The Economic Effects of the 1973 Oil Crisis

From 1974 to 1975, the US economy was in a recession. The 1975 Economic Report of the President, speaking of 1974, begins with “The story of the past year was one of inflation and recession.” America’s production of goods and services was steadily declining for almost a year, causing a rise in unemployment that would leave millions of Americans without jobs. A major priority of the Nixon and Ford administrations was curtailing high unemployment rates along with high inflation rates; a combination known as “stagflation.” The poor economic conditions were exacerbated by a stock market crash in 1973, and steep hikes in the cost of food and other essentials that would leave Americans relatively the poorest they had been since the great depression. The causes of the recession in the United States were many among a competitive new world market recovered from the devastation of World War II and monetary and fiscal policy that led to increased inflation. One of the biggest contributing factors to the recession of 1974 to 1975 was the oil crisis of 1973. The crisis would shake the fundamentals of the economy and directly pinch the pocketbooks of average consumers not only at the pump, but almost everywhere they spent money.

Stable oil prices of the 1950’s and 1960’s led industries to demand more oil for variety of applications making it an inextricable part of the global economy. An already well-developed oil extraction industry abroad made oil imports more cost-effective than developing production within the US. Oil was the main source of energy in America accounting for three fourths of the national energy budget and nearly half of that oil was imported. The oil, petrochemical and automobile industries, all particularly vulnerable to swings in oil prices, accounted for one fifth of the economy in 1975.

Cheap oil was the basis for the bustling automobile industry which was a boon to manufacturing since the 1920’s. Cars permanently transformed the structure of typical American living places from rural farmlands or crowded cities to the sprawling suburbs in between. Cheap gasoline, half as expensive as in Europe, led to the construction of interstates and highways and to government subsides for the freight truck industry which replaced the relatively fuel-efficient rail freight industry as the primary mode of freight. The dispersed suburban population became increasingly dependent on cars and trucks for transportation making impossible more fuel-efficient modes of travel such as mass transit or walking.

The US economy’s growing dependence on oil did not go unnoticed. In the years before the crisis, oil had been cheap and politically easy to come by, but that was to change. The oil crisis started when the Organization of Arab Petroleum Exporting Countries (OAPEC), which was the Arab members of OPEC, Egypt and Syria, declared an embargo banning oil exports to the US and cut oil production by five percent in response to America’s indirect military support of Israel against Iraq, Egypt, and Syria during the Yom Kippur War. Ahmed Zaki Yamani, Saudia Arabia’s minister of Oil and Mineral Resources and chief architect of the crisis, demanded that Israel pull back to its pre-1967 borders before ending the embargo and resuming production. This presented President Nixon with a perplexing set of foreign policy challenges that directly affected average Americans. Even though Nixon assured America that the oil crisis was a “temporary problem”, economists predicted the end of cheap and easy oil thereafter. Although the embargo did not dramatically change middle-east foreign policy, OAPEC had proven a point. Oil producing countries could use what was dubbed the “oil weapon” to put political pressure on western nations by significantly disrupting the global economy. The price of crude oil quadrupled from 1972 to 1974 rising from three to twelve dollars per barrel as a result of the embargo and production cuts.

A diminishing supply of oil on the world market, along with a price freeze on oil set by Nixon in 1971, resulted in shortages having an immediate impact on American families and consumers. The oil crisis struck at the beginning of the winter when demand for heating oil was high. With heating oil harder to find, some schools and offices temporarily closed. Some gas stations had long lines of idling cars waiting to refuel. Some ran out of gas or only allowed commercial vehicles to refuel. Some states limited drivers with odd numbered license plates to fill up on odd numbered days of the month and even numbered license plates to fill up on even days of the month. Many rationing devices were proposed and implemented but the shortages nonetheless continued to hamper the mobility of suburban consumers impeding their normal business activity further contributing, in a literal way, to the economic slow-down.

In his column in Newsweek magazine, famous economist Milton Friedman argued that the reason why gasoline was in short supply on the market was less the increase in price and decrease in supply of oil and more government mismanagement by artificially attempting to lower prices with price controls. To keep oil prices from surging to levels businesses could not afford, Nixon signed into law the Emergency Petroleum Allocation Act which instituted price, production, and allocation controls on the petroleum market. The low prices on gasoline gave consumers no incentive to economize their gas usage, so together they consumed more than the available supply. Friedman argued that any rationing device imposed by the government would naturally lead to shortages and in the long run be more costly than letting the free market work out prices on its own.

The increase in the price of oil had far-reaching effects throughout the economy affecting all industries related to gasoline. In 1974, over 20 percent of the production capacity of automobile companies was idle and 100,000 employees were laid off. The increasing prices of gasoline-related goods led consumers to cut back on things such as tires, campers, motel services, travel, and goods made with petroleum chemicals like plastics and polyester. Offices closed down and manufacturers were reluctant to spend money on machines that used large amounts of gasoline, expecting oil prices to rise further. Consumers cut their usage of oil-related products by $15 billion including $9 billion on cars. From higher prices on petroleum products, consumers were spending $15 to $20 billion extra dollars that went to overseas oil firms and couldn’t be spent on anything domestically produced.

Farmers were especially hit hard by the spike in oil prices and passed their increasing expenses onto consumers. Heavy farm equipment and new processing techniques made farming into an energy-intensive industry. Through advances in chemistry, oil transformed the way farmers grew crops with new petrochemical fertilizers and pesticides. After the crisis, the price of petrochemicals soared. Between 1970 and 1975, the price of propane increased by 101 percent, the price of nitrogen fertilizer increased by 253 percent, and the price of pesticides increased by an average of 67 percent. Increased expenses of farms caused food prices to rise by twenty five percent.

The government took action to decrease consumer demand for oil. In 1974, the Emergency Highway Energy Conservation Act was passed that set a maximum speed limit of 55 miles per hour on highways and interstates, although was largely ignored. The government scrambled to find alternatives to oil. Recalling the Manhattan Project, Nixon announced Project Independence in November 1973 with the goal of being independent from foreign oil by 1980. The project called for coal power plants, the completion of the Trans-Alaskan Pipeline, and mass transit. However, none of these programs were effective. The reason why attempts to curb demand for oil were doomed to fail, and why the oil crisis hit the economy so hard, was that oil had become integrated into the fundamental structure of the economy by technological advances that made petroleum-based products more profitable than their alternatives.

The energy independence rhetoric of the early ‘70s was short lived and all long-term solutions went unrealized. Oil shocks that hurt the economy would become a repeating theme in US history after 1973. The 1973 oil crisis is as relevant now as ever. A keen reader by now may have found many similarities between the 1973 oil crisis and the 2008 oil crisis and perhaps between the following recessions as well. Former President Bush has said about our dependency on oil “America is addicted to oil, which is often imported from unstable parts of the world,” which unfortunately is still true. Energy, now more than ever, is considered a national security issue tangled up in tumultuous foreign affairs. The only two solutions seem to be increasing domestic production and finding alternatives. Whether the mantra is “drill, baby, drill” or “green energy,” there are no immediate solutions. We must use history as a tool and thereby learn from the many failures of policy makers and businesses in order to make a lasting long-term solution to the oil problem a reality.

Bibliography
Friedman, Milton. There’s No Such Thing as a Free Lunch. LaSalle, Illinois: Open Court, 1975

Rosen, Sumner M. Economic Power Failure: The Current American Crisis. New York: McGraw-Hill, 1975

Heller, Walter W. The Economy: Old Myths and New Realities. New York: Norton, 1976

Commoner, Barry. The Poverty of Power: Energy and the Economic Crisis. New York: Knopf

Gas Fever: Happiness Is a Full Tank. Time. 18 Febuary 1974. Accessed from http://www.time.com/time/magazine/article/0,9171,942763,00.html

Bush: U.S. must cut dependence on Mideast oil. MSNBC.com. 1 February 2006. Accessed from http://www.msnbc.msn.com/id/11110276/

Second Arab Oil Embargo, 1973-1974. US Department of State. Accessed from http://www.state.gov/r/pa/ho/time/dr/96057.htm