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УДК 338.23
Maria Demidova International Finance Faculty Financial University under the Government of the Russian Federation
Moscow, Russia Scientific Supervisor: I. V. Tregub THE INFLUENCE OF OIL PRICES ON ECONOMIC GROWTH. THE CASE OF UNITED ARAB EMIRATES
Absract
The relationship between oil prices and economic development has been studied for a long time, however, still there are several views on this problem. In my article I will examine the historical data of oil prices, and then I will use the data from the World Bank database in order to construct econometrical model, which will include variables connected with oil prices and economic growth in United Arab Emirates for a period from 1995 to 2015 in order to establish the relationship between them.
Key words: crude oil, economic growth, econometrical model, t-statistic, probability of mistake
Информация о себе: Телефон: 8-906- 717-16-29 Е-mail: MashaMGIMO@mail.ru
Literature review of this problem and historical path of oil prices
Crude oil is the most important commodity for oil-exporting countries,
among which is United Arab Emirates. This commodity provides the country with the greatest part of revenues and the currency inflows. According to the data, in 1995 the annual amount of oil production was 290 thousand barrels per day, 83% of which accounted for Abu-dabi, 15% for Dubai and 2% Shardzha. From 1967, the United Arab Emirates is a member of OPEC (Organization of petroleum exporting countries, which was established in 1960 and nowadays has 13 countries as members, among which are Algeria, Angola, Ecuador, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates and Venezuela). Because of this membership, oil produces in UAE have to follow the overall policy of this organization and consider some quotes, which were imposed on them. However, as we can see from the history, the country consider this quotes only as recommendations and did not follow them always (for example, we can take in consideration the fact, that during the invasion of Iraq in Kuwait, the amount of produced oil was twice bigger than the amount of quotes).
However, like every another commodity, oil prices were not always stable and some shocks occurred. For a better understanding of this situation, it is important to consider the following graph and understand the reasons behind significant changes in oil prices.
Year
Source: Data from (IFS. 2015)
First significant change took place in 1973-1975, when the real world crude oil price skyrocketed from 18 dollars per barrel to more than 45 dollars per barrel. It happened because some Western European countries and the United States supported Israel during the Middle Eastern War and OPEC imposed oil embargo on them. The second change took place in 1978, when in Iran happened the Revolution. The third shock was connected with the Asian Financial Crisis (1997), causing the significant decrease in the demand for this commodity. The forth shock took place in 2008, when the global financial crisis hit each economies. And after reaching the price of USD 115 per barrel in the middle of 2008, the price decreased by more than 2,5 times and was amounted for USD 44 per barrel. The oil market managed to recover from this crise only after four years and in 2012 the prices on crude oil increased to USD 2012. However, this situation did not last for a long time and in the middle of 2014 the fifth shock took place, when after the announcement of OPEC that they were not going to cut their production, the
prices fell from USD 106 to USD 51 per barrel. We can conclude, that the market itself is unstable and it is really crucial to understand the impact of these changes on economies, especially for oil-exporting countries.
After my investigation of articles, in which were examined the factors influencing an economic growth, I came to a conclusion that all these factors can be divided into three groups. The first group consists of indicators, which are connected with the financial development. Among these indicators are private credit, commercial credit, interest rates, reserves of banks and so on. The second group is represented by the indicators of international trade and productivity, namely the amount of export, import, productivity of labor and others. The third group has indicators of macroeconomic stability (or instability), the most important of which is inflation. I want to include in my equation some indicators from each of the group mentioned above plus the indicators of oil sector in order to evaluate, whether the influences of oil sector on economic development is a significant indicator for country under consideration or not.
Modelling financial development and economic growth
Year GDP trln (current US$) Annual imported crude oil price ($ per barrel) real prices Trade (% of GDP) Imports of goods and services trln (current US$) Exports of goods and services trln (current LCU)
Y X(1) X(2) X(3) X(4)
1995 66 27 75 35 161
1996 74 32 76 36 165
1997 79 28 79 38 167
1998 76 18 85 47 178
1999 84 25 87 45 174
2000 104 39 80 42 180
2001 108 30 91 46 187
2002 110 32 93 48 200
2003 124 37 102 58 255
2004 148 46 117 78 345
2005 181 61 120 94 448
2006 222 71 119 113 560
2007 258 79 137 166 686
2008 315 105 149 220 914
2009 254 67 153 187 742
2010 286 85 151 207 827
2011 349 111 163 252 1156
2012 373 107 176 281 1380
2013 389 103 176 293 1442
2014 402 92 173 306 1437
2015 370 48 180 308 1324
In order to evaluate the relationship between oil prices and economic growth in UAE and find out which indicators have the most significant influence on economic growth, I choose the following data for a period of 21 years for a
Year Fuel exports (% of merchandise exports) Oil rents (% of GDP) Inflation, GDP deflator (annual %) Market capitalization of listed domestic companies trln(current US$) Bank liquid reserves to bank assets ratio (%)
X(5) X(6) X(7) X(8) X(9)
1995 86 14 4 18 8
1996 88 17 6 18 8
1997 87 14 -1 20 9
1998 91 8 -4 21 9
1999 91 11 8 23 10
2000 94 18 11 21 9
2001 92 17 -2 23 11
2002 95 12 4 23 10
2003 87 15 4 25 10
2004 73 18 9 55 11
2005 58 21 17 123 9
2006 60 23 12 71 9
2007 65 21 13 126 29
2008 65 24 19 107 10
2009 60 16 -15 138 13
2010 57 20 11 131 14
2011 56 25 16 94 13
2012 54 25 0 101 14
2013 52 24 -1 180 15
2014 42 21 0 202 15
2015 41 11 -11 196 17
UAE:
Broad Final World crude Crude oil Crude oil
money consumption oil production inventories future
(% of expenditure trln (mln barrel (mln contract ($
GDP) (current US$) per day) barrels) per barrel)
Year X(10) X(11) X(12) X(13) X(14)
1995 34 53 62 307 18
1996 32 58 64 290 22
1997 33 61 66 314 21
1998 36 61 67 329 14
1999 36 69 66 290 19
2000 33 71 68 286 30
2001 37 73 68 315 26
2002 42 79 67 274 26
2003 43 85 69 267 31
2004 45 103 72 293 41
2005 48 116 74 320 57
2006 48 140 73 321 66
2007 59 173 73 290 72
2008 58 207 74 334 100
2009 78 159 72 329 62
2010 74 189 74 338 80
2011 64 204 74 335 95
2012 62 192 76 365 94
2013 73 200 76 355 98
2014 76 219 78 398 93
2015 87 216 80 492 49
Source: World Bank database
According to these data, the system of equations of economic growth can be
written down this way:
Y = + C2X1 + C3X2 + C4X3 + C5X4 + C6X$ + C7X6 + C8X 7 + CçXg + Cio^9 + C11X10 + ^12^11 +
= C13 + ^14^12 + ^15^13 + ^16^14 + P2
Before estimating this system, it is important to treat each equation independently and consider the factors this equation has. The formula of first equation is:
Y = + ^2^1 + ^3X2 + C4X3 + C5X4 + QX5 + ^7^6 + ^3X7 + CgXg +
^10^9 + ^11*10 + ^12^11 + @1
Letter Variable Explanation
Y GDP trln (current US$) GDP is the main indicator of economic growth, because it represents the monetary value of all the finished goods and services produced during a particular period.
Annual imported crude oil price ($ per barrel) real prices I used this indicator as one of the measurements of oil prices.
Trade (% of GDP) Trade as a percentage of GDP will help us to estimate the influence of this indicator on the economic growth of a country.
Import of goods and services trln (current US) Import is one of the main economic indicators, therefore, it is crucial to include this variable in the equation.
Export of goods and services trln (current US) Export is one of the main economic indicators, therefore, it is crucial to include this variable in the equation.
X* Fuel exports (% of merchandise export) I decide to include this indicator in the equation in order to find the influence on economic growth not only of the export as a whole, but also of the fuel export.
X6 Oil rents (% of GDP) Oil rents is the difference between the revenues and costs of oil produces, therefore, this indicator is a proxy of country's oil wealth.
x7 Inflation (GDP deflator) annual % Inflation is a proxy of macroeconomic stability (or instability) of a country, therefore, it is important factor to consider during the estimation of economic growth.
X8 Market capitalization of listed domestic companies trln (current US) Market capitalization (also known as market value) is the share price times the number of shares outstanding. Listed domestic companies are the domestically incorporated companies listed on the country's stock exchanges at the end of the year. Thus, I will use this indicator as a proxy for financial sector measurement.
xq Bank liquid reserves to bank assets (%) Ratio of bank liquid reserves to bank assets is the ratio of domestic currency holdings and deposits with the monetary authorities to claims on other governments, nonfinancial public enterprises, the private sector, and other banking institutions.
X10 Broad money (% of GDP) Broad money is the method of calculating country's money supply. The money supply is the totality of assets that households and businesses can use to make payments. Therefore, this indicator serves as a proxy for financial market development.
X\\ Final consumption expenditure trln (current US) Final consumption expenditure is the expenditure on goods and services that is used for direct satisfaction of individual or collective needs. These expenditures will stimulate the economic growth, therefore, I include them in the equation.
The formula of second equation is:
= Cl3 + ^14^12 + ^15^13 + ^16^14 + ^2
Letter Variable Explanation
Annual imported crude oil price ($ per barrel) real prices I used this indicator as one of the measurements of oil prices.
X\2 World crude oil production (mln barrels per day) In according with fundamental economic theory, an increased oil supply leads to a lowering of its price.
X13 Crude oil inventories (mln barrels) When the price of oil is low, the producers will be increase the amount of inventories in order to force the increase in prices.
X-14 Crude oil future contract ($ per barrel) Futures contract prices are usually used as a benchmark for the future prices, however, these prices may be not justified and, therefore, companies may adjust their production or
consumption of oil applying the wrong
___assumptions._
Econometrical model
According to my model, the dependent variables are annual imported crude
oil price in US dollars per barrel and current GDP (in USD dollars). The
independent variables are trade as a percentage of GDP, imports and exports of
goods and services in current prices, fuel export as a percentage of merchandise
exports, oil rents as a percentage of GDP, inflation in form of GDP deflator,
market capitalization of listed domestic companies in current prices, bank liquid
reserves to bank assets ratio, broad money as a percentage of GDP, final
consumption expenditure, world crude oil production, crude oil inventories and
crude oil future contract prices. Data for all these indicators for a period of 21
years were taken from World Bank database.
Interpretation of results
With the help of Eviews, I got the following data: System: UAE
Estimation Method: Two-Stage Least Squares
□ate: 02^05^17 Time: 17:21
Sample: 1995 2015
Included observations: 21
Total system (balanced) observations 42
Coefficient Std. Error t-Statistic Prob.
c(U -115.6360 23.24493 -4.095315 0.0004
C(2) -0.3-22397 0.174602 -1.346469 0 0767
C(3) 0.3-0 20 3-6 0.196842 1.534407 0.1375
C(4] -0.752153 0.216363 -3.476342 0.0019
C(5) 0.236 383 0.035473 6.676303 0.0000
C(6) 0 610486 0.208374 2.929756 0.G071
C(l) 1.920535 0.699336 2.744265 0.0111
cm -0.315250 0.235369 -1.339 333 0.1925
C(9> 0.042093 0.062195 0.676372 0.5047
C[10) -0.191536 0.271363 -0.706013 0.4367
C(11) 0.350571 0.360612 0.972156 0.3403
C(12) 1.294051 0.164339 7.&71395 0.0000
c<13) 71.76630 23.62353 3.037294 0.0055
C(14) -0.939394 0.414794 -2.265927 0.0324
COS) 0.240416 0.205927 1.167435 0.2540
C(16) -0.036435 0.031200 -1.169404 0.2533
COT) 1.017010 0.033624 11.47561 0.0000
Determinant residual covariance 51.33057
With the help of Excel I found, that t critical is equal to 1,76 (with the level of certainty 90%). It means, that hypothesis about the relationship between oil prices and economic growth is confirmed with t-statistic of annual imported crude oil prices equals to 1,85 and the probability of mistake equals to 7,7%. In addition to this, according to the table provided above, the absolute amount of C(3), C(8), C(9), C(10), C(11), C(15) and C(16) is accounted for 1,53; 1,34; 0,68; 0,71; 0,97; 1,17 and 1,17, which is lower than the value of t critical, therefore, these indicators
are insignificant. Moreover, if we take into account the probability of mistake, we may notice, that the abovementioned coefficients have very high probabilities of mistakes, which account for 14%, 19%, 50%, 49%, 34%, 25% and 25%. It means, that trade, inflation, market capitalization of listed domestic companies, bank liquid reserves to bank assets ratio, broad money, world crude oil production and the prices of oil future contracts do not have a significant influence on the economic development of the United Arab Emirates, the level of which was measured with the help of GDP. At the same time, an annual imported crude oil price per barrel, import and export of goods and services, fuel exports, oil rents, final consumption and crude oil inventories are significant indicators and, therefore, have a great impact on GDP. In order to estimate the whole system, we need to find the value of R-squared in each equation:
Equation: Y = C(1) +■ C(2)*X_1_ + C(3PX_2_ + C(4)*X_3_ + C(5)*X_4_ +■ C(6)*X_5_ + C[7>*X_6_ +■ C[S)*X_7_ -i- C(9 )*X_8_ C[10}*X_9_ + G(11)
Instruments: X_2_ X_3_ xl4_ X_5_ X_6_ X_7_ X_3_ X_9_ X_10_ X_11_
R-squared 0.999498 Mean dependent var 203.1435
Adjusted R-squared 0.998884 SD dependent var 121.5770
S.E. of regression 4.061893 Sum squared resid 148.4908
Equation: X_1_ = C[13) + C[14)*X_12_ + C(15TX_13_ +■ C[16)*X_14_
Instruments: X_2_ X_3_ X_4_ X_5_ X_6_ X_7_ X_3_ X_9_ X_10_ X_11_
R-squared 0.990395 Mean dependent var 59.19938
Adjusted R-squared 0.988700 SD dependent var 31.32513
S.E. of regression 3.329861 Sum squared resid 138.4956
As we can see, R-square equals to nearly 1 in the first equation and 0,99 in the second equation. It means, that the model passed the R-square test (because R-squares in both cases are higher than 0,7) and the equation can be explained with the help of included factors by 100% and 99%. However, when the amount of R-square is so high, it means, that we have a problem of multicollinearity, in other words, some of instrumental variables are dependent from the other instrumental variables.
Then, to test the residuals of the model for autocorrelation we can use Durbin-Watson test. With the help of Eviews and tables of value of Durbin-Watson statistics for n=21 and k=9 and 17 we can find that the values are the following: DW1 = 2,2 DW2 = 1,63 and Dl =0,73 and Du=2,12. It means, that the value of DW2 is on the interval (0,73; 2,12), which means that it is impossible to conclude about autocorrelation of residuals.
Conclusion
The main role of my research was to identify and analyze the influence of oil prices on economic growth of United Arab Emirates. In order to estimate this relationship, I use GDP as a proxy for economic growth (dependent variable) and measure this parameter with the help of the following indicators: annual imported
oil price (in dollars per barrel) in real prices, trade as a percentage of GDP, import and export of goods and services in current prices, fuel export as a percentage of merchandise exports, oil rents as a percentage of GDP, inflation in form of GDP deflator, market capitalization of listed domestic companies in current prices, ratio of bank liquid reserves to assets, broad money indicator as a percentage of GDP and final consumption expenditure in current prices. Then I construct the second equation for estimation of annual imported oil price, in which I include amount of world crude oil production in million barrels per day, amount of crude oil inventories in million barrels and price of crude oil future contract in dollars per barrel.
With the help of Excel I proved the hypothesis about the relationship between oil prices and economic growth with t-statistic of annual imported crude oil prices equals to 1,85 (while t critical equals to 1,76) and the probability of mistake equals to 7,7%. In addition to this, according to the data, trade, inflation, market capitalization of listed domestic companies, bank liquid reserves to bank assets ratio, broad money, world crude oil production and the prices of oil future contracts do not have a significant influence on the economic development of the United Arab Emirates, the level of which was measured with the help of GDP. At the same time, an annual imported crude oil price per barrel, import and export of goods and services, fuel exports, oil rents, final consumption and crude oil inventories are significant indicators and, therefore, have a great impact on GDP.
Literature:
1. I.V. Tregub "Mathematical models of econometric systems' dynamic".
2. I.V. Tregub "International diversification".
3. World Bank "How is the United Arab Emirates Reacting to Low Oil Prices?"
4. Hanna Boheman and Josephine Maxen "Oil price shocks effect on economic growth. OPEC versus non-OPEC Economies".
5. Nasser Al-Mawali, Haslifah Mohamad Hasim, Khalil Al-Busaidi "Modeling the impact of the oil sector on the economy of sultanate Oman".
6. International Monetary Fund "The impact of higher oil prices on the global economy".
