Long-term closure of the Strait of Hormuz would trigger a worldwide recession, which would include the United States. At the time of this writing, the outcome of the Iran War is impossible to predict, at least for me. But the consequences of a long-lasting oil disruption would certainly be recessionary. The remainder of this article will explore the economic consequences of a one-year closure of the Strait of Hormuz.
Lower Energy Usage
Widely reported has been the statistic that about 20% of the world’s crude oil production flows through the Strait of Hormuz. And oil amounts to about one-third of the world’s energy production. That suggests about seven percent of global energy production depends on the Strait. That’s a low estimate, though, because some of the Persian Gulf’s crude oil becomes a feedstock for other products. Whatever the actual number, it’s large enough to impact the world economy.
The price of crude oil is closely watched, but price obscures the central point: We will have less energy to consume if the Strait is shut down. That’s true however we figure out who gets to use the available energy. We could have a lottery: the losers would have to stop using energy. We could issue ration coupons, as many countries did during World War II. Most people would have to use somewhat less energy. We could allocate gasoline to those willing to wait in line the longest; those not willing to wait simply would get less energy. So the critical issue is not so much the transfer of money from buyer to seller, but simply that there will be less energy to sell.
Money Loss Of Consumers
However, the money transfer will be a significant secondary effect. Consumers will pay more for gasoline, and indirectly they pay more for the diesel fuel that delivers products to stores or directly to homes. The increased spending on energy will flow into oil companies’ coffers. Eventually it will get spent, but that might not be right away, and it might not be in the same locations as where the consumers cut back their spending. Companies that make and sell consumer discretionary products—such as cars, clothing, vacations, recreation—will have lower sales and will lay off employees.
Businesses will evaluate how much of their energy cost increases they can pass on to their customers. Trucking companies, for example, will be able to pass on their costs because the end users of their services have no good alternative for getting products from a factory or distribution center to a store.
Some companies will find that energy-intensive products don’t sell as well because users have other options. Think of the plastic deck material that has become popular. When plastic—a product made from petroleum—becomes more expensive, then lumber becomes a more economical choice for the family that wants to replace their home’s deck. And simply delaying deck replacement a year is another option that will cause production of the energy-intensive product to decline. Although deck material is a very small part of the overall economy, it illustrates what will happen with many energy-intensive products that users can do without if prices go up. Reduced production of energy-intensive products will trigger more layoffs, and then reduced consumer spending.
Layoffs Part Of Adjustment Process
The layoffs are temporary adjustment problems, not permanent reductions in economic activity. Given time, we can find more energy. Some would come from increased oil and natural gas production elsewhere. Some would come from alternative energy sources, such as solar and wind, which will become more economical after oil prices rise. Nuclear power may come back. And people may shift to less energy-intensive goods.
Even without higher energy production, the economy will adjust. People will find ways to live using less energy. But the changes won’t be fast or easy. Some jobs will no longer be viable. Some recreational activity will no longer be worth the cost to the participants.
These adjustments take time and cost money. That’s certainly true of finding more oil. For new crude oil fields, geological evaluations are needed, then exploratory wells drilled, and then production wells and some infrastructure to get the oil to market. Adding to the world’s productive capacity takes time. Ten years might be a ballpark estimate, though particular projects may be shorter or longer.
Recession Would Include The United States
The recession will include the United States, even though we are a net energy exporter. Oil is traded internationally. American prices will match world prices (less the cost of transportation and some minor differences). If not, U.S. oil producers would sell their products overseas. We Americans must match international prices if we want energy for our own use. Yes, our oil companies will grow richer, but our adjustment to a world with less energy will still trigger a recession. Again, it’s a temporary adjustment problem.
What if closure of the Strait of Hormuz becomes permanent? That seems unlikely, but considering extreme cases sometimes helps our understanding. The world adjusts to scarcer energy. New employment opportunities arise in the energy sector, including the energy efficiency sector. The world will be somewhat poorer, but economic activity will adjust to the new reality. Full employment will be likely within a year.
If the Strait reopens in a few months, then less adjustment will be needed. The economy will bounce back within a month or two. We will have scars—lost potential production, lost potential consumption—but the world economy will return to full output.
