March 31, 2016

Oil Prices and the Global Economy: It’s Complicated

Oil prices have been persistently low for well over a year and a half now, but as the April 2016 World Economic Outlook will document, the widely anticipated “shot in the arm” for the global economy has yet to materialize. We argue that, paradoxically, global benefits from low prices will likely appear only after prices have recovered somewhat, and advanced economies have made more progress surmounting the current low interest rate environment.

Since June 2014 oil prices have dropped about 65 percent in U.S. dollar terms (about $70) as growth has progressively slowed across a broad range of countries. Even taking into account the 20 percent dollar appreciation during this period (in nominal effective terms), the decline in oil prices in local currency has been on average over $60. This outcome has puzzled many observers including us at the Fund, who had believed that oil-price declines would be a net plus for the world economy, obviously hurting exporters but delivering more-than-offsetting gains to importers. The key assumption behind that belief is a specific difference in saving behavior between oil importers and oil exporters: consumers in oil importing regions such as Europe have a higher marginal propensity to consume out of income than those in exporters such as Saudi Arabia.

World equity markets have clearly not subscribed to this theory. Over the past six months or more, equity markets have tended to fall when oil prices fall—not what we would expect if lower oil prices help the world economy on balance. Indeed, since August 2015 the simple correlation between equity and oil prices has not only been positive (Chart 1), it has doubled in comparison to an earlier period starting in August 2014 (though not to an unprecedented level).

Past episodes of sharp changes in oil prices have tended to have visible countercyclical effects—for example, slower world growth after big increases. Is this time different? Several factors affect the relation between oil prices and growth, but we will argue that a big difference from previous episodes is that many advanced economies have nominal interest rates at or near zero.

Supply versus demand

One obvious problem in predicting the effects of oil-price movements is that a fall in the world price can result either from an increase in global supply or a decrease in global demand. But in the latter case, we would expect to see exactly the same pattern as in recent quarters—falling prices accompanied by slowing global growth, with lower oil prices cushioning, but likely not reversing, the growth slowdown.

Slowing demand is no doubt part of the story, but the evidence suggests that increased supply is at least as important. More generally, oil supply has been strong owing to record high output from members of the Organization of the Petroleum Exporting Countries (OPEC) including, now, exports from Iran, as well as from some non-OPEC countries. In addition, the U.S. supply of shale oil initially proved surprisingly resilient in the face of lower prices. Chart 2 shows how OPEC output has recently continued to grow as prices have fallen, unlike in some previous cycles.

Moreover, even in the United States, a net oil importer where demand has been fairly strong, cheap oil seems not to have given a substantial fillip to growth. Econometric and other studies suggest that only part of the recent decline in oil is due to slowing demand—somewhere between a half and a third—with the balance accounted for by increasing supply.

So there remains a puzzle: where in the world can the positive effects of lower oil prices be seen?

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March 1, 2016

Public Roads with Private Money: A Way Ahead

[From iMFdirect] When you drive over potholes on downtown streets, are forced to make large detours to cross rivers lacking bridges, and finally arrive to find no cell coverage, connections between the global infrastructure investment gap and your pension fund might not be the immediate thing that comes to mind. But it should, because:
  • Huge pools of available assets: pension funds, insurance companies, mutual funds and sovereign wealth funds sit on $100 trillion in assets. To compare: U.S. nominal GDP in the third quarter of last year was $18 trillion.
  • Huge infrastructure investment gap: between $1 to 1.5 trillion per year worldwide.

By putting to work a small portion of the privately owned $100 trillion for global infrastructure development, the positive impact on the global economy could be bigger than any other source of large-scale private investments.

In a new paper, From Global Savings Glut to Financing Infrastructure: The Advent of Investment Platforms, several economists at the IMF, in academia, and business explored the problem of how to lure badly needed private investment into meaningful infrastructure projects on a global scale.

To enhance the cooperation between public and private partners, there is a new class of facilitators like the European Investment Bank or the Asia Infrastructure Investment Bank. But how can they avoid engaging private investment in inefficient infrastructure projects, bridges to nowhere, or avoid granting too generous concession terms, like high highway tolls?

The paper makes a number of suggestions, including the creation of infrastructure securities and a global infrastructure investment platform.

A Move South

A growing number of large resource finds are in the developing world, reflecting growing openness in their economies

High-income countries have long been the main users and suppliers of natural resources.­

It could be bauxite, copper, and iron ore across much of Europe—not to mention coal, lead, mercury, zinc, and oil and natural gas. English and Belgian coal deposits fueled the Industrial Revolution.­

When the United States achieved independence in the late 18th century it was widely thought of as a country with “an abundance of land but virtually no mining potential.” (O’Toole, 1997). But a century later, after the rebellious colonies had developed into a stable country, the United States not only became a high-income country in today’s parlance but it overtook Europe to become the world’s major resource producer.­

Today, though, the high-income-country share of global resource deposits has fallen, driven by growth in discoveries in other, less-developed parts of the world.­

We document a major shift in resource exploration and extraction from high-income regions, or the “North,” to emerging market and developing economies, or the “South.” This shift in resource discovery and extraction is associated with efforts in emerging market and developing economies to open up to foreign investment and/or improve their institutions— including through more stable government and stronger rule of law. That North-South shift mirrors on a global scale what happened in the United States after independence.­

The new policies that have sparked a move south in global resource exploration and extraction operate over and above other forces that affect natural resource exploitation, such as rising global demand, especially from emerging markets, and depletion of deposits in the North. That shift has important implications both for the welfare of individual countries and for our global understanding of the balance of forces shaping commodity markets. Moreover, the increasing number of finds in developing economies puts to rest concerns that the world will soon run out of mineral and oil resources.­

North to South shift

The data on known reserves of subsoil assets suggest that developing economies have much more oil, metals, and minerals to discover. There is an estimated $130,000 worth of known subsoil assets beneath the average square kilometer of advanced and emerging market Organisation for Economic Co-operation and Development (OECD) member countries. That is much more than the roughly $25,000 in known assets in Africa (Collier, 2010; McKinsey Global Institute, 2013).­

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