Oil's role in the US economy, including the so-called new economy, received enlightening attention last month from one of the world's most widely watched economic authorities.
The attention came in an Oct. 19 speech, at a Cato Institute conference in Washington, DC, by Alan Greenspan, chairman of the US Federal Reserve Board. Among other things, Greenspan looked for signs of economic damage in the past year's oil-price surge and found surprisingly little. And he related reasons for that lack of damage to fundamental changes in both the economy and the oil and gas business.
The economy, Greenspan said, has benefited from elimination of the federal budget deficit and rising productivity of labor. And it doesn't divide as readily as popular assumption would have it between the old and the new. In fact, there's not much old economy left.
Less division
The return of oil prices to prominence as a "macroeconomic consideration" shows there to be "less of a stark division between old and new economies than is often loosely suggested," the Fed chief said. "Even the oil industry, a presumed old-economy stalwart, is a surprisingly major player in the new."
An important characteristic of the new economy is diminished energy intensity-the amount of energy consumed per unit of growth. In advanced industrial economies, energy intensity is half its level of the early 1970s, Greenspan pointed out. Most of the improvement came in response to past oil price increases. And most of it came before 1985. The lower energy intensity reduces the amount by which an oil-price jump curtails growth, the size of the reduction being dependent on the potential to cut energy consumption and to substitute other forms of energy for oil as relative prices change.
While advanced economies were becoming less vulnerable than before to oil-price increases, Greenspan noted, technical innovation lowered the cost of bringing new sources of oil supply onto production, even as new producing regions became more remote and inhospitable than their predecessors. Technology thus has held in check the marginal cost of producing oil, which will reassert itself as the main factor in the spot price of crude once oil inventories return to normal levels and uncertainties about production from the Middle East subside.
Despite reduced energy intensity, Greenspan said, oil prices still can alter the course of US economic growth. So far, however, the effect of the recent price surge has been modest.
"Any effect on inflation expectations, at least as inferred from the behavior of long-term Treasury inflation-indexed securities, has been virtually nil," the Fed chief said. "Moreover, despite some slowing that likely has been related in part to the bite from the so-called 'oil tax' on household incomes, the growth of consumer spending has remained firm."
The industry should welcome Greenspan's observations. At the very least, it should find satisfaction in his nod toward the technical accomplishments with which it has improved the economics of its work.
Furthermore, the industry should receive a political lift from the Fed chief's comments on sustained growth of consumer spending and the absence of inflationary signs. Doomsayers eager to reregulate the oil market because of a price surge have some explaining to do. Consumer ire about gasoline and heating oil prices notwithstanding, the hardship in this buoyant economy is far from extreme.
Evolutions
What is most important about Greenspan's analysis, however, is the attention it pays to evolutions of the economy and oil and gas industry since the price shock of the 1973-74 Arab oil embargo. Too much analysis, including some from within the industry itself, draws faulty parallels between conditions of nearly 30 years ago and those of the present. The world has changed. The industry has changed. The oil market has changed.
And as a result, the economic effects of a spurt in oil prices aren't what they used to be. It's an important message. It means the government has no compulsion, other than the fleeting pique of consumers, to lurch into the market, where it can only do damage. Coming from an economist of Greenspan's stature, the message is now harder than ever to ignore.
