What is the long-term economic impact of the US shale revolution?

Recently, I had the pleasure of listening to a podcast of a recent event from the Peterson Institute of International Economics, on the economic impacts of the US oil and gas boom (see link here). The event focused on the release of a new book titled Fuelling Up: The Economic implications of America’s Oil and Gas Boom, with presentations from the authors Trevor Houser and Shashank Mohan. The topic of fracking, or hydraulic fracturing, to release gas and tight oil from shale rock, is quite intriguing, as it has the potential to alter long-run trends in both economics and geo-politics.

Geo-politically, the US shale boom, and whether or not it can reach its potential, holds great interest for international relations, as countries like Saudi Arabia and Russia have a lot to lose if US gas is exported freely. While this impact of the shale boom is vitally important, the other angle worth considering is the economic impact of the energy revolution. This is the key focus of the book, and thanks to the comment from the IMF’s Prakash Loungani, was also the focus of a recent chapter IV article on the US economy from the IMF.

In summary, both of the studies described positive impacts from the energy boom, but they are only modest in nature. This economic impact is minor, according to the IMF, not least because the mining and energy-intensive sectors of the economy are only a small fraction. While both studies do highlight some potential short term benefit to the US economy, both of them seemed to agree that the shale boom will not lead to a long-run increase in the potential growth rate of the US economy. This is due to the notion that the energy boom is simply about making energy cheaper, and as the economic slack subsides in the short term, the increased activity from some sectors will be competing against other sectors in a general equilibrium setting, and thus not actually increasing the supply potential of the economy overall. So this got me thinking, is it really the case that the shale boom, with all the hype around it, does not increase the supply potential or long-run economic growth of the US economy? Is it true, as Prakash Loungani says at the conference, that we should not get ‘carried away with the shale gale’?

In what ways could the shale revolution in the US increase the long-run, potential output of the economy?

In and of itself, it may well be right that the shale revolution is no more than a lower energy price in the longer run than would have occurred in the absence of this technology. But the question could be raised as to what indirect effects could it encourage that would increase potential GDP?

One indirect effect could result from American firms importing more machinery and the embodied technology due to lower energy costs for production. At the margin, lower energy costs may encourage more firms to enter manufacturing, and for those already in the sector, it may allow more expenditure on machinery and research and development. If this were to occur, it would have an impact on the productivity of the US economy and thus impact long run growth.

Another possible indirect channel could be the terms of trade over the longer run. While not part of the classical theory of long run growth, there is a lot of empirical evidence that a country’s terms of trade can influence it’s economic growth. Papers like Mendoza et al (1997) have hypothesized a link between terms of trade and savings behaviour, with a positive change in the terms of trade leading to increased consumption and thus growth in the long run. Consequently, if the shale revolution led to an improvement in the terms of trade over the next decade or so, then it may also lead to an increase in the long run growth of the US economy.

All very interesting and quite important implications of the US energy boom to keep an eye on.

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