Academic journal article IUP Journal of Applied Economics

The Economic Effects of Oil Prices Shocks on the UK Manufacturing and Services Sectors

Academic journal article IUP Journal of Applied Economics

The Economic Effects of Oil Prices Shocks on the UK Manufacturing and Services Sectors

Article excerpt

This paper investigates the relationship between changes in oil prices and the UK's manufacturing and services sectors performances. Only a few studies have been conducted at the sector level; the goal of this paper is to contribute in that direction. In a more detailed analysis, three sets of Vector Autoregressive (VAR) models are employed using linear and nonlinear oil price specifications among several key macroeconomic variables. From the linear oil price specification VAR model, the impulse response function reveals that oil price movement causes positive effects in both the output of manufacturing and services sectors. The variance decomposition shows that oil prices are quite important as a cause of the variance of the UK services sector output, while they do not have such a large role in the variance of the UK's manufacturing output. From the asymmetric specification, it has been found that positive oil price changes determine a consistent contraction in manufacturing output, while the services sector does not seem to be affected by the increases. Alternatively, negative oil price changes show that manufacturing output does not increase much despite a decrease in oil prices. The services sector is much more affected by oil prices decreases than increases. Finally, considering the Net Oil Price Increase (NOPI) specification, it has been found that the manufacturing sector is much more affected by oil price changes than the services sector.

(ProQuest: ... denotes formulae omitted.)

Introduction

Oil prices have increased sharply over the past few years. Being prone to sharp fluctuations, oil prices have repeatedly been blamed for causing undesirable macroeconomic impacts. The UK economy is a distinct case not only because it was a net oil exporter (until the end of 2005), but oil price changes are crucial in explaining the economic performances of that economy as a whole.

The growth of both UK manufacturing and services sectors is regarded as a crucial element in the future of the UK not only because of the sectors' contribution to external financing, but also because of their importance as sources of both employment and wealth.

Relative to the importance of these sectors in the UK economy, this paper aims to discover if the volatility of the UK manufacturing and services output is due to fluctuations in oil prices. It also employs the VAR analysis in order to forecast the effects of an oil price shock on the variables used in this analysis, how long such effects last, and when maximum repercussions can be expected. The results of this study can add something new to the dearth of existing economic literature about effects of oil prices on different economic sectors.

This study is organized as follows: It presents the relationship between UK manufacturing and services sectors and oil price shocks. Then, the theoretical framework used in this study is discussed to assess the above-mentioned relationship. Subsequently, the results of the econometric analysis are presented and finally the conclusion is offered.

Literature Review

The discovery of oil in the North Sea represented large increases in the national wealth of the UK. At the same time this discovery contributed to the rapid growth of the UK energy sector. Together with the great increase in energy prices during the 1970s, the development of oil resources allowed this country to move from the position of being a net importer to being a net exporter of oil (Figure 1).

As we can see from Figure 1, at the end of 2005, total UK oil production was 1.81 million barrels per day, although from 1999 there was a decline in production due to several reasons, mainly the maturity of the UK's oil fields and the growth of costs due to the shifting of production to remote areas in the North Sea.

During the first half of the 1970s, the UK economy was mainly based on the manufacturing sector, much of the discussion following the energy boom in the UK did not focus on these new-found riches, but on the probable adverse effects of the booming energy sector on that sector. …

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