International Adjustment to an Oil Price Shock : The Role of Competitiveness

It is common political practice to blame the presently poor performance of OECD economies on huge raw material price increases during the 70s. This view is apparently backed by recent small-country oil-shock analysis showing within theoretical models how trade deficits and output and employment losses inevitably occur in net oil importing countries. The paper argues that, by its very nature, an oil shock afflicts an OECD country not in isolation. This requires theoretical analysis of an oil-importing economy together with its major trading partners. The paper demonstrates that due to a country-specific superior technological adjustment the oil shock may possibly give a competitive edge to one country or a group of OECD countries. Then a trade diversion among trading OECD economies benefits a few of them at the expense of other and may be strong enough to weaken or even turn around negative output and employment effects which originated from the real income trasnfer towards oil producers. Additionally, assessment of real and price level effects of an exchange rate change reveals that in general the beggar-my-neighbor property of a devaluation can be destroyed if imported intermediate goods like oil are taken into account. This outcome should also have some bearing on economic modelling of transatlantic relations under flexible exchange rates.Published in connection with a visit at the IIE