TransForum Vol. 3, No. 4

VIEWING OUR ECONOMIC FUTURE

For most of last year, government officials, economists, and the rest of us wondered, "Is a full-blown recession lurking in the not-so-distant future?" The million-dollar question had many economists pondering probable scenarios. Among them was Dan Santini of Argonne's Center for Transportation Research. This economic wizard didn't need a crystal ball to foresee the future. Instead, he relied on two simple, but practical models he developed to predict oil price shocks and subsequent recessions. Santini used these models to predict, in a 1999 conference paper, the 2000-2001 oil price shock andsubsequent recession.

Although many economists believe that the terrorism of September 11 tipped the economy into a recession, Santini asserts that the sharp decline in the rate of economic growth from 2000 to 2001 would, with or without September 11, have been comparable to or greater than those that preceded the recessions of 1970, 1980, or 1991.

An important emphasis of Santini's theory is the effect of the transportation sector (in its entirety) on the economy. According to his theory, after a fuel price increase, motor vehicle sales and output decline, pulling the other elements of the economy downward in rapid succession. In other words,recessions are caused primarily by significant difficulties in the transportation sector. Thus, while terrorism was not a factor in Santini's prediction, to the extent that declines in aircraft sales and air transportation are having a strong negative effect, what we have seen since September is consistent with his general arguments.

Santini's prediction of a recession after a fuel price shock is based on statistical investigations using data from the late 1800s to the present. "Over the full period examined, my historical statistical analyses showed that recessions tend to follow sharp fuel price increases by one year. These analyses suggested that if there was going to be a recession this time, it would be in 2001."

Santini has accurately predicted two other sharp fuel price shocks — in 1985 (a dramatic drop) and 1989. He also warned of the high risk of a recession in an 1989 paper — a recession that occurred in the second half of 1990 and first quarter of 1991.

In both the 1990 and 2001 cases, the oil and gasoline price shock triggered a sharp decline in motor vehicle output, which was followed by economic decline in the rest of the economy, and a recession. Santini points out that the declines in motor vehicle output in both cases preceded disastrous events in the Middle East. In 1990, Iraq invaded Kuwait, causing another upward push to oil prices that had previously risen significantly, but had begun to move down. In 2001, the terrorist attacks also occurred months after the motor vehicle output decline had bottomed out and gasoline prices had begun to move down.

What about oil use and energy security today? "What is happening now is in some ways reminiscent of the mid 1970s, when the Arab oil embargo and oil price shock of 1973-74 caused a lengthy recession in 1974-75. A discouraging difference is that the United States is much more dependent on Middle Eastern oil than it was in 1973, and this dependence is rising. On the positive side, the reasonably rapid decreases in dependence after the more recent 1988-1990 oil price shock serve as a reminder to Middle Eastern producers that alternatives are available.

Rising shares of imports from the Persian Gulf preceded the oil price shocks of 1978-1981, 1988-1990, and 1998-2000.

Santini recommends that economists show more interest in fuel efficiency at times when fuel prices are low and supply seems abundant — an approach that has gained popularity recently. "Fuel prices are among the most volatile of all prices, and repeated fuel price shocks that slow or reverse economic growth have actually been typical of the U.S. economy for two centuries now." To create a more stable economy, he suggests that the United States begin adapting its behavior, as have such energy-poor industrialized nations as France, Japan, and Germany. Those nations combine higher fuel taxes and more fuel-efficient technologies. By following the example of these nations, the United States could help ensure that its economy is less susceptible to the effects of global instability and oil price shocks.