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By Philippe Martin*

September 19, 2005

Liberation - Original Article (French)    

Up until now, the global economy has done well in resisting higher oil prices. The barrel passed the $50 level, the $60 level, and recently the $70 level, and each time, economists rang the alarm bells predicting a weakening in growth and even a global recession. And each time, the global economy has fared well, with growth forecasts for 2005 exceeding 4%. The basic reason for this encouraging strength in global growth is that it is the growth itself that is at the heart of rising oil prices.

Gas-Rationing in 1973. Odds and Evens.

In economic jargon, the raising of oil prices was, up to now, an endogenous phenomenon. It is because China and the United States have high growth rates (and are not very efficient users of energy) that demand for oil has exceeded supply. The increase is therefore different from the oil crises (exogenic) of 1973, 1979 and 1990, which were all caused by political factors that triggered a reduction in supply. Strictly speaking, then, the raising of oil prices is not a shock, at least it wasn’t until Katrina came along and changed everything.

In and of itself and beyond the human tragedy, the hurricane will have little economic impact: history teaches us that natural disasters are quickly absorbed economically. The example of the Kobe earthquake of 1995, which killed over 6,000 people, destroyed more than 100,000 buildings and left hundreds of thousands homeless, is a case in point. The economic cost was estimated at approximately 2% of Japanese GDP, much more than the potential impact of Katrina on the United States; however, the Japanese economy regained its growth rate prior to the earthquake in a little over a year. In fifteen months, the Kobe area was again at 98% of its previous productive capacity, and reconstruction generated a boom in investment. Katrina will thus have an economic impact only insofar as it affects long-term oil prices, i.e. if it morphs into an oil crisis. It is still too early to tell. However, experts worry that, in a sector where investments were already manifestly insufficient, the United States has lost over 10% of its refinery capacity.

It is also the first oil crisis that has resulted from globalization, and this is something that changes the way a shock is transmitted. There is the classical first wave: the price of oil goes up, purchasing power in each country falls and consumption suffers. Now there is a second wave: it is hardly a distortion to say that the Americans have become the global consumers of last resort, buying imported products for human consumption from China, which itself buys European machine tools. This is why if American consumption falls, it is likely that the effects will be felt well beyond U.S. borders. This consumption is fragile, however, in particular because of the real bubble: by again using a slightly exaggerated expression of economist [Paul] Krugman, Americans grow rich by selling each other houses paid for with loans from the Chinese. The shock of Katrina is that, by reducing the purchasing power of American consumers, it could tip this fragile balance. The drop American consumer confidence, measured by the University of Michigan’s index of consumer confidence announced on Friday, was surprisingly deep. When one adds this to the current account deficit: economists are divided over how balance can be regained, with or without a strong drop in American consumption. 

One of a Number of Runaway Oil Rigs in the Gulf of Mexico.

China also appears particularly vulnerable to an oil crisis: to produce, it uses twice as much energy as the global average, and its growth is dangerously dependent on exports to the United States. Chinese domestic consumption represents only 42% of GDP against 35% for exports. The entire Asian production chain would be affected by any reduction in Chinese exports. Historically, European growth was always more sensitive to fluctuations in oil prices than the United States: it is estimated that every $10 increase in a barrel of oil reduces growth by 0.5 % in Europe and 0.3 % in the United States.

But these estimates fail to account for the effects on global commerce, which could turn out to be much more negative than previous oil shocks. This, just as a number of signs seemed to point to a rebound of European growth. The scenario of a slowdown, indeed of a worldwide recession, even a short one, has been announced and contradicted many times, and has now surfaced again.  If it such a slowdown does occur, it will probably result in a sharp drop in oil prices in 2006.

*Philippe Martin is a professor at the Université Paris1 Panthéon-Sorbonne and researcher at the Teaching Center of Socio-Economic Research and Analysis