Gloom
and doom is wreaking havoc in financial and commodity markets as oil prices
probe new lows. Headlines proclaim that domestic energy producers face
bankruptcy, layoffs, and can’t pay back toxic loans. Meanwhile,
energy-producing countries must contend with deteriorating public finances and
recession. The old reliable China is no longer around to take up the slack in
energy and commodity markets. It turns out, so the business-page pundits say,
that low energy prices are a curse that could push the U.S. and the rest of the
world into recession. An article on the Wall Street Journal op ed pages,
no less, warns
that “we face the first one (recession) ever
caused falling oil prices.” Student of Economics 101 learn the opposite: low
energy prices, resulting from exogenous forces, stimulate the economy. Can it be that widespread belief in bad
economics can send the world economy into a nose dive?
Our
media business gurus have fallen for the “that which is seen and that which is
unseen” illusion of which the French economist Frederic Bastiat warned in 1850. Bastiat applied this
principle to international trade, where those who lose from trade are more
visible and vocal than those who gain. Business journalists write about the
“visible” loss of jobs in the oil patch. They do not write about the
“invisible” gains of chemicals, heavy manufacturing, transportation, and even
many services from lower energy costs. At best, they use Keynesian blinkers to
focus on the extra pocket money of consumers from lower pump prices, but worry
that spooked households are saving their windfall, not spending (despite no
evidence of an increase in the saving rate). Yes. Keynes still dominates
the financial press.
There
is no doubt that the Petro States are being deeply harmed by the collapse of
oil prices. Russia relies on oil for more than half of its state revenue and is
completing two years of recession with more likely to come. Saudi Arabia and
Kazakhstan join Russia in drawing down oil funds accumulated during good times.
Petro States with access to capital markets may have to sell shares of their national oil companies to survive. There is even
discussion of public offerings of Aramco and Rosneft. The Venezuela of the Chavistas
can no longer afford payoffs to core voters or ship subsidized oil to Cuba.
Iran is returning to world oil markets just in time for historically low
prices.
The
Petro States account
for only around ten percent of world GDP. The oil and gas sector accounts for a
half of one percent of employment in the United States. Their losses are the
“what is seen.” Those who gain from lower energy prices account for the bulk of
world output and employment.
Returning
to basic economics: There seems to be agreement that the massive negative oil
price, shock is the result of the fracking revolution; e.g., the consequence of
technological change. Standard macroeconomic principles texts teach that
exogenously-induced lower energy prices reduce the cost of doing business
throughout the economy, thereby increasing aggregate supply. More aggregate
supply means higher real GDP and a lower price level. We certainly learned the
negative effects of positive energy price shocks in the mid-1970s and early
1980s. Should we not expect now to sit back and enjoy the reverse? That’s not
the case. For some strange reason, economic journalists and pundits have
concluded that low energy prices are harmful.
Pundits
complain that politicians are interested in the short run and that CEOs worry
only about quarterly earnings. Economic pundits are equally handicapped by
short-run thinking. The aggregate supply curve may not shift to the right
immediately, but it will.
Economists
work on the principle of abstraction: Economic theory aims to isolate the most
important factors causing economic phenomena, brushing aside the less
significant ones with the ceteris paribus assumption. Abstraction tells us that
the gains from lower energy prices are widespread throughout the U.S. and world
economy, whereas the losses are limited geographically and sector-wise. Financial
writers should begin their analysis with the economic basics and not get distracted
by other details. In this case, by ignoring the supply side, they are missing
the elephant sitting in the corner.
