Wednesday, April 29, 2009

On oil and the recession

By Boatboy

Almost as footnote to my earlier post "Green or Not," The Atlantic dished this little item up a few days ago.

In it, Derek Thompson reviews
a Brookings Institution paper written by James Hamilton forecasting a drastic market downturn should oil prices spike, and compares the forecast with the last two years when oil prices did spike.

Hamilton went back to 2003, when crude oil was around $30 a gallon and forecast what an oil shock like the one we experienced in 2007-08 (when oil peaked around $140) would do to GDP. He graphed the result through the end of 2008 and, lo and behold, it was damn close to actual GDP.


What about real estate, subprime mortgages and defaults? Hamilton says the housing industry had been tightening up long before the recession -- "subtracting 0.94% from the average annual GDP growth rate over 2006:Q4-2007:Q3." And housing is factored into Hamilton's analysis. It was just one of a handful of multipliers that always turn down during oil shocks.

The Real Time Economics Blog at WSJ moves the theory forward with a pretty interesting bit of revisionist history. The grand retelling goes something like this. Cheap gasoline from the 1990s into this decade encouraged families to set up their homes farther from the cities where they worked. But as the price of gas began to increase, it put a big strain of these families' commutes. With gas rising from $2 to $4, the price of these long drives doubled, straining those families' most expensive payments, namely: mortgages. When families realized they could not afford their exurban commutes, they sold their homes for a big loss. Voila: Their mortgage crisis became a bank crisis and the rest is our living history.
I find Thompson's closing comments particularly telling:

My head's still spinning a bit, but it's interesting to think about the political consequences of a report like this being mainstreamed. If the idea somehow stuck that an oil shock was responsible for the financial crisis, it could be a significant catalyzer for the push toward energy reform. Today we're seeing a great national movement to change Wall Street because the general consensus is that Wall Street caused this crisis. Whether Hamilton's theory is wacko or brilliant, just imagine what a national movement to revolutionize America's energy consumption would look like. What if we had oil parties instead of tea parties, demanding more government investment in alternative fuels and subsidies for green technologies. That would really be something.
Also of note are Hamilton's own words, on his own blog:

My paper uses a number of different models that had been fit to earlier historical episodes to see what they imply about the contribution that the oil shock of 2007-08 might have made to real GDP growth over the last year. The approaches surveyed include Edelstein and Kilian (2007), who examined the detailed response of various components of consumer spending, Blanchard and Gali (2007), who studied the extent to which the contribution of oil shocks has significantly decreased over time, my 2003 paper, which emphasized the role of nonlinearities, and a model-free data summary of the observed behavior of different economic magnitudes following this and previous oil shocks. Although the approaches are quite different, they all support a common conclusion: had there been no increase in oil prices between 2007:Q3 and 2008:Q2, the U.S. economy would not have been in a recession over the period 2007:Q4 through 2008:Q3. [emphasis added]
Progressives have long maintained that the US suburban/exurban lifestyle is inefficient to the point of waste, and encourages overexpenditure on energy and materiel. Hamilton now shows us that this may well be true, and adds on a layer of vast economic vulnerability incurred through energy dependency.

If Hamilton's theories are to be believed in whole, the US needs a far more radical rethinking of its preferred lifestyle for the long term than has been discussed to date. Interim solutions, such as alternative energy and hybrid vehicles, are just that: temporary solutions to what will likely become a permanent problem. Unless vast resources of cheap, non-polluting energy can be sourced and managed domestically, the exurb is ultimately finished, since it will become economically unfeasible to commute any substantial distance or to travel far for shopping. Commercial distribution channels will also need to be rethought in this light: the great centralised warehouse may also become a thing of the past.

Regardless of the long-term implications of the paper, the work is a clear demand for a new, more conscientious approach to energy policy and urban development. This should also include industrialised agriculture, as that behemoth is a voracious consumer of petroleum products yet, due to its nature, frequently left out of petroleum-based energy policy debates.

Doing so, it would necessarily distinguish between the rural - farming, ranching, etc - and the urban/exurban markets: rural communities should be supported even as the larger urban/exurban communities are revisited in light of this new information. Too little thought is given to the distinctions between the rural landscape, isolated from the major energy consuming markets and largely self-sufficient, and the ever more costly urban environments that drive most energy and civic planning policies, and most resistance to urban-centred efforts at energy efficiency stem from their unthinking application to the countryside where such concerns are measurably smaller and less immediate.

Regardless of the planning remaining to be done, the paper presents an excellent take on the correlation between the costs of sprawl and the economic health of the industrial West. The built-in inefficiencies of the suburb and exurb, coupled with the uncertainty of energy supply - particularly oil - to maintain that sprawl, can be seen to have substantial impact on market sectors not immediately connected to those inefficiencies and uncertainties. Whether or not Hamilton's paper spawns the movement for energy independence Thompson describes, the mumbers deserve the attention of policymakers, and the implications demand public dialogue on the correlations between imported resources and community development.

(h/t Andrew Sullivan)

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