High Oil Prices Threaten The Global Economic Recovery

Since oil prices exceeded $70 per barrel earlier this year, analysts, economists, and central banks have been fretting about whether higher crude prices could disrupt the momentum in global economic recovery from the pandemic. 

Most experts argue that inflationary pressure is no doubt rising in developing economies, which are more sensitive than developed markets to rising oil prices. Fuel and food prices generally account for more consumer spending in emerging economies, so they hurt them more than mature markets when oil prices rise. Inflation concerns have also started to emerge in the United States and other developed countries. 

Yet, most analysts believe that oil prices—currently at around $75 a barrel—are not as high as to seriously slow down economic growth, especially in the U.S. and Europe. In those areas, services account for a large and growing share of gross domestic product, and the cost of oil as a share of GDP is still below the long-term average. 

Oil prices have not reached the point yet where they could derail the economic rebound in developed markets, economists and analysts told The Wall Street Journal last week. 

Globally, the cost of oil as a share of GDP, also known as the oil burden, will rise this year because of the higher oil prices, but it will still stay below long-term averages, according to estimates from Morgan Stanley cited by the Journal.

In 2021, the oil burden is set to increase to 2.8 percent of the world’s GDP if prices average $75 a barrel. But even this higher burden than in previous years would be lower than the long-term average of 3.2 percent, the investment bank says.

Oil would have to average $10 a barrel higher—$85—in order for the so-called oil burden to reach the long-term average, the Journal quoted a Morgan Stanley report from earlier this year.  

Current economic projections for developed economies show that this year’s oil price rally will not be a significant bump to the post-pandemic growth recovery. 

Just last week, the European Commission (EC) raised its short-term economic growth projection for the European Union and the Eurozone, expecting the economy to expand by 4.8 percent in 2021 and by 4.5 percent in 2022. The latest forecasts in the Summer 2021 interim Economic Forecast are 0.6 and 0.5 percentage points higher for the EU and the Eurozone, respectively, than in the spring forecast made just a quarter ago. 

Still, the Commission expects rising energy and commodity prices to put upward pressure on inflation this year, alongside production bottlenecks and shortage of some raw materials. 

However, pent-up consumer demand in developed economies, mostly in the United States and Europe, is set to sustain the economic rebound and offset, at least for now, the rising oil burden, analysts say. 

In Europe and the United States, the pressure of higher oil prices on economic growth “is small in the context of the very strong growth expected as they emerge from the Covid crisis,” Bloomberg Economics’ Maeva Cousin and Ziad Daoud note. 

That’s not only because current projections see a strong rebound in developed economies, but also because less oil is now needed to produce a dollar of GDP in mature economies where the share of the services sector is growing, according to the Journal. 

Rising crude prices are expected to have a small effect on the overall economic growth and outlook on developed economies than they did a few decades ago. But higher prices are certainly challenging to developing economies, especially those heavily dependent on oil imports such as India. Inflationary pressures are stronger there, and analysts see $80 oil as the red line beyond which oil demand destruction begins. 

“Above that, we would expect quite a bit of demand destruction to kick in,” Martijn Rats, chief oil analyst at Morgan Stanley, told CNBC earlier this month. 

“That then would have implications for economic growth because if oil demand doesn’t grow quite as fast anymore then an awful lot of other industrial economic processes depend on that,” Rats noted.