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May 29, 2006

Higher Oil Prices Can Benefit E. Asia

Kaoru SUGIHARA (Professor, Kyoto University)

'Oil Triangle' binds Asia to Middle East and U.S. as global economic order

The unprecedented economic growth during the postwar period in much of East Asia has been powered by oil imports from the Middle East. Despite the recent rise of oil prices to new highs above $70 per barrel, there are few signs of a major slowdown in demand in the region, led by China's strong appetite for imports.

During the period of high-speed growth, cheap oil from the Middle East helped expand heavy industry in Japan.

During the 1974-85 period, Japan posted an average annual trade deficit of $17 billion with the oil-producing countries around the Persian Gulf. But that was offset by an average trade surplus of $16.6 billion with Western countries.

Meanwhile, the trade deficit of the U.S. and European Community with Japan was financed by flows of oil money from the Middle East into the West through sales of weapons or Middle Eastern investments in American and European securities.

This "Oil Triangle" pattern of settlement between East Asia, the Middle East and the West has been part of the foundation of the world economic order since the 1970s.

This has reinforced the international division of labor that had developed during the 1950s and the 1960s, in which the industrialized West dominated the global markets for weapons and financial services, while East Asian countries focused on production of civilian manufactured goods.

This system has more or less defined the position of East Asia in the world economy to this day. Japan's pacifist postwar Constitution, which has strictly limited the growth of the arms industry in Japan, has contributed to the maintenance of this arrangement by keeping Western military industries free from competitive pressure from East Asia.

In turn, Middle Eastern oil producers have used part of the money they earned from oil exports to Japan to buy weapons from the U.S. and Western Europe. This recycling of capital back into the West via arms exports to the Middle East has cemented Western dominance in world financial markets.

Meanwhile, Japan's financial services companies have remained uncompetitive against their Western rivals, which has hampered the flows of funds into Tokyo. As a result, Japan's economic growth has been dependent on the world order underpinned by the military and financial supremacy of the West.


The growth of Japanese oil imports started slowing in the mid-1980s due to the development of alternative energy sources and energy-saving technologies. Then, in the 1990s, the Newly Industrializing Economies (Hong Kong, Singapore, South Korea and Taiwan) emerged as major exporters, increasing their trade surpluses with Western countries while importing a growing amount of oil. Combining Japan and the NIEs, the Oil Triangle has actually expanded.

Despite the dollar's sharp slide against the yen since the 1985 Plaza Accord, East Asia has continued to run a chronic trade surplus with the West. This structure has been supported partly by East Asian purchases of U.S. and European government bonds and partly by continued strong imports of Middle Eastern oil by East Asia.

Since the turn of the century, China has emerged as a new, enormously influential player, creating tidal waves of cheap exports washing into the U.S. and the European Union, while importing a rapidly increasing amount of oil. This has further enlarged the Oil Triangle, as economic ties within East Asia have become closer.

In the past three decades, East Asia has been growing by financing its huge purchases of oil with a trade surplus with the U.S. and Western Europe. Consequently, industrial products from East Asia have made deep inroads into markets around the world, while capital from this region has kept pouring into Western nations.

At the same time, the energy efficiency of the industries in East Asia, especially in Japan, has been improving steadily.

However, this structure of global trade has been no boon for developing countries in other regions. In fact, many countries in Latin America and Africa have suffered under a combination of the harsh competition from East Asian manufacturing exports and higher oil prices. They have failed to emulate the success of the NIEs and put their economies on the growth path. Even oil-producing countries, such as Iran, Nigeria and Venezuela, have not been successful in developing their industries despite massive inflows of oil money, as they lacked a solid foundation for industrialization.

Ironically, the biggest beneficiaries of rising oil prices have been resource-poor East Asian countries, such as Japan and NIEs.

The bright Side

In a market economy, higher oil prices stimulate the development of alternative energies and energy-saving technologies. Global competition under a free trade regime is the principal driving force for fuel-efficient economic growth.

In this economic dynamics, many oil-producing countries have failed to raise the energy efficiency of their industries by artificially keeping down domestic oil prices. This has happened in the U.S. as well as in many oil-producing developing countries.

On the downside, the Oil Triangle has been an important reason why East Asia, and even the EU, had no choice but to support the basic framework of the U.S. policy, including its use of military power, toward the Middle East.

Demand for oil will remain strong for years to come. The lesson from the widely different economic fortunes of East Asia and developing countries in other parts of the world is that higher oil prices sorely test the ability of governments to promote energy-efficient economic growth.

The most important outcome of East Asia's economic miracle has been the discovery of the path leading to energy-efficient growth. Efforts should continue to build a global economic order that promotes the diffusion of this knowledge to the rest of the world.

(Originally appeared in the May 15, 2006 issue of The Nikkei Weekly, reproduced here with permission.)

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