Oil Price, Green House Gas and Economic Growth

The rising in oil price to its psychological level has undoubtedly created some growing concerns among the world’s society. Many solutions were being offered, from the most rational unto the irrational one. The concerns are mounting since the OPEC meeting has a very little impact on the price stabilization. Observers point out consumption rate as the main cause of the oil price surge. Restriction in consumption is viewed as a necessary condition to stop the oil price hike. This restriction is also viewed as a main condition to reduce the green house gas emission as a result for the abundant use of the fossil fuel. But is this restriction is necessary? Wouldn’t it only lead to a slower economic growth? Is it right to sacrifice a long term achievement to a short term shock? This article aims to answer all of these questions.

Restriction in consumption equals to impotent ion

From the weekly time series data ranging from 1997 until 2007, the trend in oil price hike will surely continue. An oil price projection using the Auto Regressive Integrated Moving Average (ARIMA) model which I had done in Asia Pacific Initiative Forum at Keio University, justifies the presumption. The oil price will go beyond its psychological level at US$ 100/barrel, and will continue to skyrocketing. Moreover, the oil price consumption growth rate is believed to play an important role in the oil price formation.

With the inelastic structure of oil price in terms of demand, this projection is making sense. The inelastic structure creates a huge inertia momentum so that the current hike in the oil price could not refrain the consumption level. In other words, if the presence of alternative energy that can be used massively is still vague, the oil price will continue to hike beyond imagination.

Restriction in consumption is most likely to correlate with the slower rate of oil price hike, but this action has a major consequence. With the restriction, every economic agents will be forced to refrain their economic activities especially which corresponds with the using of fossil fuel. This restriction, instead of becoming a solution, will create problems which have a long run impact. The most noticeable fixture is the obstruction in economic growth. Although it is not the only source of the society’s well being but economic growth is still viewed as a necessary condition for welfare.

The economic growth slow down will constrain the creation of new job opportunities. The discourage workers resulting from the lack of job will contribute to the rising in unemployment rate. These unemployed people will become poor because the absence of sustainable income. In aggregate terms, this will only hampers the community welfare. Restriction in consumption is a form of impotent ion, because it functions as a constraint in empowerment. In addition, the act of postponing oil consumption in current time will not shift the long term price structure. This hypothesis is a rational one since the fossil fuel is un renewable resource so that in the future, with the absence of alternative energy, the fossil fuel consumption will go back to its natural level and leads the price to continue rising.

The Solution

Question then arise; what policy is the most suitable to stop the rising in oil price? The answer is quite simple: do nothing! This answer surely raises one’s eyebrows but it turns out to be the most realistic solution. As describes earlier, every intentions to intervene the price through restriction in consumption will be in vain since the price will go back to its natural level.

There will surely be some sacrifice with the do nothing policy. The most apparent sacrifice is the collapse of industries, but it is important to note: this will only happens in the short run. In the long run, with the industry’s increasing economies of scale, industry will have the capability to substitute the fossil fuel with other form of energy that is cheaper and friendlier to the mother earth.

This process could go on even without government intervention since the forcing tools come naturally from the rising in oil price. It is surely a good news not only for a long run economic growth but also for the sustainability of the Mother Nature.

The Hypothetical Kuznets Curve

Nicholas Stern, a British economist and a former World Bank’s official, published a review which described global climatic change and its economic impact in the late 2006. In the review, Stern mentioned about the Kuznets Inverted U Curve.

The curve briefly describes the existence of a quadratic relationship between economic growth and the emission of green house gas. In a low level of income, the bigger the income the bigger the oil consumption which results a higher emission level. But the curve has a turning point whereas in a high level of income, the bigger the income the lesser the oil consumption which results in a lower emission level.

Based on the theory, I make an analysis through a Vector Auto Regressive model which aims to see the relationship between GDP growth, the oil consumption rate and the emission rate. The result is quite similar to the curve’s description whereas in the long run, with the rising in the world’s GDP growth, the oil consumption rate will be decreasing resulting in a lower level of emission.

With all the logic describes earlier, it is wrong to restrict consumption, because it will happens naturally with the rising in price. The ability to develop alternative energy will increase along with the world’s GDP growth. With the do nothing policy, in the long run we will have more stable economic growth and cleaner environments.