THE OIL INDUSTRY'S IMPACT ON THE LOCAL
ECONOMY
Dr. Euric Robb, Deputy Governor, Central Bank
This paper may be conveniently divided into three sections. In the first section, I will briefly review the performance
of the economy it recent years in order to identify the "drive mechanism" (a term very familiar to the
petroleum engineers amongst you). Having done this, I will be in a position to analyze the performance of the
economy in 1982 in some detail and, finally, in the third section to place within a consistent framework the prospects
for 1983.
I. The Boom Years 1974 - 81
During the period 1974 - 81 the Trinidad and Tobago economy experienced boom conditions characterised by high rates
of growth of real GDP, high levels of Government revenue and expenditure, balance of payments surpluses, a strong
foreign reserves position, large increases in the money supply and in credit to the private sector, rapid growth
of incomes and a significant reduction in the level of unemployment. We experienced an unprecedented improvement
in the standard of living of the majority of the population over a very short period of time.
It is common knowledge that the buoyancy of the economy was due almost entirely to the windfall revenues derived
from the oil industry'. The increases in the price of oil in 1973 - 74 and again in 1979 - 80, produced a large
and favourable shift in the country's terms of trade and, therefore, in its real income. By this I mean that the
things we produce were suddenly invested with new value such that they could be exchanged for many more of the
things we purchase from other countries.
To be more precise, I would say the thing we produce, for all that happened was that a barrel of oil could be exchanged
for a much larger basket of imported goods and services than previously.
Presented at the GSTT Seminar on The Oil Industry's
Impact on the Local Economy;
Review 1982/Forecast 1983
held on Friday April 29, 1983
This increase in real income occurred despite the fact that the oil industry is a virtual enclave with most of
the production in the hands of foreign-owned companies. The industry's links with the domestic economy comprise
wages and salaries paid to local labour, local materials and services and government tax take. 0n average, labour
payments and local materials and services form a small part of the cost of production. Government tax take is the
most significant link between the petroleum sector and the rest of the economy and it is the mechanism by which
the increase in the value of oil was translated into higher real income and, hence, living standards, for the community
as a whole.
It is appropriate, therefore, to focus on Government's fiscal operations. Between 1974 and 1981, current revenues
increased from $1,297.8 million to $6,818.6 million. Revenue from the petroleum industry which rose from $888
million to $4,253 million accounted for 61 percent of the absolute increase in revenue over the period. Its contribution
to total revenues fell over the period owing to the buoyancy of taxes on the non-oil sector but this performance
of non- oil revenues in a sense derives from the availability of the ample oil revenues.
The growth of revenues made it possible for the Government to launch a large expenditure program. Current expenditure
increased from $670 million in 1974 to $3,564.8 million in 1981, or at an average annual rate of growth of 27.9
per cent while capital expenditure grew at an average annual rate of 40.5 percent as it rose from $287.5 million
in 1974 to $3,808.0 million in 1981. In 1974, governmet7t expenditure was equivalent to 29.5 percent of GDP but
by'1981 it had increased to 40.4 percent. Clearly it had grown in a manner and to an extent where it became a dominant
influence in the economy. I must add, however, ~that since this level of government spending was largely financed
from the taxation of an enclave sector it did not crowd out the domestic private sector by starving it of financial
resources. As the pace of economic growth quickened, however, competition for scarce human and physical resources
may have limited the potential growth of the domestic private sector in those years.
Nonetheless, the high level of government expenditure provided the stimulus for increased growth in the non-oil
economy. By the end of the decade of the /970's the non-oil economy had built up a growth momentum which was strong
enough to offset a fall in the real value added of the oil sector thereby ensuring that the economy as
a whole continued to expand in real terms. For example, between 1978 and 1981, real value added in the oil sector
declined at an annual rate of 6.6 percent yet the entire economy attained a very respectable annual growth rate
of 5. 1 percent in real terms in a world and regional economy beset by recession. The main centres of growth were
construction, transport, storage and communication, distribution and the financial sector the construction sector
in particular was directly stimulated by high levels of government capital expenditure. You will note that the
sectors which experienced the highest growth are service activities largely oriented to satisfying demand in the
domestic market. The sustained growth of the economy was accompanied by a rapid expansion of employment such
that the unemployment rate fell from a peak of 15 percent in 1975 to 10.4 percent in 1981.
This service-based pattern of growth derives directly from the nature of the economy's "drive" mechanism.
Government expenditure pumped a lot of liquidity (literally "money") into the banking system which was,
therefore, in a position to provide increasingly large doses of credit to the domestic economy. Between 1974 and
1981 the domestic budget deficit rose from $265 million to $2,481 million or at an average annual rate of37.6 percent;
total deposits of commercial banks increased at an annual average rate of 25.2 percent, bank credit by 30.3 percent
and the money supply (currency in circulation and demand deposits) by
. 30.9 percent the increase in monetary resources exceeded the trend rate of growth of non-oil GDP and, therefore,
contributed to the creation of excess domestic demand with its inflationary consequences. However much of the demand
arising from easy availability of credit and large increases in incomes spilled over into imports. The economy
was easily able to pay for such imports because there was a large inflow and buildup of foreign exchange reserves
owing principally to the fact that the oil companies settle their tax liability in US dollars and the Government
accumulated large fiscal surpluses, in spite of the rapid growth of expenditure.
II The Transition: 1982
In many respects 1982 may be characterised as a year of transition. With the exception of the fiscal and monetary
variables, the strong up ward movement in the key indicators which we observed during the boom years was reversed.
The economy as a whole achieved a 3.9% growth in real GDP, approximately the same as in 1981, but the non-oil economy
lost much of its dynamism. Its growth rate of 4.7 percent in 1982 was markedly lower than the 6.2 percent rate
of growth recorded in 1981 and the trend rate of 7.1 percent, over a period 1979 to 1981.
The slowdown in the growth of the economy occurred despite the fact that government expenditure expanded at a faster
rate than in previous years and its domestic budget deficit almost doubled in size. Total expenditure grew by 51
per cent largely because of retroactive wage payments. At the same time, current revenue had stagnated owing to
a decline in oil revenues from $4,253 million to $3,531 million or about 17percent - the first fall in oil revenues
since 1973. This occurred because of the continuing fall in domestic crude oil production (-7 percent) and weak
prices in an international oil market characterised by falling demand, over supply conditions and erosion of OPEC's
cohesion and market power. The combination of sharply higher expenditure and stagnant revenues resulted in the
emergence of an overall fiscal deficit - also the first since 1973. The deficit of $3,300 million was equivalent
to 18.5 percent of the country's GDP at market prices. There are only a few countries capable of financing a fiscal
deficit of this size without complete dislocation of the economy.
How did Trinidad and Tobago manage this deficit and what were its effects on the economy in 1982? The expansion
of expenditure and the consequential large fiscal deficit permitted the economy to record a modest real growth
in 1982 despite the deepening recession worldwide. Since economic growth and hence domestic income and demand were
fairly buoyant despite falling export earnings, the economy experienced a deficit in its transactions with the
rest of the world (i.e. a balance of payments deficit) - the first such deficit in nine (9) years. But, the savings
accumulated in the boom years allowed Trinidad and Tobago to continue living in 1982 as though oil earnings had
not declined. The government financed its deficit by withdrawing $2941 million from its past savings and the country
covered the shortfall in its foreign exchange requirement by drawing down $525 million from its accumulated stock
of foreign exchange reserves.
During 1982 there had been some controversy as to whether or not the economy had gone into recession. Obviously.
an economy which records a 3.9% growth in real GDP, finances a budget deficit equivalent to 18.5 percent of its
GDP without creating a foreign exchange crisis and where the number of people employed rises by about 3% is not
in recession. The year 1982 was a period of transition not recession which was possible only because the fiscal
savings accumulated in the boom years were available for injection into the economy thereby permitting the "drive"
mechanism to function though less power fully than it had done previously.
III. Forecast: 1983.
The strategy underlying the 1983 budget envisages the continuation of the stabilisation process which we experienced
in 1982. However, owing to:
(i) the heavy drawdown of past savings in1982;
(ii) The fall in officially quoted oil prices in the first quarter of the year; and
(iii) the unsettled condition of the major international financial markets;
it is not realistic to expect similar success in stabilising the domestic economy or the balance of payments as
occurred in 1982.
The fall in the price of crude oil (by almost US $5 per barrel) and the decline in crude oil production and refinery
throughput locally have several implications for our economy. The most obvious are: a reduction in government
revenue, lower inflow of foreign exchange and loss of jobs in the oil industry (including, of course, the numerous
service and supply firms). The reduction in government revenue will be larger than the additional revenues to be
raised through various Fiscal measures adopted in the 1983 Budget - though not as large as some estimates which
I have seen quoted in the press. Since the financing of the budget deficit envisages a significant increase in
borrowing both at home and on foreign markets, it will be necessary to cut the proposed expenditure in some areas.
Similarly, the lower inflow of foreign exchange as a result of lower tax payments by oil companies calls for the
tightening of existing policies and adoption of new measures in order to contain the size of the balance of payments
deficit which we will experience in 1983. In general the policy measures which must be adopted to offset the adverse
effects of developments in the oil sector will further weaken the "drive" mechanism which powered the
economy through the boom and smoothed the transition to lower growth in 1982.
The fundamental economic lesson which we must learn in 1983 is that our real income as a nation has declined.
A barrel of oil can no longer pay for the basket of goods which it commanded in 1980. With lower income we have
all to accept a downward adjustment in our standard of living since our accumulated wealth, particularly in the
form of fiscal surpluses, cannot tide us over until such time as the terms of trade improve - the consensus of
opinion is that oil prices will continue to decline in real terms and possibly even in nominal terms over the next
few years. In the circumstances, we have to begin the adjustment of our expectations and style of living 1983.
This means, for example, that we must curtail our consumption particularly of inessential imported goods and services
such as vacation travel (expenditure of $310 million in 1982 compared to $62 million in 1977), whisky ($10 million
in 1977, $33 million in 1981) apples and grapes ($3.3 million in 1977, $9.4 it; 1981), and wines ($2.2 million
in 1977, $6.6 million in 1981).
IV. Conclusion
The engine of growth for the economy of Trinidad and Tobago has been government expenditure. The budget is the
mechanism through which the real gains in the purchasing power of our major natural resource - oil - have been
transferred into demand for goods and services in the rest of the economy. The rising demand stimulated the growth
of production which the economy could finance since the government pumped liquidity into the financial system by
incurring a large domestic budget deficit. However, the engine of growth has been slowing down-because oil revenues
began to decline in 1982 and will fall sharply in 1983. The existence of fairly large fiscal surpluses at the
end of 1981 facilitated a slow adjustment in 1982, but the decline in oil prices and virtual exhaustion of past
savings have substantially reduce the energy of the "drive" mechanism.
Accordingly, we must accept a larger adjustment of the economy in 1983 in terms of lower growth, possibly rising
unemployment, further drawdown of foreign reserves to finance a balance of payments deficit and a lowering of our
standard of living in tune with the collective loss of real income.
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