As we saw in Part 1 of this blog, oil prices have fallen by some 46% in the past five months. In that blog we looked at the implications for fuel prices. Here we look at the broader implications for the global economy? Is it good or bad news – or both?
First we’ll look at the oil-importing countries. To some extent the lower oil price is a reflection of weak global demand as many countries still struggle to recover from recession. If the lower price boosts demand, this may then cause the oil price to rise again. At first sight, this might seem merely to return the world economy to the position before the oil price started falling: a leftward shift in the demand for oil curve, followed by a rightward shift back to where it was. However, the boost to demand in the short term may act as a ‘pump primer’. 
The higher aggregate demand may result in a multiplier effect and cause a sustained increase in output, especially if it stimulates a rise in investment through rising confidence and the accelerator, and thereby increases capacity and hence potential GDP.
But the fall in the oil price is only partly the result of weak demand. It is mainly the result of increased supply as new sources of oil come on stream, and especially shale oil from the USA. Given that OPEC has stated that it will not cut its production, even if the crude price falls to $40 per barrel, the effect has been a shift in the oil supply curve to the right that will remain for some time.
So even if the leftward shift in demand is soon reversed so that there is then some rise in oil prices again, it is unlikely that prices will rise back to where they were. Perhaps, as the diagram illustrates, the price will rise to around $70 per barrel. It could be higher if world demand grows very rapidly, or if some sources of supply go off stream because at such prices they are unprofitable.
The effect on oil exporting countries has been negative. The most extreme case is Russia, where for each $10 fall in the price of oil, its growth rate falls by around 1.4 percentage points (see). Although the overall effect on global growth is still likely to be positive, the lower oil price could lead to a significant cut in investment in new oil wells. North sea producers are predicting a substantial cut in investment. Even shale oil producers in the USA, where the marginal cost of extracting oil from existing sources is only around $10 to £20 per barrel, need a price of around $70 or more to make investment in new sources profitable. What is more, typical shale wells have a life of only two or three years and so lack of investment would relatively quickly lead to shale oil production drying up.
The implication of this is that although there has been a rightward shift in the short-run supply curve, if price remains low the curve could shift back again, meaning that the long-run supply curve is much more elastic. This could push prices back up towards $100 if global demand continues to expand.
This can be illustrated in the diagram. The starting point is mid-2014. Global demand and supply are D1 and S1; price is $112 per barrel and output is Q1. Demand now shifts to the left and supply to the right to D2 and S2 respectively. Price falls to $60 per barrel and, given the bigger shift in supply than demand, output rises to Q2. At $60 per barrel, however, output of Q2 cannot be sustained. Thus at $60, long-run supply (shown by SL) is only Q4.
But assuming the global economy grows over the coming months, demand shifts to the right: say, to D3. Assume that it pushes price up to $100 per barrel. This gives a short-run output of Q3, but at that price it is likely that supply will be sustainable in the long run as it makes investment sufficiently profitable. Thus curve D3 intersects with both S2 and SL at this price and quantity.
The articles below look at the gainers and losers and at the longer-term effects.
Articles
Where will the oil price settle? BBC News, Robert Peston (22/12/14)
Falling oil prices: Who are the winners and losers? BBC News, Tim Bowler (16/12/14)
Why the oil price is falling The Economist (8/12/14)
The new economics of oil: Sheikhs v shale The Economist (6/12/14)
Shale oil: In a bind The Economist (6/12/14)
Falling Oil Price slows US Fracking Oil-price.net, Steve Austin (8/12/14)
Oil Price Drop Highlights Need for Diversity in Gulf Economies IMF Survey (23/12/14)
Lower oil prices boosting global economy: IMF Argus Media (23/12/14)
Collapse in oil prices: producers howl, consumers cheer, economists fret The Guardian (16/12/14)
North Sea oilfields ‘near collapse’ after price nosedive The Telegraph, Andrew Critchlow (18/12/14)
How oil price fall will affect crude exporters – and the rest of us The Observer, Phillip Inman (21/12/14)
Cheaper oil could damage renewable energies, says Richard Branson The Guardian,
Richard Branson: ‘Governments are going to have to think hard how to adapt to low oil prices.’ John Vidal (16/12/14)
Data
Brent crude prices U.S. Energy Information Administration (select daily, weekly, monthly or annual data and then download to Excel)
Brent Oil Historical Data Investing.com (select daily, weekly, or monthly data and time period)
Questions
- What would determine the size of the global multiplier effect from the cut in oil prices?
- Where is the oil price likely to settle in (a) six months’ time; (b) two years’ time? What factors are you taking into account in deciding your answer?
- Why, if the average cost of producing oil from a given well is $70, might it still be worth pumping oil and selling it at a price of $30?
- How does speculation affect oil prices?
- Why has OPEC decided not to cut oil production even though this is likely to drive the price lower?
- With Brent crude at around $60 per barrel, what should North Sea oil producers do?
- If falling oil prices lead some oil-importing countries into deflation, what will be the likely macroeconomic impacts?
The retail food industry is an oligopoly – a market dominated by a few big firms, with interdependence between them. This means that each firm considers the reaction of all its competitors when making any decision. Pricing is one of those key decisions and this is one of the reasons why price wars tend to break out in this industry.
For consumers, price wars are usually seen as a good thing, as it means prices in the supermarkets get forced downwards, thus reducing the cost of living. Low prices in this case are one of the key benefits of competition. However, there are costs of such fierce competition for suppliers. 
As final prices to customers are pushed down, small competitors are likely to feel the squeeze and may be forced out of the market. The other losers are suppliers. The big supermarkets are likely to pay lower prices to their suppliers, thus adversely affecting their livelihood. Research suggests that throughout 2014, 146 food producers entered insolvency, which is significantly higher than last year.
Accountancy firm, Moore Stephens, has blamed the supermarket price war for this rise in insolvencies in the food production sector. Duncan Swift from this firm said:
“The supermarkets are going through the bloodiest price war in nearly two decades and are using food producers as the cannon fodder…Supermarkets have engaged in questionable buying practices for years, but it’s getting worse and clearly wreaking havoc on the UK food production sector.”
The British Retail Consortium has said that placing the blame in this way was too simplistic. A commentator suggested that many suppliers have long-standing relationships with the supermarkets they deal with, suggesting that relations were good and sustainable.
Furthermore, it was suggested that the demise of these producers may be due to many other factors and the data on insolvencies did not show that those firms affected were suppliers to the supermarkets. There is a Groceries Code Adjudicator in place to ensure that the supermarkets do not abuse their power when it comes to dealing with their suppliers, but the power of this person is limited, leaving suggestions remaining that suppliers are vulnerable. The following articles consider both the good and bad of price wars.
Articles
Questions
- What are the characteristics of an oligopoly? Why do price wars tend to break out in oligopolies, such as the supermarket industry?
- Apart from the supply-chain pressure from supermarkets, what other factors could have caused so many small food producers to become insolvent?
- How does the supermarket supply chain work and why have the price wars led to suppliers being squeezed?
- Use a diagram to illustrate the impact of the price war on (a) the supermarkets and (b) the suppliers.
- How important is the Groceries Code Adjudicator and should she be doing more to protect suppliers?
- If supermarkets are cutting prices, is this an indicator of unfair competition or good competition?
With Christmas approaching, sales will once again begin to rise and cards will be written. Mail services will be at their busiest as we post millions of cards and parcels every day. But, the question is: will they arrive? Workers in the supply chain at Royal Mail have voted to strike over pay.
Since the part privatisation of Royal Mail, many criticisms have emerged, ranging from the price at which shares were sold, the efficiency of the Royal Mail, suggestions of varying prices for delivery depending on location, and now over pay. As with any labour market, there is a demand and a supply of workers and the intersection of these curves creates our equilibrium wage. If the wage is forced up above the equilibrium wage by the actions of trade unions, then there is the potential for unemployment to be created.
The Communications Workers Union (CWU) feels that their pay is insufficient. Dave Ward, Deputy General Secretary of CWU said:
“Thanks entirely to the unreasonable attitude of Post Office management, a pre-Christmas national strike is looking inevitable…The workforce has made a major contribution to the company’s success and have every right to their fair share.”
However, the head of the supply chain at Royal Mail has responded to the threats of strike, referring to the 5% pay rise promised to its workers over the next three years, saying:
“We are undertaking the biggest modernisation programme in UK retail history to ensure we become commercially viable and reduce our reliance on public money…We urge the CWU to reconsider their unrealistic demands and discuss an affordable pay deal rather than call strike action which can only cost our people money.”
The row over pay is not the only way that job losses could emerge. A major criticism levelled at the Royal Mail is its lack of efficiency, especially in terms of cost reductions and work flexibility. 
The Royal Mail has become increasingly concerned by competition, especially as its low-cost competitors can choose to whom they deliver. Those living in built up areas receive mail, but for those living in more rural areas, some of Royal Mail’s competitors will not deliver there, because of the higher costs. Royal Mail does not have this luxury and hence must deliver to loss-making places. Royal Mail says that this is creating unfair pressure to its business and is calling for these competitors to be forced to deliver to rural areas and small businesses. However, one such company, Whistl, has said that the figures from Royal Mail suggest that ‘productivity is not a sufficiently high enough management priority.
If the strike does go ahead in the build up to Christmas, then the management priorities of Royal Mail will certainly be under scrutiny. The following articles consider the current situation.
Articles
Questions
- If there is strike action in a labour market, what can we conclude about the market in question in terms of how competitive it is?
- Is strike action completely pointless?
- What actions could workers take, other than strike action, to achieve a resolution of their grievances? Discuss what employers could offer in an attempt to resolve the situation?
- What are the arguments for making Royal Mail’s competitors deliver to all places, just as the Royal Mail must do?
- The efficiency of the Royal Mail has been called into question. If efficiency improved, would this mean that pay rises were more or less feasible?
Lloyds Banking Group has announced that it plans to reduce its labour force by 9000. Some of this reduction may be achieved by not replacing staff that leave, but some may have to be achieved through redundancies.
The reasons given for the reduction in jobs are technological change and changes in customer practice. More banking services are available online and customers are making more use of these services and less use of branch banking. Also, the increasingly widespread availability of cash machines (ATMs) means that fewer people withdraw cash from branches.
And it’s not just outside branches that technological change is impacting on bank jobs. Much of the work previously done by humans is now done by software programs.
One result is that many bank branches have closed. Lloyds says that the latest planned changes will see 150 fewer branches – 6.7% of its network of 2250.
What’s happening in banking is happening much more widely across modern economies. Online shopping is reducing the need for physical shops. Computers in offices are reducing the need, in many cases, for office staff. More sophisticated machines, often controlled by increasingly sophisticated computers, are replacing jobs in manufacturing.
So is this bad news for employees? It is if you are in one of those industries cutting employment. But new jobs are being created as the economy expands. So if you have a good set of skills and are willing to retrain and possibly move home, it might be relatively easy to find a new, albeit different, job.
As far as total unemployment is concerned, more rapid changes in technology create a rise in frictional and structural unemployment. This can be minimised, however, or even reduced, if there is greater labour mobility. This can be achieved by better training, education and the development of transferable skills in a more adaptive labour force, where people see changing jobs as a ‘normal’ part of a career.
Webcasts
Lloyds Bank cuts 9,000 jobs – but what of the tech future? Channel 4 News, Symeon Brown (28/10/14)
Lloyds Bank confirms 9,000 job losses and branch closures BBC News, Kamal Ahmed (28/10/14)
Article
Lloyds job cuts show the technology axe still swings for white collar workers The Guardian, Phillip Inman (28/10/14)
Reports
Unleashing Aspiration: The Final Report of the Panel on Fair Access to the Professions Cabinet Office (July 2009)
Fair access to professional careers: a progress report Cabinet Office (30/5/12)
Questions
- Is a reduction in banking jobs inevitable? Explain.
- What could banks do to reduce the hardship to employees from a reduction in employment?
- What other industries are likely to see significant job losses resulting from technological progress?
- Distinguish between demand-deficient, real-wage, structural and frictional unemployment. Which of these are an example, or examples, of equilibrium unemployment?
- What policies could the government pursue to reduce (a) frictional unemployment; (b) structural unemployment?
- What types of industry are likely to see an increase in employment and in what areas of these industries?
The typical UK high street is changing. Some analysts have been arguing for some time that high streets are dying, with shops unable to face the competition from large supermarkets and out-of-town malls. But it’s not all bad news for the high street: while some types of shop are disappearing, others are growing in number.
Part of the reason for this is the rise in online shopping; part is the longer-term effects of the recession. One consequence of this has been a shift in demand from large supermarkets (see the blog, Supermarket wars: a pricing race to the bottom). Many people are using local shops more, especially the deep discounters, but also the convenience stores of the big supermarket chains, such as Tesco Express and Sainsbury’s Local. Increasingly such stores are opening in shops and pubs that have closed down. As The Guardian article states:
The major supermarket chains are racing to open high street outlets as shoppers move away from the big weekly trek to out-of-town supermarkets to buying little, local and often.
Some types of shop are disappearing, such as video rental stores, photographic stores and travel agents. But other types of businesses are on the increase. In addition to convenience stores, these include cafés, coffee shops, bars, restaurants and takeaways; betting shops, gyms, hairdressers, phone shops and tattoo parlours. It seems that people are increasingly seeing their high streets as social places.
Then, reflecting the widening gap between rich and poor and the general desire of people to make their money go further, there has been a phenomenal rise in charity shops and discount stores, such as Poundland and Poundworld.
So what is the explanation? Part of it is a change in tastes and fashions, often reflecting changes in technology, such as the rise in the Internet, digital media, digital photography and smart phones. Part of it is a reflection of changes in incomes and income distribution. Part of it is a rise in highly competitive businesses, which challenge the previous incumbents.
But despite the health of some high streets, many others continue to struggle and the total number of high street stores across the UK is still declining.
What is clear is that the high street is likely to see many more changes. Some may die altogether, but others are likely to thrive if new businesses are sufficiently attracted to them or existing ones adapt to the changing market.
How the rise of tattoo parlours shows changing face of Britain’s high streets The Guardian, Zoe Wood and Sarah Butler (7/10/14)
The changing face of the British High Street: Tattoo parlours and convenience stores up, but video rental shops and travel agents down Mail Online, Dan Bloom (8/10/14)
High Street footfall struggles in August Fresh Business Thinking, Jonathan Davies (15/9/14)
Ghost town Britain: Internet shopping boom sees 16 high street stores close every day Mail Online, Sean Poulter (8/10/14)
Questions
- Which of the types of high street store are likely to have a high income elasticity of demand? How will this affect their future?
- What factors other than the types of shops and other businesses affect the viability of high streets?
- What advice would you give your local council if it was keen for high streets in its area to thrive?
- Why are many large superstores suffering a decline in sales? Are these causes likely to be temporary or long term?
- How are technological developments affecting high street sales?
- What significant changes in tastes/fashions are affecting the high street?
- Are you optimistic or pessimistic about the future of high streets? Explain.
As we saw in Part 1 of this blog, oil prices have fallen by some 46% in the past five months. In that blog we looked at the implications for fuel prices. Here we look at the broader implications for the global economy? Is it good or bad news – or both?
