Words of sage wisdom, indeed.

-- Chance (fruiloops@hotmail.com), September 03, 2001.

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