Brent crude hit $112 a barrel last Friday. Goldman Sachs says it could reach $147 if the Strait of Hormuz stays closed; the futures market predicts it will be $86 in six months. Anyone who knew for sure could make a fortune. But no one does.
The inexorable pressure on governments to “do something”, always has dangers New Zealand has been here before. Twice. First in 1973–74 and again in 1979–80.
Lessons can be drawn about the additional pain from responding by borrowing, palliatives and risky investments.
To understand the scale of the 1970s oil shocks: oil-related imports consumed 5% of New Zealand’s merchandise export income in 1970. By 1980–81, that figure was 21%.
This problem was on top of the need from 1973 to find new export markets after the UK joined the EEC. The oil shocks wrecked the country’s balance of payments.
Governments cannot make economic pain disappear. An oil price shock reduces what exports can buy. In 1976, the higher import prices relative to export prices since 1973 was equivalent to a 70% drop in export receipts.
No subsidy, no price freeze, no rationing scheme reverses that. Government policy can only decide who bears the cost and when. Every delay to adjusting increases the cost
This story of the 1970s is not a story of politicians. They were able and intelligent. They needed to show leadership, allow adjustment, protect the vulnerable, and maintain public confidence — and try to get re-elected
These are inherently democratic, but competing, pressures. In the 1970s, the response was a combination of sensible measures, palliatives, and dangerous gambles with other people’s money. It all ended in a lot of pain.
Borrowing and hoping: 1973–74
Just as the Arab oil embargo quadrupled oil prices in late 1973, Bill Rowling found himself prime minister after the sudden death of Norman Kirk. He faced an economy in freefall, a deep moral commitment to full employment, and a general election looming in 1975.
His government borrowed heavily offshore to fund twin deficits — current account and fiscal — while deploying price controls that suppressed the adjustment signal households and businesses needed.
Ever since this episode, New Zealanders have owed overseas much more than they own.
Robert Muldoon, barnstorming the country in opposition, called it “borrow and hope.” It was, and the pressures on politicians today are much the same.
Wage freezes and Think Big: 1979–80
Muldoon inherited the debt and made a creditable start on adjustment. His 1976 Budget cut deficit spending sharply. By 1977, rising unemployment had pushed him to ease up. He brokered a wage and price agreement with the Federation of Labour.
Then came the second oil shock. The Iranian Revolution in 1979 doubled global oil prices again, erasing two years of painful progress in months. New Zealand’s export prices fell relative to import prices to levels not seen since the Great Depression. Muldoon reached for command and control: carless days, a wage and price freeze, and massive spending on government-guaranteed energy substitution projects, known as Think Big.
Each step was publicly defended by appeal to the need to adjust or to protect some group. At $35 per barrel in 1980, backing gas-to-energy conversion plants could be sold as a win for jobs and the balance of payments. The wage freeze brought measured inflation down sharply.
But, by 1984 it had all unravelled. The wage freeze became a trap. Inflation broke out as soon as it was lifted. Lower oil prices wrecked the economics of Think Big. New Zealanders lost on the higher oil prices and the project losses reduced the gains when oil prices fell. Pain deferred was pain increased.
The same trap, again
Today’s government faces similar conflicting public pressures. Petrol prices will rise. Airlines will increase fares. Freight costs will feed into everything.
The pressure to cut fuel taxes, cap pump prices, and subsidise transport operators will be intense, immediate, and humanly understandable. It needs to be resisted. The higher prices are the incentive to do things differently.
Thus far, the government has commendably resisted price regulation and subsidies. Its targeted income relief for the most vulnerable, without thwarting price signals is better.
Another risk is on the investment side. At $100+ for a barrel of oil, there will be pressure on government to commit taxpayer money to specific oil-replacing projects (such as electric vehicles). That pressure is dangerous.
Future prices for oil today suggest it will be $86 in six months, yet Goldman Sachs thought $60 was a reasonable 2026 average just weeks ago. Any major public investment premised on sustained high future prices is risky. Where possible, private capital, not taxpayers’ funds, should make those risky bets.
A public that pressures government for palliatives or headline oil-substituting spending risks making itself worse off. “Voter beware” is a worthy maxim.
To read the article on the NZ Herald website, click here.