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Fall in Oil Prices in the mid 2014 Report

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Updated: May 27th, 2020

Introduction

There has been a dramatic fall in oil prices across the world in the recent past beginning in mid-2014. The decline in oil prices will have impacts on the economies of the world. One of the economies that have already begun experiencing economic effects of the declining oil prices is the United Kingdom (UK).

The fall in oil prices has been described as either a big tax cut or a contributor to potential deflation in the UK. However, these two arguments are subjective since they will vary in terms of consistency and industry. It is expected that the drop in oil prices will boost employment and investment and hence raise revenues in the UK.

It is also projected that the drop in oil charges will negatively affect the oil and gas extraction industry. However, the cost of the input will fall to counter the negative effects. Oil-consuming industries such as the transport sector will also benefit since people will relocate their capital, especially from less oil-dependent sectors.

Household income will also increase with a decline in oil prices. The overall outcome will be a rise in consumer spending. Household income will go up due to two major factors that are pegged to oil prices. First, prices of consumer goods will fall with the falling oil prices in the UK.

However, the reduced prices of goods and services will result in devaluation of the UK economy. Inflation rates will also decrease to the extent of forcing the UK banks to reconsider their lending rates (Bloomberg 2015). Secondly, the real wages will also rise with the falling oil prices. In fact, Lincoln (2015) addresses the issue of inflation in the UK.

In fact, the Bank of England tabled a written document to a British government official demanding answers concerning the witnessed deviations (Lincoln (2015). This outcome will be attributable to the fact that a fall in oil prices will result in a fast growth of various sectors of the economy.

As a result, these sectors will highly require labour. Competition for the available labour will result in an increase in wages. This paper seeks to explore the assumption that a fall in oil prices is either a big tax cut or a contributor to potential deflation in the UK.

Oil Decline and its Impacts

Inflation

The argument that a decline in oil prices has resulted in tax cut in the UK is a misplaced projection. On the contrary, a fall in world oil prices has resulted in increased revenue and tax collection by the government of the UK. Since a fall in oil prices increases economic activities in the UK, the amount of government tax revenue has also been on the rise.

The amount of tax to be collected from personal income by the government has also increased with the increased employment and spendable income. Moreover, tax collection from the corporate sector also increases with a fall in oil prices since many companies intensify their manufacturing activities with reduced cost of production.

The trade deficit has been narrowly affected by the fall in oil prices. A low cost of oil prices translates to a decline in the cost of production, especially for oil-intensive industries. If the prices of oil continue to fall or fall permanently, the cost of production in industries that depend on energy is expected to be low.

The low cost of manufacturing will then be transferred to the clientele of the manufactured products, thereby reducing the rates of inflation directly. However, a rise in the real GDP and collective demand is likely to make the charges of merchandise go up.

In his view, Barwell (2007) says that this effect will be offset by the saved purchasing cost, thereby resulting in low consumer prices. Therefore, the low oil prices are good news for the UK consumers and the government.

Consumers are expected to continue benefiting from the cheaper prices of goods and services. They have increased their spendable income following the cost-saving mechanisms that have come with the decline in oil charges.

On the other hand, the government has collected more tax from the increased number of employed people and from the increased amount of goods that citizens have been able to purchase. As Rafiq (2014) asserts, the balance between GDP and the reduced cost of goods and services will result in reduced inflation.

Household Spending

Consumers in the UK market will benefit from the reduced oil prices. Household spending increases with the available cost-saving strategies that result from the reduced oil prices (Misati, Nyamongo & Mwangi 2013). Since most of the industries depend on energy for production, a reduction in energy prices in the UK has translated to the witnessed low cost of production.

As a result, the industries have reduced the cost of their goods and services to the advantage of the UK consumers. Real house spending has also increased with the reduced oil prices. Since low oil prices increase the activities of most of the industries, labour demand has also increased to the extent of raising the wage levels in the UK economy.

Increased wages have augmented the spending power since money is available in the hands of the UK people. However, according to Misati, Nyamongo and Mwangi (2013), if the demand for goods and services continues to increase, there is a possibility that goods will run out of stock and consequently result in high prices.

This claim implies that the projected devaluation in the UK economy is unlikely to happen due to this balancing effect. It is important to consider the likely direct effect of reduced oil prices on spendable income that has to be witnessed, regardless of whether the changes in price are temporary or permanent.

Government Revenue

Barwell (2007) confirms how the UK government collects revenue from the process of oil exploration, production, and distribution. Such taxes are classified as petroleum revenue tax, supplementary tax, and corporation tax. Trends in revenue collection by the UK government have followed the situation in the oil industry over the years.

However, this condition may not hold in the near future. For example, there has been a decoupling relationship between the prices of oil and the amount of collected revenue since other factors in the economy may offset the expected decline in revenue because of the reduced oil prices.

In the UK oil industry, revenue collection declined by 45% in the 2012-2013 fiscal year and 25% in the 2013-2014 fiscal year. This state of affairs was attributed to the low levels of oil production and the increased expenditure. However, as Rafiq (2014) reveals, low revenue collection from the oil industry may not necessarily mean low proceeds to the economy.

On the contrary, a reduction in oil prices across the world has a positive impact on government tax revenue in the UK. It is true that the total amount of tax revenue that the government of UK collects from the oil industry will decline with reduced oil prices in the world market.

However, it is clear that the avenues that low prices of oil are likely to open will increase tax revenue with a higher mark compared to the amount that is currently gathered from the oil industry.

The implication is that the balance of revenue tax that could have been collected from the oil industry will be easily offset by the contribution from other sectors (Misati, Nyamongo & Mwangi 2013).

Such contribution will include employee taxable income, tax levies from the expanded industrial avenues, and the increased tax collection from consumer goods whose demand will have gone up following the available high spendable income.

The UK Trade Deficit

A balance of import and exports is crucial to the UK economy. MacCoille (2008) confirms how both domestic spending and exports are great contributors to the economic growth of a particular country. Although the UK is a big importer of oil and oil products, a decline in the world oil prices may have a small effect on its economy.

However, a decline in oil prices results in the expansion of the UK’s domestic industries that in turn lift people’s spending power (Guidi 2010). This outcome is expected to narrow the UK’s trade deficit. It is also likely that the decrease in oil prices will result in an increase in exports as the UK economy continues to expand.

The low cost of production in the UK’s oil-intensive industries implies a higher rate of production and hence more goods and services for the export market.

However, this economic situation is likely to be balanced by the increased spendable wages. Since low prices of oil will result in discounted goods in the UK, the long-term effect will be an increase in spendable income and hence wealth creation.

Empowerment of the local citizenry means that most of the goods that are produced locally have to be consumed locally since people have the money to spend in purchasing the products.

When the UK domestic spending rises, there is a likelihood of wealth creation within the country. Industries will expand their production since the cost will continue to be low while people will continue to save and purchase more with the available spendable income.

In the end, exports will significantly go down. MacCoille (2008) confirms how a decline in exports implies reduced export taxes. Since the available income is anticipated to be high, part of the spending will be focused on buying more imports. The implication is that tax collection from imports will also increase.

Guidi (2010) asserts that the quickly expanding economy that will result from the low cost of production will also lead to the growth of the overall UK economy.

The intensification of the economy will translate into increased demand for imports such as machinery, labour, and raw materials. As a result, the economy of the UK will experience a narrowing of trade deficit with the decline in world oil prices.

Conclusion

A decline in the world oil prices will result in increased tax collection and devaluation of the UK economy. The overall impact of the falling oil prices will be positive economic growth in the UK. Industries and economic activities will expand.

The cost of industrial production will decrease, thus allowing quick expansion and increased production of goods by industries that are currently highly reliant on oil. However, low prices of oil in the world market will affect the UK’s oil industry negatively, thereby contributing to low tax revenue to the economy.

This discussion finds that low tax revenue from the oil industry will not affect the overall revenue collection by the UK government. On the contrary, various industries will expand with the decline in oil prices. Low cost of production, for example, in the agriculture industry, transport, and manufacturing industries will be witnessed.

These industries will increase their tax remittance to the government. Moreover, the industries will raise employment in the countries. Consequently, many employees will also pay taxes to the government. Consumers will also have a spendable income, meaning that they will purchase more products and save money through the reduced prices of goods.

Hence, the low cost of production in industries because of the reduced oil charges will end up at the consumer doors since the prices of goods and services will go down.

Therefore, this discussion confirms that devaluation of goods and services will not necessarily imply a tax cut since a tax decline in the UK’s oil extraction, production, and transport industry will be offset by other sectors that will grow rapidly, thanks to the reduced oil prices.

References

Barwell, R 2007, ‘The macroeconomic impact of higher energy prices on the UK economy’, Bank of England Quarterly Bulletin, vol. 47 no. 4, pp. 522-532.

Bloomberg 2015, UK Annual Inflation Rate Falls Below Zero. Web.

Guidi, F 2010, ‘The Economic Effects of Oil Prices Shocks on the UK Manufacturing and Services Sectors’, IUP Journal of Applied Economics, vol. 9 no. 4, pp. 5-34.

Lincoln, H 2015, British Monetary Policy: Wrong Target. Web.

MacCoille, C 2008, ‘The impact of low-cost economies on UK import prices’, Bank of England Quarterly Bulletin, vol. 48 no. 1, pp. 58-65.

Misati, N, Nyamongo, M & Mwangi, I 2013, ‘Commodity price shocks and inflation in a net oil-importing economy’, OPEC Energy Review, vol. 37 no. 2, pp. 125-148.

Rafiq, S 2014, ‘What Do Energy Prices Tell Us About UK Inflation?’, Economica, vol. 81 no. 322, pp. 293-310.

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