Arab freedom is worth a short shock

A poster showing Libyan leader Moammar Gadhafi is burned by a protester with Arabic writing translating as 'We Embrace the Glory with You', during a demonstration against him in Benghazi, eastern Libya, Wednesday, March 2 , 2011. (AP Photo/Kevin Frayer)

2 Mar 2011
Martin Wolf
Financial Times

What might the Arab uprising mean for the world? No one knows the answer to this question. But this should not prevent one from making a guess at the range of uncertainty.

As an economist, I find one aspect of these events peculiarly heartening: they demonstrate that the forecasting ability of experts on politics is at least as limited as that of economists. All such events are inherently unforecastable. This is not because they are “unknown unknowns”. They are rather “known unknowns”: thus we know that many countries are vulnerable to such upheavals, but no one knows when or even whether such an event might occur. We do not even know the probabilities of such events. As Hamlet says, “the readiness is all”.

What, then, can we say about the political consequences? One conclusion is that the notion of an “Arab exception” to the appeal of freedom of expression and political participation is dead. Yet we also know that the road from repression to stable democracy in poor countries with weak institutions and histories of repression is long and hard. The difficulties of post-Ceauçescu Romania, in spite of its engagement with the European Union, indicate the scale of the task.

Beyond this, a big question is how far the unrest might spread, not only within the Arab world, but also outside it. The assumption had been that the ability of oil exporters to spread wealth internally would protect them. After Bahrain and, still more, Libya, this is no longer convincing. Geographic and cultural distance from the epicentre should give some protection, as should economic dynamism and competent governance. But these events show how universal is the yearning for a political voice. The idea of cultural immunity to these allegedly western ideals looks less credible. This wave may dissipate; others will follow.

Now turn to the economic consequences. So long as oil producers were immune, these could be deemed minimal in the short run and modest in the long run. Even Egypt’s economy is smaller, at market prices, than that of the Czech Republic. But, it appears, oil producers are not immune after all. As a result, oil prices rose above $114 a barrel on Tuesday, 64 per cent higher than in May 2010. For those with memories of past shocks, this is a worrying omen. The question is: just how worried should we be?

As Gavyn Davies noted in an excellent comment on FT.com last week: “Each of the last five major downturns in global economic activity has been immediately preceded by a major spike in oil prices.” Sometimes those spikes were triggered by supply shocks, as in the 1970s. Sometimes they were triggered by demand surges, as in 2008. But the outcome was always unhappy. Stephen King of HSBC also waxed pessimistic: “Regular as clockwork, increases in oil prices of more than 100 per cent lead to declining GDP.”

An oil shock has complex economic effects: it transfers income from consumers to producers; it lowers overall spending, as consumers normally cut their spending more quickly than producers increase theirs; it shifts spending away from other goods and services; it makes net oil exporting countries richer and net oil importers poorer; it raises the price level; it lowers real wages and the profitability of energy-using industries; and it reduces supply as capacity becomes uneconomic.

Some effects are quite immediate – the impact on the price level, for example. Some are inherently long term and so depend on the durability of the shock – the impact on capacity being an example. In addition, some effects are direct and others depend on policy responses.

What can we say about all such impacts, at this early juncture? Mr Davies notes that, at current prices, a jump in prices of $20 a barrel would raise spending on oil by about 1 per cent of world spending on all products. Over the past 10 months, however, prices have risen by $40. That would make the effect close to 2 per cent of world output – enough to trigger a noticeable global slowdown, at least in the short run. On balance, as Mr Davies notes, the impact on emerging economies, which are more energy-intensive than the advanced countries, would be larger. The US, with its wasteful energy policies, is also far more vulnerable than its peers.

Beyond that, much would depend on the durability of the price spike and on the policy responses. If the recent jump proved short-lived, the economic effect would be reversed. Among important questions is how far such unrest affects other producers, particularly Saudi Arabia. For now, the latter can replace lost Libyan production: Libya’s output – some 2 per cent of the world’s total – is less than Saudi Arabia’s excess capacity. Moreover, any reduction in output even in directly affected countries should be brief, provided capacity is undamaged: governments of oil exporting countries want revenues. Democratic governments might need the revenues more than despots.

The more spenders believe the shock is short term, the more inclined they will be to dip into their savings. Hitherto, energy-importing emerging economies suffered from a limited ability to borrow, inadequate currency reserves and weak external positions. When emerging economies borrowed in the late 1970s, to finance oil imports, they finished up with a massive debt crisis in the 1980s. This should be true no longer. They, too, can spend through a brief shock.

In addition, so long as inflation expectations remain in check, central banks need not engage in pre-emptive tightening. In this respect, the high-income countries are in rather better shape than emerging countries, where inflation is a bigger danger and inflation expectations less well anchored.

We end, then, where we began, with a high level of uncertainty. We know that the political upheaval is highly significant, probably a historic watershed. We know, too, that the oil shock may be quite important, albeit very far from catastrophic and possibly rather brief. Overall, then, the long-run political implications seem much more significant than the economic ones. But such optimism about the short-term economic effects depends, in part, on the assumption that the further spread of unrest is now contained. That would also depend on the continuation of the bad old bargain: repression as the price for stability in oil supply. It is an attractive bargain to consumers. But is it morally desirable or even politically sustainable in the long run?