Hadi Salehi Esfahani is a professor of economics whose research focuses on Middle East and Third-World economies. He is executive secretary of the Middle East Economic Association, a non-political organization of economists and scholars. Oil, of course, is the Middle East's biggest industry, and the rapid increase of oil prices has raised concerns that the world economy is facing a new round of instability. He was interviewed by News Bureau Business and Law Editor Mark Reutter.
The oil price shocks of 1973-74 and 1979-80 caused major disruptions to the U.S. economy. With the price of crude oil jumping to $75 a barrel and gas nearing $3 a gallon at the pump, are we headed toward an energy-driven recession?
An energy-driven recession is unlikely. Some slowdown in growth is quite possible, but not a recession. Two major things have changed since the 1970s that should help the economy now. First, the country is far less energy-dependent than it used to be. This is largely because the economy has moved away from manufacturing toward the production of services, which are not very energy intensive. So an increase in oil price has less effect on production and prices nowadays. The second factor is that economists know much more about the dynamics of the economy and provide much better advice to the Federal Reserve and the government about policies that mitigate adverse effects such as oil price shocks.
Since the 1970s, there have been frequent calls for policies that ensure energy security for the U.S. But isn't the country today more dependent on foreign oil, especially oil from the Middle East, than ever before?
If you define dependence in terms of share of imports in total energy use, yes, the U.S. is more dependent on foreign oil. But this is not correct if you take a broader perspective. As I just mentioned, energy use relative to GDP production has gone down. So overall we are less dependent on energy. Another consideration is that the oil market has many more players nowadays, which gives us greater independence from groups like OPEC [Organization of the Petroleum Exporting Countries]. Finally, many businesses have evolved towards systems that can switch to alternative sources of energy or can reduce energy costs with marginal investments. In sum, we have more flexibility in terms of where we want to buy oil and the way we want to use it.
Why hasn't the U.S. made better strides at switching to alternative sources of energy since the 1970s?
Let me first say that the U.S. has in some ways made progress, partly through investment in alternative-energy production processes and partly through outsourcing to countries that produce goods with less or alternate sources of energy. But overall I agree that more could have been done. Certainly, the relatively low price of oil over the last two decades diminished the incentive to invest in alternate sources. With crude oil prices tripling over the past four years, we are likely to see much greater efforts to tap into non-oil sources.
What can the government do today?
Washington can adopt strategies that speed up the process of switching away from oil. Adopting new energy sources involves a "network effect" in which it becomes worthwhile for each of us to do something because many others are doing the same thing. For example, cars using natural gas could become a much more attractive choice to individual consumers if the market for them were larger and there were service stations offering the fuel and repair shops able to fix them. This requires coordination, infrastructure, and incentives. The government can aid in this process through its tax policies, research programs, and by actively educating the public.