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Don’t beg Opec cartel for more oil Samuel Brittan Financial Times 16/09/05 Large and sudden increases in oil prices produce a special problem for macroeconomic policy – for two reasons. First, oil and related energy items account for a large portion of most countries’ expenditure. Second, the benefits of the oil price increase go in large part to countries that are unlikely to spend immediately more than a modest proportion of their windfall. Should policy be tightened to offset the impact on the inflation index or loosened to offset the contraction in real spending power it brings about? Oil prices have doubled since early 2004 and forward markets suggest that the trend will continue upwards. These dilemmas were thoroughly investigated in the aftermath of the first oil shock after the 1973 Yom Kippur war when some countries, such as the UK, initially tried to spend their way out of the recessionary impact, with disastrous effect, while countries that were then more “hard money”, such as Germany, gave priority to keeping the lid on inflation. As a result a useful doctrine was developed, mainly by the Organisation for Economic Co-operation and Development. On the one hand policy should “accommodate” the direct impact on price levels of the increase in oil and associated energy prices, as to attempt to roll it back would be prohibitively costly. On the other hand, it should be made clear that monetary and fiscal policy would ensure that this impact effect was once-for-all and not allowed to trigger a self-defeating wage price spiral. In other words OECD consumers had to take a real income knock on the chin. A complication since the 1970s has been the introduction of inflation targets. The impact effect of the present oil price explosion is bound to take some inflation indices above their targets. This would give Mervyn King, the Bank of England governor, his long awaited opportunity to write a letter to the chancellor of the exchequer explaining away a temporary breach of the inflation objective. History rarely repeats itself exactly. Earlier oil price explosions were triggered by the actions of Opec and the first Iraq war. This time oil production has come up against capacity constraints, evident even before Katrina. Oil producers have been finding difficulty in increasing output enough to meet increased demand from new economic players. In the distant days when I studied microeconomics the situation would be known as one of a rising supply curve. The price increases provide a continuing incentive to consumers to find ways of economising on energy in general and oil in particular, and to producers to invest in extraction and refining equipment. Above all, they provide more incentives to develop substitutes for oil than all the summit conferences until kingdom come; and they do more to discourage gas-guzzling than any amount of debate on climate change. The last thing we need is to surrender to Poujadist hauliers’ blockades as happened last time or to impose an excess profits levy on oil companies. There is, however, still a macroeconomic policy problem. Faithful readers will recall my use of nominal gross domestic product growth as a way of stating the generally agreed objective of relatively non-inflationary growth. For many countries it can be put very roughly at 5 per cent a year, more or less equally divided between 2-3 per cent inflation and the same amount of real growth. In the new scenario the inflation component will increase slightly and the real growth component be reduced. This tentative arithmetic could easily prove much too optimistic. The Texas energy specialist, Matthew Simmons, has suggested that the world derives false comfort from Saudi Arabian assurances of willingness to increase production to meet consumer shortfalls (Twilight in the Desert, Wiley). He argues that Saudi production is close to its peak sustainable volume and is likely to go into decline in the foreseeable future. Meanwhile, the most important thing is for Group of Eight countries to avoid negotiating in a begging posture with Opec. Whatever the short-term attractions of such a course, it tends to legitimise the cartel, politicise the world economy even further and multiply all the difficulties we face.
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