The 1973 oil crisis and now

Larry Elliott Guardian News Service London

For those of us old enough to remember, it's time to wallow in memories of the last oil crisis. Yes, oil prices are up and the world economy is teetering on the brink of disaster. Welcome back to 1973.

At least that's what the more lurid reports suggest. Oil prices are not going to stop at their current record US$42 a barrel or even at $50 a barrel, but are heading all the way to $100 a barrel. It can't be long before we're told that it will cost a one hundred pounds Sterling to fill up the family saloon. A summer of discontent is inevitable as the fuel protesters dust off their placards and plan their barricades. As for the economy, the dizzying cost of energy will bring the whole edifice to its knees within months.

This is all rattling good fun, but most of it is utter rubbish. At their present level, there is no reason to expect oil prices to have anything like the impact they had in the aftermath of the Yom Kippur war in the autumn of 1973, when a fourfold increase in the cost of crude brought an end to the west's long postwar boom. The security situation in Saudi Arabia would have to become far more unstable for the more extreme predictions to come to pass.

That's not to deny that there are some historical parallels. Then, as now, the Middle East was in a highly febrile state. Then, as now, there was a sense among the Arab oil producers that a rightwing American administration was too kindly disposed towards Israel. Then, as now, demand for oil was strong.

Moreover, if the intervening three decades have taught us anything, it is that the west remains heavily dependent on cheap oil for its prosperity. The lessons of the 1970s have not been well-learned and, until they are, the developed world will be vulnerable to ever-more frequent spikes in the price of oil.

It's one thing to say, however, that the world faces a long- term energy challenge, quite another to believe that economic meltdown is just around the corner. There are a number of reasons why it isn't, at least not yet. The first is that oil prices are not really that high. Once inflation is taken into account, oil prices are back to where they were in 1974 and only half the level of the late 1970s.

The second is that the global economy was more precariously poised in the early 1970s. Inflationary warning signals had been flashing hard for several years, the Bretton Woods system of fixed exchange rates had broken down, commodity prices were rising rapidly.

There are certainly inflationary pressures evident both globally and domestically today, but to nothing like the extent that they were 30 years ago. The global economy has not enjoyed a long period of strong, uninterrupted growth; rather it has only just emerged from the weakness caused by the collapse of the stock market bubble at the end of the 1990s. Britain's housing market looks like an accident waiting to happen, but prices are rising at 20 percent rather than 50 percent, and inflation in the remainder of the economy is running at only just over 1 percent, at least on the official figures.

A third difference is the likely policy response to any oil shock. Put simply, rising oil prices represent a transfer of purchasing power from consumers to producers. Businesses pay more to transport their goods and heat their premises, and they pass the extra costs on to customers, many of whom are also paying more for their petrol. Back in 1973, workers were protected against increases in the cost of living by threshold agreements, whereby any increases in prices above a certain level triggered increases in wages. All this did was to ratchet up business costs still further, creating an inflationary spiral and a climate in which firms laid off workers in order to stay afloat. This was so-called "stagflation" -- recession and inflation at the same time.

In today's climate, with independent central banks ruling the roost, there would be a somewhat different approach. Members of the Bank of England's monetary policy committee say that they would be relaxed about higher oil prices provided businesses and employees took the increase on the chin. Any indication, however, of attempts by businesses to bump up prices or of pressure from workers for compensatory pay awards would result in swift pre- emptive increases in interest rates to damp down inflation.

Finally, producers have no long-term interest in seeing the global economy go down the tubes. In the coming months, there seems little doubt that prices will stay high. Demand is strong, oil stocks are low and, in the U.S., there is insufficient capacity to turn crude into refined products. Eventually, however, analysts expect stocks to be replenished and extra capacity to become available and for demand to ease back, partly as a result of more costly energy.

If sustained at their current level, oil prices may shave around half a percentage point off global growth this year. The hit to living standards caused by dearer energy will reduce growth in consumer spending -- and there will be a political price to pay for that -- but with world output expected to rise by more than 4 percent, the impact would not be enough to cause a full-blown recession.

All this is subject to one crucial caveat: Secure oil supplies from a stable Saudi Arabia. A major terrorist attack on the Saudi infrastructure or a toppling of the pro-west regime by Muslim fundamentalists would render everything said above null and void. There is a sliding scale here. Evidence that the terrorists had switched their focus to oil installations -- even if unsuccessfully -- would have a psychological impact on prices, probably pushing them to $50 a barrel.

Real damage to a pipeline that restricted supply could make talk of an $80 barrel of crude less fanciful than it is today. Regime change akin to that in Iran, which precipitated the record real oil prices in the late 1970s, would threaten to keep them at a cripplingly high level for long enough to ensure a long and damaging recession. It is the outcome feared by George Bush. The question is whether his actions have made it more or less likely.