SYNOPSIS: The New Economy is more subject to the Old than most people think
Everybody knows that the economic crises of the 21st century will be high-tech, high-concept affairs: our networks will be disrupted by hackers or our markets will be trampled by the electronic herd. Nobody thinks that the new economy is vulnerable to mundane, old-economy crises like those of the 1970's. Gasoline lines, a world held for ransom by the Organization of Petroleum Exporting Countries -- those scenes are as dated as bell-bottoms and disco.
So even though crude oil prices have surged above $30 a barrel, even though the U.S. energy secretary's pleas to OPEC to loosen up are starting to sound a bit desperate, it's hard to get worked up about the situation. Surely we cannot really be at risk of replaying the 70's energy crisis, which was caused by...actually, what did cause the energy crisis?
I haven't forgotten about the Yom Kippur War or the overthrow of the shah. But why did those temporary disruptions cause oil prices to remain very high for more than a decade? Incredibly, there is no widely accepted answer; nor is there even a live debate about the issue. In fact, I haven't been able to find a single economics research paper published after 1991 that even tries to make sense of the era of high oil prices. And if we don't know why it happened then, how can we be sure that it won't happen now?
The immediate oil problem is a matter of physical constraints. Philip Verleger, one of the few really good economists to stay focused on oil when the subject became unfashionable, points out that it takes quite a while to get the stuff here from the Middle East. So even if OPEC countries increase output sharply after their meeting later this month, we can't expect real market relief until mid-May. Since the output increases now being discussed look too small even to stop the drain on much-depleted inventories, let alone rebuild them, a summer spike in gasoline prices -- $2 a gallon, maybe even $2.50 in some places -- looks entirely possible.
Will that price spike be short-lived? Not necessarily. The world market for oil is one in which the normal rules of supply and demand do not work very well, at least in the short run. Given time, higher oil prices induce people to drive smaller cars, heat their homes with gas and generally cut back on their oil consumption. High-priced oil is also a stimulus to exploration and production around the world. But in the short run neither the supply of nor the demand for oil responds much to its price.
Worse yet, past experience suggests that some oil-producing nations may actually reduce output when the price rises. With plenty of cash flowing in, they start to regard oil left in the ground as a pretty good investment. They can also afford to start being good cartel members, doing their bit to drive prices up still further. As the economists Jacques Cremer and Djavad Salehi-Isfahani pointed out 20 years ago, this means that an oil market disruption can, for a time, be self-reinforcing: higher prices lead to lower overall supply and hence to still higher prices. (Incidentally, this means that oil crises aren't all that mundane after all: at a deep level they resemble Asian-style financial crises, which are also all about self-reinforcing market instability.)
Mr. Verleger laid out a scenario -- not a prediction -- in which oil prices actually continue to rise through this year, reaching something like $40 a barrel, and in which small swing producers, including Iraq, start to have considerable market power.
There are good reasons to discount that scenario. Oil producers like Mexico and Kuwait are reluctant to face American ire. They also know that too high a price will be self-destructive, setting the stage for an eventual crash. And in any case, our own economy is less vulnerable to oil shocks than it used to be: America now burns only about half as much oil per dollar of real G.D.P. as it did back in the early 70's. So the odds are against a full-dress replay of the energy crisis.
Still, I can't help feeling uneasy. A small voice keeps warning that those who have not even tried to understand the past may be condemned to repeat it.
Originally published in The New York Times, 3.5.00