Oil & unemployment
One thing that peeves me about reporting on oil prices is the tendency to see them only in terms of the “misery” they cause motorists. But history suggests that oil matters more than this. My chart - stolen and adapted from Andrew Oswald (pdf) - shows the point for the UK. It shows that oil prices predict unemployment, with a lag of around 18 months. Rises in oil prices in 1973-74, 1979-80 and in the mid-00s led to rising unemployment. And falling oil prices in 1986, 1998 and 2003 led to falling unemployment. The reason for this is simple. Higher oil prices hurt companies as well as motorists. One reason for this is that if people are spending more on petrol they’ve less cash to spend on other things, so retailers suffer. But also - obviously - higher oil prices raise firms’ energy and transport bills. At the margin, this causes them to shrink production and lay off workers or even go out of business altogether.So far, so simple. But four things complicate the relationship:1. What causes higher oil prices? If prices rise because of supply restrictions - which was obviously the case in 1973-94 and 1979 - it is unambiguously bad for jobs. If, however, price rises reflect a global economic boom or loose monetary policy - as was the case in 2005-07 - their effect is ambiguous. This is because the things that cause higher oil prices also help create jobs. It’s not entirely clear which is the case now: there might be an element of betting on a worst-case scenario - rather than genuine supply problems - in the Brent price. 2. What are firms’ expectations for oil prices and demand? Firms do not lay off staff immediately as oil prices rise. If they think there‘s a good chance of prices falling back - which there is, given their volatility - or if they think economic conditions generally will improve, they might soldier on in the belief that the squeeze on their cashflow is temporary. It is only when they realize that higher prices and weaker demand are here to stay that they sack workers. In this sense, responses to higher oil prices are like responses to exchange rates: the volatility of both dampens firms’ immediate reaction to them. This means its hard to find a precise mechanical relationship between oil and employment decisions, as the link is mediated by animal spirits. 3. How do wages respond to higher oil prices? If workers were to quickly and easily accept lower incomes to offset high oil costs, unemployment needn’t rise. However, in efficiency wage models, this doesn’t necessarily happen.4. Are the firms most exposed to higher oil prices the same ones who are sitting on large cash piles, or not?Higher oil prices interact with credit constraints. If a firm can’t raise the cash to see itself through the squeeze imposed by higher oil costs, it will be quicker to go bust or lay off workers. Because firms, in aggregate, have been accumulating cash for years, you might think they are not credit-constrained. Such a belief, though, is an example of the representative firm fallacy. It is possible that the firms sitting on cash are not the same firms which suffer most from rising oil prices. To the extent that they differ, the oil price hit will be quicker and harder.These four uncertainties mean we can’t say for sure whether, when, or by how much unemployment will be affected by higher oil prices. What we can say, though, is that there is a danger here.