Oil Price Impact on Inflation and Global Finance Since 1973
The Rise in Oil Prices and Inflation Trends
The new monetary system is characterized by high volatility but also by great flexibility in the two main adjustment mechanisms: the exchange rates of major Western currencies and movements in the balance of payments. This feature facilitated the absorption of the imbalance that occurred in international payments after the first oil shock of 1973. The rising oil prices resulted in a decrease for Western economies of some 150 billion dollars between 1973 and 1978. This rise was a punitive operation by OPEC countries against the West for their assistance to Israel during the Yom Kippur War. Surprised by this, consumer countries reacted by enacting provisions designed to save energy and use other forms, such as nuclear and renewables, in addition to promoting oil exploration outside of OPEC.
However, these were long-term policies, so oil demand in industrial countries remained high, leading to imbalances in trade balances, accelerating inflation, and international monetary disorder. The oil crisis triggered the economic crisis. Although the situation improved between 1974 and 1978, Iran’s revolution altered the market again: in 1980, OPEC raised prices once more. This second shock hit weakened economies, and the increase in the energy bill was even more difficult to absorb.
Regarding price movements and inflation, the crisis presented a very original appearance. Instead of an initial phase of deflation, like the one that occurred after 1929, there was a clear inflationary trend from the very beginning. In the ten years leading up to 1974, inflation reached an average of 10% in OECD countries. Although the trigger of the phenomenon was the rise in oil prices, other structural elements should not be neglected, such as the tertiary sector of the economy and the disappearance of the role of industry as a snubber of inflation. All this was now becoming a major problem, and government action had, as one of its priority objectives, the control of rising prices.
Capital Movements
On the financial side, from 1980 onward, there was a greater tendency towards globalization due to the free movement of capital. Financial globalization rests on a freer flow of capital, the abolition of intermediaries, and the communication of national financial systems. This fostered a global capital market. Liberal theory posits that global growth has been favored because it facilitates a more efficient placement of capital, reduces the costs of intermediaries, and obliges governments to be responsible in their economic policies. These statements must be qualified because of the emergence of new risks. Floating capital today represents a total volume of about 4 trillion, likely to move almost instantaneously from one financial center to another in search of better remuneration, obeying their movements sometimes to mere rumors and not to data analysis of economic fundamentals. The monetary and financial spheres are disconnected from the real economy.
New Directions in State Policy
The fact that governments were faced with new problems caused by double-digit inflation rates, floating exchange rates, wide-open capital markets, and disturbances in the balance of payments and the terms of exchange was the origin of significant changes in the goals and tactics of official policy. The problems of inflation and unemployment played a central role in the economic and political debate for most of the period. It was in this context that neoliberal economics became dominant both in theory and macroeconomic policy.
The reason was that Keynesian theory was unable to provide an adequate explanation of the stagflation that followed the economic crisis of the seventies. This has some irony because Keynesian economic theory came to dominate 30 years earlier because the neoclassical economic theory, which supports neoliberal economics, was itself unable to explain the enormous and lasting unemployment of the last Great Depression. During the 1970s, most countries deployed policies to relaunch the economy while trying to maintain the wage level. However, the result was an increase in inflationary pressures and budget deficits, while unemployment and inflation grew. At the same time, corporate margins were degraded under the effect of market saturation of durable goods and the allocation of productivity gains to wages.
There was an ideological swing toward Friedman’s monetarism and to the views of Hayek and the neo-Austrians, who saw unemployment as a useful corrective. From the eighties onward, governments inclined toward strict policies of neoliberal inspiration, which gave priority to fighting inflation through wage moderation and the restoration of the trade balance through competitiveness. There was a steady decline in public sector business. Although inflation was reduced dramatically, it was not possible to relaunch investment and employment. The latter only fleetingly progressed between 1986 and 1990, after which unemployment increased further and economic growth slowed.
This has opened the debate on the need for another policy. A policy that requires concerted action at the OECD or European level whose purpose is to allocate a substantial portion of productivity gains to higher wages and demand stimulation. The European growth initiative proposed at the Edinburgh Summit in 1992 went in that direction. However, the requirements of the convergence criteria of the Maastricht Treaty have prevented the progress of the project.
Since the 1980s, increasing inequality, unemployment, and exclusion compound the difficulties of financing social protection systems, also affected by the aging population and the economic crisis. As the necessary adjustments were made by way of increased social security contributions, the damaging impact of these overly focused attention and criticism of economic agents. In fact, theoretical analyses began to develop that questioned the efficiency of these systems and recommended control of social spending, referring to the crisis in the welfare state. In these texts, it is sometimes forgotten that social expenditures have avoided the collapse in demand and production, as happened during the crisis of the 1930s.