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Surviving oil shocks

With US Treasury secretary John Snow ratcheting up his criticism of Opec, it is clear the Bush administration is alarmed about rising oil prices. But while the negative impact of the run-up in energy costs is undeniable, it has yet to derail the US economic recovery.

Compared with other rich economies, the US is notably energy-dependent. Aside from Americans' umbilical attachment to their cars, life in the rapidly growing cities of the southern and western states would be sweaty and unpleasant indeed without air-conditioning. American energy use makes it resemble a grimy, gas-guzzling developing economy more than a green rich nation: a dollar of US gross domestic product takes one third more energy to produce than a dollar of output in Japan or western Europe. Gasoline taxes, though they have the advantage of making energy consumers bear the associated environmental costs - "internalising externalities" in the language of economics - remain politically toxic. The Bush camp recently attacked John Kerry for once supporting an energy tax.

Nonetheless, the onward march of energy-saving technology, the growth of the weightless service sector relative to heavy manufacturing, and the realisation that Opec - as well as the Internal Revenue Service - has plenty of power to exact tribute from US consumers have combined to reduce the US's economic vulnerability to an oil shock. Not only does each real dollar of GDP take half as much energy to produce as before the oil embargo in 1973, but, perhaps more surprisingly, the overall consumption of energy per capita in the US has essentially been flat for the past 30 years. Sports utility vehicles are less important to the economy than their dominance of suburban driveways suggests.

One rule of thumb, used by the International Monetary Fund, is that a sustained $10 per barrel rise in the oil price slices only 0.3 percentage points off annual US GDP growth: not negligible, but not disastrous. Yesterday's news of a thumping rise in retail sales in March suggests consumers have not yet been knocked off their stride by higher pump prices.

The Federal Reserve, fortunately, is not about to cock its revolver for an interest rate rise purely because of rising oil costs. If anything, higher oil prices in current circumstances are likely to be disinflationary in the medium term because they reduce real wages and profits - as the 4,000 workers soon to be laid off by DuPont because of rising energy prices can testify. As the saying within the Fed goes, higher gasoline prices are a roadside tax collector in cash. Unless inflationary expectations are rising, there is no need to react to one-off changes in price caused by energy price rises.

In the longer term, for both economic and strategic reasons, the US would be wise to reduce its energy dependency. For now, unless oil prices accelerate sharply upwards, it should be able to ride out the shock.

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