Main Point: Healey examines the causes
of the significant slowdown in economic growth following the “golden years from
1951 to 1973” and the role of both OECD and OPEC countries in the 1st
and 2nd oil crises. He draws two important conclusions. 1) The only
certain way for consumer countries to discourage producer countries from
cutting output is through conservation and the development of alternative
energy supplies. 2) In order to regain high levels of economic stability and
economic growth, countries must strive toward convergence of domestic economic
performances. (i.e. a narrowing of the gap between surplus and deficit
countries and those where currencies are appreciating and depreciating.)
I.
The article begins by
attributing the strong growth experienced between 1951 and
1973 to four main factors. The first is the broad
acceptance of free trade, in practice as well as in principle, an assertion the
author supports by citing the correlation between growth of GDP in individual
countries and the growth of world trade. The second is the employment of
Keynesian techniques of demand management. Thirdly, Healey points to the Bretton
Woods agreement as having reduced economic uncertainty through fixed currency
parities and as having kept inflation low by imposing financial discipline. The
final factor is the availability of cheap energy, particularly cheap oil. He
sees the subsequent reversal of all these factors as responsible for the impending
economic slowdown, which he predicts will stretch into the foreseeable future.
Of these reversals, the energy problem is the most pressing: “the Middle East
began to exploit their new political independence of the West, just as the
West’s dependence on their oil became absolute.” (p. 218) The rest of the
article focuses on what can be learned from the impact of oil power over the
last six years (1973-1979) and its ramifications for the world’s monetary
arrangements.
II.
The inflation in the early
70’s was due to factors that had nothing to do with oil. Several factors, including the breakdown of
Bretton Woods, caused inflation to be high and rising by the middle of 1973,
before the increase in oil prices had taken place. In fact, it was partially in
response to inflation in the industrialized world that OPEC raised oil prices.
The result was a huge drop in world demand, an equivalent rise in prices and an
OPEC surplus of 65 million in the first year. There has been a great deal of
debate over whether or not this could have been avoided had consumer countries
financed their deficits through borrowing to recycle OPEC surplus, as advised
by the IMF, rather than removing their
deficits through inflation. As it turned out, those few who did adhere to this
recommendation, including Britain, Italy and the U.S., faced high deficits on
current account, leading to the depreciation of their currencies and still
higher inflation. Countries which ignored
the IMF’s advice and took the latter measure were, by 1978, running a surplus
much greater than the OPEC countries, and it was their behavior that continued
to deflate world demand. Recognizing the need to remedy the divergent economic
performances, Germany and Japan increased domestic demand, while their
counterparts moved into balance on current account. The U.S. continued to lag
behind, due in large part to Congress’s failure to legislate Carter’s energy
program.
Several unforseen
occurrences resulted from the first oil crises. The private banking system, particularly
the Euromarkets, played a much larger role in recycling the OPEC surplus than
expected. The speed at which rising import demand diminished OPEC surpluses was
also greater than anticipated. Non-oil developing countries proved surprisingly
resilient to the oil shock, partly because they were less dependent on oil than
OECD countries, partly because they benefited from the availability of OPEC capital, which allowed
them to borrow from private banks without the restrictive measures which the
IMF would have imposed. In addition the crisis made clear the inability of market
forces to break an oil cartel, and led to big changes in economic behavior
throughout the industrial world.
III.
There are important
differences between the first and second oil shocks. First of all, the impact
of OPEC surplus on demand was smaller the second time around because the
immediate percentage reduction in world demand was less. On the other hand, government
concern about inflation led to competitive exchange rate appreciations through
higher interest rates, despite the subsequent hike in unemployment and
reduction in economic activity. It was still unclear when this article was
written whether this reaction would produce a greater or lesser shock to
business than the first oil price increase. It was already clear, however, that
the government’s indifference to policy effects on unemployment would make
trade unions less likely to accept lower real wages.
Thirdly, while the difference in balance-of payments
performance among major oil consuming countries was much smaller, the
divergence of inflation and savings rates was much more dramatic. These
differences made foreign exchange more turbulent because of the varying impact
of oil price increases between countries. Such uncertainty created a flight away
from money to gold and commodities, creating a speculative environment similar
to that of the late 20’s. Another problematic difference was the diminished absorptive
capacity of the OPEC countries. Further more, it was harder for non-oil
developing countries to finance their deficits because lending systems were
strained from the last oil shock, and because of tight money policies like Mr.
Volcker’s. Reduced export markets as a result of protectionist measures by
industrialized countries compounded the problem for developing countries.
Lastly, OPEC countries had become more sophisticated since the last oil shock,
both in their use of oil prices as a political tool and in their investment of
surplus profits. The only way consumer countries can discourage the
manipulation of this tool in the future is through conservation and the
development of alternative energy sources. Faced with a future fall in prices, OPEC
will no longer be motivated to restrict output in the present.
IV.
Sudden changes in the supply
or price of oil can inflict worldwide damage on political, social and economic
stability, including in OPEC countries. Mutually beneficial arrangements
establishing relative certainty can be found. Consumer nations could, for
example, accept price increases indexed
to inflation in exchange for guaranteed output by producers. The problem is
getting governments to accept and act on such arrangements. Despite this
difficulty, some level of cooperation between consumers and producers is necessary
to prevent further deterioration of the situation.
V.
Healey predicts that the
‘80’s will be a particularly volatile decade unless some international action
is taken to control the oil situation. When exchange rates are floating they
are most affected by balance of payments on current account, prospective as
well as present; recurrent shortages of oil and continued increases in price are
likely to cause major divergences in balance of payment performances.
Speculation on futures, as mentioned in section three, has contributed to
currency turbulence and, in addition, had striking affects on the distribution
of wealth. The author calls for some financial regulation, but warns that too
much could dry up the supply of loans available to finance 3rd World
deficit. Given that the risk of default could bring the whole international
banking system down, he calls on the IMF to make further funds available.
Countries have failed to confront international finance problems, despite their gravity, because of
their belief in the ability of market forces to right the situation. There is,
however, no such thing as free trade in currencies; at best there exists a
system of dirty floats. Therefore, the “choice is not between a free market in
currencies and international regulation, but between uncoordinated national or
regional controls, which may tend to increase turbulence, and some coordinated
international control to reduce turbulence.” If industrial countries fail to
produce the latter, OPEC will continue to protect itself through manipulation
of oil.
VI.
Healey concludes that it
would not only be unproductive, but impossible for every county to run a
surplus on current account and make its currency strong is. Instead they should
focus on the more practical goal of convergence of economic performances. In
addition, he admonishes countries to avoid a fatalistic view of the international
monetary system, in favor of the pursuit innovative strategies that address the
situation and that can revitalize the international monetary system in the long
run.