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Unforeseen consequences

A lesson in unforeseen consequences

One of the ways you know that you are dealing with a religion is when the priests reject evidence because it conflicts with the model of how the world is meant to be.  Indeed, history is littered with the corpses of apostates, blasphemers and heretics who had the temerity to tell the truth to power.  Science, by contrast, is rooted in doubt.  Karl Popper, one of science’s greatest philosophers, made clear that it is impossible to know anything for certain.  The best you can do is to disprove a wrong idea.  But you can never prove a true one.

It is in this light that we should view the neoclassical economics models that “proved” that low oil prices are a good thing because they stimulate growth in an otherwise stagnating economy.  Low oil prices, we were told, were like a tax cut for the workers.  Not only were we saving on the petrol and diesel used to fuel our cars, but on all goods or services that included transport costs in their price.

The extra spending power that low oil prices were supposed to give us, would cause more consumer spending.  This would increase business profits, trigger new investment, and ultimately lead to renewed economic growth.

Fast forward twelve months and things are looking very different.  Or, to put it another way, the model was wrong.  Low oil prices have either caused or exacerbated a growing global economic crisis – the very opposite of what was meant to happen.  There are lots of reasons why.  Among the most obvious was the fact that people do not follow “economic reasoning.”

People had no obligation to spend any savings they enjoyed.  They could just as easily have used savings to pay off their debts.  Alternatively, they could save against the time when prices rose again.  And, of course, we are assuming that the savings got as far as the end consumer.  But we know that both fuel companies and energy suppliers sat on the savings for the best part of a year before starting to hand them over.  Nor was there any obligation on companies selling goods and services to pass their transport savings on to their consumers.  They, too, might opt to pay off debts or save against the day when prices rise once again.

So lower oil prices have not delivered the economic upswing that the high priests of neoclassical economics promised.  Worse still, today there is growing evidence that low prices are having a catastrophic impact on the supply side.  Oil companies are slashing investment in future exploration and production, and laying-off thousands of skilled workers.  This, in turn, is devastating for local economies that developed around the oil industry.

Governments, still struggling with post-2008 debts, are also suffering.  In the UK for example, North Sea oil has switched from being a mainstay of UK government income to yet another state-subsidised liability.  Indeed, set aside the global companies (BG, BP and Shell) and the remaining 112 publicly traded North Sea oil companies are now worth less than Marks & Spencer.

These are just the obvious impacts of low oil prices.  But there are other, less foreseeable consequences:  The rise in US and UK road deaths, for example; or the collapse of East African piracy; or, even less obviously the increase in air fares.  There are even those who argue that low oil prices will do more to cripple ISIL than western air strikes have managed – although this may well backfire as the same low oil prices help to undermine the legitimacy of the Middle East monarchies.  With oil debt now beginning to infect the global and banking system, the unforeseen consequences of low oil prices might be about to get an order of magnitude more serious.

Perhaps the lesson for economists – and the politicians who they advise – is to ditch the models that caused the problem, and start looking at the evidence before it is too late.  As Albert Einstein said:

“We cannot solve problems at the same level at which we created them.”

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