Analysis of the potential
economic consequences for the EC of the Iraq /Kuwait
crisis.
Since 1990 the world economy has been attacked by an unexpected rise in oil prices. It is considered that an increase to an average of $30 per barrel in 1991 would represent an increase in oil price by about 70%. The effects will also be influenced by the US dollar against the EMS currencies, the domestic inflation rates, and the energy dependence. The two scenarios illustrate that if the oil price increases will cause an immediate increase in price levels with insignificant medium term effects that would not stop the long run growth perspective of the Community. The past oil shocks have demonstrated that uncoordinated policies and wage reactions can lead to negative macroeconomic impacts and cause diversity between countries.
1.Recent evolution of the
oil market
This is an analysis of the effects of the increasing oil prices since the invasion of Kuwait since 1990. By the time this article was written the situation in the Gulf was very uncertain and the oil prices were dominated by speculation. The study is based on two different scenarios describing two possible evolutions of oil prices.
(i) Evolution of the dollar-quoted oil
market-price.
Since 1990 if we take into account the example of the spot price of Brent crude the average daily quotations in dollars increased from USD 17.3 per barrel in July to USD 35.1 in September and USD 36.0 in October. In this case it is assumed that the rise in spot market prices will be maintained during several quarters and that the average oil price will reach UDS 30 per barrel in 1991, so oil importers will face a dollar price increase of about 70% with respect to 1989 average price. In addition, the dollar import price is an important factor in the final impact of oil price increases and energy balances and costs in the Community. In one hand the dollar evolution with respect to national currencies as well as the evolution of the real price of oil, which determines the effective price effect to EC economies should be taken into account. In the other hand, the evolution of oil and energy dependence since 1972 would also affect the EC economies.
(ii)The influence of exchange-rate
variations
Because the price of oil is quoted in the dollars the Community economies may amplify or reduce dollar changes. During 1981-85 the dollar appreciation against the ecu increased the impact of the 1981 oil price rise. In 1991 the evolution of the dollar against the ecu indicated that if maintained it will dampen the price effect.
(iii) The evolution of the real price of oil for the
Community
The cost of a change in oil prices for the Community is also influenced by the evolution to the oil price in relation to domestic inflation. The assumptions made for the nominal price of oil said that the ecu/dollar rate and average inflation in 1991 the real price of oil would still remain at a lower level in 1991 than it was in 1974. In few words it would be equivalent to 75% of the level of 1974 and 50% of the price of 1981.
(iv) The evolution of oil and energy
dependence
Because of the technological innovations and specific energy policies within the Community, energy intensity has declined 25,6% between 1973 and 1989. In addition the oil consumption per unit of GDP has decreased by 43,6% in that same period of time. This occurred because of the substitution by other sources of energy instead of oil. The exploitations in the North Sea by the UK and Denmark, the import dependence of the Community has decreased con respect to the rest of the world. If there were a price oil increase it would have a very small impact on the Community net oil bills. But we have to remember on the impact on oil and energy is very critical and could have a very negative effect on Community’s macro economy.
2.Oil scenarios and their
macroeconomic implications
The uncertainty of what could be the solution to the Gulf War lead to a variety of possible oil prices (temporary and long-lasting) composed by price increase with impacts on the Community’s such as growth, inflation, employment, or in the case of a political solution it could be a rapid fall of the oil price. As we all know two scenarios were investigated in this analysis. The first scenario is about oil price assumptions. It assumes a negotiated solution to the Gulf crisis and the return to a normal situation in the oil market in the middle of 1991. At the beginning this would temporary increase the price of oil import price to a maximum of USD 33 per barrel in the first semester of 1991; then it is assumed that the prices are going to fall to a new stable level of USD 25 per barrel in the second semester of 1991. The second scenario is based in a long-lasting crisis and a decreasing supply causing prices of imported oil to increase by USD 15. These scenarios will be analyzed thru many specific steps. In the first step, the scenarios will be analyzed without the impact of the dollar fall. However a fall in the dollar would be reduce the impact of the increasing dollar in the Community oil bill, which is expressed in ecus. In addition the dollar fall not only affects the oil price, but it also affects the price of other imported goods. In the second step the scenarios will be combined with the dollar fall. In the third step the present scenarios will be analyzed with the impact of the oil price on wage formation. We have to remember that these scenarios are just for illustrative purposes.
(i) Impact of the oil price increase ‘stricto
sensu’
The first scenario shows a slowdown of the real GDP by about 0,4 points in 1990 and 1,3 points in 1991. Inflation would increase by 1,4 points in 1990 and 2,2 points in 1991. The rate of unemployment would increase from 0,3 to 0,6 points; the public budget and current balance would change from 0,3 to 0,5 points of GDP. The second scenario would have impacts in 1991 50% larger than those of the first scenario.
(ii) Effect of the fall of the
dollar
When the fall of the dollar is introduced in the scenarios inflation was reduced by 0,7 points in 1991. But it will have a negative impact on growth by about 0,1 points per year. These could be the results from the two opposite effects of an ecu appreciation. In addition it affects competitiveness inside the EC and makes a negative impact on real GDP growth.
(iii) Effects of different wage
behavior.
In steps 1 and 2 it is assumed that an increase in domestic prices due to oil prices will increase wages within one year. According to this the inflationary impact would be reduced by 0,8 points in 1991 and inflation can be brought back to the pre-crisis of 1990-94. The growth of the real GDP will be a little higher.
3.Individual country
considerations
(a) EC member countries
Among the largest ERM countries the impacts of external positions would be the almost the same. Further problems can cause problems in Spain, Italy and possibly France. The smallest ERM countries are in a better position because they have current balance surpluses, so they are capable of absorbing oil price increases.
(b) United States and Japan
Growth and inflation problems in the U.S. could be of the same magnitude than those of the EC. In the U.S. there is an increase domestic oil production, which is compensated by their higher intensity of oil use per unit of GDP. Japan would benefit from its energy saving programs and would have lower impacts on growth, inflation and current balance.
(c) Eastern and Central Europe
countries
For these countries is not that simple because their energy and oil consumption is very high. These economies import their oil from the Russia at a price that now follows the international market price; these countries are vulnerable to increases of oil prices.
(d) Less developed countries
It is obvious that less developed countries would be hit more than industrialized countries. They will also be affected by the slowing demand coming from the industrialized countries. In addition the non-oil producing countries will register an increase on their debt charges due to a rise of nominal interest rates.
4. Overall evaluation and
policy implications of the oil price rise scenarios
Now the results of the scenarios are compared, and the impact for the EUR 12 is smaller than the previous impacts of 1974 and 1979; the following factors explain the results: 1/ the oil price increased less than the previous oil price shocks; 2/ Since 1992 the use of energy per unit of GDP has decreased by one quarter in the EC; 3/the use of oil products was reduced because of new sources of energy; 4/the dependence on extra EC oil sources was reduced by new intra EC oilfields in the north sea.
By Francisco
Martinez