Asymmetric effects of oil price shocks in oil‐exporting countries: the role of institutions

• Published date: 01 June 2015
• DOI: http://doi.org/10.1111/opec.12050
• Date: 01 June 2015
• Author: Saeed Moshiri

Asymmetric effects of oil price shocks

in oil-exporting countries: the role

of institutions

Saeed Moshiri

STM College, University of Saskatchewan, Saskatoon, Saskatchewan, Canada S7N 0W6. Email:

smoshiri@stmcollege.ca

Abstract

Many empirical studies on the oil price shock effects on the economies of oil-exporting countries

have assumed a linear relationship between the shocks and macroeconomic variables, offering no

insights on the dynamics of different types of shocks. The literature also assumes a homogeneous

response to oil price shocks by oil-exporting countries.This paper investigates the non-linear effects

of oil price shock on macroeconomic performance in the context of two groups of oil-exporting

countries using a VARmodel with price shocks estimated by a GARCH method. The model consists

of oil price shocks and economic growth as two major variables of interest as well as intermediate

variables such as investment,exchange rate, and inflation rate. The sample includes nine major oil-

exporting countries, six developing and three developed countries, for the period 1970–2010. The

results indicate that not all oil-exporting countries are alike in responding to oil shocks. While oil

shocks have asymmetric effectsin oil-exporting developing countries; lower oil prices lead to major

revenue cuts and ensuing stagnation in the economy, but higher oil prices and accompanying higher

revenues do not translate into sustained economic growth;they do not have significant effect on eco-

nomic growth in oil-exporting developed countries. The panel data estimation results also suggest

that heterogeneous responses to oil price shocks in oil-exporting countries can be explained by dif-

ferences in their institutional quality,par ticularlygovernment effectiveness.

Keywords:Oil price shocks, oil-exporting countries, asymmetric effects, VAR, institutional quality.

JEL classification: E32, Q43, C3

1. Introduction

The oil price shocks in the 1970s generated extensive literature on the effect of oil price

shocks on economic performance in both oil-importing and oil-exporting countries. Most

studies supported theoretical predictions of supply-side shock models in oil-importing

countries, indicating that higher oil prices would lead to loweroutput and higher aggregate

prices (Brown and Yücel, 2002).The Dutch disease model (Corden and Neary, 1982) also

provided a theoretical frameworkto explain the transmission mechanism of the effects of

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an oil price boom on the economic performance of an oil-exporting country. Recent litera-

ture suggests that oil price shocks have lost their impetus in oil-importing countries due to

structural changes in favour of non-energy intensive sectors, more flexible labour hours,

and improvement in monetary policy (Blanchard and Gali, 2007). However, oil is still a

main driver of economic activities in most oil-exporting countries and, therefore, any

change in oil prices has a dramatic effect on their economic performance. Since the first oil

price shock in 1973, oil prices have been subject to extensive fluctuations with a marked

increasing trend in the 2000’s. The important question to ask is how oil-exporting coun-

tries have sailed through these fluctuations over the past 40 years, and, especially, if the

responses to positive and negative shocks have been symmetric.1The traditional models,

such as Dutch disease, apply to a representative oil-exporting country, whereas oil-

exporting countries are heterogeneous in their degree of development, and,therefore, the

predicted responses may not be similar.

Oil revenues can indeed contribute to economic growth in oil-exporting developing

countries largely because they provide much-needed financial resources for those coun-

tries. However, high oil revenues also encourage exactly those economic conditions

that stifle growth: appreciation of exchange rates, inflation, and rent-seeking. This

bi-directional effect of oil windfalls is clearly reflected in the empirical literature. Some

studies on single or multi oil-exporting countries show that oil has been a curse (Eltony

and Al-Awadi, 2001; Sachs and Warner, 2001; Ayadi, 2005; Berument et al., 2010), but

other studies such as Esfahani et al. (2012) suggest that oil has contributed positively to

long-run economic performance of oil-exporting countries. However, these studies

assume a linear relationship between oil price and economic growthand do not discer n the

effects of positive and negative shocks of oil prices. By allowing for non-linearity in the

model, we can track down the sources of oil price shock effects on the economy of oil-

exporting countries. In general, positive oil price changes are good news for oil-exporting

countries because they bring in foreign reserves and investment opportunities, and nega-

tive oil price changes are bad news because they restrain the revenuesand halt investment

projects. However, oil price changes might cause non-standard effects as positiveoil price

changes may lead to stagnation due to higher inflation and a dampening in the tradable

sector, and negative changes may induce diversification in economic activities and an

increase in non-oil exports leading to economic growth.

This paper investigates the effect of oil shocks on the economic performance of

major nine oil-exporting countries using a non-linear framework. In particular, the posi-

tive and negative oil shocks are specified in a vector autoregressive (VAR) model to

capture the dynamic effects of the shocks and their transmission mechanism on the

major macroeconomic variables. The estimation results are then used to test for asym-

metric effects of oil shocks on economic growth. Specifically, the paper aims to test

three hypothesis as follows. Firstly, while negative oil price shocks have detrimental

Oil price shocks in oil-exporting countries 223

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