Responding to the Oil Shock; R. Gonalez and R. Folsom

In the face of these developments, neither Keynesians .nor monetarists have been able to supply a consistent explanation for the macro economic behavior of the U.S. economy since the first oil shock in 1973. Nevertheless, the main economic events of this period can be ex plained by assuming that private decision makProfessor Gonzalez teaches in the Department of Adminis trative Sciences at the Naval Postgraduate School. Profes sor Folsom teaches in the Department ofEconomics at San Jose State University. Although solely responsible for the views expressed here, as well as for any errors, the authors greatly appreciate comments by J. Paul Leigh, Tim Sass, and David Saurman. ers responded rationally to the energy "crisis" while policy makers, particularly the monetary authorities, did not. In terms of aggregate economic output, en ergy is a complementary resource to both labor and real capital (including other natural re sources). The shocks that decreased the avail ability of oil to the U.S. in the 1970s must have greatly decreased the (marginal) productivity of labor and also capital at that time. In contrast, if labor and the owners of real capital both be lieved that the energy crisis was temporary, and that energy would once again be plentiful, the oil shocks may not have significantly depressed the expected future opportunities for labor and capital in the 1980s.

Workers and capitalists may have been un impressed by the argument-advanced by many energy "experts" in the 1970s-that the rise in oil prices was a sign of dwindling worldwide energy sources. Instead, they may have realized that high oil prices almost certainly would in duce energy conservation and the discovery and development of new oil supplies not controlled by the cartel, and might stimulate the develop ment of alternatives such as solar power. If they correctly perceived the energy situation as a temporary disruption caused by the OPEC car tel, they should have assigned a high probabil ity to a recovery of energy supplies in a not too-distant future. Cartels rarely prevail for long against com petitive market forces that move investment to the activities expected to be most profitable. Moreover, even if a profit-maximizing oil cartel had a perfect and unassailable monopoly, it would not reduce oil production permanently, but would merely shift production to the future.

If we suppose that the suppliers of labor and capital anticipated the return of more plentiful energy supplies, and responded rationally to the difference between existing and expected future opportunities created by the oil crisis - and by government policies that were at least partly reactions to the oil crisis2 - by reallocating labor effort, leisure, and capital use over time, then the economic history of the U.S. in the 1970s and first half of the 1980s could read as follows:3 The demand for labor decreased with the fall in its productivity, but real wages did not fall significantly because workers did not expect the oil crisis to last, and therefore they were reluc tant to accept real wages lower than those they expected in the future. Instead they accepted unemployment and greater leisure, expecting to increase their labor supply to above-normal lev els in the future, when energy supplies and la bor productivity had returned to normal.