The OPEC Oil Embargo and Third-World Debt

by Dale H. Easley
Department of Natural and Applied Sciences
University of Dubuque

7/17/2000

1973 is an important year for understanding the economy of the last quarter of the 20th century. That was the year of the OPEC ¹ Oil Embargo. Prior to 1973, oil prices were about $3 per barrel. Oil was developed and produced by American and European companies who paid royalties to OPEC countries. The OPEC countries had little to say about the price of oil. Then in 1973, war broke out (once again) between Israel and surrounding Arab countries. The U.S. strongly supported Israel. Our Arab allies, such as Saudi Arabia, stayed neutral until they felt their nose had been rubbed in it—a glitch resulted in U.S. warplanes being seen resupplying Israel during the daytime. Up until then, U.S. planes had flown in and out at night. OPEC retaliated by cutting off oil to the U.S. and some of its allies. Feeling its power, OPEC later offered to resume selling oil, but at the price OPEC set of $13 per barrel. Because OPEC controlled so much of the world's oil, it was able to dictate this price. Their use of, and loss of, this control determined the wealth and poverty of much of the world's population for decades to come.

The quadrupling of oil prices sent a shock wave through the world economy. The industrialized countries initially underwent massive inflation, such as during President Carter's administration. They responded to high oil prices by reducing demand, improving efficiency, and developing new petroleum energy sources, particularly in Alaska and the North Sea. In the developing third-world, the story was far different. Reducing demand was less of an option, because their main use of energy was the industry they were trying to develop to advance economically. They lacked economic reserves for funding the higher energy costs. The third-world countries' main strength was in raw materials to be exported to the developed world. These materials did not see a corresponding rise in price to match the cost of importing fuel.

In order to pay for imported fuel and other increased costs, third world countries began borrowing from U.S. and European banks. These banks were flush with cash from OPEC countries. In order to make interest payments on the OPEC deposits, the banks needed to make loans. Money was loaned to third-world countries with little of the usual accountability required in banking. Basically, to receive a loan one must usually show a means to repay it and its interest. Many of the loans to third-world countries went to pay for fuel or imports. These investments did not produce anything of economic value sufficient to enable the borrowers to repay their loans. Amazingly, some oil-exporting countries, such as Mexico, also went deeply into debt. In order to make payments, these countries must export more than they import. By 1988, the flow of money had reversed, with a net loss of money out of the third-world countries. Thus, easy money coupled with poor banking practices and poor public policy began to impoverish third-world countries.

As it became increasingly clear that many third-world countries could not repay their loans, credit dried up. These countries became seen as a poor financial risk. With no further loans coming in and an inability to make their loan payments, the world's financial systems were again endangered. Two existing international organizations, the World Bank and the International Monetary Fund (IMF), stepped in to try and clean up the mess. In order to prop up a country's financial system, the World Bank/IMF required structural adjustment. Structural adjustment requires a country to lower tariffs, privatize inefficient public companies, reduce government subsidies, and open up their economies to the market rather than government control. In return, debt payments on loans are reduced or written off. Though long-term economic benefits may result, in the short term, the poor tend to suffer from the reduction in government services, such as health care and education.

Third-world countries initially greeted the OPEC embargo with cheers. Some of their own were sticking it to the rich guys. Even though they had to pay more for oil, they hoped that 1973 was the beginning of a change in the international economic system. Oil was a commodity whose price was being controlled by the producer—how about coffee, or copper, or fruit? Because of developed countries' addiction to imported oil, OPEC was able to get away temporarily with its embargo. That sort of control never developed for coffee growers or other commodity producers. And OPEC's embargo didn't last—it, too, fell victim to market forces. By the end of the century, oil prices had dropped to below those of 1973, adjusted for inflation. Today we see oil prices once again zooming and people complaining about gasoline prices. Perhaps we're destined to go through another cycle like that after the 1973 embargo. The root cause, our addiction to oil imports, is back to where it was in 1973, perhaps worse. Hopefully, the third world will have learned its lesson better than we have.

Footnotes:

¹OPEC is the Organization of Petroleum Exporting Countries.

For more information, check out the energy statistics at http://www.simmonsco-intl.com/web/index.asp