Severe unrest in the Middle East has historically been a source of oil spikes, which have triggered three of last five global recessions [Reuters]

The idea that it is severe unrest in the Middle East that has historically been a source of oil spikes and these have been the triggers of global recessions is only part of a bigger story. Simplifications of this sort are easy for the media, but are dangerous for decision making.

I do not want to see global stagflation, but this is unlikely unless the economists advise both monetary and fiscal institutions to do the wrong things ... which they might! In my view lack of employment and a failure to understand how available people can be deployed to satisfy critical needs is the key issue at hand. Political turmoil in the Middle East only has powerful negative economic and financial implications when the economic models remain the same and the assumptions are no longer valid. The risk of double-dip recession for the global economy is that economists do not change their models to reflect changed situations.

I cannot believe an economist of Nouriel Roubini's stature would write that it was severe unrest in the Middle East that has been the source ... that is cause ... of oil-price spikes. I was under the impression that it was the effectiveness of OPEC as a production cartel that forced the complete reset of the global oil equilibrium. The role of the Yom Kippur War in 1973 was a factor, but not the underlying cause of the re-ordering of the oil sector.

In my experience the stagflation of the early 1970s was caused by the unwinding of the 'go-go'years in the late 60s together with the unwinding of the Vietnam War ... and then on top of this the OPEC induced oil price increases. This was an economic event of historic scale that moved the value adding in the oil industry from the international oil companies to the oil producing and exporting countries.

I do not see either the Iranian revolution in 1979 or the Iraq's invasion of Kuwait in 1990 as being key causes of stagflation at their respective times, nor being particularly similar. In the late 1970s, the economies of North America and Europe were struggling from the oil shock of 1973 and 1974, and the Iranian situation was just another issue.

The Reagan era in the 1980s was a triumph of politics over economics and produced a fragile economy in the US with increasing deficits and a very costly banking crisis. By 1990 there was talk about Japan being the driver of the next decade with the US playing an inferior role. I would argue that US productivity was more of a factor than the price of oil in moving the US into recession. Iraq’s invasion of Kuwait in August 1990 was a secondary factor.

By the time the financial sector started to implode in 2007-2008, all sorts of things were going on, but turmoil in the Middle East oil supply was not a big factor. Iraq was a wild card since 2003. The fact of oil prices increases during 2008 might well have been just another part of the ridiculous speculation that took over almost every aspect of the financial and capital markets, including commodities. Food prices also increased before the financial implosion and collapse of Lehman Brothers. Financial shocks happened because economists and banking executives got almost everything wrong and were completely out of control.

There are two ways to have stability ... one is to have repression by the state, and another is to have a populace that is treated fairly. The double standard about stability is a problem and must be solved. North Africa and the Middle East will be a lot more stable when the people of this area are seeing meaningful socio-economic progress. Oil prices will respond to supply and demand much more reasonably when there is people stability more than regime stability. The idea of containing political expression is very dangerous.

Even before the recent Middle East political shocks, oil prices had risen above $80-$90 a barrel, an increase driven not only by energy-thirsty emerging-market economies, but also by non-fundamental factors: a wall of liquidity chasing assets and commodities in emerging markets, owing to near-zero interest rates and quantitative easing in advanced economies; momentum and herding behavior; and limited and inelastic oil supplies. If the threat of supply disruptions spreads beyond Libya, even the mere risk of lower output may sharply increase the “fear premium” via precautionary stockpiling of oil by investors and final users.

The latest increases in oil prices - and the related increases in other commodity prices, especially food - imply several unfortunate consequences (even leaving aside the risk of severe civil unrest).

First, inflationary pressure will grow in already-overheating emerging market economies, where oil and food prices represent up to two-thirds of the consumption basket. Given weak demand in slow-growing advanced economies, rising commodity prices may lead only to a small first-round effect on headline inflation there, with little second-round impact on core inflation. But advanced countries will not emerge unscathed.

Indeed, the second risk posed by higher oil prices - a terms-of-trade and disposable income shock to all energy and commodity importers - will hit advanced economies especially hard, as they have barely emerged from recession and are still experiencing an anemic recovery.

The third risk is that rising oil prices reduce investor confidence and increase risk aversion, leading to stock-market corrections that have negative wealth effects on consumption and capital spending. Business and consumer confidence are also likely to take a hit, further undermining demand.

If oil prices rise much further - towards the peaks of 2008 – the advanced economies will slow sharply; many might even slip back into recession. And, even if prices remain at current levels for most of the year, global growth will slow and inflation will rise.

What policy responses are available to dampen the risk of stagflation? In the short run, there are very few: Saudi Arabia – the only OPEC producer with excess capacity – could increase its output, and the US could use its Strategic Petroleum Reserve to increase the supply of oil.

Over time - but this could take years - consumers could invest in alternative energy sources and reduce demand for fossil fuels via carbon taxes and new technologies. Because energy and food security are matters of economic as well as social and political stability, policies that reduce commodity-price volatility should be in the interest of producers and consumers.

But the time to act is now. The transition from autocracy to democracy in the Middle East is likely to be bumpy and unstable, at best. In countries with pent-up demand for higher income and welfare, democratic fervor could lead to large budget deficits, excessive wage demands, and high inflation, ultimately resulting in severe economic crises.

Roubini suggests that a bold new assistance program should be designed for the region, modeled on the Marshall Plan in Western Europe after WWII, or on the support offered to Eastern Europe after the collapse of the Berlin Wall. Please NO. The situation is very different and the times are very different.

The idea that financing should come from the International Monetary Fund, the World Bank, the European Bank for Reconstruction and Development is awful. These organizations have no money and no underlying economy that their money might be based upon. They get their money from governments and the capital markets and serve merely as conduits with high overhead and little sensitivity to what really is needed.

There is no reason whatsoever why the countries that are progressing through a transition should not finance themselves in the first instance, helped modestly by bilateral support from willing friends like the US, the European Union, China, and oil exporting states with surplus liquidity. We should support efforts to progress these economies in ways that result in higher standards of living for the people of the country, and especially young people. The goal should not be couched in terms like stabilizing the countries’ economies which is tantamount to saying that the ststus quo is good enough ... which it is not.

I would agree that the stakes are high. Unsatisfactory economic progress in the countries of the region are more unstable than the political relationships, and repression is not the answer, even in the short term. The status quo is likely to have higher levels of social disorder than progressive socio-economic action. A certain amount of confusion and chaos is to be expected, but it will reduce if there are jobs and opportunities. Repression of organized violence, and/or civil war will not put an end to economic and political turmoil ... merely delay what is inevitable.

While there is risk-sensitivity in oil prices, a period of high prices might be good for an economy like the US where there is energy profligracy. The US needs to get serious about how it uses energy and use less. Higher prices would help in this important economic reset, though there would be pain!

Peter Burgess