Thursday, February 11, 2016

The Political Economy of Oil (and Other Sectors of a Modern Economy, Considered Separately)

There has been a lot of talk recently about the impact of falling oil prices on global equity and bond markets.  One simple comparison can’t capture all that’s going on, but for starters here’s how the daily price of West Texas Intermediate stacks up with the S&P 500.  I’ve converted both to indexes of their initial values as of July 1, 2015.

Source: FRED

The first thing to notice is that oil prices are far more volatile than this specific equity index, but that’s not very enlightening, since oil is a single commodity while the S&P is a basket of 500 different items.  More interesting is whether they’re aligned in any way.  I don’t think formal tests will help much because equity prices are influenced by many factors that typically emerge and recede in importance over time.  A better way to consider it is to look at different historical episodes and ask whether they are consistent with a compact set of plausible stories.

Obviously there are periods when the two indices move together and periods when they come apart.  It is pertinent that two particular episodes of oil price distress, late August and late January, are associated with sharp equity downturns.  The period from November to January, however, saw oil prices slide while equities held their own.  Perhaps the rate of oil price decline is a factor: it has to be rapid enough to move equities.

Now the reason I mention all this is not because I want to improve anyone’s investment performance, but because it poses what I regard as one of the central questions in political economy, whether the “branches of capital” metaphor has lost most of its salience.  To put it in very simple terms, once upon a time it was common to think of capital as divided between various sectors: there was industrial or manufacturing capital (maybe divided between light and heavy industry or home market and exporters), financial sector capital, real estate capital and so on.  If you were interested in the relationship between capital and political processes, you thought in terms of the agency or structural influence of these various branches on political outcomes.  Whether a government took action that favored or undermined a particular sector depended on the power, potential and actualized, of that sector.  The data that political scientists use to assess the role of wealth (capital) in politics is largely organized on such a sectoral basis.

But what if the sector delineation is less important now than in the past?  For instance, what if the fortunes of non-oil sectors of capital (expected future profits) are tied more closely to the fortunes of the oil producers than in the past?  This would fundamentally alter how we think about the political economy of oil and have large implications for strategies to curtail the use of fossil fuels, for instance.

The short run relationship between oil prices and equities, even if we restrict it to episodes that support the “integration of the branches” hypothesis, is not very revealing.  It could be, for instance, that oil price movements are interpreted as coincident indicators of macroeconomic forces: falling oil prices mean falling incomes and demand in advance of the statistical reports that might validate these trends.  But it could also mean that, in a more financialized economy, there is more cross-dependence of the values of a range of financial instruments on one another: think of the large financial portfolios now held by nonfinancial corporations, greater diversification of portfolios in general, the integration associated with many types of derivatives, and the network effects of increased securitization (use of some financial instruments as collateral for others).

You could approach the same question from the starting point of politics.  When Clinton was elected in 1992 there was a big surge of public interest in and support for health insurance reform.  Remember Harris Wafford?  He was elected in a special senatorial election in Pennsylvania in 1991 in which his advocacy of public health insurance was the overriding issue.  The momentum seemed to be on the side of reform.

The political strategy of reformers was to isolate the health insurance companies.  Yes, they were rich and powerful, but surely their interests were in conflict with nearly every other branch of capital.  After all, most employers were suffering from the high cost of health care provided as a form of compensation to employees; surely they could be enlisted to neutralize or even overwhelm the bleatings of just one sector.  Based on this strategy there was a long period of negotiation over policy details to bring as many other branches of capital on board.  In the end, however, the strategy failed: no amount of policy tinkering could convince the rest of business to oppose the health insurers, and Harry and Louise were left without debating partners.

Nor was the situation very different in 2009 when Obama turned his attention to health care reform: the absence of a public option is directly due to the lack of any financial counterweight to the health insurance sector.  Safeguarding the profits of insurers was the price of getting a bill passed.

And now the issue of the day is climate change, and the sector under direct threat is fossil fuels.  Activists have largely converged on a strategy that is reminiscent of what was tried in health care in the early 90s: isolate the energy companies.  Only a small portion of capital is actually invested in oil, coal and natural gas; make this one sector the target and bring the rest of capital on board.  But this will work only if the branches-of-capital metaphor actually applies, and there is every reason to doubt that it does.  There was no great coalescence (pun intended) of non-carbon capital around climate legislation in 2009, nor should we count on it in the future.  My reading of the recent history of the European Trading System, moreover, is that energy-invested capital has not been isolated there either; this is ultimate reason why carbon prices collapsed into meaningless.

To sum up, the question of the extent to which the interests and power of capital are integrated and can’t be decomposed into particular branches is one of the central uncertainties in political economy, and the answer has great significance for political strategy on the ground.  I think some insight can be gained from more fine-grained analysis of co-movements across financial sectors, particularly in combination with event studies.  Carefully examined case studies might help as well.  At this point, what I most want to say is that there is lots of talk about political economy but hardly any research on the political economic problems that matter most for political action.

8 comments: said...

On the matter of the basic relation, the more interesting one is really the relation between US GDP and oil prices, which is pretty clear cut, lower oil prices, better GDP performance, although there is a reverese causation that when the GDP goes into a major recession or depression, that can lead to a major decline in oil prices, as in 1930 and 2008.

Anyway, sticking with stock markets and oil prices, I think aside from these GD and GR cases, you have to look very hard to find cases where they moved together aside from within the last year, which looks to me absurdly anomalous and too focused on a return to 2008 (which I do not see), not to mention too much hyperventilating about the financial problems coming from the oil-producing patch (bankruptcies by North Dakota frackers are really going to bring down the US financial sector? I seriously doubt it). There is also the fact that declines in retail gasoline prices have not matched the declines in crude oil prices, and this is where the rubber hits the road in terms of stimulating the economy.

So, let us go back a bit. When did we have the boomiest stock markets (sometimes matched by GDP)? Well, the 1960s look great on both fronts. Crude oil prices were about a dollar a barrel the whole decade, and retail gasoline was cheap (bring on those big gas-hog US cars!). We had oil price shocks in 73-74 and 79-80, and both the GDP and the stock market took big hits. Oil prices dropped in 81-82 and stayed down, even going lower in 86 temporarily. This helped the rapid bounceback from the 82 recession, with the stock market taking off and eventually getting into a bubble into Oct. 87.

Then we have the last round of really low oil prices, the late 90s. Both the GDp and the stock market did very well, with again the stock market getting into a bubble, although that was tied to dotcom stocks rather than oil, although people forget how those very low oil and gasoline prices bolstered that very nice boom that lowered unemployment and poverty rates across the board even as inflation remained low (opposite of the stagflation of the 70s).

So, Peter, I do not think the case is so even handed as you say. Lower oil prices will eventually kick in to stimulate the US GDP, whether or not it stimulates the US stock market, I do not know. But you have way exaggerated how even this debate is.

Peter Dorman said...

Barkley, I think you're missing the point of this post. I'm not discussing the relationship between oil prices and economic growth or long-term ups and downs in equities. This is about the relationship between event-driven changes in oil revenues and non-oil profit expectations as a point of entry into the larger political economic question of sectoral profits are less susceptible to isolation than in the past.

Mary Robinson said...

But, the spx contains a fairly large oil industry component. Would it not be more useful to divide the spx into industry segments and see the strength of the effect there?

Peter Dorman said...

Mary, yes, certainly. And there begins a project, since the kind of hypothesis I'm proposing is not restricted to oil. Really the question is about the interdependence of profit expectations net of their cyclical component. Can a political movement say, "we want a policy that will benefit society but hammer sector A" and enlist the other sectors against A? said...


Unless a sector uses oil or an energy input that oil could substitute for, their profits improve when oil prices fall and their stock prices should go up. The current market seems oblivious to this basic fact.

That said, you may be right on the larger pol econ issue that other sectors may not want to see too much squashing of oil sector profits because they may fear that they will be next. said...

Oh, and of course industries providing inputs to the oil sector are also hurt when oil prices fall.

Peter Dorman said...

Barkley, I could be very wrong but my hypothesis is financialization, as I briefly sketch at the end. If this hypothesis is true, it's not accurate any more to think of firms simply as production/sales units with inputs and outputs; they are portfolios with lots of interdependent valuation.

But this is empirically testable, directly and indirectly. One purpose of my post is to see if I can interest anyone in such tests.

And if the hypothesis is disconfirmed, I still read the recent history of health care and climate policy as saying that it's unlikely to expect that a single sector can be defeated in isolation by forming an alliance with the rest of capital. The problem would be to explain why.

Unknown said...

I wonder to what extent "Oil is special" in that there are multiple second order effects. The fall in oil prices may be good for GDP but the sudden reversal of petrodollar financial flows are themselves going to alter the investment prospects buy reducing the supply of investment. Oil is too concentrated a resource in some ways to really infer effects. Every major oil country and the related individuals are tapping their savings to smooth consumption. From a US dollar perspective this is contractionary which itself could effect the future path of interest rates.

I think you may be right but the weird structure of the oil market may make it hard to figure out how interconnected the economy is on a sectoral level.