Oil and the Recession

I want to draw your attention to a fascinating speech by Jeff Rubin, formerly Chief Economist with CIBC World Markets, the investment banking arm of the Canadian Imperial Bank of Commerce. The transcript of the speech is at The Oil Drum. In the speech Mr. Rubin traces the intricate interaction between oil prices and economic growth, particularly in the U. S.:

Gee, I wonder what happened to oil prices before this recession. It seems to me that oil prices went from about $30 barrel, at the beginning of 2004, to almost $150 barrel by 2008. Even in real terms, that is, inflation-adjusted, that price increase was over double the price increase of either the first or the second OPEC oil shock. If they had led to devastating recessions, why would not the biggest oil shock of them all, be the obvious culprit for what has been the deepest recession to date?

There are many ways in which oil shocks create global recessions. First, the transfer of income. When oil went from $30 barrel, to about $147 barrel, over $1 trillion of income was transferred from the industrialized oil consuming world to OPEC. Now, that was not neutral for the economy, because the savings rates from which money was coming from, like the United States, was virtually 0%, meaning that consumers spent everything they made. And where the money was going to, places like Saudi Arabia, or Kuwait, or the United Arab Emirates, had savings rates of almost as high as 50%, so it certainly was not demand neutral.

High price also create recessions by crowding out non-energy expenditures. Two years ago, when gasoline cost us $4 gallon, low-income Americans were paying more to fill their tanks than they were to fill their stomachs.

But by far, the most important mechanism, the most important path, by which oil prices cause recession is through their impact on inflation, and their impact on interest rates.

He takes note, correctly, of the subsidies by which oil-producing countries including Russia, Mexico, Venezuela, Iran, and Saudi Arabia encourage their citizens to consume more oil. He fails to consider the implications of the similar subsidies that India and China.

He further notes that time is running out:

Now, a lot of people will say, “Jeff, economic history tells us that scarcity is the mother of invention. Give us 10 to 15 years of adjustment, and we will develop alternate technology, so we won’t be carbon-dependent.”

And they are right. Give us 10 to 15 years, and we will solve this on the supply side. But as I say, our rendezvous with triple digit oil prices is not in 10 or 15 years; it is in 10 or 15 months. So instead of trying to turn cow-shit into high octane fuel, we are going to have to learn to get off the road, and that is just what happened. In 2009, there were 4 million fewer cars on the road than there were the year before. In the next ten years, 40 million North Americans will be taking the exit lanes. The question is, “Will there be a bus to get on?” Instead of giving $40 billon to General Motors, what we should have done is spend $40 billion on public transit, so there would be a bus to get on.

The very forces that render oil’s competitors economically feasible, high oil prices, constitute a substantial drag on the economy that we can ill afford.

There are actions that we can take in the near term to reduce our consumption of oil. Among these are for us to end our own subsidies of oil consumption. These range from the maze of direct and indirect tax incentives for oil consumption to maintaining the free transit of oil in the Middle East. The amount spent on highway construction and maintenance in the U. S. is about twice what gasoline taxes bring in as revenue. The difference is a subsidy to oil consumption.