Do oil prices affect real GDP growth?

Conventional wisdom would suggest that an increase in global oil prices would hurt the oil importing countries and, perhaps, reduce their GDP growth rates — and have the opposite effect on oil exporters. But data for the last 15 years does not corroborate with that claim.

The five-year rolling average for crude oil prices and growth rates of real GDP show that economic growth for the US, China, and India — three of the top ten oil consumers — did not suffer from rising oil prices. Nor did the economies of Saudi Arabia, Russia, and Mexico — three of the top ten oil producers across the globe, receive an unusual lift from such a trend.

For instance, oil price increased at a higher rate in 2006 compared with 2005. Prices rose by 1.62 per cent in 2005 and 1.87 per cent in 2006.

During this period, India's real growth rate in GDP also increased from 5.61 to 6.38 per cent. So did China's — from 9.18 to 9.76 per cent. But Russia's GDP growth rate decreased from 6.86 to 6.13 per cent, despite it being a major exporter of oil!

This only goes to prove that oil prices are just one among many variables which can affect a significant metric such as GDP.

oil vERSUs other commodities

Unlike many other commodities, the oil market is not subject fully to free forces of competition.

On the demand side, oil is an important input in producing most goods and services — either directly as a raw material, indirectly as fuel to fire manufacturing units or for transporting other goods and services.

Also, substitutes for oil are limited, making oil all the more precious. So typically, the demand for oil is likely to be more price inelastic than most other commodities.

On the supply side, only few countries possess huge oil reserves. Some of the oil-producing nations (OPEC nations) typically collude among themselves; notably, they agree upon the total amount of oil to produce, the price to target, and markets to distribute it in, all of which exclusively cater to their best interests.

Besides, speculation on the future movement of oil prices and geo-political issues related to oil production and supply also contribute to a distorted equation.

Crude prices which hit $145 and crashed to less than $50 a tonne within a span of few months between mid 2008 and 2009 beginning is one of the examples in this regard.

UNCLEAR relationship

Such a mercurial change in a short time does not conform to conventional demand and supply dynamics. Perhaps, such complexities in the oil market are one of the significant explanations as to why the real GDP growth rates of countries do not respond to oil prices.

Another possibility is that that oil importers are increasingly becoming more energy-efficient and, therefore, able to use oil more efficiently.

Or, countries are striving to substitute oil with alternative sources of energy. But, neither of the hypotheses above is supported by empirical evidence.

Countries such as India and China heavily subsidise the price of crude oil, and thus prevent complete pass through of oil prices to consumers. Such subsidies should affect the medium and long-term real GDP growth rates of these countries. Data does not present any such evidence, either.

What this analysis suggests is that while oil price has significant bearing on economic growth, it possibly cannot completely explain the changes in economic growth pattern.

After all, the uproar that oil prices can completely change the GDP growth rate trajectories of countries might have to be taken with a pinch of salt!

> ramaprasad.r@thehindu.co.in

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