No. 10 — March 10, 2000


Weekly Review

--- by Douglas Ostrom

In the Japan of 1980 or even 1990, alarm bells would have been sounding over the current run-up in international crude oil prices. This time, however, the reaction is relatively subdued despite certain conditions that would seem to call for heightened awareness. As in the United States, the Japanese response to $30-a-barrel oil is closer to grumbling than to sustained anger or fear.

A resource-poor Japan long has worried about access to a secure and reasonably priced supply of petroleum. This concern reached a fever pitch in the 1970s and the early 1980s when crude oil prices averaged more than $30 a barrel. Some, but by no means all, analysts attributed the sharp downturn that Japan experienced in the 1973-74 period to what generally is referred to as the first oil crisis. The country suffered an even longer, although not as severe, recession as a result of the 1979-80 oil crisis.

In certain respects, the current problem would seem to be more serious than the situation in 1973 or in 1979. Although analysts disagree about whether Japan is in a recession, growth in recent years has been anemic at best despite historically low oil prices. Moreover, in late February, Tokyo-based Arabian Oil Co., Ltd. lost its production rights in the Saudi-controlled part of the Khafji oil field in the Persian Gulf (see JEI Report No. 9B, March 3, 2000). These rights dated back some 40 years and long had been symbolic of what once were wide-ranging efforts to establish a stable source of crude in the volatile Middle East.

Despite the economy's problems, officials in Tokyo have tended to shrug off both the run-up in world oil prices and the loss of the Saudi concession. Part of the explanation for this blase reaction is that the canceled output represents a mere 2 percent of Japan's oil imports. More significantly, the role of petroleum in the economy — expressed as the bill for imported oil as a share of nominal gross domestic product — has declined steadily in recent years. From a high of 5 percent at the time of the second oil crisis, crude oil imports shrank to 0.75 percent of GDP in 1989, the eve of the price jump before the 1990-91 Persian Gulf War. With 1990's surge, the share edged up to just above 1 percent. The high prices proved to be short-lived, however. Furthermore, the importance of oil to Japan's economy declined through most of the last decade, hitting a low of 0.58 percent in 1995 in response to that year's strong yen, which led to lower yen-denominated costs despite an increase in the price expressed in dollars per barrel.

The trend is even more dramatic if the effects of changing prices and exchange rates are removed by measuring barrels of imported oil per unit of real GDP. By this yardstick, purchases in 1999 reached an estimated 3.25 barrels per million yen of GDP measured in 1990 dollars — the smallest figure since before the oil crisis of the early 1970s. In other words, the role of oil in the Japanese economy declined through most of the 1980s and the 1990s, even taking into account the relatively low prices that prevailed until recently.

Economic policymakers in Tokyo are not the only interested parties taking a fairly nonchalant view of today's high and still-rising oil prices. Currency dealers have the same attitude. In the 1970s, the role of oil loomed so large in Japan's economy that its inflated crude bill led to a sharp increase in the supply of yen on world markets, depressing the currency's value. The cheaper yen, in turn, made Japanese exports more competitive in the United States and in other foreign markets. As a result, Japan appeared to have solved the problem of higher oil prices at the expense of U.S. companies competing with Japanese imports. Of course, American consumers got some relief from the steep oil prices through an increased selection of fuel-efficient vehicles and other made-in-Japan products.

This time around, the yen barely has budged as the price of oil has soared. The role of crude in the world's second-largest economy no longer is big enough to affect the exchange rate like it did in the 1970s. Even if it had that effect, American consumers probably would derive few benefits since virtually all of the big-selling Japanese-badged cars and light trucks are assembled in North America, making their prices less sensitive to exchange rate fluctuations.

Moreover, to a much greater degree than two decades ago, the yen moves against the dollar not just on the basis of shifting demand for vehicles and other products but also as a consequence of changes in international capital markets. The reactions of investors to a central bank's response to hiked oil prices may be a more important factor in exchange rate movements than the cost of petroleum itself. If the Bank of Japan tightened monetary policy because of higher crude prices, the yen's drop in value could be minimized, as it was during the second oil crisis, or even reversed.

These possibilities notwithstanding, higher oil prices still have a negative impact on Japan's economy. The nation has to exchange more of its output for any given volume of oil. Put another way, higher oil prices mean lower real incomes. But the same would be true if the price of any good or service imported in significant quantities were to increase. The rising price of oil demonstrates the general proposition that a country suffers when the cost of imports goes up. That rule applies to the United States as well as to Japan.

In short, the alarm bells that went off during the two oil crises of the 1970s should have served as a wake-up call to those still-numerous analysts on both sides of the Pacific who believe that little harm will result to a nation's prosperity from restrictive policies that lift the prices of imports. To that extent, the murmurs of discontent currently heard over high oil prices are but a weak substitute.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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