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The rise and fall of oil The "journal‘ in the box below is taken from a document called ’World Oil Market and Oil Price Chronologies, 1970 — 2002," displayed on the Web site of the US Department of Energy’s Energy Information Administration (www.eia. doe.gov). The entries relating to October 1973 have been chosen as our point of departure in the search for an answer to the question: What was the impact of the Yom Kippur War on the global economy? The enormous impact of the war on every aspect of Israeli life, not least the national economy, tends to massively distort the Israeli view of the repercussions for the rest of the world. It is fairly easy, in fact, to make the case that, in terms of the global economy, it was the single most important event of the 1970s — or, at the very least, one of the top three or four. But the "oil shock‘ of 1973-74 was not an Israeli phenomenon, nor was it caused by Israel. Indeed, it had very little to do with Israel, beyond its starting point in the Yom Kippur War. This may surprise many Israelis and may seem like another attempt at ’revisionism" — but the facts are quite clear-cut. The chronology begins in 1970 because that’s when the oil market began to change. True, OPEC — the Organization of Petroleum Exporting Countries — was founded in September 1960, in Baghdad. But for the first 10 years of its existence, it was largely silent. However, following such seminal changes as the 1969 coup in Libya that brought Muammar Gaddafi to power in that oil-rich state, and the rise of the Ba’ath regime in Iraq, a new militancy became apparent. OPEC countries, both in the Middle East and in Latin America, began to demand two things: ownership of the oil fields that Western companies had discovered and developed in their territories, and much higher taxes — with correspondingly higher prices — for the output. Before January 1, 1970, virtually nothing had happened; thereafter events began to accelerate. The focus was on ownership and price, as well as greater cooperation between OPEC countries — which, in turn, gave OPEC increasing importance and influence. Three items from 1971 clearly show that the trends had nothing to do with Israel and the Arab-Israel conflict: o February 24 (1971): Algeria nationalizes 51 percent of French oil concessions o April 2: Libya concludes five weeks of negotiations with Western oil companies in Tripoli, on behalf of itself, Saudi Arabia, Algeria and Iraq. The agreement raises posted prices of oil delivered to Mediterranean countries from $2.55 to $3.45 per barrel; provides for a 2.5% annual price increase plus inflation allowance; raises tax rates, etc. o July 31: Venezuela’s Hydrocarbons Reversion Law mandates gradual transfer to government ownership of all "unexploited concession areas‘ by 1974 and ’all their residual assets" by 1983. LET’S EXAMINE the actual developments in the oil market more closely. Graph 1 (see page 21) shows very plainly that the rise in the oil price was a process that began in 1971, and took off in 1973. The start of each year, from 1971 onwards, saw a rise in the official price of Saudi light crude — then the benchmark price for oil. Thus the price in force for the first nine months of 1973 ($2.59 per barrel) was already 44% higher than the 1970 price ($1.80) — far more than the cumulative rate of inflation in that period. What happened in October 1973? On the one hand, the Arab world sought to demonstrate its unity and solidarity in the struggle against Israel and its Western supporters. On the other hand, OPEC — a commercial organization of countries with no connection to the Arab-Israel conflict, saw its opportunity and seized it: prices doubled in October, and doubled again in January, so that in the space of four months, the official price of crude oil increased by a cumulative measure of 450%. Whether the motives behind this development were political or commercial — or a bit of both — the result was a dramatic and thoroughly negative development in the global economy. In order to understand why the oil shock triggered the worst recession that the developed economies had suffered since the Second World War, it is necessary to reconstruct the political and economic reality of the early Seventies. Given the extent to which the world has changed in the intervening 30 years, this is no simple matter. IN 1973, the central feature of global politics was the Cold War. There were two clear superpowers, and it was by no means obvious which was the stronger. Granted, the US economy seemed to be comfortably outpacing the Soviet one, but the gap was not seen as widening. On the contrary, the formerly undisputed primacy of the US in the immediate post-war decades was giving way to a new reality. US secretary of state Henry Kissinger spoke of a "multi-polar world," in which Russia and America would have to share the spotlight with new players. These included Europe, in the shape of the six-nation European Economic Community (later to become the European Union), which had just expanded (on January 1, 1973) to embrace three new members: Britain, Ireland and Denmark. Europe was seen as an economic powerhouse, thanks primarily to the impact of the post-war recovery of the German economy, the Wirtschaftwunder. But even this was overshadowed by the extraordinary development of the Japanese economy which, in the early Seventies, was moving from "developing‘ to ’developed" at an unprecedented speed. Finally, there was China, still under the control of Mao Tse Tung, as he was then called in the West. Following the Kissinger-inspired rapprochement between Richard Nixon’s America and Mao’s China, everyone believed that China was reemerging as a major player on the world stage — and, best of all from America’s viewpoint, it had totally split away from Russia. Nevertheless, despite all the "multipolar" talk, the real action was between the US and the USSR. Many minor and some major wars being fought around the world at that time — the Arab-Israeli one being merely the most prominent — were perceived as being fought by proxies of the two superpowers. Indeed, the Yom Kippur War was to create severe tension between the superpowers, as a result of the Israeli army’s defeat of Syria and Egypt (although Egyptian president Anwar Sadat had expelled his Soviet military advisers in 1972). But the US, in 1973, was weighed down by the burden of defeat in Vietnam and the deterioration in the US economy — itself stemming, in significant measure, from the impact of the Vietnam War. In fact, at this point in time, the Western world’s economies were uniquely vulnerable to precisely the sort of external blow that the oil shock was going to deliver. For various reasons, they had become synchronized: they all boomed together in 1971-72, reaching a peak in early 1973 (see Graph 2, page 21). Hence they were all ripe for a collective downward lurch. Once again, it would be quite wrong to see October 1973 as the starting point of the recession, or the Yom Kippur War as its sole cause. The data make it plain that all the leading economies had experienced a downturn earlier that year and were heading into recession. What the oil shock did was to ensure that what might otherwise have been a short, sharp downturn actually became a long and harsh slump. CONTINUING ALONG this path, we can similarly dispel the myth that the Yom Kippur War was the source of the inflationary syndrome, the primary economic blight of the 1970s. The facts, again, are otherwise. The inflationary process may be traced back at least to the early Seventies, perhaps even to the late Sixties — some American economists blame the way the Johnson administration funded the Vietnam War for unleashing the inflationary devil. What’s certain is that with the devaluation of the US dollar in August 1971 and the collapse of the Bretton Woods system of fixed exchange rates, the entire global economy became unsettled. Rapid expansion of economic growth, rampant printing of money, allowing exchange rates to float — all these are acts of human policy that occurred in 1971-73. One consequence was the surge in the price of gold (see Graph 3, page 21), which had been trading at a fixed price of $35 per ounce since the days of Franklin D. Roosevelt until Richard Nixon broke the link in August 1971. Add to these man-made sources of instability some freak global weather, including droughts and other agricultural events and you have a situation in which commodity prices of all sorts start rising rapidly. A dramatic example of just how pervasive commodity price inflation was in those years is provided by a much humbler item — sugar, which has no connection to crude oil. The rise in the price of sugar provided a clear portent of what was to occur in every other commodity, including oil. This was the general background already in place around the world. To complete the picture, we have noted the desire on the part of the dominant producers of the most important industrial raw material — crude oil — to raise the price and reduce supply. This ambition pre-dated the Yom Kippur War, but the war provided a unique opportunity to achieve the goal and it was seized with gusto. The story of the various government responses to the oil price shock is a study in contrasts. Although every country intervened in its domestic market, using price controls, rationing of various sorts, subsidies, fines and all the other carrots and sticks in the governmental arsenals — nevertheless, they achieved vastly different results. Inflation is an outstanding example of these differences. In general, the oil price shock became both the primary cause of inflation in 1974-75 and the justification for virtually every other price in the economic system to rise, thereby threatening that an inflationary spiral would take hold. But, as Graph 4 plainly shows, that outcome was by no means inevitable. In the US, inflation took off, reaching double-digit levels that were still only half the rate in Britain and Japan; in Germany, on the other hand, it didn’t — the Bundesbank (central bank) simply didn’t let it. By the same token, although Japan briefly lost control of inflation, allowing it to rise above 20% in 1974, it very quickly recovered its balance and regained control. Britain, on the other hand, lost control of its economy completely — for reasons that had far more to do with militant union leaders than Arab oil sheikhs. Only with the arrival in office of Margaret Thatcher, in 1979, did the situation improve. Confirmation that an oil shock need not result in a prolonged inflationary cycle — and that the lessons of 1973 had been learned, albeit the hard way — was provided over the following two decades: The very different circumstances pertaining in the world economy in 1979-80 and in 1990-91, when oil prices again rocketed, and the very different policy response to these shocks, ensured that no general inflation developed. Inflation was only one aspect of the overall economic impact, if the most visible. We have already seen (Graph 2) that Japan was the first of the major economies to resume economic growth. This was not through luck or happenstance. The Japanese determined to let the full cost of expensive oil feed through to their industrial sector, thereby spurring a tremendous effort to become more fuel-efficient and, by extension, to boost efficiency in every respect. The result was that Japan bounced back quickly and emerged from the trauma stronger than ever. Europe, by contrast, found it much more difficult to adjust, either politically or economically. Continental Europe spent a decade or so trying to save industries that were inefficient and/or uncompetitive, before finally launching the Single Market project in 1985, which became a temporary focus of growth and joint development. The US also floundered — not surprisingly, since the Nixon administration was mired in the Watergate scandal and the country was still traumatized by Vietnam. But the underlying market-oriented nature of the US economy ensured that the corporate sector would adjust — even if it meant that bastions of the economy, such as the auto industry, almost collapsed under the strain. The repercussions of the oil crisis spread ever-further — for instance to South America. Here, US banks found a ready outlet for the huge sums of money they were taking in from the governments of oil-producing countries — the so-called petrodollars. By 1982, the corrupt dictatorships that had borrowed this money were on the verge of bankruptcy and obliged to default, nearly taking the US banking system down with them — but that’s a story of the 1980s. Yet what of the recipients of what was rightly termed the greatest transfer of wealth in history? The oil shock brought OPEC countries huge and almost instant mega-wealth; what did they do with it? The short answer is that they blew it. The more correct economic answer is that the money was spent on consumption and on investments, which largely failed. The consumption aspect includes all the endless tales of extravagant waste and opulence on the part of Saudi and other princes, ministers, etc. This is well-documented. But much more disastrous was the way in which massive welfare state systems were created overnight in many Arab countries. These provided free health, education and other services to the citizens of the lucky countries — but these developments, too, proved counterproductive. In no Arab country was an industrial base built and developed by and for locals. Classic examples are provided by the huge refineries and petrochemical plants in the Gulf states, built by Japanese and operated by other foreign technicians; yet no large-scale manufacturing industry, such as plastics or chemicals, developed around them. Far worse were the extraordinary attempts to grow wheat in the Saudi desert, or Gaddafi’s megalomaniac projects in the Western Desert — but these at least had the merit of being "investments," rather than overt and gross self-indulgence. The only Arab OPEC countries that made serious moves in the direction of industrialization and the development of an urban middle class, in the recognized sense of these terms, were Iran, Iraq and Algeria. Iran went down the path of Islamic revolution, spending most of the 1980s repelling the Iraqi aggression, and has since receded further and further from the living standards and potential promise achieved under the Shah’s repressive regime. Algeria saddled itself with a socialist regime that not only buried the economy, but also — through overt secularism and anti-religion — fomented the growth of Islamist opposition, which has mired the country in bloody civil strife. As for Iraq — Saddam Hussein seized power in 1979, invaded Iran the next year… and that was pretty much the end of Iraqi economic development. What little took place was blown away by the Americans in the first Gulf War and strangled by a decade of UN sanctions and Saddamist theft. Overall, it is fair to say that the accrual of wealth by OPEC in the 1970s, and in particular by the sparsely-populated Gulf Arab states, had no parallel in history in terms of speed and scale. Yet, the squandering of this wealth is similarly unmatched. In a sense, this outcome may be seen as miraculous from Israel’s point of view, because, had the unique opportunity of the 1970s been fully utilized by its enemies, the results would surely have been grim. Yet, in another sense, Israel is also a victim of the terrible waste and the missed opportunities. Had the Arab states turned to the path of economic development, would they not have also chosen the path of accommodation with Israel and mutually beneficial development? The example of Anwar Sadat indicates that this possibility did indeed exist — but also how difficult it would have been to translate into reality.
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