Oil & unemployment

One thing that peeves me about reporting on oil prices is the tendency to see them only in terms of the “misery” they cause motorists. But history suggests that oil matters more than this. My chart - stolen and adapted from Andrew Oswald (pdf) - shows the point for the UK. It shows that oil prices predict unemployment, with a lag of around 18 months. Rises in oil prices in 1973-74, 1979-80 and in the mid-00s led to rising unemployment. And falling oil prices in 1986, 1998 and 2003 led to falling unemployment.
The reason for this is simple. Higher oil prices hurt companies as well as motorists. One reason for this is that if people are spending more on petrol they’ve less cash to spend on other things, so retailers suffer. But also - obviously - higher oil prices raise firms’ energy and transport bills. At the margin, this causes them to shrink production and lay off workers or even go out of business altogether.
So far, so simple. But four things complicate the relationship:
1. What causes higher oil prices? If prices rise because of supply restrictions - which was obviously the case in 1973-94 and 1979 - it is unambiguously bad for jobs. If, however, price rises reflect a global economic boom or loose monetary policy - as was the case in 2005-07 - their effect is ambiguous. This is because the things that cause higher oil prices also help create jobs. It’s not entirely clear which is the case now: there might be an element of betting on a worst-case scenario - rather than genuine supply problems - in the Brent price. 
2. What are firms’ expectations for oil prices and demand?  Firms do not lay off staff immediately as oil prices rise. If they think there‘s a good chance of prices falling back - which there is, given their volatility - or if they think economic conditions generally will improve, they might soldier on in the belief that the squeeze on their cashflow is temporary. It is only when they realize that higher prices and weaker demand are here to stay that they sack workers.
In this sense, responses to higher oil prices are like responses to exchange rates: the volatility of both dampens firms’ immediate reaction to them. This means its hard to find a precise mechanical relationship between oil and employment decisions, as the link is mediated by animal spirits.
3. How do wages respond to higher oil prices? If workers were to quickly and easily accept lower incomes to offset high oil costs, unemployment needn’t rise. However, in efficiency wage models, this doesn’t necessarily happen.
4. Are the firms most exposed to higher oil prices the same ones who are sitting on large cash piles, or not?
Higher oil prices interact with credit constraints. If a firm can’t raise the cash to see itself through the squeeze imposed by higher oil costs, it will be quicker to go bust or lay off workers.
Because firms, in aggregate, have been accumulating cash for years, you might think they are not credit-constrained. Such a belief, though, is an example of the representative firm fallacy. It is possible that the firms sitting on cash are not the same firms which suffer most from rising oil prices. To the extent that they differ, the oil price hit will be quicker and harder.
These four uncertainties mean we can’t say for sure whether, when, or by how much unemployment will  be affected by higher oil prices. What we can say, though, is that there is a danger here.

Comments

[guthrie]

How about the local issue that the UK is now importing more oil and gas, and an increasing amount at that. Therefore our balance of payments will get worse, which I assume would have some effect on the value of the pound over time.

[Strategist]

Hear, hear, Guthrie.
It's quite one thing to have a useless shit economy that is spectacularly wasteful of energy when you have enough oil and gas for all your own needs plus a little bit to sell to help pay for imports.
Quite another when you have to generate a dollar in export earnings for every dollar of oil you burn, before you've even started generating earnings to pay for imports of everything else.
It seems to me plausible that the British economy we have become used to is spectacularly fucked. Conventional market economists have been remarkably blind to this; anyone know why?

[Agog]

"Therefore our balance of payments will get worse..."

Ceteris paribus.

As if we're powerless to respond, as if we have no other wealth, no skills to offer...

[Matthew]

The amount of oil we produce is clearly an important factor - as a net exporter the country gets richer from higher oil prices, now we don't. It doesn't really show up in the data though (although perhaps explains a little why low oil prices in late 1980s didn't reduce unemployment?)

[guthrie]

Agog - I'm pretty sure we do have other things to offer, I just don't quite know what they are, not being an economist or whatever. But given our balance of payments on goods has been highly negative for the last 15 years, not even balanced by services, you've got to wonder exactly how things are supposed to get better. Perhaps you have an idea?

[Metatone]

Worth noting that the marginal cost of oil production appears to be circling the $80 mark...

http://www.eurotrib.com/story/2011/2/25/65550/4909

There is volatility, but the baseline does appear to have moved.

[Strategist]

"As if we're powerless to respond, as if we have no other wealth, no skills to offer..."

Of course Britain has precious little other natural wealth. Oats? Herring? Sorry mate, we've fished all those out.

And as Guthrie points out, the revealed preference of the market is that we make relatively few things beyond weapons that foreigners want to buy.

Those free market economists who think adjusting from an oil-bankrolled economy to an non-oil bankrolled is a simple process that the invisible hand will do for us by magic have simply no idea how hard it will be to catch up with the world-beating companies and products of the Germans or the Japanese.

We've got the wind and the tides and need to get on the case of harnessing those. We're making a pretty half arsed job of it so far.

[guthrie]

If i'm understanding the data correctly, there are other financial things going on which help balance up the balance of trade, the problem being that such things hardly benefit the rest of the populace since it goes to the finance industry who then spend it on German engineering and French champaigne. Taxing the finance people helps fund some social relief etc, but the new government doesn't seem quite so interested in keeping these things going.

[Tari Ledsome]

Yes, it is becoming a global phenomenon! Hybrid cars can lessen our dependence on foreign oil and help develop locally-sourced resources such as biofuel.