Cut growth

Published by rudy Date posted on July 5, 2008

by Alex Magno
from Philippine Star

It’s pretty much like tearing off a limb to save one’s life.

In the face of galloping inflation driven by unabated oil price increases, most economies have taken defensive measures by choosing to cut growth. The most obvious way of doing that is to raise interest rates. The European Central Bank did just that a few days ago.

Raising interest rates is akin to going to the dentist. It is not something one relishes doing; but something that has to be done nonetheless.

Raising interest rates pushes up the cost of money. That, in turn, discourages investments and dampens demand. It reduces the capacity of an economy to open new job opportunities, thereby penalizing the poor and the young above all else.

This policy tool is not fool-proof by any measure. Higher interest rates may also contribute to pushing up inflation by raising the costs of doing business. There are areas in the economy where demand will likely remain constant despite increases in cost: among them, fuel and food consumption. Unfortunately, these are the two commodities most responsible for the inflationary surge in the first place.

Everything that could be done for the immediate abatement of the oil price surge has been done — to no avail.

Led by Saudi Arabia, the oil-producing countries have committed to raise production. That has not impressed the market. Since the Saudis announced production increases by nearly a million barrels a day, oil prices continued to advance. Two days ago, a new record was set when oil traded at over $145 per barrel.

Analysts are saying that oil will pierce the $150 level this month. At least one investment bank has predicted oil prices to rise to $250 before beginning to soften. Yet another investment firm is predicting that the global economy will continue to experience difficulties for the next five years.

The unabated rise in oil prices have, for a while, been blamed on speculation by the large investment funds. That may be true to an extent. But in the last analysis, oil prices reflect the dynamics of supply and demand. Where there is ample supply of oil, speculators could not profit even if they wanted to.

That is true as well with food prices. If there was an ample buffer stock of grains, no speculative activity could happen. Speculators can only thrive when supply is uncertain.

Because of the planting cycles, it is easier for food prices to ease. Much more difficult for oil supply to be ample — not today and probably never ever again.

Economists go by the mantra that the solution to high prices is high prices.

In the case of rice, for instance, better prices have encouraged farmers to plant more of the crop. Even large agribusinesses have set aside part of the land intended for other cash crops to rice cultivation, simply because it is profitable to do so.

In the case of fossil fuels, which require millions of years for nature to process, additional supply will not be forthcoming. The known reserves of oil are quickly dwindling. The rapid growth of populous economies such as China, India and Brazil is pushing up total world demand for the increasingly scarce economy.

The only solution to high oil prices is demand management in the short-term and substitution in the long-term. The former will be painful and the latter will be long in coming. In the case of energy substitutes, the wheels of technological progress grind exceedingly slow.

The European governments, even in the face of raucous protests from truck drivers and private motorists, have taken the brave and correct decision not to withdraw heavy taxation on oil use. High oil prices will encourage more prudent consumption, the production of more efficient vehicles and the development of new technologies such as hydrogen-powered cars that emit water.

Yielding to the populist — and myopic — demand to reduce taxes in order to cut prices will create bigger trouble down the road. It will keep demand going, thereby pushing prices higher. It will reduce the ability of governments to fund pollution mitigation measures and attend to the social costs of imprudent use of a fuel source that damages the environment.

The US, the world’s largest and most inefficient user of oil, has been reluctant to adopt better emission standards, participate in global efforts mandated by the Kyoto Protocol and penalize oil use with stiffer tax penalties. The costs of proper energy demand management are simply too high for the Americans, whose human settlements are spread out and heavily transport-dependent — reflective of a society that flourished during the era of cheap oil and that will likely wither in an environment of costly fuels.

In this country, too, there is no lack of populists who would rather pander to short-sighted popular demands rather than support painful but sustainable energy demand management strategies.

Some are making a show out of demanding that fuel be exempted from value-added taxation. Others are simply rabble-rousing by pinning the blame for high prices on the deregulation of the domestic oil industry. The latter group more properly belong to another planet.

There are simply no painless pathways away from the challenges imposed upon us by global economic conditions. We cannot wish away a regime of expensive oil. And to cope with it in a sustained way, we will have to accept, as the rest of the world has, a regime of lowered growth into the foreseeable future.

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