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Gas Prices, Consumers and the Economy

Prof. Peter Morici - 4/13/2011

Gasoline prices are soaring passed $4.00 a gallon in many places and driving will continue to be more expensive. Unless consumers are determined to again recklessly pile up credit card debt, higher gas prices will profoundly slow other purchases and the economic recovery.

Over a three year period, most folks don’t have much control over how much they spend on rent and mortgage payments, utilities, tuition, and food, or how much they drive. Gasoline absorbs 15 percent or more of most household budgets, and the necessity of getting to work and driving kids to soccer practice does not relent when gas prices jump.

With gas prices up from $2.75 a gallon since last September, higher prices translate into a 5 percent cut in discretionary income, and Americans will be eating fewer restaurant meals, wearing fewer new clothes, curtailing summer vacation plans, and postponing furniture purchases and home improvements.

As most money paid for higher priced gasoline leaves the country to pay for more expensive imported oil and does not return to buy U.S. exports, this shift in consumer spending reduces demand for what Americans make and slows economic recovery.

GDP was up 3.1 percent in the fourth quarter of 2010 and employers are hiring again—unemployment may not be as low as we would like but it is coming down. But for the first quarter of 2011, economic forecasters have lowered estimated growth to 2.7 percent from 3.4 percent just a month ago, and if growth stays that subdued, 50,000 or more jobs will be lost each month on account of higher energy prices.

Gasoline prices are likely to continue rising, and the impact on jobs creation and unemployment will worsen. China continues to grow at 9 or 10 percent a year, and Beijing regulates gasoline prices and subsidizes oil imports to meet growing domestic needs. This pushes the impact of tight global oil supplies and Middle East disturbances onto the United States and other big importers.

Oil prices could easily stay above $125 a barrel and gasoline prices could pierce $4.50 a gallon before moderating this summer or fall. That would further slow growth to about 2 percent and kill most jobs creation.

Growth at less than 2.5 percent is difficult to sustain. At less than 2.5 percent growth, most businesses can meet new demand by raising productivity, hiring slows or stops in most industries, and layoffs accelerate in slower growing sectors—pessimism grows, retail sales slow and the conditions for a new recession emerge.

U.S. policy has been to discourage domestic drilling for oil and gas and bank on alternative energy—such as solar, wind and nuclear. Events in Japan make nuclear power a much less likely option than three months ago, and fully electric vehicles that could exploit more abundant electricity from alternative sources are at least ten years away from having any significant impact on U.S. gasoline consumption.

Freeing up drilling for domestic oil and gas, greater emphasis on natural gas use for urban fleets, and more rapid build out of high-efficiency gas powered cars, hybrids and plug in hybrids would do a great deal to rev up the U.S. economy, create jobs and reduce the grip of foreign oil.

Higher gasoline prices are always painful, but if more of the gasoline purchased were refined from domestic oil and more resources were focused on reducing domestic gasoline use altogether, the money spent would stay in the United States to create jobs. American prosperity would be much less vulnerable to events in the Middle East, Africa and other unstable places around the globe.