Sean O'Grady: The global economy will have to adjust – and it will

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The Independent Online

Short term, there's no doubt that oil at $250 a barrel would be as traumatic a shock to the world's economic system as anything that has been thrown at it since the end of the Second World War. It would be worse than the oil shocks of 1973 and 1979.

Even as they stand now, oil prices have quadrupled since 2004; another doubling would be catastrophic for the world's economy, which is already teetering on the edge of recession. The chances are that the lethal combination of stagnating output and rising inflation – which has been called the "new stagflation" – would become more painful. Spending power is being sucked from the world's major economies. Only rapidly growing China, India and the other emerging nations stand in the way of a global slump.

Much of the reason why the price of oil, food and almost every other commodity has soared in recent years is down to the insatiable appetite of the Chinese for the raw materials of their industrial revolution. Even now China is growing at more than 10 per cent a year. (We'll be lucky to see 1.8 per cent). But it is difficult to see it withstanding the impact of such inflation. Its heavy industrial growth is exceptionally energy-inefficient and dirty – coal being the fuel of choice for much power generation. It would also be unable to withstand the collapse in Western demand for their exports. We should then see China stumble. That will be to no one's great benefit.

Longer term, though, there is every reason for optimism. Economies always adjust. The world is far less reliant on oil than it was in the 1970s. The high price will – again – call forth those traditional economic responses, substitution and increased supply.

Even the much-rumoured oil in the Falkland Islands might be recovered at these prices. The world's car makers will, as ever, offer more fuel-efficient vehicles. Small things – energy saving light bulbs, double glazing, more efficient appliances – will help, as will the more ambitious technologies: the hydrogen fuel cell, renewable energy supplies, second, third and fourth-generation biofuels (which will be sustainable).

President Bush may have been wrong to reject the Kyoto treaty, but he was right to press the case for technological advance as an answer to climate change. It's also the answer to the oil crisis.

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