Janet Bush: Stop worrying about $66 a barrel: oil prices are a measure of strength, not weakness

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The Independent Online

In Britain, the Bank of England is clearly looking at record crude oil prices with equanimity - otherwise it wouldn't have just sliced 0.25 per cent off base rates. Its latest Inflation Report was a suitably mild-mannered affair, with the Bank forecasting a short period of subdued growth and slightly higher inflation, followed by a dip in inflation and a reacceleration of growth. This is hardly the stuff of a 1970s-style crisis.

The outlook in the "gas-guzzling" economy of the United States, where nine out of 10 of the economic recessions since the end of the Second World War have been preceded by a dramatic rise in the price of oil, seems no less unruffled. The US Federal Reserve has nudged Fed funds another 25 basis points higher to 3.5 per cent and signalled that rates would continue to rise at "a pace likely to be measured" despite surging oil prices. Signs are, the Fed said, that aggregate spending appears to have strengthened, and long-term inflationary expectations are "well contained".

There is a relatively established rule of thumb that high crude oil prices depress growth and raise inflation. The International Energy Agency reckons that a $10 a barrel crude oil price rise takes about 0.5 per cent off growth and puts 0.5 per cent on to prices in the first and second years. Crude prices have been on a sustained and sharp upward curve for some time, and yet prices and growth have not reacted in the way economists' models suggest they should. Why? There seem to be a number of plausible reasons. The first point to note is that, when adjusted for inflation, crude prices are actually only around a third of the level they reached in the late 1970s. In today's prices, the 1980 price was equivalent to $60 a barrel.

The second is that governments, to an extent, have learnt the lesson of the 1970s. For a start, they are better prepared for disruptions in supply leading to higher prices, building up larger strategic reserves. More importantly, they have encouraged a diversification away from oil through gas taxes and fuel efficiency standards, for example. In the 15 countries of the European Union, for instance, the IEA estimates that oil's share of total energy consumption has fallen from 60 per cent in 1973 to some 40 per cent by 2001. In Britain, spending on oil used to be equivalent to 6 per cent of GDP; it is now just 2 per cent.

Even the US is less dependent on oil. William Poole, the president of the Federal Reserve Bank of St Louis, cites government policies such as the Corporate Average Fuel Economy standard, which has made cars more fuel-efficient, and estimates that, as a percentage of overall US output, the amount of oil the US uses has fallen by half over the past 30 years.

Another difference between now and the 1970s is that the price of crude, analysts argue, has been driven upwards far more by demand than by supply. Yes, there have been worries about supply from Venezuela and Nigeria to Iraq and Saudi Arabia; but the real reason for $66-a-barrel crude is the unprecedented demand from developing economies such as China and India and, in fact, the developed economy of the US, where growth is being fuelled by an unprecedented dose of Keynesian deficit financing and artificially low interest rates.

In 2004, global oil consumption (despite the diversification away from oil and towards other energy sources in industrialised countries) grew at a faster rate than at any other time for 25 years. Whereas in the past, high oil prices caused economic weakness, this time they are being caused by significant pockets of economic strength, and this is a very different dynamic.

World inflation is not rising because while Chinese demand for oil is pushing crude prices up, it is also, on the back of low labour costs, exporting cheap consumer goods to the Western consumer. So higher petrol prices are offset by lower prices for televisions and computers. At the same time, any dampening effect on economic growth in developed countries is being compensated for by faster growth in China and other developing economies.

Given that economics is known as the dismal science, it goes against the grain to be optimistic, but shouldn't we just stop worrying about high oil prices, go on being addicted to our cars and go to bed thanking our lucky stars for the sweat and tears of the Chinese worker?

A note of caution comes from the country of the moment - China. We have, of course, seen China looking ever more publicly for more assured oil supplies. There has been its recent effort, for instance, to take over Unocal, the US oil company, and its large investments in petroleum production in countries such as Sudan and Venezuela. But it has also moved aggressively to develop alternatives. By 2020, starting from almost nothing, China is planning to supply 10 per cent of its needs from renewable sources including wind power and solar energy.

It aims to produce 20,000 megawatts of energy from wind by 2020. It is ironic - given the oil obsession of America's Texan President - that China's wind programme was seeded, according to the US press, by a Chinese delegation's visit to a wind farm in Utah and its subsequent purchase of some turbines.

And, meanwhile, the US has just passed an energy bill that analysts unanimously argue will have virtually no impact on America's dependence on foreign oil. Federal officials project that by 2025 the US will have to import 68 per cent of its oil to meet demand, up from 58 per cent now. We may not be facing a 1970s-style world economic crisis (at least for now); but don't expect any modification to America's oil-driven foreign policies.

A stimulating lunch while Niger starved

Stung by criticism of its competence, the International Monetary Fund has taken to calling itself a listening and learning institution. But is there evidence that it is doing either? Let us take the current famine in Niger, a country that the IMF's managing director, Rodrigo de Rato, visited only in May.

Presumably, he was examining what the IMF could do to mitigate the death toll? Well, no. Strangely, he didn't mention the famine in his statement at the end of the visit. He did say how much he had appreciated a "stimulating luncheon discussion with the Secretary General of the Muslim Association, the Secretary General of the Traditional Chiefs' Association and the former Governor of the Central Bank of West African States". He noted, with satisfaction, that "Niger has made significant progress in restoring macroeconomic stability and liberalising the economy".

The IMF's home in Washington is just a few blocks away from the Pennsylvania Avenue headquarters of USAID, whose Famine Early Warning Systems Network (FEWS NET) has been predicting famine in Niger for months. It was already evident in late 2004 that drought and a plague of locusts had destroyed much of the harvest; the Niger government produced estimates of large deficits in cereals and pasture, and the UN issued warnings about impending famine. In January this year, the World Food Programme (WFP) reported chronic malnutrition; Médecins Sans Frontières reported that it was treating more than 12,000 children under five, four times as many as in 2004. By March, FEWS NET and the WFP concluded that 2.5 million people - some 20 per cent of Niger's population - would need food assistance through September 2005.

So, just up the avenue from the IMF, the word was out, the warnings delivered; famine was already raging in the Niger countryside while Mr Rato was enjoying stimulating luncheon discussions. The IMF, still an awesomely powerful gatekeeper to the flow of funds to the developing world, doesn't so much live in an ivory tower as a concrete bunker of neo-liberal ideology cut off from reality.

In his speech, Mr Rato said that "the President [of Niger] and I agree that a strengthening of the public finances was key to the maintenance of macro-economic stability and that a robust structural agenda was essential to lay the foundation for private sector-led growth". Locusts clearly aren't his thing.

Janet Bush is director of Advocacy International

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