Collaborative Paper By Hannah Brendell and Princesse Karemera
Overview of the financial crisis
Thesis:
The OPEC Oil Crisis of 1973-1974 led to a global recession/crisis not only due to opposing political motivations but also because of economic tensions caused by the end of the Bretton Woods System and globally higher inflation rates.
Creation of OPEC:
The OPEC Oil Crisis was set into motion by key oil producing nations in the Middle East in the early 1970s. The Middle East holds the largest oil deposits in the world, approximately 63% of global oil reserves are found in countries such as Saudi Arabia, Iran, Kuwait, Iraq, Qatar and the United Arab Emirates (Ditté, Roell, 4). These main countries are also referred to as the “Gulf Six”. The Organization for Petroleum Exporting Countries generally known as OPEC was started in 1960, aligning themselves not only to other oil-producing countries in the region but also to the developing world (Garavini,476). The co-operation between oil-producing countries and the rest of the developing countries further embolden actions by OPEC and allowed the fears in the industrialized countries. This region was crucial for the oil supply of industrialized western countries and creating a collective organisation increased its power in the global market.
Reasons for Crisis:
The reasons for the onset of the OPEC Oil Crisis have been equated to both economic and political reasons. The economic reason lies within the disintegration of the Bretton Woods System in 1970. The end of the Bretton Woods System resulted in high inflation in international markets.
The political reason for the crisis is linked to Arab-Isreali tensions and intervention by the United States in favour of Israel. In October of 1973, an attack was staged against Israeli forces occupying parts of Egypt and Syria which went on to be called the Yom Kippur War. Ten days later, as the fighting continued, Sadat repeated his proposal for a separate Egyptian-Israeli peace settlement, and the following day four foreign ministers representing 18 Arab countries met with President Nixon to present a wider plan for peace. While in negotiations regarding the Egyptian-Israeli conflict, a secret airlift with military supplies was organized by America for Israel. The Nixon administration refused to support either proposal. Meanwhile, to reduce pressure on Israel to negotiate (Mitchell, 197) America was given an ultimatum to cease its support of Israel or face retaliation by OPEC countries. The United States did not stop its support of Israel however and ultimately led to the oil embargo and increased oil prices.
What Happened:
The Oil Crisis meant that OPEC countries cut in the supply of oil by 5% and raised the price of crude oil by 70 percent (Garavini, 474 and Mitchell ,190). A list was created of preferential countries and non-preferential countries which resulted in the United States being a recipient of the price hikes as well as the Netherlands and Portugal (Turk ,216) the new price and banned exports to the United States, embargo on all oil reserves to US as well as US allies. Embargo and increase in the prices of oil were 2 separate issues. The embargo against the United States lasted until March 1974 (Garavini, 480), Consumption of oil fell by 6.3% in big consumer countries such as Japan, France and the United States by April of 1974. Government had to prepare mechanisms for fuel rationing and a program to reduce the country’s oil consumption (Mitchell, 191).
Explain how the crisis unfolded connecting to international financial concepts in the class
In international finance, we learned multiple events and how they have impacted the global economy. The OPEC crisis is known as one of the biggest crisis that affected the global economy negatively by causing a global recession, trade deficit, unemployment, inflation and other economic chaos. The OPEC crisis of 1973 was partly related to the Bretton woods system because it was one of the most subtle reasons why the crisis happened. When the Bretton Woods exchange rate collapse, there was room for institutional involvement and thus giving more power to OPEC in the economy. The Bretton woods as we learned in class, was a system in which countries other than the United States pegged their currencies to the U.S dollar, and the U.S government was obligated to exchange at a fixed price, U.S. dollars for gold with the central banks of other countries. The United States resisted tightening policies, which could have reduced or reversed U.S. payments deficits. Instead, in 1971 the U.S. government suspended the exchange of gold for dollars and imposed a 10 percent tariff to force other countries to revalue their currencies.
A trade deficit is when a country’s imports are higher than its exports.
Inflation is a percentage increase or decrease in the prices of goods or services over a period of time. During the OPEC Oil Crisis an increase in inflation was a fundamental problem which influenced the later recession from 1974 to 1975. A recession is when key economic indicators such as employment, income, manufacturing and gross domestic profit. A Financial crisis is when the value of assets decline drastically making it difficult for businesses and consumers to pay off their debts and companies experience liquidity shortages. The Oil crisis was therefore a financial crisis which lead to a recession that significantly impacted the American and global market (Pugel and Balance).
What policies contributed to or were used throughout the crisis? What were the impact of these policies?
In response to the US support of Israeli in the Yom Kippur war, OPEC nations decided to engage in a revolution. The first major policies from OPEC nations were the reduction of oil production and the advancement on foreign oil interest in Arab world. In regard to reducing oil production, OPEC countries saw that opportunity as a way for the USA to withdraw its support of Israel. The second policy, which later on, was not implemented totally aimed to remove all OPEC and arab countries financial reserves from the US.
However, OPEC nations considered the reduction of oil production as an efficient response given that the United States depended strongly on its oil imports from OPEC nations. Regardless of the OPEC’s policy, the US continued supporting the Israeli and hence did not obey the wishes of OPEC nations. Therefore, the US’ resistance to the demand of OPEC nations led to a total embargo and wished and therefore, its resistance to the demand of OPEC nations led to a total embargo. At this point, the US was considered to be a hostile country and marked as an unfriendly nation. The United Arab Emirates, Saudi Arabia and all nations decided to ban oil shipments supply to the United States by 5%. (Mitchell ,190).
Within a short time, the price of oil increase from $3 to $12 a barrel and the price never went down. OPEC nations implemented this policy because the decrease in production and the increase in oil prices was not going to hurt the OPEC nations’ economy but instead affect the United States negatively more than another country. For instance, “the price of crude oil was increased by 70%, agreed to production cutbacks to enforce the new price and banned exports to the United States.” (Garavini, 474). The increase in price led to a tremendous decline in the economy of the US.
Furthermore, as the US was hurt by the oil embargo, it implemented policies that could lift and adjust its economy. However, these policies later on caused more harm than good. “Governments worsened the problem by mismanaging the crisis, adopting emergency measures that impeded the distribution of oil and made the shortages more severe” (Mitchell, 191). The government implemented price controls that aimed to maintain the price of oil affordable, but this made the situation worse and hence created shortages.
In addition, high prices of oil and the price controls led to inflation and recession that lasted for a long time. The price control had a negative on oil consumption as well and that affected the American lifestyle. For instance, through the control of oil consumption and the energy policy per president Nixon’s request, gas stations had to close on weekends, a speed law of 50-55 miles per hour was introduced in order to conserve gas and the government required full cut of outdoor lighting. Thus, this policy reduced consumer spending overall because people had to save more money in order to afford oil().
Is there an international component:How did it affect other countries or the global economy
Like the United States, the rest of the world was affected by the oil crisis particularly developing countries. This oil shock was affected by international changes such as the end of the Bretton Woods system. Globally prices of raw materials increased rapidly in 1971–1973 with growing fear of exhausting the world’s natural resources particularly oil deposits.(Garavini, 481).
The OPEC crisis caused three major negative impacts on the global economy. First, the OPEC crisis led an extreme decline of growth rates. According to Pascal and Roell, the worldwise growth was 6.9% in 1973, and by 1974, the growth rate decreased to 2.1% and 1.4% in 1975 (7). We can see a major impact on the global economy and other countries other than the United States. Thus, this is a major shift of the world’s economy.
Furthermore, the OPEC crisis led to a decrease in international trade. By 1973, trade played a big role in the global economy. Before the OPEC embargo, trade growth was at 12% and by 1974, it declined to -5.4% and -7.3% by 1975. Moreover, the OPEC crisis led to a fall in foreign direct investment (FDI). Foreign Direct Investment was at 40% in 1973 and a year later, it fell by 20%. Overall, the OPEC crisis led to a high increase in unemployment and inflation throughout the entire world. Furthermore, developing countries were negatively affected by the OPEC crisis. Around the time of the OPEC embargo, most third world countries took debt from the world bank and the IMF. “The combined deficit of oil-importing developing countries from the United States rose from $11.3 billion in 1973 to US$37 billion in 1974. It further expanded from US$42 billion in 1978 to US$88 billion in 1980”(Parfitt and Riley 2). In this case, we see that developing countries especially african countries were vulnerable and had no other choice other than accepting the loans given that most African countries gained their independence and were building their economy from colonization.
Can this type of crisis happen again? Were domestic or international safeguards were put in place?
It is very unlikely for such a crisis to happen again given that the United States market is more diversified and resilient. There has been a shale gas revolution which has resulted in the United States having a vast amount of natural gas making it completely independant should it choose (Brooks 2) It is also now an exporter of refined products Considerably in better condition due to increased oil and natural gas production. Given the instability in the region since 1970 (Bryce 1) FED price controls implemented by President Nixon trying to decrease consumption by rationing oil backfired and resulted in shortages.
Interest rate was not stable at the time with the Fed raising and lowering it numerous times throughout the crisis which resulted in companies being unable to properly plan for the market. Businesses made sure that prices were high so as to not make unexpected losses, this however only exacerbated inflation rates. People were also not hired in this time with businesses fearing the instability at the time (Amadeo). The FED however has since taken steps to prevent such negative actions in the economy. Now the FED is more consistent with their policies and intentional about signalling any actions they plan on taking in a given economic period. (Amadeo)
Internationally measures have been taken to prevent an oil crisis through organisations like the ECG, the IMF and the IAE. Under the Energy Coordinating Group (ECG) economic measures were created to ensure future stability of oil supplies and to figure out how best to cope with the consequences of the oil crisis. The International Monetary Fund (IMF) helped shape energy policy through the International Energy Agency (IEA), which implemented the International Energy Program. The IEA was founded in November of 1974 and continues to function as the central multilateral coordinating organization of Western industrialized countries in the field of energy (Turk,210).
Why this is an important event to understand
It is important to understand this because the Oil Crisis was directly led to the 1973-1975 recession in the United States. Understanding this crisis also lead to the development of a new field of study called resource economics.Before the crisis oil was not a concern of theoretical economists but since then that has shifted (Mitchell, 199-200). Economists such as Paul Frankel and Edith Penrose Essentials of Petroleum (1946), research on the economics of oil placed the subject within the framework of industrial economics, concerned with the behavior of firms, vertical integration and industrial structure, transfer prices and tax policy,and the underlying issue of the relationship between industry and government.
Furthermore, OPEC crisis is important to study and get informed about because it shows the different negative impacts that monopoly and dependence can harm the entire world. For instance, the OPEC countries used their monopolistic power to direct and dicte how the rest of the world’s economy would run. Plus, oil is an important commodity that is used on a daily basis. It is definitely clear that consumers can be hurt and hence leading to a dramatic collapse of the economy. Furthermore, the OPEC crisis taught the affected countries self-reliance. For instance, the United States decided to research and develop a method that could use less fuel which led them to be less dependent on foreign oil.
Currently, the United States is considered to be at a better position versus OPEC as the US is the biggest export of refined oil products(Bryce 3). Also, the OPEC crisis is an example of how international trade is essential and good for the world’s economy. Relating to the concept of Absolute advantage, we can see that without trade, the entre world suffers. Lastly, it is necessary to remember that the OPEC crisis was triggered by political interest. At first, the issue was not economical at all but the embargo ended up affecting the economy because OPEC nations had oil, which is a commodity that the US depended on. Thus, political tensions have a big impact on economic decisions and how the economy operates overall.
Works Cited:
- Mitchell T. The Resources of Economics, Journal of Cultural Economy, 3:2, 189-204, (2010) DOI: 10.1080/17530350.2010.494123
- Ditté Pascal, and Peter Roell. “Publication.” Publication – Center for Security Studies | ETH Zurich, https://css.ethz.ch/en/services/digital-library/publications/publication.html/20499.
- Verrastro, Frank A, and Guy Caruso. “The Arab Oil Embargo-40 Years Later.” The Arab Oil Embargo-40 Years Later | Center for Strategic and International Studies, 16 Oct. 2013, www.csis.org/analysis/arab-oil-embargo%E2%80%9440-years-later.
- Türk, Henning. “The Oil Crisis of 1973 as a Challenge to Multilateral Energy Cooperation among Western Industrialized Countries.” Historical Social Research, vol. 39, no. 4, Dec. 2014, pp. 209–230. EBSCOhost, doi:10.12759/hsr.39.2014.4.209-230.
- Parfitt, Trevor W., and Stephen P. Riley. The African Debt Crisis. Routledge, 2013.
- Issawi, Charles. “The 1973 Oil Crisis and After, by Charles Issawi.” Journal of Post Keynesian Economics, Taylor & Francis Journals, 1 Jan. 1979, ideas.repec.org/a/mes/postke/v1y1979i2p3-26.html.
- Brooks, David. “Shale Gas Revolution.” The NewYork Times 3 Nov. 2011 https://www.nytimes.com/2011/11/04/opinion/brooks-the-shale-gas-revolution.html
- Bryce, Robert. “40 Years After OPEC Embargo, U.S. Is Energy Giant.” Bloomberg 10 Oct. 2013 https://www.bloomberg.com/opinion/articles/2013-10-10/forty-years-after-opec-embargo-u-s-is-energy-giant
- Amadeo, Kimberly “OPEC Oil Embargo, Its Causes, and the Effects of the Crisis” The Balance, March 2019. https://www.thebalance.com/opec-oil-embargo-causes-and-effects-of-the-crisis-3305806
