oil price shock

oil price shock (1973, 1979) The trigger for two worldwide economic crises in the 1970s and early 1980s, caused by a sudden and drastic increase in the price of crude oil. In 1973 Arab states responded to US and general Western support for the Yom Kippur War by a dramatic and unprecedented reduction in oil production, while all oil exports to the USA and the Netherlands (Europe's central entrepôt for oil) were halted. This caused a quadrupling of the price of crude oil, to around $6 per barrel. It was the first time oil had been used as a political weapon, while the Arab oil-producing countries realized for the first time their global power.

The second oil price shock was caused by the Iranian Revolution in 1979. Prices for crude oil jumped to $23 per barrel, and reached a peak of $34 per barrel. The motives for this were less political. Instead, it was caused by nervousness and uncertainty about the stability of a major regional power among the oil-producing states in the Persian Gulf. In addition, defensiveness against Khomeini's new aggressive Islamic fundamentalist theocracy caused an unusual burst of Arab solidarity, enabling the realization of oil-producing quotas which reduced supply and increased prices.

Both oil price shocks caused economic and social upheavals unprecedented since World War II. The high oil prices plunged the fledgling states of Africa and Latin America into deep economic crises. This usually led either to political coups or, as regimes tried to avoid public dissatisfaction, to large-scale borrowing and a sharp rise in Third World debt. Particularly for African countries, this problem of high debts was compounded by the fall of commodity prices in the 1980s, which made up most of their export earnings. In Anglo-American and European societies, too, it caused the greatest economic dislocations since 1945. After more than two decades of more or less uninterrupted economic boom and full employment, these countries had lost their flexibility in the labour market. Labour refused to compensate for the increases in production costs by significant reductions in their real wages. This led to spiralling unemployment, though this effect was rather less marked in the USA and Canada. Ultimately, the oil price shocks were the catalysts for the demise of a Keynesian welfarist perception of almost inevitable growth and prosperity. Subsequently, economic and social life was characterized by greater flexibility and insecurity.

Perhaps their most dramatic impact was on the Communist Comecon countries. These experienced the economic crises with a time-lag, as prices for Romanian and Soviet oil, which were not immune from world price fluctuations, were fixed every five years. Even the oil-producing USSR and Romania were adversely affected by this development, since they too had to pay higher prices for high-quality goods and machinery made in Asia or the West with their limited funds of hard currency. Given the increasingly run-down nature of these command economies, the oil price shocks dealt a crucial blow to regimes running an already bankrupt economic system. The ideological raison d'être of these countries demanded the maintenance of full employment and at least constant living standards. It was the inability of these command economies to absorb the effects of the oil price shocks that formed the underpinning to the (economic) collapse of Eastern Europe and the Soviet Union in the late 1980s.