past months have witnessed soaring oil prices in international
markets, which have come on top of increases in the
previous three years. In the third week of August
world trade prices of crude oil nearly touched $50
per barrel before settling somewhat lower. But further
increases are not ruled out in the near future.
While crude oil prices have been rising since March
this year, thus far the month of August has seen the
most rapid increase, as Chart 1 shows. The most recent
increases have been driven by a number of factors.
The most important factor, of course, is the continued
resistance of the Iraqi people to the US military
occupation. The inability thus far of the US army
to contain the armed struggle of the militia of Muqtada
al Sadr and others despite using blatant violence
even against civilians, along with the growing sabotage
of oil facilities and destruction of oil pipelines
in Iraq, has reduced exports and led to expectations
of uncertain future supplies from that country.
In addition, the threats of terrorist attacks in the
world's largest oil producer, Saudi Arabia, are growing
and also have been increasingly realised in recent
months. The nervousness this has created in world
markets has not been neutralised by OPEC's promises
of boosting production. More recently, the travails
of the giant Russian oil company Yukos have also contributed
to rising oil prices.
Normally, some of this supply uncertainty would be
considered as inevitable and would have only a marginal
effect on markets. At present, however, these factors,
as well as other potential issues such as instability
in Venezuela or strikes in Norway, or indeed any changes
in any oil-producing country, can have substantial
effects on prices at the margin and cause sudden price
spikes. This is because world demand for oil rules
very high at present. In consequence, current oil
production is extremely close to current capacity,
and there is little margin for major increases in
supply in the near future.
World demand for oil has been fuelled not only by
growth in the US, but also by strong demand from other
countries. China's imports of crude oil have increased
by more than 40 per cent since the beginning of 2004.
This is not all for current consumption rather it
reflects stockpiling by the Chinese government, a
shift from holding excess dollar reserves to holding
Even the US government is continuing to add to its
Strategic Petroleum Reserve, rather than depleting
it in order to reduce oil prices. The Bush administration
has made it clear it would not intervene to release
any of these stocks unless the oil prices goes to
levels of $55-60 per barrel before the November elections.
Market analysts do predict that the current high levels
of OPEC production (which was 29.8 million barrels
per day in July, only 0.5 million barrels below total
OPEC crude oil production capacity) are likely to
push prices below $40 per barrel by the last quarter
of 2004. Nevertheless, it is unlikely that 2005 will
witness a sharp decline in crude oil prices, simply
because world demand is expected to continue to grow
and keep inventories tight. Global oil demand is currently
projected by the US Department of Energy to exceed
2 million barrels per day this year as well as in
So if oil prices do continue to rise, what are the
implications? Some observers have already sounded
the alarm bells. OPEC itself has predicted that the
global economic recovery could be in jeopardy in prices
remain at current levels (around $40 per barrel) for
the next two years. An OPEC report projects that this
would reduce growth in Europe and the US by between
0.2 and 0.4 percentage points.
Asian economists have been even more pessimistic.
Kim Hak-Su, the Executive Secretary of UN-ESCAP (the
United Nation's Economic and Social Commission for
Asia and the Pacific) has suggested that oil prices
of around $40 per barrel would mean a 0.5 percentage
point reduction of growth in the region, and $50 per
barrel would mean a 1 percentage point reduction.
Such projections usually hinge around the perceived
trade-off between growth and inflation, and are predicated
on the assumption that oil prices increases will lead
to more general inflation. Governments attempting
to combat inflation will then embark upon contractionary
fiscal and monetary policies, which will bring down
inflation but also imply lower rates of aggregate
It is correct to assume that governments across the
world remain obsessed with inflation control, because
the political economy configurations that have led
to the domination of finance still persist. However,
the prior assumption, that oil price hikes necessarily
lead to higher inflation, may not be so valid any
Certainly it is true that for a very long period
in fact almost the whole of the second half of the
20th century oil prices showed a strong relationship
to aggregate inflation rates in the world economy.
Between 1970 and 2000, for example, world trade prices
and oil prices were strongly positively correlated
and in the largest economy, the US, the Consumer Price
Index inflation tracked movements in world oil prices.
However, there is evidence that such a relationship
may be changing. Chart 2 indicates the annual percentage
changes in world oil prices and average inflation
rates in industrial and developing countries, especially
Two things stand out quite sharply in this chart.
The first is that oil prices were exceptionally volatile
over this period, rising and falling dramatically.
The second is that such fluctuations appear to have
had little impact on aggregate inflation rates in
either developed or developing countries. Rather,
such inflation rates have been relatively stable and
even fallen slightly compared to the earlier decade.
So what has changed in the world economy to cause
such an apparently established relationship to break
down? To begin with, it is worth remembering that
even the currently high oil prices are still well
below their real levels in the 1970s, when the oil
price shocks generated stagflation. But there are
other forces which have reduced the responsiveness
of the general price level to energy prices.
The first important factor is the reduced dependence
of the industrial economies upon oil imports, at least
in quantitative terms. For the group of industrial
countries in the OECD, net oil imports accounted for
2.4 per cent of GDP in 1978, but have since fallen
continuously, to amount to only 0.9 per cent of GDP
But the second factor may be even more significant.
This is a distributional shift, whereby the burden
of adjustment to higher oil prices is essentially
borne by workers across the world and non-oil primary
commodity producers in the developing countries. This
means that even though energy is a universal intermediate
good, its price rise does not cause prices of many
other commodities and especially the money wage
- to increase accordingly. This in turn enables aggregate
inflation levels to remain low even though oil prices
may be increasing.
It is well-known that the period since the early 1990s
has been once of a substantial decline in the bargaining
power of workers vis-à-vis capital in most
of the world, and this has been reflected in declining
wage shares of national income and real wages that
are either stagnant or growing well below productivity
increases. This provides a significant amount of slack
in terms of the ability of employers to bear other
input cost increases. In addition, this disempowerment
of workers also means that such input cost increases
can be passed on without attracting demands for commensurate
increases in money wages in the current period.
Along with the working class, the peasantry and other
non-oil primary commodity producers have also been
adversely affected and been forced to take on some
of the burden of adjustment. Indeed, even manufacturing
producers from developing countries have been forced
in a situation where intense competitive pressure
has ensured that they cannot pass on all their input
Chart 3 indicates the annual changes in the world
trade prices of oil, non-oil primary commodities and
manufactured goods. It is evident that the prices
of other primary commodities have generally been more
depressed, falling between 1995 and 1999, and barely
increasing even in years when world oil prices rose
sharply. Similarly manufactured goods prices also
have hardly increased, and have also been falling
in absolute terms over much of this period. Only in
the period since 2001 is there some evidence of all
three sets of prices moving together.
So does this mean that the oil price is no longer
an issue of concern for those interested in the aggregate
growth of the world economy? Not at all; in fact,
such a conclusion would not only be unwarranted, it
could also be extremely misleading.
It is clear from the preceding argument that the adverse
impact of oil prices upon inflation can only be contained
by suppressing and reducing the incomes of workers
everywhere and peasants in the developing world. But
there are limits to the extent to which such incomes
can continue to be reduced, since such a process has
already been under way for some years, and it cannot
be intensified in most countries without causing social
unrest and political instability.
This means that continuing high prices of oil are
likely to place governments across the world in a
dilemma. If they continue with the practices of the
recent past of forcing the majority of the people
to bear the burden, they risk losing legitimacy with
the people. In any case these policies have become
so unpopular and are meeting with more and more distrust
and resistance. This is of special significance in
those developed countries (including the US and UK)
where elections are due in the near future. But it
is also true of some developing countries (including
India) where the balance of political forces may be
shifting in some small degree in favour of the working
class and peasantry after more than a decade of extreme
tilt in the opposite direction.
So this particular strategy has its limits. However,
the alternative strategy, of using contractionary
monetary policies to bring down aggregate inflation,
would also be extremely unpopular since it would add
to unemployment and material insecurity which are
already at high levels.
It appears that if governments are to take into account
this requirement of popular legitimacy, they must
be prepared to live with higher inflation in the medium
term. How far this is compatible with the domination
of international finance capital is something that
remains to be seen.