After four years hovering at about $100 per barrel, the price of oil has suddenly collapsed -- and is expected stay at $70 or less in 2015. Both more supply and less demand are behind the change: large producers in the Arabian Peninsula keep pumping apace, the US is "fracking" away at its shale reserves, and China's economic growth is slowing down -- all at the same time. This has sent economists rushing to assess what cheap oil means for the global economy. Depending on the model they use and the assumptions they make, they estimate a net stimulus that ranges from small to very small. But, behind the word "net," lies a wide spectrum of gains, pains, people, and policies.
Simulations by the World Bank's Global Practice for Macroeconomic and Fiscal Management suggest that, everything else equal, the global economy will grow a tenth of 1 percent faster if oil prices in 2015 stay a third below their average level of 2014. As a group, rich countries will benefit more than developing ones -- think of less expensive energy helping with Europe's recovery. Oil exporters -- like Nigeria, Russia, and Venezuela -- stand to lose a great deal, while oil importers -- like China, India, and Japan -- will gain a bit. And growth in oil-rich regions like the Middle East, Central Asia, and West Africa may decline rather sharply -- by two or more percentage points.
So far, so predictable. What makes the World Bank team's simulation interesting is that even among oil exporters the impact will vary a lot. The reason is that they are not all equally prepared to cope with the fall in oil prices -- not all of them used well the "good times" of $100-plus a barrel. This is a key point: The effect of cheaper oil on any one country -- and on its people -- depends not just on whether it sells petroleum or not but, if it does, on whether it has created the external and fiscal "buffers" to cushion a plunge in prices. The typical buffers are little or no foreign debt, large reserves of foreign currency, balanced fiscal budgets, sovereign wealth funds, and flexible public expenditures -- while not perfect, Colombia, Malaysia, and Norway are examples of that.
Why are those macroeconomic buffers so important? Because they help protect the poor. Without buffers, an abrupt loss of export earnings means slower or negative growth, higher inflation, and less government revenue. That is, fewer jobs, pricier food, and less social assistance. In other words, for unprepared oil-exporting countries, cheaper oil means more poverty. At present, there are some 700 million people in such countries -- 80 million of whom already live on $1.25 a day or less.
Of course, unlike simulations, in the real world "everything else" does not stay equal. Low prices discourage new investments in exploration, especially for shale oil, something that may over time raise prices back up -- by some projections, oil prices could recover their 2014 level as early as 2019. More to the point, politicians and policy-makers can and do react to shocks. What should they do in this case, especially if they happen to lead an oil-exporting country and care about poverty?
Six areas for government action stand out. First, secure your financing. Calculate your cash needs for the next couple of years as if all your expenditures were untouchable, and sign today the loans you know you will need tomorrow. [NB: With interest rates currently at rock-bottom levels, this is smart debt management anyway.] Second, prioritize your public investment. Decide now which projects you will slow down, postpone, or drop, if you were to run out of money. Third, audit your social safety nets. You may be called upon to fund temporary employment programs, feed children in schools, and pay for direct cash transfers. If you don't have the necessary logistics in place -- including an updated register of who is poor and how to reach them -- you'd better start working on it.
Fourth, stress-test your banking system. What would happen to your banks if, all of a sudden, foreign currency became scarce? Are their loans concentrated on a few construction or trading companies that could go belly up as the oil boom comes to an end? Fifth, identify who will suffer when crisis strikes. Who are the winners and losers? Will the impact be felt in a single, remote rural area where your oil is extracted? Will a devaluation of the national currency make imported food unaffordable for the urban poor? Will the affected belong to a specific racial, religious, or regional group? Whose consumption will get more expensive? And whose assets will lose most value? This kind of "political economy analysis" is invaluable because it highlights the road-blocks in your decision-making.
Finally, don't waste the shock. A major change in your external environment can help you tackle long-neglected internal reforms. This is a great time, for example, to remove subsidies to fossil fuel or to make life easier for industries that can export something other than oil. It is also high time to change the behaviors that make your economy buffer-less: fiscal budgets that are built on over-optimistic price projections, public spending that is borderline extravagant, pledges of oil revenue to over-borrow, and political reluctance to create rainy-day funds. Whether your country sells or buys oil, whether it is rich or poor, a slump in international oil prices can be turned into a fine development opportunity.
Follow Marcelo Giugale on Twitter: www.twitter.com/Marcelo_WB
