The effects of oil price shocks on the macroeconomy: economic growth and unemployment in Saudi Arabia

• Date: 01 June 2020
• DOI: http://doi.org/10.1111/opec.12179
• Author: Najla Almutairi
• Published date: 01 June 2020

The effects of oil price shocks on the

macroeconomy: economic growth and

unemployment in Saudi Arabia

Najla Almutairi

Administrative and Social Sciences, Applied Studies and Community Service College, King Saud

University, Riyadh, Saudi Arabia. Email: nalshotity@ksu.edu.sa

Abstract

In contrast to the majority of studies which focus primarily on oil-importing countries in describing

the mechanism by which oil price shocks affect economic activities, this study focuses on oil-

exporting countries. Saudi Arabia is taken as a key example in considering two macroeconomic

variables: economic growth and unemployment. This study examines changes in these variables in

terms of the effects of two types of disturbances: demand and supply, following Blanchard and

Quah’s(American Economic Review 1989; 79: 655) approach. The findings of impulse response

analysis and variance decomposition indicate that oil price shocks play a key role in the

fluctuations in economic growth and unemployment in the Saudi economy.

1. Introduction

Since the first oil price shock took place in 1973, the issue of whether there is a real link

between oil price shocks and economic activity has been an important subject for

researchers. A number of studies support the conclusion that an increase in oil prices

gives rise to a decrease in aggregate output and other macroeconomic variables. Most of

these studies cover importing countries, and in particular, developed countries, but there

is also a stream of studies which focus exclusively on the United States and which

attribute contractions in aggregate output to an increase in oil prices. Hamilton (1983)

showed that a rise in oil prices contributed to all but one of the post-World War II

recessions in the United States.

Oil-exporting countries have also received attention in the current literature, although

there are fewer studies. See, for example, Spatfora and Warner (1995), Eltony and Al-

Awadi (2001), El-Anshasy et al. (2005), Mehrara and Oskoui (2007), Farzanegan and

Special thanks: I would like to express my gratitude and appreciation to Professor Kaddour Hadri

from Queen’s University Management School, Belfast for his invaluable and generous comments

on the econometrics aspects.

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Markwardt (2009), Omojolaibi and Egwaikhide (2014), Ftiti et al. (2016), and Koh

(2017). These studies conclude that oil price shocks have a great impact on

macroeconomic variables. A number of empirical studies found that there is a significant

relationship between oil price shocks and unemployment (Gisser and Goodwin, 1986;

Mory, 1993; Papapetrou, 2001 and Robalo and Salvado, 2008). These studies relate to

both more and less developed oil-importing countries, but the coverage of developed

economies is predominant.

The effects of oil price shocks on oil-importing countries differ substantially from oil

exporters. While an increase in oil prices negatively impacts economic activity in oil-

importing economies, such increases boost economic performance in oil-exporting

economies. This paper examines the effect of oil price shocks on economic activities in

an oil-exporting country, whereas most studies focus primarily on oil-importing

countries. Kilian (2008) points out that high oil prices improve the terms of trade for oil-

exporting countries, which can then improve government expenditure through high oil

rents. If an increase in oil prices is important for economic prosperity in exporting

countries, a decrease in such prices leads to deterioration in their economic status.

Oil prices have recently decreased dramatically. According to the World Bank

(2017), the average price of crude oil fell by over half, from $104 in 2013 to around $45

in 2016. This abrupt downturn in oil prices has created harmful effects for oil producers.

Koh (2017) attributes the great fall in oil prices that occurred in 2014 to several demand-

and supply-side factors. These include the following: (i) contraction in the global

demand for oil, in particular, coming from Europe and China, (ii) abundance in oil

supply due to increases in the production of US shale, (iii) volatility of supply due to

geopolitical tensions in the Middle East and Russia, and (iv) the decision of OPEC to

maintain the level of production at 30 million barrels per day.

This recent major plunge in oil prices has led to renewed interest in studying the

impact of oil price shocks on the economy. As Saudi Arabia is among the largest

producers of oil, the impact of negative oil price shocks is likely to have been greater

than elsewhere. This case, therefore, warrants our particular attention.

There are very few studies which focus on Saudi Arabia, particularly when

examining the effects of oil price shocks on output (Tuwaijri, 2001; Al-obaid, 2002;

Diboo˘

glu and Aleisa, 2008; Algahtani, 2016). For example, a recent study by Algahtani

(2016) examined whether movements in the oil price affected the Saudi economy in the

period from 1970 until 2015, using the VAR\VECM model. The results showed that oil

prices were associated positively and significantly with GDP in the long term.

This study will build on the previous studies on Saudi Arabia in three ways. Firstly,

it will construct a simple conceptual model which seeks to explain the mechanism by

which oil price shocks affect economic activity in Saudi Arabia. Current models focus

predominately on oil-importing countries. Even the limited number of studies on oil-

OPEC Energy Review June 2020 ©2020 Organization of the Petroleum Exporting Countries

182 Najla Almutairi