Do you remember the energy crisis of 1979? I hope not—or at least I hope most of you don’t. Because I like to believe that my readers are not all old codgers like me.
I do, however, remember the gas lines and the fear they instilled. I remember the Iranian hostage crisis and the idea that we were all vulnerable to political instability on the other side of the world. I remember the rise in electricity prices followed by higher inflation across the board.
And Donald Trump took us to war with the country that was at the center of that crisis. It must be denied: Iran’s regime is corrupt, and it would be a good thing if this war led to its collapse. But my topic today is the consequences of the US attack.
Almost everyone thinks that the economic fallout from Operation Male Insecurity Epic Fury will be much less than the fallout from the rise of the mullahs almost 50 years ago. And they are probably – maybe – right.
But it’s worth asking how come The world economy looks less vulnerable to instability in Iran now than it did in 1979. The main explanation is not what you might think. And it is also worth asking what innovations have come out in the last 47 years.
The following table shows some factors that help explain how the Middle East’s economic instability has changed since the eve of the Iranian Revolution.
Source: Our World in Data, FRED
As the first row of the table shows, Iran, while an important producer of oil, only accounts for a modest portion of the world’s oil production. On that basis alone one would not expect the ban on Iran’s exports, which is happening as you read this, to cause a significant rise in global oil prices.
However, in 1978 Iran did not account for a large part of the world’s oil production. So why did world oil prices rise 165 percent after the Iranian Revolution? Fear of confusion in some countries of the Middle East caused imagine hoardingfollowed by Saudi production cuts that kept prices high. Today’s lesson is that when analyzing the impact of events in Iran on the international oil markets, we must consider the impact of exports from Iran’s neighbors.
And that worries us. In 1979 the major powers in Iran, whatever they did with oil production and exports from their country, could not affect the exports from Saudi Arabia, Kuwait and so on. Today, the Iranian regime has a large number of weapons and drones, which it has already used to attack Dubai, Bahrain, and other countries in the region. Oil shipments through the Strait of Hormuz, which is the route through which most of the Middle East’s oil reaches international markets, appear to have more or less reached a peak. to stop completely.
And the world still relies heavily on Middle Eastern oil. As shown in the second row of the table, the Middle East’s share of the world’s production is slightly lower than it was in 1978. This share has remained high despite the increase in US production, shown in the third row of the table, which has made America self-sufficient in oil but has not changed the fact that Middle Eastern oil remains important to the economy of the world.
As of this morning, oil prices were $10 per barrel higher than they were in mid-February. This will add 25 cents to the price of a gallon of gasoline. Currently the market is betting on a short, not-so-disruptive war, although that could change.
However the economic impact of the oil price shock should be less than it was in the 1970s, for two reasons.
First, the major economies are less dependent on oil than they were in the 1970s. The “oil intensity of GDP” is the ratio of oil consumption (measured in terawatt-hours of energy) to real GDP, measured in 2017 dollars. This indicator has decreased by more than 70 percent since the 1970s, which tells us that today’s economy uses less oil to produce a given amount of output than the economy of the 1970s. One way to see this is to compare the growth in US real GDP to the change in US oil consumption since 1978:
Source: Our World in Data, FRED
The US economy has tripled in size, but oil consumption is now about the same as it was in the late 1970s.
How did we manage that? Among other things, the gas mileage of the average car has doubled. Also, cheap natural gas has replaced oil in many uses, for example in home heating, and renewable energy is also starting to take off.
The reduction in US oil GDP means that even if the current war causes a large, sustained increase in oil prices, there will be less economic damage caused than a similar increase would have done a few decades ago.
The next row of the table shows another reason to be less concerned about oil shocks than before: Reduced risk of stagflation. The oil shock of 1979 hit an economy that was already suffering from inflation. Moreover, it was an economy in which, to use Federal Reserve jargon, expectations of future inflation were “weak”: Companies reacted to sudden price increases by raising their own prices in the belief that there would be more to come, workers wanted wage increases to offset rising costs of living, and so on. As a result, the oil price shock of 1979 brought about an increase in the price of wages.
Today, inflation – still hovering above the Fed’s target of 2 percent – is much lower. Also, surveys show that most people expect inflation to return to normal in the future. So any effect of a new war on inflation is likely to be short-lived.
So far, it’s reassuring. But there are, as I see it, at least two reasons – in addition to the threat of transportation – to be moreworry about war in the Middle East more than we would have done decades ago.
First the financial weakness. In 1979 the US financial system was still heavily regulated, so there was little room for bank runs and other mistakes. Today many observers have been warning about possible risks to financial stability, quickly from personal credit. Would a war with Iran cause a financial crisis? I don’t know, but it doesn’t seem too scary to care.
Also, would war burst the market bubble? The next to last row in the table shows the price-earnings ratio of the S&P 500, which was low in 1978 but very high now. Will the high value be stable if the fallout from the war causes major economic damage?
Finally, one point that I have not seen many observers emphasize is that the modern Middle East is now playing an important role in the world economy that goes beyond its role as a major oil hub. Dubai in particular is an important place in the global financial system, as well as playing host to many of the super rich who thought they had found a safe haven. One indicator of this change is the transformation of Dubai International Airport into one of the most important travel hubs in the world.
To the extent that the war disrupts this new work of the region, it will be another danger to the economy of the country.
I don’t want to do doomsayers. But I worry that people are too complacent about the economic risks created by this war.
MUSICAL CODA
#War #Oil #World #Economy
