Question

Impact of reduction in oil prices on global economy essay

Answer 1

Oil prices have increased sharply over the past few years. Despite this rise in oil prices, growth of the global economy in all regions of the world is still strong and is expected to remain so for the next few years. The impact of oil price fluctuations on global economic growth has reduced as compared to previous decades. The global output lowered by approximately 1.5% when the oil prices shot up between 2003 and 2005 (EIA, 2008).
The impact that oil has on growth is quite striking. Many companies are forced to take up new oil prices, change the mode of using their factors of production and also do away with unprofitable sectors. This reduces the profitability of industries. It can also cause world wide recession due to reduction of real wealth as governments increase their protectionism on imports and exports. Major Price shifts may also occur especially in economies that have many monopolies. Various policies all over the world are unsuitable and fail to address the effects of oil prices. Governments from some developing countries have set up systems of control which protect consumers and businesses from the price increases. However, these controls only protect growth in the short-term; in the long run, it affects financial stability and leads a government into debt (Selim, 2008, 300). The governments should focus on both short-term and long-term oil market volatility.
There is a tendency of the players in the oil industry over investing or under investing in oil extraction projects and this leads to mixed cycles. The current high prices are as a result of the underinvestment during the 1990s when the prices were low. For instance, 1997-1999 was characterized by low oil prices which contributed to lowered expenditure in oil exploration. These low prices, however, led to the high prices in 1999 to 2000 (Wright, 2008, 750). .
In the near future, however, the oil prices may collapse again due to growth in emerging markets such as China and India among others. Most oil consuming countries have developed mechanisms to deal with the volatility of oil prices. However, poor global financial systems and rigidity in the economies and policies of oil producing countries has increased the concentration of risks in these producing countries. The producing countries should be assisted in managing oil price volatility and diversification of economic risks. This is the greatest problem that the global economy is expected to address in regards to oil. However, the task may be quite difficult because the oil producers prefer to maintain control over oil production. Non-oil production in the producing countries should be prevented from shocks by diversifying their economies. This could be achieved through improved risk sharing mechanisms in both production and financial markets. Increasing the flexibility of exchange rates could also assist in protecting non-oil production (Mabro, 2006).