NEW HAVEN—Oil shocks four decades ago transformed the world economy and geopolitical landscape, and the latest oil crisis threatens to do the same. The price of oil hovered near $100 per barrel during the past three years, and the recent vertiginous fall in price to near $50 per barrel has sent markets reeling. Ali al-Naimi, oil minister of Saudi Arabia, considered the industry’s most powerful decision maker, said oil could fall to $20 a barrel.
While oil-consuming nations celebrate, the exporting nations anticipate unprecedented economic and political challenges. Most countries are importers of oil, so they will benefit from lower prices.
Lower prices improve economic prospects by way of two main mechanisms:
The first is through better public finances. In many developing countries, governments heavily subsidize energy usage by selling fuel for automobiles far below the market price. These policies have been destructive on many levels. By reducing fuel prices, such subsidies discourage fuel efficiency, exacerbating global warming. And they impose a dangerous burden on public finances because governments are on the hook when oil prices increase. Though fuel subsidies are often rhetorically justified on the grounds that they help the poor, research suggests that in most countries the middle class receives the bulk of benefits.
Some developing countries have taken advantage of lower prices to cut or eliminate fuel subsidies. When prices are high, scrapping subsidies shifts costs to consumers and risks political backlash. Now, however, extremely lower oil prices provide political cover to undertake tough reforms. Indonesian President Joko Widodo, for example, is developing a plan to sharply cut fuel subsidies and redirect public spending to more productive uses, such as infrastructure or education. If more countries follow Indonesia, the policy changes facilitated by lower oil prices will underwrite more economic growth for years to come.
The second mechanism by which oil consumers benefit from lower prices is straightforward – households have more money to spend on other goods. In the United States, for example, consumers spent $370 billion on gasoline in 2013, according to analysis from Goldman Sachs. That constitutes roughly 3 percent of total household spending. Lower prices may save American consumers $125 billion over the coming year. Chinese consumers are less avid drivers than Americans, but they too will notice the economic effects as energy costs influence the price of food – Chinese spend near 27 percent of their income on food while Americans spend about 6.5 percent. Indeed, across the world, consumers will experience similar windfalls if oil prices stay low. In economic terms, this will function as a medium-size tax cut and boost consumption as people can afford to buy more goods or save.
Both the short and long-term effects of lower oil prices bode well for the global economy. But there are downsides, too, including threats for Japan and the European Union. Japan has suffered from years of falling prices and low inflation, and the governor of the Bank of Japan, Haruhiko Kuroda, has declared a goal of returning Japan to “normal” levels of inflation, meaning an increase in prices each year of at least 2 percent.
Similarly, falling prices in Southern Europe coupled with stagnation in Germany threaten to pull the entire eurozone into sustained deflation, thus dragging down regional economic growth yet further. For both Japan and the EU, lower oil prices complicate monetary policymaking as central bankers currently look for higher, not lower prices.
Japan has already embarked on one of history’s largest programs of so-called “quantitative easing,” by which the central bank increases the money supply in order to spark gross domestic product growth and higher prices. Many economists have urged the EU to do the same, but complicated politics – and Germans’ aversion to active monetary policy – restrict Europe’s ability to enact an expansive monetary policy.
