Re: WTO and OPEC

[Paul Davidson <pdavidson@xxxxxxx>]

At 05:55 PM 3/6/2000 -0500, you wrote:

> OPEC came into existence following Arab Oil embargo which started
> October 19-20, 1973 and ended March 18, 1974.


This is factually wrong. OPEC was formed in the early 1960s and tried
several times to raise oil prices in the 1960s -- always failing miserably.
In large part this was because the multinational oil companies controlled
foreign oil production and as both the buyer of foreign oil and the seller
they maintained an "orderly" market for non-US oil production. (The US
market was maintained orderly by the "prorationing" provisions of the Texas
Railroad Commission and the state of Louisiana.)

For a history of OPEC see Morris Adelman's  THE WORLD'S PETROLEUM MARKET.

Events in the early 1970s -- particularly in the US i.e., the phased
removal of oil import controls by the Nixon Administration where the
domestic price of crude oil was in excess of $8 per barrel and the OPEC
price was $2 a barrel -- flooded the OPEC producers with demand -- and , in
the short-run, created a tremendous potential monopoly power for the Oil
producing nations.   All that was required was a spark to ignite the
economic and political ambitions of the Gulf nations-- that spark was the
Yom Kippur war of 1973 and then the  Gulf nation's exercise of power to
embargo oil exports to the nations helping Israel.  The success of this led
the Gulf nation's to removal of control of  the oil concessions they had
granted- -- and finally to OPEC  as the oil cartel.  When they drove up
prices sufficiently-- to approximately $15 a barrel in 1973-4 and almost
$30 in 1979, they created tremendous incentives to explore for oil in non
OPEC regions (e.g., North Sea) . The coming on stream of these other
sources of oil combined with the Volker global Depression of  1979-80
closed the gap between supply and demand and reduced the market power of
OPEC dramatically. The higher interest rates caused those OPEC nations --
and those who though not OPEC members beneficiaries e.g., Mexico, to step
up production to try to earn more $$$ to service their international debts.

As Henry correctly points out:

> By 1981 the effects of seven years of increased prices had had taken its
> toll on demand in the form of more energy efficient homes, industrial
> process, and in substantial increases in automobile gasoline mileage. At
> the same time crude oil production was increasing in the rest of the
> world, simulated by higher prices. OPEC's total production stayed
> relatively constant during this period around 30 million barrels per
> day. However, OPEC's market share was decreased from over 50 percent in
> 1974 to 47 percent in 1979. The loss of market share was caused by
> production increases in the rest of the world. Higher crude prices had
> made exploration more profitable for everyone not just OPEC and many
> rushed to take advantage of it.
>
> The rapid price increases of 1979 and 1980 served to accelerate
> consumer's moves toward efficiency.  They also fueled an increased non
> OPEC production. This was compounded by the deregulation of domestic
> crude oil prices in the United States. U.S. producers experienced the
> effects of increases in world prices plus the additional increase
> brought on by price deregulation.



> Demand had peaked in 1979 and it became clear that the only way to for
> OPEC to maintain prices was by reducing OPEC production. OPEC reduced
> its total production by a third during the first half of the 1980s. As a
> result OPEC's share in world oil production dropped below 30 percent.
>
> Looking at OPEC member's share within OPEC and not their share of total
> world production, Saudi Arabia acted as swing producer for OPEC during
> the first half of the 1980s in an attempt to shore up declining prices.
> By 1986 the Saudis tired of this role.  Other OPEC member countries were
> cheating on their quotas. In response Saudi Arabia rapidly increased
> production causing a major price collapse.
>
> It was almost three years before prices began to recover. The lower
> prices did have a positive result for OPEC. It encouraged increased
> consumption and halted production increases in much of the rest of the
> world, causing among other things, the oil depression in Texas. By the
> end of the decade of the 1980s OPEC and prices seemed to have
> stabilized.
>
> OPEC, or any other cartel, faces a problem of optimization in their
> attempts to control prices.  The problem is to determine the level of
> production which meets their collective goals of highest price with the
> biggest volume. For OPEC, this means maintaining production levels which
> insure the highest prices possible without encouraging competition
> outside of OPEC or significant conservation measures on the part of
> consumers.


For those interested in seeing the Keynes-type analysis of these problems
in terms of Keynes's concept of "user costs" -- see Chapter 6 appendix in
the GT see, "Oil, Its Time Allocation and Project Independence" by P.
Davidson, L. h. Falk, and H. Lee, THE BROOKINGS PAPERS ON ECONOMIC
ACTIVITY, summer 1974., reprinted in INFLATION, OPEN ECONOMY AND RESOURCES,
Volume 2 of The Collected Writings of Paul Davidson, edited by Louise
Davidson (Macmillan, 1991)

> The current oil price is an inventory problem rather than a long term
> pricing issue.  When Clinton threatens to release US strategic reserves,
> OPEC signaled its decision to increase production immediately. Many
> economists think that U$35 dollar oil in the long run, instead the
> current US$20 price, is good for the global economy.  At any rate, oil
> is no longer is critical factor for the US economy which is incresingly
> less dependent on oil for growth.

Unfortunately, I disagree with the last two sentences.  For me, this is
like deja vu. In the 1970s, the rise in oil prices was defended as good for
the global economy -- for it forced people to conserve.  Many orthodox
economists invoked the Hotelling rule for depletable resources to indicate
that the oil price would be $100 per barrel (in 1970s dollars) by the year
2000 , e.g. Bill Nordhaus of Yale in an important study often cited at the
time. This was often used in Congressional hearings to defend doing
nothing---. But the impact was global inflation and higher unemployment


My study for Brookings tried to explain why this was simply bosh -- and
lower oil prices was good for economic growth.

Redistributing some much off the global income so quickly lead to a
potential financial problem for oil consuming nations trying to finance
their global oil consumption (e.g., Brazil, Hungary,  etc.) In the absence
of a global central bank, the recycling of Petrodollars was invoked.  This
lead to huge increases in international indebtedness and when Volker raised
interest rates pushing LIBOR sky high -- the international debt crisis of
the 1980s.  Brady bonds, etc are the remaining ghosts of this era which
still can haunt us.  --See ECUADOR.

In yesterday's WSJ there was an article indicating that this time the Gulf
OPEC states would not " CONSUME", I.E., SPEND their rapidly rising revenues
-- therefore putting a new highly deflationary force into a global economy
which is already teetering.  Japan, for example,will be faced with
significantly  higher oil import bills -- and as a recent posting on the
pkt net points out the Japanese need to increase their net foreign
investment (i.e., exports minus imports) if they are to  start growing again.

$35 dollar oil good for the global economy.  If you believe that i have a
bridge over the East River in NY that I think you will want to buy.

> Ricardo coined the term comparative advantage which has been the
> foundation for international trade.
> When country A is better than country B at making automobiles, and
> country B is better than country A at making bread. It is obvious (the
> academics would say "trivial") that both would benefit if A specialized
> in automobiles, B specialized in bread and they traded their products.
> That is a case of absolute advantage.
> But what if a country is bad at making everything?  Will trade drive all
> producers out of business? The answer, according to Ricardo, is no. The
> reason is the principle of comparative advantage, arguably the single
> most powerful insight in trade economics.
>
> According to the principle of comparative advantage, countries A and B
> still stand to benefit from trading with each other even if A is better
> than B at making everything, both automobiles and bread. If A is much
> more superior at making automobiles and only slightly superior at making
> bread, then A should still invest resources in what it does best -
> producing automobiles - and export the product to B. B should still
> invest in what it does best - making bread - and export that product to
> A, even if it is not as efficient as A. Both would still benefit from
> the trade. A country does not have to be best at anything to gain from
> trade. That is comparative advantage.
>
> The theory is one of the most widely accepted among trade economists. It


The trouble with the theory of comparative advantage is that it is like
Say's Law -- only true in a classical economy -- or in a global economy  AT
FULL EMPLOYMENT.  The theory assumes-- among other things -- that both
labor and capital are not mobile across national boundaries.  When capital
is very mobile and labor is not,  the benefits from comparative advantage
can (need not always) quickly disappear, especially if the result is a lack
of full employment effective demand globally.

Paul Davidson
Holly Chair of Excellence in Political Economy
Editor, JOURNAL OF POST KEYNESIAN ECONOMICS [JPKE]
Economics Department -- 523 SMC
University of Tennessee
Knoxville, Tennessee 37996-0550
email: Pdavidson@xxxxxxx;   phone: (865)974-4221;    fax: (865) 974-4601
http://econ.bus.utk.edu/Davidson.html