The Impact of the 2014 Oil Shock on Arab Economies

Transcription

1 The Impact of the 214 Oil Shock on Arab Economies Mohamed Hedi Bchir Jose Antonio Pedrosa-Garcia 1 Abstract This study uses a multi-country, multi-sector, recursive dynamic, global CGE model to assess the implication of a drop in oil prices for Arab economies. Overall the results are as expected: oil-importing countries benefit (particularly Morocco, but also Tunisia and Jordan). In turn oil-exporter lose, especially Saudi Arabia but also Oman. However, importers gain is smaller than exporters loss. The simulations show that the larger the shock, the more important are the consequences on GDP growth, total investment, skilled and unskilled unemployment rates. The sectoral implications are also clear: sectors intensive in oil (e.g. metal) are positively affected and vice versa. Larger shocks are associated with higher benefits from flexibility in the allocation of resources in the long run. Oil price shocks can also induce higher unemployment which can stick in the long run. Indeed as oil exporters are intensive in capital and capital is associated with knowledge, when the oil sector is shocked skilled labor fares worse than unskilled one (in oil importing countries the effect is opposite). Given the fiscal policy of high subsidies and handouts in oil-exporting countries, its consequences could potentially turn sociopolitical were those fiscal policies to be terminated. To address such threat countries may turn to their SWFs, but only Saudi Arabia has a large-enough buffer. Another option is debt, which is particularly appealing given the current context of ultra-low interest rates. Yet, the current slump in oil prices presents a unique opportunity to undertake subsidies reforms which may arguably be the soundest option in the long run. Some oilimporting countries that have moved in this direction are Tunisia, Egypt and Morocco. However, such oil exporters as Bahrain and Kuwait have also started to implement subsidy reforms. The great unknown is what will be the reach of those reforms... 1 This paper has been published as Chapter 3 in ESCWA s Survey of Economic and Social Developments in the Arab Region The views and interpretations do not necessarily reflect those of the United Nations or its member countries. Both authors work at the Economic and Social Commission for Western Asia (ESCWA). for correspondence: pedrosagarcia@un.org 1

2 1. INTRODUCTION Despite considerable increase in the use of alternative sources of energy and efficiency improvements, oil remains one of the most strategic commodities in modern economy. The twentieth century has been called the hydrocarbon century : at the beginning of the century global oil output was about 15 million barrels per year, while at present this amount is extracted in just a few days. Oil prices are one of the most significant explanatory variables of global growth and more than any other commodity, and their fluctuations can be intense and hardly predictable. Explaining oil prices fluctuations and assessing their macroeconomic consequences at country and global level has become one of the most and recurrent topics in economic literature. Over the past forty years, researchers have explored the relation between oil price shocks and macroeconomic performance. The 1973 oil crisis was a particular turning point and substantial empirical literature on the macroeconomic impact of oil supply appeared thereafter. Some early studies noted that higher prices of energy resources, relative to the prices of labor and capital, resulted in a loss of economic capacity and higher output prices. 2 In 198, it was estimated that the shocks depressed real output by two percent in 1974 and by five percent in 1975 (prices rose by four percent in 1974 and by another two percent in 1975). 3 In 1983, James Hamilton published a seminal study on oil shocks. Hamilton looked at how oil prices affected the U.S. economy with a Vector Auto Regressive (VAR) system using quarterly data of Gross National Product and other macroeconomic variables. The results were clear: all but one of the post-world War II recessions in the USA were preceded, typically with a lag of 9 months, by a dramatic increase of oil prices. 4 Several other studies corroborated Hamilton s findings, and other documented similar relations for countries other than the US. 5 Hamilton s 1983 study belonged in a period in which all the large oil price movements were upward, and therefore did not explore what happens in periods of price declines. Knut Mork (1989) showed that if Hamilton s sample is extended to 1988 (prices dropped drastically in the mid-198s), the results persist in the longer sample and are strengthened by the correction for price controls. On the other hand, an asymmetry in the responses is quite apparent in that the correlation with price decreases is significantly different and perhaps zero. 6 Other research showed evidence that oil prices no longer Granger cause many U.S. macroeconomic indicator variables in data after A number of studies suggested that this breakdown of the oil price - economy relation was a result of misspecification of the oil price rather than a weakened effect. Then, the literature refined positions about oil price measurement and specifications. 8 For instance, some economists incorporate different 2 Rasche, Tatom Mork, Hall Hamilton See e.g. Burbidge and Harrison Mork, Hooker Hamilton

3 transformations of oil price data to account for possible non-linear relationships. 9 It has also been argued that what matters are different measures of oil price volatility 1, which suggests the role of expectations: the most important aspect is how surprising an oil price increase was relative to the observed recent evolution of prices. In this vein, it has been claimed that only price changes which establish new annual highs should be considered. 11 Rises in oil prices deteriorate the terms of trade, implying a wealth transfer from net oilimporting countries to net oil-exporting ones. 12 In today s context, it has been estimated that the slump in oil prices since mid-214 represents a value transfer of 1.6 trillion USD from oil-producing to oil-importing countries. 13 In the literature the transfer of wealth has been qualified by a number of authors, however, as higher oil price shocks can affect the economy both directly and indirectly. 14 The indirect effect is transmitted through trade: oil-importing countries import less from oil-exporting countries. As a result of the indirect effect, even net oil exporters cannot escape the negative effect of high oil price shocks. For example, Malaysia and Indonesia are net oil-exporters and major trading partners of Singapore, an oilimporter. While higher oil prices impact negatively on Singapore s GDP growth, Malaysia and Indonesia reap the benefits in terms of higher export revenues. This in turn increases their imports from Singapore. The net effect of oil prices on the latter, therefore, depends on the magnitude of these direct and indirect effects. In turn, this depends on how trade-dependent countries are, and how net oil-exporting countries use their extra windfall purchasing power. Higher oil prices make the oil sector more attractive to invest in. However, they also diminish the profitability of sectors for which oil is vital (e.g. transportation). This explains the large investment in renewable energies when oil prices are very high. On the other hand, when oil is cheap investments in clean energies have to be heavily subsidized if they are to be undertaken. Similarly, it is worth noting that if oil prices were to remain low, the use of oil would be favored relative to other more polluting fuels such as coal, especially in China where it is widely used. An additional effect is on exchange rates. Research has shown that oil prices significantly explain movements in the value of the U.S. dollar (USD) against major currencies from the 197s to As oil is denominated in USD, higher prices are associated with an appreciation of the USD (countries demand more USD to buy oil). However, to the extent that importing countries sell those USD revenues and convert them into their national currencies, the effect may fade away. As with any other export commodity, increases in the real price of that commodity lead to an appreciation of the exporting country s currency. This rationale is consistent with recent evidence. In the case of the current slump of oil prices, Russia and Nigeria have seen large depreciations of their currencies. As countries import in USD and may have debt denominated in USD, weaker currencies trigger fiscal tightening efforts. If Sovereign Wealth Funds (SWF) are available, it may be tempting to draw from them because the relative value of net foreign asset holdings has 9 Cuñado and De Gracia (23) 1 See e.g. Lee, Ni and Ratti (1995) and Ferderer (1996) 11 Hamilton (1996) 12 Dohner By Barclays, as reported at ValueWalk Abeysinghe Lizardo, Mollick 21 3

4 increased -especially in the current context of quantitative easing (QE) in some of the most important world economies. Indeed, it has recently been noted that the asset structure of SWFs is starting to change (especially of those fueled by oil revenues): SWFs are becoming more liquid, as their share of investments in money market funds has grown, and the balance of SWFs has remained stable or declined for some countries, but not increased. 16 To assess the relation between oil prices and the economy methodological issues have also been raised over time. For instance, it has been argued that in most of the research relating oil price shocks, the reasons underlying those shocks are ignored, which is a mistake because not all oil shocks are alike. 17 To address this it is necessary to account for the endogeneity of energy prices, and differentiate between the effects of demand and supply shocks in energy markets. 18 For Arab economies the influence of oil prices is very important, as the region is a major actor of the global oil market. While no individual country can influence the price by itself, Arab countries combined role in the Organization of Petroleum Exporting Countries (OPEC) and their low production cost allows them to control a large part of the global supply, and therefore to affect the world s oil price. Oil has played an essential role in the Arab world s socio-economic development, shaping decisively the Arab world and its modern-day development trajectory. Nonetheless, few studies have focused on the economic implications of oil prices on the economies in the region. Thus, the recent slump in oil prices is an occasion to contribute towards filling this gap. 2. THE IMPORTANCE OF OIL IN THE REGION Arab countries hold approximately 71 per cent of the world s total proven reserves (Annex Figure 16). In 211, they produced 22 million barrels per day which represent nearly a third of global oil supply, making the region the world s most important supplier of crude oil. 19 However, there is great variability in oil production. Figure 1 shows that growth has been more volatile than oil prices, but the mismatch has declined over time. Broadly, economic performance and oil prices are loosely correlated but this includes different price periods and all countries. 16 Financial Times 215a 17 Kilian Kilian Fattouh and El-Katir, 212 4

5 Figure 1. Relation between Arab growth rate and oil prices Natural log of (Brent price) Growth Source: Authors own elaboration based on data from the World Bank 215a To assess country specific patterns over time table 1 shows correlation coefficients for the entire period (column 1), the first half (column 2) and the second half (column 3). The time break up is relevant. It has often been noted that during the first boom (197s) Arab oil exporters did not follow prudent macroeconomic policies, although they have done so in the last 15-2 years, especially through the accumulation of reserves. 2 The coefficients in table 1 show that not only oil is important for Arab growth; overall it has become more important over time (the coefficients increased from.237 to.2726). The move has been driven by such countries as Djibouti, Saudi Arabia, Sudan and Yemen. Conversely, the relation (either positive or negative) between growth and oil prices has faded way for such countries as Algeria, Egypt, Kuwait and Oman. This would be explained by economic diversification in those countries - although not necessarily out of hydrocarbons: e.g. if the gas sector is highly promoted dependence from oil is reduced. TABLE 1. CORRELATION COEFFICIENTS BETWEEN GROWTH AND OIL PRICES BY COUNTRY (1) (2) (3) Algeria.2968*.7368* Comoros Djibouti.882* * Egypt * Iraq Jordan Kuwait *.1713 Lebanon Beattie 214 5

6 Morocco Oman *.2833 Qatar Kingdom of Saudi Arabia * Somalia Sudan * * Syria Tunisia United Arab Emirates (UAE) Palestine * * Yemen * * Total Arab * Significant at 1 percent level, ** significant at 5 percent level; *** significant at 1 percent level Source: Authors own calculation Oil-exporting countries rely heavily on oil revenues to fund their budgets. For instance, in 213 oil rents amount to 53.8 percent of GDP in Kuwait. 21 In Saudi Arabia, oil and gas revenues in 21 were equivalent to 9 percent of government income and 88 percent of exports. 22 Fiscal breakeven oil prices per barrel have been estimated as follows: Kuwait (52 USD), Qatar (59.4 USD), UAE (81.3 USD), Saudi Arabia (84.3 USD), Oman (89.4 USD), Algeria (16.7 USD), Bahrain (126.9 USD). 23 Based on these estimates, Oman and Bahrain would be the most affected by the current drop in prices because they have a high fiscal breakeven and low reserve buffers: their SWF are estimated at 13 and 1.5 billion USD, respectively, while Algeria s is estimated at 5 billion USD. 24 At the other extreme, Kuwait, Qatar, the UAE and Saudi Arabia have a similar shock absorption capacity, although in 213 Saudi Arabia has reserves estimated at 718 billion USD (Table 2). Saudi Arabia s huge reserves have been accumulated thanks to the fact that it s got the lowest cost of production per barrel in the world, estimated at 1 USD. A second vital link between oil and countries economy is subsidies, which apply to both net oil exporters and importers. Globally, 2 percent of global government revenue is spent on subsidies each year, but this situation is much more pronounced in the Arab region, which spends 8.6 percent of its GDP (approximately 25 billion USD) in subsidies. 25 Table 2 below shows that very significant shares of government spending go to subsidies and other transfers. 21 World Bank Natural Resource Governance Institute IMF Sovereign Wealth Fund Institute, Sdralevich et al

7 TABLE 2. KEY INDICATORS OF THE IMPORTANCE OF OIL FOR EXPORTING COUNTRIES, IN 213 OR CLOSEST YEAR Oil price at fiscal breakeven 26 Gross official reserves (billion USD) 27 Subsidies and other transfers ( percent of expenses) 28 Algeria Bahrain Kuwait Libya Oman Qatar Saudi Arabia UAE The main uses of subsidies are petroleum and food products but the subsidization rate is usually higher in oil exporting countries: the average subsidization rate is 77.5 percent of the total fuel cost in Algeria, 78.4 percent in Kuwait, 77.3 percent in Saudi Arabia, and 65 percent in the UAE; Egypt is the first net-importer at 61.2 percent. 29 The current drop in oil prices offers a unique opportunity to smoothly reform subsidies. Indeed, several countries have made efforts to implement reforms and reduce or eliminate subsidies since 214: Tunisia (April), Egypt (July), Kuwait (September), and Morocco (February 215) WHY THE SHARP DROP IN OIL PRICES? Historically, the oil market has experienced many shocks between 196 and 214 (Figure 2 below). First, the oil supply shock of was a boldly visible event followed by considerable turmoil. The 1979 oil crisis occurred in the wake of the Iranian revolution. The protests shattered the Iranian oil sector. OPEC nations increased production to offset the decline, and the total loss in production was about 4 percent. A widespread panic resulted, however, driving the oil price to double its previous level. By the early-to-mid-198s, continuing increase of North Sea, Mexican and Angolan oil output led to OPEC experiencing falls in its market share. At the same time, Saudi Arabia increased oil production despite the context of slow world oil demand growth, which led to the oil price collapse of IMF IMF IMF Government Finance Statistics Yearbook, as available at the World Bank s World Development Indicators (215) 29 International Energy Agency (213) 3 Financial Times 215c 7

8 Figure 2. Average price of crude oil in current US$ since Global crisis Present 1 Strong demand, stagnant supply 8 Iran-Iraq war 6 Iranian revolution Gulf War I Asian crisis Arab Spring & Japanese tsunami 4 OPEC Embargo 2 Gulf War II September 11 Source: Oil price series were extracted from International Financial Statistics The 199 energy crisis was milder and briefer than the two previous oil crises (1973 and 1979). The Iraqi invasion of Kuwait in 199 effectively removed some 9 percent of world oil production from the market and caused considerable uncertainty in the oil market. Oil went from US$ 17 to US$ 25 per barrel during the crisis. A second, minor decline in oil prices took place in the beginning of 1996 when Iraq began exporting oil under the oil-for-food deal. 31 Prices would go down again as the Asia crisis hit and world demand slowed down, but they would go back up shortly after. In the beginning of 1999, the threat of a new oil shock appeared especially following California's energy crisis 32 and the tensions in the Middle East (with the beginning of the second intifada). These factors were compounded with the emergence of new industrial superpowers: China, India, Brazil, Turkey and Iran (with a combined population close to 2.8 billion). In the next years oil prices went up not so much due to a shortfall of supply, but to a steady growth in demand. After the September 11 th terrorist attacks in 21, the US war in Iraq and ensuing instability in the region led to a significant hike in prices. Oil prices rose to unprecedented levels, but in 27 when the financial crisis hit, oil prices declined drastically due to a weak global demand. 31 Although established in April 1995, the implementation of the oil-for-food program started only in December 1996, after the signing of the Memorandum of Understanding (MOU) between the United Nations and the Government of Iraq on 2 May The California electricity crisis of 2 followed a failed partial-deregulation, in 1996, of the electricity market in the state. The energy crisis was characterized by a combination of extremely high prices and rolling blackouts. Price instability and spikes lasted from May 2 to September 21. Rolling blackouts began in June 2 and recurred several times in the following 12 months. 8

9 Uncertainties over the supply of oil linked to the 21 events known as the Arab Spring helped oil prices to regain previous levels. Since then prices stayed relatively stable, hovering around 11 USD for around 3 years and reaching a peak at 115USD in mid 214 (Figure 3 below). Then, around mid 214 prices started to fall; between July 214 and January 215, prices in the world market for crude oil (using Brent as benchmark) decreased by 58 percent. The plunge constitutes the second largest fall over a twelve-month period in the last 5 years. 14 Figure 3. Evolution of oil prices between January 214 and April J-14 F-14 M-14 A-14 M-14 J-14 J-14 A-14 S-14 O-14 N-14 D-14 J-15 F-15 M-15 A-15 WTI Brent OPEC Source: EIA for WTI and Brent; OPEC for OPEC Basket The reasons behind the recent and marked drop in oil prices are multiple. Although the USA has a ban on oil export since the 197s, the rapid expansion of North American crude thanks to new technologies in shale oil extraction, horizontal drilling, and exploration in deep offshore (more than 2, m deep) has constituted a significant expansion of supply, while such traditional suppliers as Saudi Arabia have remained quite stable (Figure 4 below). Indeed, it has been shown that three-fifths of the oil price drop in the second half of 214 was caused by growth in supply, which would raise global economic activity between.3 and.7 percent in Arezki and Blanchard (214) 9

10 Jan28 May28 Sep28 Jan29 May29 Sep29 Jan21 May21 Sep21 Jan211 May211 Sep211 Jan212 May212 Sep212 Jan213 May213 Sep213 Jan214 May214 Sep214 Jan28 May28 Sep28 Jan29 May29 Sep29 Jan21 May21 Sep21 Jan211 May211 Sep211 Jan212 May212 Sep212 Jan213 May213 Sep213 Jan214 May214 Sep214 Figure 4: Crude oil production The United States (thousand barrel per day) Figure 5: Crude oil production Saudi Arabia (thousand barrel per day) Source: EIA Source: JODI But the demand side has also contributed to this evolution. International organizations, including the United Nations (215) and the World Bank (215) has forecasted that global growth in 215 is expected to remain much weaker than it was during the 23-8 period (when oil prices rose substantially). In the same vein, growth projections in the Euro area, China, Japan, and Russia are slower than initially projected. The International Energy Agency (IEA) expectations of global demand for oil have been revised downwards on several occasions during the last year. Between July and December 214 alone, the projected oil demand for 215 has been revised downwards by.8 millions of barrels per day. 34 Technology improvements have contributed to reducing the demand for oil. 35 Improvements in energy efficiency allowed the oil-intensity of global GDP to be halved since the 197s. In the region, the surge in investments in renewable energies -estimated at $25 billion in has led to an increase in production capacity with renewable energies of 25 percent. Faced with this situation, in November 214 OPEC producers decided to maintain the same level of production to keep their market share. 37 The move was controversial because producers with the highest-breakeven prices (e.g. Venezuela) wanted to cut production to see oil prices rebound. The Saudi Arabia led the position of the cartel, however, arguing that it is not OPEC that increased supply. If there are cuts to be made it should be by all producers, not only by OPEC, a strategy that seems to have yielded results IEA, 214a and 214b 35 Technological advancement affected both supply and demand side. Improvements in RE and EE technologies lowers the demand for energy consumption; while innovations in drilling technologies decrease the cost of the extraction of offshore hydrocarbon resources (As observed in Brazil, and Mexico) and allow exploration and extraction in ultra-deep offshore areas. 36 ESCWA (215) 37 Financial Times Financial Times, 215c 1

11 Other explanations of Saudi Arabia s reaction not to cut production and let prices surge have emphasized geopolitical reasons as well. According to some of those, not only the Saudi Arabia would keep its market share and put financial pressure on shale oil producers to drive them out of the market; low prices put pressure on Iran s endeavors for the supremacy in the region (in the context Sunni vs Shi a), and on Russia (a move that would be very well seen in the USA and Europe, who have imposed sanctions on Russia in response to its actions in Ukraine). This study remains agnostic about the political underpinnings, although it must be noted that as of May 215, shale oil producers have started to face financial strains: they have increased their debt levels and some of them have already filed bankruptcy. Saudi Arabia has also retained its market share. 4. RESULTS The use of CGE to analyze the macroeconomic impact of an oil price shock is relatively new. The idea is to measure the structural (not cyclical) impact of a singled-out shock on oil prices. For instance, using a dynamic CGE model it has been shown that the oil price rise during the period would have caused a decrease of 2 percent to 3 percent of GDP annually in six oil importing countries (Bangladesh, El Salvador, Kenya, Nicaragua, Tanzania and Thailand). 39 It has also been estimated that in 1 years, a doubling of oil prices could cause a 14 percent loss of economic output in Turkey. 4 Using a Global CGE model to assess the effect of an increase in oil prices, it has been demonstrated that a 5 percent increase in oil prices could reduce global GDP by 1.5 percent by 22; GDP reductions would be smaller than 1 percent in most developed countries or regions. However, the losses would be much higher in emerging developing economies such as China, India, Thailand, Indonesia, Malaysia, and economies in transition. 41 Under the same methodological approach, this analysis uses a modified version of MIRAGE, a multi-country, multi-sector, recursive dynamic, global CGE model to assess the economic implication of a drop in oil prices for Arab economies. The tool also gives the possibility of discerning the mechanisms through which the shock is transmitted, including the reallocation of resources within the economy s productive structure. Moreover, it captures the effects on unemployment and fiscal policy. 1. Short-term implications of a 1 percent decline in oil prices The initial simulation consists of a shock in oil prices, driven by an increase of the US supply of oil (all the other producers maintain their supply at the 214 level). The shock is supposed to take place early in 215 and be maintained until 22. The results show that as a whole, the Arab region would lose 1.5 percentage points in the year following the shock (Figure 6). The impact of lower oil prices on individual countries depends on their situation in the oil market (net exporters or net importers). Oil exporting 39 Sanchez (211) 4 Aydın and Acar (211) 41 Timilsina (213) 11

12 countries would lose 1.88 percentage points of growth, while the rest of Middle East countries would lose 2.73 percentage points of growth. Saudi Arabia s loss is estimated at 2.58 percentage points of growth, while Kuwait s is 2.28 percentage points. Oil importing countries do benefit, but the gain is lower than the loss registered by oil exporters. The average gain is.5 percentage points of additional growth. Morocco is the greatest winner, with 1.35 percentage points of extra growth, followed by Jordan (.25) and Tunisia (.22). The impact on Egypt, Bahrain and Emirates is negligible, as these countries face a combination of positive and negative effects that offset each other. Figure 6. Short-term implications of 1 percent decline in oil price: Difference in growth in the first year after the shock 1.35 Morocco Non exporting Arab Countries Jordan Tunisia Egypt Bahrain Union of Arab Emirates -.97 Qatar Oman Total Arab Countries Arab Oil Exporting countries Rest of North Africa Kuwait Saudi Arabia Rest of Middle east countries Source: Authors simulation As expected, the nature of the effects also varies across sectors. Oil production and construction are negatively impacted by the shock, while oil-intensive sectors such as chemical products, metal, transport and oil refinery see their production increasing (Table 4 in the Annex). These results are in line with previous research noting that output in oil-exporting countries could contract by.8 to 2.5 percentage points in the year following the shock. 42 Similarly, previous works have pointed out that a 1 percent decrease in oil prices would raise growth in oil-importing economies by.1 to.5 percentage points, depending on those countries share of oil imports to GDP. 43 Furthermore, the estimates are in line with previous results that find a significant and positive effect of oil prices on the output of Algeria, Iran, Iraq, Kuwait, Libya, Oman, Qatar, Syria, and the UAE; but a non-significant effect on the output of Bahrain, Djibouti, Egypt, Jordan, Morocco, and Tunisia. 42 World Bank 213; Berument et al. 21; Feldkirchner and Korhonen World Bank, 213; Rasmussen and Roitman,

13 2. Medium-term implications The medium term effect is simulated by a permanent 1 percent price reduction during the period 215 to 22. In this timeframe, the reallocation of resources among sectors would be expected to assuage the growth implications of the shock. On average, the net result for the region is a growth loss of.15 percentage points. Oil exporting countries would lose annually.6 growth points while oil importing countries would win.15 percentage points of growth (Figure 7). Figure 7. Medium term implications of 1 percent decline in oil price: Difference in growth in the first year after the shock Morocco Non exporting Arab Countries Jordan Tunisia Egypt Bahrain Union of Arab Emirates Qatar Oman Total Arab Countries Arab Oil Exporting countries Kuwait Rest of North Africa Saudi Arabia Rest of Middle east countries Source: Authors simulation For Arab oil exporters the shock affects the profitability of investments, especially in the oil and construction sectors (Table 5 in the Annex). According to the simulations and despite maintaining the level of public investment unchanged 44, total investment could be reduced by 4.4 percent in 215 and by 3.6 percent cumulatively between 215 and 22 compared to the reference scenario (Figure 8). This effect is more visible in oil-exporting countries, especially in Saudi Arabia where total investment could be reduced by 8.7 percent in 215 and by 7 percent between 215 and 22. In Kuwait, the reduction would be of 9.8 percent and 7 percent, respectively. For the rest of North Africa the loss is estimated at 6.9 percent and 5.8 percent, respectively, and for the rest of the Middle East at 3.4 percent and 2.7 percent. In oil importing countries the shock affects positively the profitability of oil-consuming sectors (especially chemical products, oil refinery and metal sectors). This leads to an 44 This hypothesis was adopted after the declaration of most of GCC s economic authorities that the decline of oil prices will not affect their public investment plans and that they will use their strategic reserves to finance their public deficit. 13

14 increase in total investment of.5 percent, which reaches 1.5 percent in Morocco and 1.1 percent in Jordan in 215 (Figure 8). Figure 8. Variation of total investment compared to the reference scenario after a 1 percent reduction in international oil prices Jordan Tunisia Morocco Egypt Non exporting Arab Countries Kuwait Rest of Middle east countries Rest of North Africa Bahrain Oman Qatar Union of Arab Emirates Saudi Arabia Arab Oil Exporting countries Total Arab Countries Source: Authors simulation The variation of investment is also linked to trade (Figure 9): as Arab oil exporters receive less foreign exchange (because they export less), their currencies lose strength and their imports decline. This decline is approximately 6 percent depending on the scenario: -5.5 in 215 and -6.8 percent in the medium run (as economic structures are more flexible and adapt). Countries that suffer this phenomenon most are those most reliant on oil (e.g. Saudi Arabia and Kuwait). Conversely, Morocco, Jordan and Tunisia import more: as now they spend less of their resources on oil, they can use those more funds to import. With regards to exports, the pattern is not inverse to that of imports (Figure 1). The reason is that by having weaker currencies, countries can export more. This offsets the shockinduced loss of export revenues but exports from oil-exporting countries still decline slightly (-.1 percent). Other countries such as Tunisia and Morocco export considerably more because they have small economies that are very export-oriented; ceteris paribus, paying less for their energy costs can boost their productivity and hence their exports. 14

15 Figure 9. Variation of total Imports compared to the reference scenario after a 1 percent reduction in oil prices Figure 1. Variation of total Exports compared to the reference scenario after a 1 percent reduction in oil prices Jordan Tunisia Morocco Egypt Non exporting Arab Countries Kuwait Rest of Middle east countries Rest of North Africa Bahrain Oman Qatar Union of Arab Emirates Saudi Arabia Arab Oil Exporting countries Total Arab Countries Tunisia Morocco Egypt Non exporting Arab Countries Kuwait Rest of Middle east countries Rest of North Africa Bahrain Oman Qatar Union of Arab Emirates Saudi Arabia Arab Oil Exporting countries Total Arab Countries Source: Authors simulation On the given 6-year timeframe, the simulated shock induces structural changes in countries economies. This includes the use of factors of production such as labor, which is of particular importance given the high unemployment rates in the region. Keeping the supply of labor constant, firms demand less labor because they have lower activity levels (as they export less). The overall effect is the same for both skilled and unskilled labor. For the entire region, unemployment increases by 2 percent in 215, which is reduced to 1.4 percent in the larger timeframe (215-22) as factors of production are more flexible (Figure 11 and Figure 12). 15

16 Figure 11. Variation of skilled unemployment Figure 12. Variation of unskilled unemployment Jordan Tunisia Morocco Egypt Non exporting Arab Countries 5.2 Kuwait Rest of Middle east countries Rest of North Africa Bahrain Oman Qatar Union of Arab Emirates Saudi Arabia Arab Oil Exporting countries Total Arab Countries Morocco Egypt Non exporting Arab Countries Kuwait Rest of Middle east countries Rest of North Africa Bahrain Oman Qatar Union of Arab Emirates Saudi Arabia Arab Oil Exporting countries Total Arab Countries Source: Authors simulation The simulated 1 percent negative shock in oil prices is lower than the actual shock experienced between July 214 and January 215. Thus, it is important to explore sensitivity of the results presented so far with regards to the magnitude of the shock. To do so, the results of five types of shock are described: from 1 percent incrementally to 5 percent. As the difference between oil exporters and oil importers is vital, the simulation results are presented in 3 categories: for the entire sample of Arab countries (Figure 12), for oilexporting only (Figure 13), and for oil-importing only (Figure 14). Overall, the simulations show that the larger the shock, the more important are the macroeconomic consequences with regards to GDP growth, total investment, skilled and unskilled unemployment rates. This result is robust to all scenarios. Larger shocks exhibit higher slopes over time, however, which implies that the harder are oil prices shocked, the more flexibility in the allocation of resources pays off in the long run (Figure 12). The elasticity of different dimensions varies within a specific shock magnitude. GDP and investment have slightly positively-sloped curves, while unemployment rates show much higher negative elasticities, especially in high-magnitude shocks. The unemployment patterns show that shocks can have a lock-out effect, whereby people who are unemployed stay there - regardless of their skill level (Figure 12). The key threshold is 2 years, which corresponds to the often-accepted definition of long-term unemployment. 16

17 Although the reasons for that threshold go beyond the scope of this study, this would be consistent with a common view that beyond that threshold, workers skills are likely to be considered obsolete by employers, while job-seekers are likely to lose hope and put less effort trying to find a job. The interpretation is similar when only oil-exporting countries are considered (Figure 14). However, skilled unemployment is slightly more vulnerable than unskilled, which is not surprising because skilled workers are more closely connected with the oil sector. As the scale of the y-axis is the same in all charts for an easy comparison, the graphs show that the overall result in the region (Figure 13) is driven mainly by oil exporters (Figure 14). Indeed considering oil-importers only (Figure 15), the results are broadly symmetric: countries benefit from negative oil shocks in all four dimensions, the elasticity of the macroeconomic effects is higher as the intensity of the shock rises, and the differences between skilled and unskilled labor are largely negligible. However, in oil-importing countries unskilled workers would benefit much more than skilled ones. This can be interpreted under a trade perspective: oil importers benefit from lower oil prices, they export more and in so doing, they absorb more unskilled workers - relative to skilled ones, who would not have much difficulty in finding jobs anyway. 17

18 Figure 13. For entire region: difference between reference projection and projection after permanent oil decline of: GDP Total Investment % -5 1% 2% -1 2% 3% -15 3% 4% -2 4% -25 5% 5% Skilled Unemployment rate Unskilled unemployment rate 1 5% 8 4% 6 3% 4 2% 2 1% Source: Authors simulation % 4% 3% 2% 1%

19 -2 Figure 14. For oil exporters: difference between reference GDP projection and projected GDP after permanent oil decline of: GDP Total Investment % % -4 2% -1 2% -6 3% % -8 4% -25 4% % -35 5% Skilled Unemployment rate Unskilled unemployment rate % % % 14 4% % 1 3% 8 6 2% 8 6 2% 4 2 1% 4 2 1% Source: Authors simulation

20 Figure 15. For oil importers: difference between GDP projection and projected GDP after permanent oil decline of: GDP Total Investment % 4% 3% 2% 1% % 4% 3% 2% 1% Skilled Unemployment rate Unskilled unemployment rate % 2% 3% 4% 5% % 2% 3% 4% 5% Source: Authors simulation

21 5. CONCLUSION Overall, the results of a negative shock in oil prices are as expected: oil-importing countries benefit from a shock in oil prices (particularly Morocco, but also Tunisia and Jordan). In turn, oil-exporting lose, especially Saudi Arabia but also Oman. However, importers gain is smaller than exporters loss. The simulations show that the larger the shock, the more important are the consequences on GDP growth, total investment, skilled and unskilled unemployment rates. The sectoral implications are also clear. Sectors that are intensive in oil (e.g. metal) are positively affected and vice versa. Larger shocks are associated with higher benefits from flexibility in the allocation of resources in the long run. As a particularly relevant result, oil price shocks can induce higher unemployment which can stick in the long run, particularly beyond a 2-year timeframe. Indeed as oil exporters are intensive in capital and capital is associated with knowledge, when the oil sector is shocked skilled labor fares worse than unskilled one. (And in oil importing countries the effect works in the opposite direction). Given the fiscal policy of high subsidies and handouts in oilexporting countries, its consequences could potentially turn sociopolitical were those fiscal policies to be terminated. To address such potential threat countries might turn to their SWFs, but only Saudi Arabia has a large-enough buffer. Another option is debt, which is particularly appealing given the current context of ultra-low interest rates. Yet, the current slump in oil prices presents a unique opportunity to undertake subsidies reforms (especially for oil importers), which may be the most sound option in the long run. Indeed, some countries that have moved in this direction are Tunisia, Egypt and Morocco. However, Kuwait also started to implement subsidy reforms. Will more oil-exporters follow? 21

22 6. ANNEXES Figure 16. Crude oil reserves by the end of Iran 1% Iraq 1% Kuwait 7% Non-OPEC 19% OPEC 81% Saudi Arabia 18% UAE 6% % Venezuela 2% Ecuador 1% Libya 3% Nigeria 2% Qatar 2% Algeria 1% Angola 1% 45 Source: OPEC

23 TABLE 3. PRODUCTION BY SECTOR COMPARED TO THE REFERENCE SCENARIO AFTER A 1 PERCENT REDUCTION IN INTERNATIONAL OIL PRICES Saudi Arabia Qatar United Arab Emirates Kuwait Bahrain Oman Morocco Egypt Jordan Tunisia Rest of North Africa Rest of Middle east countries Agriculture Food Products Textile oil Gas and mining Chemicals Products Oil Production Metal Electronic equipments Machinery Other transport equipments Other Manufacture Products Construction Transport Other Services Source: Authors simulation TABLE 4. INVESTMENT BY SECTOR COMPARED TO THE REFERENCE SCENARIO AFTER A 1 PERCENT REDUCTION IN INTERNATIONAL OIL PRICES Saudi Arabia Qatar United Arab Emirate Kuwait Bahrain Oman Morocco Egypt Jordan Tunisia Rest of North Africa Rest of Middle east countries Agriculture Food Products Textile oil Gas and mining Chemicals Products Oil Production Metal Electronic equipments Machinery Other transport equipments Other Manufacture Products Construction Transport Other Services Source: Authors simulation 23

24 REFERENCES Abeysinghe, T. (21), "Estimation of direct and indirect impact of oil price on growth", Economics letters, vol. 73, no. 2, pp Aydın, Levent and Mustafa Acar (211). Economic impact of oil price shocks on the Turkish economy in the coming decades: A dynamic CGE analysis, Energy Policy, Vol. 39, pp Arezki, R. and O. Blanchard, (214). Seven Questions about the Recent Oil Price Slump. IMFdirect - The IMF Blog, December 22, 214. Beattie, A. (214) Ready or not: oil exporters facing low prices, Financial Times Blog Beyond BRICS. Available at: (Posted on November 7 th 214 Last accessed May 26 th 215). Berument, H. M., Ceylan, N. B., and Dogan, N. (21). The impact of oil price shocks on the economic growth of selected MENA countries, Energy Journal, vol. 31, no. 1, pp Burbidge, J. and Harrison, A. (1984). Testing for the Effects of Oil-Price Rises using Vector Autoregressions, International Economic Review, vol. 25, no. 2, pp Cuñado, J., and Pérez de Gracia F. (23). "Do oil price shocks matter? Evidence for some European countries." Energy Economics 25.2: Dohner, R. S. (1981) "Energy prices, economic activity and inflation: survey of issues and results." Energy prices, inflation and economic activity. Ballinger, Cambridge, MA. ESCWA (215), Changing Oil Prices: A Reading through a Regional Lens, Background Paper for Discussion, Sustainable Development Policies Division 17 April, 215 Fattouh, B. and El-Katir (212), Energy and Arab Economic Development, Arab Human Development Report Research Paper Series, United Nations Development Programme Regional Bureau for Arab States. Feldkirchner, M. and I. Korhonen. (212). The Rise of China and its Implications for Emerging Markets - Evidence from a GVAR model Institute for Economies in Transition Discussion Papers 212-2, Bank of Finland. Ferderer, J.P. (1996) On price volatility and the macroeconomy, Journal of Macroeconomics, vol. 18, issue 1, December 1996, pp Financial Times (214) Oil plunges and OPEC tests the mettle of US shale industry (Anjli Raval and Neil Hume). Available on:

25 a feabdc.html#axzz3bfl72cuq (Posted on November 27 th 215 Last accessed on May 26 th 215). Financial Times (215a) Sovereign wealth funds start to leak oil (Steve Johnson). Available on: 144feab7de.html#axzz3bFL72cuq (Posted on March 22 nd 215 Last accessed May 26 th 215). Financial Times (215b), Developing economies: Taking a load off (Borzou Daragahi). Available at (Posted on February 11th 215 Last accessed on May 26th 215). Financial Times (215c), Saudi claims oil price strategy success (Anjli Raval). Available on: 144feab7de.html#axzz3bFL72cuq (Posted on May 15 th 215 Last accessed on May 26th 215). Hamilton, J.D. (1983), "Oil and the macroeconomy since World War II", The Journal of Political Economy, pp Hamilton, J.D. (1996), "This is what happened to the oil price-macroeconomy relationship", Journal of Monetary Economics, vol. 38, no. 2, pp Hooker, M.A. (1996), "What happened to the oil price-macroeconomy relationship?", Journal of Monetary Economics, vol. 38, no. 2, pp IMF, Middle East and Central Asia Department (214) Regional Economic Outlook Update, Statistical Appendinx, May 214. IMF, Middle East and Central Asia Department (215) Learning to Live With Cheaper Oil Amid Weaker Demand, Regional Economic Outlook Update, January 21, 215. International Energy Agency (213), Fossil-fuel consumption subsidy rates as a proportion of the full cost of supply, available at: Kilian, L. (28), "The economic effects of energy price shocks", Journal of Economic Literature, vol. 46, no. 4, pp Kilian, L. (29), "Not all oil price shocks are alike: Disentangling demand and supply shocks in the crude oil market". American Economic Review, 99.3: pp Lee, Kiseok, Shawn Ni, and Ronald A. Ratti. (1995) "Oil shocks and the macroeconomy: the role of price variability." The Energy Journal. pp

26 Lizardo, R.A. & Mollick, A.V. (21), "Oil price fluctuations and US dollar exchange rates", Energy Economics, vol. 32, no. 2, pp Mork, K.A. & Hall, R.E. (1979), "Energy Prices, Inflation, and Recession, ". Mork, K.A. (1989), "Oil and the Macroeconomy When Prices Go Up and Down: An Extension of Hamilton's Results", Journal of Political Economy, vol. 97, no. 3, pp Natural Resource Governance Institute (215). Available at: OPEC Annual Statistical Bulletin 214. Avaiable at: pdf Rasche, R.H. & Tatom, J.A. (1977), "Energy resources and potential GNP", Federal Reserve Bank of St.Louis Review, no. June Rasmussen, T. N. and A. Roitman. (211). Oil Shocks in a Global Perspective: Are they really that Bad? IMF Working Paper WP/11/194. International Monetary Fund, Washington, DC. Sanchez, M. V. (211). Welfare Effects of Rising Oil Prices in Oil-Importing Developing Countries, Developing Economies, v. 49, iss. 3, pp Sdralevich, C., Sab, R. Zouhar, Y., Albertin, G. (214) Subsidy Reform in the Middle East and North Africa: Recent Progress and Challenges Ahead, International Monetary Fund, ISBN: Sovereign Wealth Fund Institute (215). Available at: Timilsina, G.R. (213) How Much Does an Increase in Oil Prices Affect the Global Economy? Some Insights from a General Equilibrium Analysis World Bank Policy Research Working Paper No. 6515, Washington, DC. United Nations (215), World Economic Situation and Prospects 215, New York ValueWalk (215). Price Drop Leads To $1.6 Trillion Transfer From Oil Producers to Oil Consumers: Barclays, Available on: (Posted on January 3 th last accessed on May 26 th 215). 26