Wednesday, August 21, 2013

The oil choke collar and wages

. - by New Deal democrat

I remain mystified why virtually the entire Econo-commentariat fails to notice the importance of the Oil choke collar operating in the background of almost all economic events. It is clear to me that the constraint imposed by the vanishing supply of cheap petroleum is an important determinant of how weak the economy has been since even before the great recession.

To refresh your memory, here is a graph of the price of Oil (blue) for the last 50 years, and the price of gasoline (red) since the EIA started keeping statistics in the early 1990's, adjusted by average wages. I use wages as the deflator since the price of Oil itself is a component of the CPI. Both are normed to 1 at the peak in July 2008:

It is fair to categorize what happened between 1999 and 2008 as the second Oil shock, the first being the 1970's. And both had similar economic outcomes. In fact, at one point Prof. James Hamilton estimated that the Oil shock of 2008 was responsible for about half of the GDP loss during the great recession.

Further, note that in a "real" sense, the prices of Oil and gas remain very elevated, far higher than at any time except for the end of the 1970's and in early 2008. If Oil were not such a constrained resource, and gas was priced at $1.60 or even $2.60 a gallon vs. around $3.60 a gallon, as it has been for the last 2 years, there is little doubt that we would be seeing a much stronger recovery.

To make the point, well, more pointedly, the below graph shows the CPI (green) , CPI ex-energy (blue), and median wages from the Employment Cost Index (red):

Normally it takes about 12 months or so for energy prices to feed through into the broader array of prices. Notice that the "ex-energy" measure of CPI makes more subdued peaks and troughs, and does so about 12 months after the measure that includes energy. It's bad enough that the Employment Cost Index decreased from growing at over 3% YoY before the recession to only 1.5%-2% per year since, but notice that when the YoY increase in the price of gas has exceeded the increase in median wages, it has correlated with a virtual stall (or worse) in GDP. Conversely GDP has recovered when the YoY increase in the price of gas has been below the increase in median wages.

In short, the paltry increase in nominal median wages is only half of the story of working class wage stagnation. The other part is the surge in the real price of Oil, its continued highly elevated price, and its effect of being a choke collar constraining the economy.