The Impact of Rising International Crude Oil Price on China's Economy an Empirical Analysis With CGE...

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404 Int. J. Global Energy Issues, Vol. 27, No. 4, 2007

Copyright © 2007 Inderscience Enterprises Ltd.

The impact of rising international crude oil priceon China’s economy: an empirical analysiswith CGE model

Ying Fan

Center for Energy and Environmental Policy Research,Institute of Policy and Management,Chinese Academy of Sciences, Beijing 100080, ChinaE-mail: [email protected]

Jian-Ling Jiao

Hefei University of Technology, Hefei 230009, ChinaE-mail: [email protected]

Qiao-Mei Liang

Center for Energy and Environmental Policy Research,Institute of Policy and Management,Chinese Academy of Sciences, Beijing 100080, ChinaE-mail: [email protected]

Zhi-Yong Han

National Natural Science Foundation of China,Beijing 100085, ChinaE-mail: [email protected]

Yi-Ming Wei*

Center for Energy and Environmental Policy Research,Institute of Policy and Management (IPM),Chinese Academy of Sciences (CAS),P.O. Box 8712, Beijing 100080, China

Fax: +86-10-62542619 E-mail: [email protected]: [email protected]*Corresponding author

Abstract: Many studies, as well as historical events, indicate that oil priceshocks affect the macro economy of a country. In this paper we build a ChineseComputable General Equilibrium (CGE) model, with which we simulate theimpact on the Chinese economy of international crude oil price when it rises by5%, 10%, 20%, 40%, 50% and 100%. Simulation also identifies the effects oflow/medium/high technological advances in the crude oil mining, petroleumand chemical and transportation sectors on fighting the risk of oil price shocks.



The impact of rising international crude oil price on China’s economy 405

The results indicate that international crude oil price has negative effects on

Chinese real GDP, investment, consumption, import and export, amongst arange of economic indices. Technological advances have positive effects onfighting back the risk of oil price shocks, especially the technological advancesin petroleum and chemicals, whilst the transportation sector has a greatereffect on resisting oil price risk. An international oil price hike holds moredisadvantages for rural residents’ welfare. These results would be valuablereference information for policy makers.

Keywords: crude oil price; CGE model; price risk; technological advance.

Reference to this paper should be made as follows: Fan, Y., Jiao, J-L.,Liang, Q-M., Han, Z-Y. and Wei, Y-M. (2007) ‘The impact of risinginternational crude oil price on China’s economy: an empirical analysis withCGE model’, Int. J. Global Energy Issues, Vol. 27, No. 4, pp.404–424.

Biographical notes: Ying Fan is a Professor at the Institute of Policy andManagement, Chinese Academy of Sciences, China. In 2004, she was a visitingscholar at Cornell University, USA. Her research lies in the field of energy policy and system engineering.

Jian-Ling Jiao is a Lecturer at the Hefei University of Technology, China.

Qiao-Mei Liang is currently a PhD candidate at the Institute of Policy andManagement of the Chinese Academy of Sciences, China. His researchinterests focus on energy environment and energy issues, modelling andanalysis.

Zhi-Yong Han is a research assistant at the National Natural ScienceFoundation of China, China.

Yi-Ming Wei is a Professor at the Institute of Policy and Management of theChinese Academy of Sciences. In 2005, he was a visiting scholar at HarvardUniversity, USA.

1 Introduction

After the two big oil crises in the 1970s and 1980s, it is generally believed that increasein crude oil prices contributes to inflation, at the same time bringing down demand forconsumption, slowing down economic growth, and resulting in economic depression.The main reason is that crude oil and its products are the principal raw materials for

industrial production. High energy prices have influenced national economies since theyear 2004; moreover, the problem of fiscal impact of oil price fluctuation in everycountry’s economy has become the global focus of attention.

There are many literatures on the impact of oil price fluctuation on macro economics;and they all invariably have similar results. Hamilton (1983), for example, found thatthere is a strong relationship between oil price fluctuation and the US real GDP. Otherstudies have found that the relationship was asymmetric and that the impact of oil pricefluctuation on an economy when price goes up has greater economic effects than when



406 Y. Fan, J-L. Jiao, Q-M. Liang, Z-Y. Han and Y-M. Wei

the price goes down (Mork, 1989; Gately and Huntington, 2002; Cunado and Gracia,

2003; Davis and Haltiwanger, 2001). Other studies suggested that the depression wascaused by high oil prices; that different overarching monetary policies may causedifferent results. The notion of the causal relationship between monetary policy and thedepression after high oil prices has attracted keen academic interest (Rasche and Tatom2001; Ahmed et al., 1988; Gertler and Watson, 1997; Rhae et al., 2001; Bjrnland, 2000).In addition, there are studies that found that the impact of high oil prices on the economywas more remarkable in the 1980s. Clearly this relationship is non-trivial and complex,with some literatures regarding the relationship and impact on the economy of oil pricefluctuation as nonlinear. Hence, oil price fluctuation and its specific relationship to GDPhas been the subject of extant research (Keane and Prasad, 1996; Hooker, 1996; Lougani,1986; Hamilton, 1996; Balke et al., 1999). Moreover, other literatures found that theeconomic impact induced by oil price fluctuation is different at differing periods,

or on different countries. The impact on Germany and USA’s economy (they are bothdependent on oil imports), caused by oil price fluctuation in the 1970s and 1980sis an interesting example. The negative impact on the USA is greater than that onGermany; likewise, export dependent UK and Norway each have differing consequences:the impact on UK’s economy is negative, but on Norway’s economy it is positive(Bjrnland, 2000).

Doroodian and Boyd (2003) used a dynamic CGE model to examine the impact of oil price shocks on inflation in the USA. Their results suggest that while a shock of themagnitude experienced in the 1970s will have a fairly severe effect on such things asgasoline and refinery prices, the aggregate price changes will be largely dissipated overtime at the aggregate level. Furthermore, the aggregate level of prices (CPI and PPI) willfall over time as the level of technological advances rise. Uri (1997) used a CGE modelto simulate the impact of the gasoline and electricity price-shock on the Mexicoeconomy.

China became a crude oil net import country in 1996. The overall tendencyfor crude oil imports, and its level of dependence on international oil markets, graduallyincreased year by year; the only exception being during the Asian FinancialCrisis in 1998. China’s crude oil imports totalled 120 million ton in 2004 causing itsdependence on international oil to be at around 42%. It has been estimated that theimport of oil by China will reach 230 million tons; increasing its dependence oninternational oil by some 60%. The Chinese crude oil price has basically realisedco-movement with international crude oil price after the reform and adoption the‘oil pricing mechanism’ in 1998. Any fluctuation in crude oil prices in internationalmarkets will inevitably influence Chinese domestic prices; and in turn, will influence theChinese economy. Such relational pricing mechanisms and impacts can be represented

using a CGE model that reflects a dynamic Chinese economy. Figure 1 represents thetrends of Chinese oil consumption, net import and dependence on international oilmarkets from 1993 to 2002.




Figure 1 Chinese oil consumption, net import and degree of dependence on international oil

2 Computable General Equilibrium (CGE) model

The theory underlying the CGE model originated from the publication of the book An Introduction to Political Economics (Walras) in 1874. He advanced the theoreticalmodel of General Equilibrium. Subsequently, the existence, uniqueness, and stabilisationof the model’s solution were proved by Arrow in 1951, and Arrow and Debru in 1954.Scarf provided an integrated convergence algorithm to compute fixed points in 1967,which made it possible to compute equilibrium prices. It is Scarf’s work that made theGeneral Equilibrium model a practical application model from its pure theoreticalframework.

The basic idea of General Equilibrium theory is: according to the principle ofmaximising profit or minimising cost, producers make input decisions under resourceconstraints. Producers then determine optimal supply; according to the principle ofmaximising utility. Consumers make optimal expenditure decisions under budgetconstraints; this ultimately, determines optimal demand. Equilibrium price makes optimalsupply equal to optimal demand. This results in resources having the most rational use,consumers getting satisfaction, and the economy reaches a stable equilibrium state.

Early-stage CGE models include Johansen (1960) and Harberger (1962) who built thetwo-sectors CGE model; Shoven and Whalley (1973, 1974) built a CGE model on TaxReform for developed countries. Global Trade CGE models have also been developed(Shoven and Whalley, 1992; McFarland et al., 2004). Almost all countries now havevarious CGE models to explore relevant policy development (Bye and Åvitsland, 2003;Dellink et al., 2004; Willenbockel, 2004; Das et al., 2005; Mustafa, 2005). The merit ofthe CGE model is that it embodies market mechanisms and policy instruments which play an important role in identifying price incentive mechanisms. Moreover, they candescribe inter-dependence factors that exist in production, demand and international

trade. When an economy suffers an unexpected shock, we can study the impact of theshock on gross economics, economic structure, relative prices, and so forth. The CGEmodel is an appropriate tool for studying various impacts when an economy suffersunexpected international oil price shocks.

Literature on Chinese CGE models has increased in recent years. CGE modelsspecifically using Chinese characters include: DRCCGE developed by The DevelopmentResearch Center of the State Council (DRC) (Zhai and Li, 1997; Li et al., 2000),PRCGEM developed by Chinese Social Science Academy (Zheng and Fan, 1999;Wang and Shen, 2001), CNAGE model (Glomsrd and Wei, 2001), Sulphur-Tax CGEModel for China (Wu and Xuan, 2002); and applied research on analysing CO2 control in




China using a CGE model (Zhang, 2000). These models are mainly used in policy

simulation such as international trade, tax, or the environment (for example, Sulphur-Taxor CO2 tax). Hou and Xuan (2003) developed a one sector CGE model to analyse theimpact of international crude oil price shock on the Chinese macro economy. Wei (2002)used the CNAGE model to simulate the impact of international crude oil price rises onthe Chinese economy.

In this paper we discuss the building of our CGE model that was developed bydrawing upon the above literatures. Application of the model allowed simulation of theimpact of international crude oil price occurring with differing shocks on several Chineseeconomic indices together with the impact on import/export/value added at the industrylevel. We also simulated the action of crude oil mining, petroleum and chemical, and thetransportation sectors occurring at low/medium/high technological advances on resistiveeffects of oil price risk.

3 CGE model based on simulating the impacts of international crude oilprice hikes on Chinese economy

3.1 Model structure

Our CGE model is composed of six modules; they are price module, production module,revenue and consumption module, trade module, investment module and macro balanceand model closure module. For emphasising energy and energy related sectors, weconsider 12 sectors (Table 1): they are Agriculture (AGRI), Heavy Industry (HIND),Light Industry (LIND), Petroleum and Chemistry (PECH), Construction (CONS),Transportation (TRAN), Commerce (COMM), Nonmaterial (NONM), Coal Mining

(COAL), Crude oil Mining (OIL), Natural Gas (GAS) and Electricity (ELEC).Also considered are four kinds of agents: they are rural residents, city residents,enterprises and government. Additionally, two kinds of factors are considered:Labour and Capital. To compute the impact on rural and city residents caused by oil prices fluctuation, we added the welfare module to our CGE model. Whilst this did notcontribute to a final solution, it was possible to compute residents’ welfare (upon finalexecution of the model).

Table 1 Sectors in model correspond to sectors in the input-output table

Sectors in model 40 sectors 124 sectors

01 Agriculture 01 001~00502 Heavy industry 04~05, 13~26 009~013, 048~085, 087~089

03 Light industry 06~10 014~03504 Petroleum and chemical 11~12 036~047

05 Construction 27 09006 Transportation 28~29 091~099

07 Commerce 30~31 100~10108 Nonmaterial 32~40 102~124

09 Coal mining 02 00610 Oil mining 03 00711 Natural gas mining 03 008

12 Electricity 24 086




Prices module

Prices module is composed of definitions of various prices in the CGE model;included is the Armington assumption (Armington, 1969). The assumption is made thatChinese international trade contribution to the global trade is small enough; and Chinese production and the domestic price does not influence international price; and that Chinaonly accepts international prices. Compound commodity prices mean that imported product prices are compounded by the product prices supplied for the domestic market.This supposes that they satisfy the constant elasticity substitute function, which indicatesthat consumers minimise their expenditure, and that producers maximise their profit.Value added price is a compound commodity price that is taken off indirect taxes andmedian inputs. The price index is defined by the GDP deflator, calculated by nominalGDP divided by real GDP.

Production module

In our model a 2-nested production function is employed. First, every sector uses labourand capital to produce value added products (according to a CES function). Subsequently,the value added and its median input to produce gross production is calculated, accordingto the Leontief function. Technologies are taken into account by production functionswhich exhibit constant elasticity of substitution. Technological progress (both embodiedand disembodied) is taken as exogenous to the model. For every sector listed in Table 1, production in each period is represented as a Constant Elasticity of Substitution (CES)value added function of capital and labour inputs, where the elasticity of substitution canvary between zero and infinity. Hence, we have

( 1) / ( 1) / /( 1)[ ]i i i i i i

i i L i K iV L K σ σ σ σ σ σ φ δ δ

− − −

= +

where V i is the value added in sector i; σ i is elasticity of input substitution in sector i,φ i is an output scaling parameter which can allow technological change, Li is labour atsector i; K i is capital at sector i; and δ ’s are share parameters defined so that

, 0 L K δ δ >

and

1. L K δ δ + =

The outputs of the other manufacturing goods industries also enter the production-function specifications as fixed-factor components of the nationalinput–output matrix for the 12 production as a Figure 2 shows. It is assumed that in each period, producers maximise profits in a competitive market environment. Treating outputand input prices as parameters, profit maximisation, based on the production technology,yields output supply and factor demands for each production sector and factor market inthe model.




Figure 2 Production structure

Revenue and consumption module

This module expresses rural and city residents’ demand for commodities and service.Residents’ incomes come from labour income, capital income, and transfer payment fromthe government, enterprise and rest of the world to the residents. It represents disposableincome, after taking off income tax. Residents’ savings are residents’ disposable incomemultiplied by marginal propensity to save; the consumption by residents of commoditiesis described by the Extended Linear Expenditure System (ELES). Government incomecomes from enterprises direct taxes and indirect taxes, residents’ income taxes, importtaxes, etc. ‘Total saving’ is composed of residents’ savings, government’s savings,enterprise savings and foreign net savings.

Trade module

Producers and consumers select a group of compound commodities compounded byimports and domestic products according to the Armington assumption. The importdemand function is obtained by minimising CES cost function; the export demandfunction is obtained by maximising CET profit function.

Investment module

Total investment equals total savings. This supposes that every sector’s investment is afixed proportion of the total investment.

Macro balance and model closure module

Model closure conditions include market equilibrium and macro equilibrium. There arefour market equilibriums in the model; they are commodity market equilibrium,factor markets equilibrium, capital market equilibrium and foreign exchange marketequilibrium.

Commodity market equilibrium indicates that every kind of compound commoditiessupply equals the domestic demand for this kind of commodity. Domestic aggregatesupply comes from domestic enterprise production and import. Domestic aggregatedemand is divided into two parts: one is the other sector’s median input demand; anotheris the government and residents’ final demand and investment (see Figure 3).




Figure 3 Commodities’ flow

Factor market equilibrium means that the aggregate demand for every kind of factorequals its aggregate supply. We suppose that the factor market can make full adjustmentfor the factor’s relative price in every sector when it suffers an external shock such as inthe labour market where labour aggregate supply is a given exogenous variable, everysector’s relative wage is an endogenous variable, and labour supply allocation in everysector is decided by relative wage.

Capital market equilibrium means total savings equals total investment.Foreign exchange market equilibrium means the balance of foreign exchange receipts

and expenditures. Foreign exchange expenditures are composed of import expenditures

and the transfer from capital income to the rest of the world. Foreign exchange receiptsare composed of export receipts, the transfer from the rest of the world to residents, togovernment, and foreign net savings.

Welfare module

We use Hicks equivalent variation to measure the impacts of residents’ welfare when oil price rises. On the basis of every kind of commodity’s price before implementing a policy, Hicks equivalent variation measures utility change with payment function(Varian, 1992). In this paper we measure the change of residents’ welfare before and afterthe change of international crude oil price, on the basis of commodity’s price before theoil price rise.

.b s b b

h i ih i ih

i i

EV PZ CDh PZ CDh= ⋅ − ⋅∑ ∑

Here EV h is the variation of the residents’ welfare. b

ihCDh and s

ihCDh are consumption to

commodity i before and after the oil price change, respectively.

3.2 Calibration and data

The model is calibrated to a 1997 data set with these data coming from a variety ofsources. Data on the following were obtained: income and expenditures for each of theincome categories; the amount of imports and exports in each of the traded sectors;




use of labour and capital by each of the producing sectors as well as their level

of output; investment by sector; government revenues and expenditures. These datamainly come from the Chinese Input-Output Table (1997), Chinese Statistical Yearbook(1998, 1999, 2000) and Almanac of China’s Finance and Banking (1999), amongst othersources.

Apart from a large amount of original data, many parameters are also usedin the model. These include the supply and demand elasticity for commodities, production elasticity of factors, trade substitute elasticity of commodities, plus others.These parameters are sets of coefficients which are related to the technological aspectsof the model. Some of them are estimated using traditional statistical inference; someare collected from the existing literatures (Wu and Xuan, 2002; Zhang, 2001).All parameters, however, have been calibrated to a 1997 base. A number of dataadjustments are necessary to impose a general equilibrium structure on the economy.

Basically this required us to eliminate all inconsistencies in the Social Accounting Matrix(SAM) and fit all production and utility parameters so that the model replicates the actual1997 data (Ballard et al., 1985).

4 Analysis and discussion of simulated results

4.1 The impact of international crude oil price rises on the Chinese economy

We call the state before any international oil price rises, the ‘base state’. Using the previously described model, we empirically studied how the Chinese economy would beaffected when international crude oil price rises by 5%, 10%, 20%, 40%, 50%, 100%,respectively. Figures 4–13 show the results. They are the impact on real GDP, total

investment, consumption of rural/city residents and government, RMB exchange rate,GDP deflator, import/export, and value added, respectively.

The rise of international crude oil price causes a reduction in Chinese real GDP.Figure 4 shows that Chinese real GDP reduces 0.029%, 0.053%, 0.088%, 0.126%,0.137%, 0.159% when international crude oil price rises by 5%, 10%, 20%, 40%, 50%,100%, respectively.

Figure 4 Impact on real GDP

The rise of international crude oil price causes production cost to increase; this reducesthe products’ profit; diminishes the return on investment and cuts down total investment.Chinese total investment will be cut by 0.026% and 0.106% if the crude oil price rises by10% and 50%, respectively.




Figure 5 shows the impact on consumption. First, government consumption reduces

but then also increases – which reflects the rigidity of government consumption Second,rural/city residents’ consumption decreases with the oil price rise; note that the degree ofrural residents’ consumption is bigger than that of city residents. The reason for theresult is that rural residents’ real income reduces much more than that of city residentsas a Figure 6 shows. Rural residents’ income mainly comes from sales of agricultural products; however the input cost of chemical fertilisers and pesticides has a bigger range,and the prices of agricultural products only have a small range.

The hikes in international crude oil price bring about sliding pressure for the RMBexchange rate (Figure 7). But the range is not great. When crude oil price rises by 10%,RMB exchange rate slides by 0.226%; the RMB exchange rate slides by 0.755%,when crude oil price rises 100%. In addition, the RMB exchange rate quickens its slidingwhen the oil price goes down by small amounts; after rising by a certain degree the

sliding velocity tends to be gentle. Chinese imported products become more expensive,and export products become more inexpensive due to the slide of RMB exchange rate.In turn, this increases the pressure on China’s foreign exchange payment. However, therange of the RMB exchange rate sliding is moderate, so the impact of an oil price hike onthe Chinese economy is not serious.

Figure 5 Impact on consumption

Figure 6 Impact on residents’ real income




Figure 7 Impacts on GDP deflator and exchange rate

The Chinese overall price level goes up when international crude oil prices rise; which brings about inflationary pressure. Figure 7 shows the change of overall price levelmeasured by a GDP deflator as oil price rises. The results show that Chinese pricelevels rises by 0.4% and 0.8% when the international crude oil price rises by 20%and 100%. The same is true of real GDP and total investment: when internationalcrude oil price shows a small rise, the speed of price level rise will accelerate; when therange of international crude oil price rises beyond 50%, the speed of price level rise willslow down.

Chinese import/export cuts down when the international crude oil price rises(Figure 8). However, the range of import reduction is greater than that of exports.For example, as international crude oil price rises by 20%, imports cut down by 1.468%,and exports cut down by 0.841%. The result may imply that the impact of oil price on

Chinese Balance-of-trade Payments is not as serious as some might envisage. The reasonis that the RMB exchange rate depreciates if oil price rises, which makes Chinese exportsmore competitive, and subsequently weakens Chinese import capacity.

Figure 8 Impact on import/export

Figures 9–11 show the results of import, export and value added variation in PrimaryIndustry, Secondary Industry, Tertiary Industry. Import reduces by 1.941%, exportreduces by 1.763% in Primary Industry if crude oil price rises by 50%. The reason forthis result is probably related to the small elasticity in demand of agricultural products’and their high import taxes, which reflects the policy of government protection towards




agriculture, and supports export of agricultural products. The major reason of value added

reducing in the agricultural sector lays in input cost increasing; however, the prices ofagricultural products only have a small rise, thus leading to the profit coming down in the primary industry. With regard to the Secondary Industry, if international crude oil pricerises, import/export both decrease, and the range of import is greater than that of export.The difference between Primary industry and Secondary industry is that value added inthe Secondary industry increases as crude oil prices rise. Import reduces by 2.417%,export reduces by 1.811% and value added increases by 0.291% in Secondary industry ifinternational crude oil price rises by 50%. The reason lay in the rising of domesticcrude oil prices as international crude oil prices rose; also oil prices risk diffusionalong with the industry chain. This is due to crude oil being a primary energy; itsdownstream is very long with almost all sectors, far and near, suffering its pricefluctuations. The impact on the petroleum and chemical sector is greatest because of the

tight relationship between it and crude oil. All Chinese large-scale petroleum enterprisesare integrated upstream-downstream enterprises. About 80% of the crude oil used bytheir downstream products are supplied by only 20% of the enterprise’s upstream;(Chinese degree of dependence on international oil is 20.17%). When there are rises ininternational crude oil price, these enterprises’ upstream products (crude oil) prices alsogo up; but the price range is greater. Combined with these factors, the profit of theChinese petroleum enterprises does not reduce but, in fact, increases; which is consistentwith the fact that the more oil price rises, the more petroleum enterprises profit.

Figure 9 Impact on import based on industry level

Figure 10 Impact on export based on industry level




Figure 11 Impact on value added based on industry level

In the Tertiary Industry, imports reduce as oil price rises. However, value-addedincreases when the range of oil price rising does not go beyond 40%. Moreover, if therange of oil price rise continues, exports will decline. The reason probably lies in real income suffering little impact when crude oil prices rise a little, (and Chinese labour ischeap), so countries importing from China do not reduce their imports. However, whenthe range of rise in crude oil price is greater, real income reduces considerably.In addition, Tertiary Industry products have a larger elasticity of demand; thus importreduction begins from the Tertiary Industry, causing reductions in exports. However,whether rises in oil price are small or large, the impact on the Tertiary Industry is muchsmaller than that of the Primary and Secondary Industry.

The hike in international crude oil price brings about a rise in China’s domestic crudeoil price. Domestic crude oil price rises by 5.258% and 8.494% if international crude oil

price rises by 20% and 50%, respectively. Figure 12 shows the results of other sectors’ products supply price variation caused by international crude oil price rise of 20% and50%. The prices of all sectors prices go up. The price of petroleum and that in thechemical sector has greatest range, when compared with heavy industry. The agriculturalsector has the smallest range. When international crude oil price rises by 50%, the rangein petroleum and chemicals is 1.670%, in the heavy industry it is 1.084%, in theelectricity sector it is 0.898%, in construction it is 0.814%, and in agriculture it is0.263%. The results show that prices go up the most when there is a strong relationshipwith crude oil. Since prices go up in all sectors, the level of cost-push inflation will beraised.

Figure 12 Impact on supply prices




International crude oil price rises makes energy more expensive, which spurs enterprises

on to energy conservation. Figure 13 shows the change of energy demand in unit GDP.The rise of international oil price makes crude oil become more expensive; the next isnatural gas. So the demand for crude oil and natural gas in unit GDP reduces much more.When international oil prices rise by 20%, the demand for crude oil in unit GDP reduces by 1.294%; natural gas reduces by 1.159%, coal reduces by 0.287%, and electricityreduces by 0.083%. The results indicate that China’s energy efficiency still has a longway to go on one hand; on the other hand, the rise in oil price will lead to a change in theChinese energy structure, that is to say, expanding the current tendency of substitutingcrude oil and natural gas with coal and electricity.

The increase in international crude oil price will stimulate investment in the crude oilmining sector, and expansion production. Tables 2 and 3 show capital input increases of16.497%; and labour input increases of 16.814% if international crude oil price rises by

10%. In addition, oil price rise has the most important impact on capital and labour inputdemand in the natural gas mining, petroleum and chemical sectors than in the heavyindustry and coal mining sectors. Our simulated results are under the hypotheses thatlabour and capital markets are able to reach full equilibrium state when the Chineseeconomy suffers oil price shocks. Therefore, increased labour and capital inputs aretransferred from other sectors- which are mainly the natural gas mining, petroleum andchemical, heavy industry and coal mining sectors.

Figure 13 Impact on energy demand

Table 2 Relative change of capital input

Price (%) AGRI HIND LIND PECH CONS TRAN COMM NONM COAL OIL GAS ELEC

5 –0.156 –0.247 –0.080 –0.605 –0.140 –0.149 –0.161 –0.105 –0.254 8.765 –0.476 –0.12310 –0.294 –0.469 –0.156 –1.116 –0.261 –0.280 –0.305 –0.199 –0.476 16.497 –0.883 –0.229

20 –0.519 –0.834 –0.286 –1.906 –0.454 –0.493 –0.540 –0.352 –0.831 29.038 –1.520 –0.398

40 –0.806 –1.305 –0.463 –2.848 –0.692 –0.704 –0.840 –0.549 –1.276 44.933 –2.293 –0.607

50 –0.894 –1.449 –0.519 –3.122 –0.763 –0.846 –0.932 –0.609 –1.409 49.755 –2.521 –0.669

100 –1.084 –1.763 –0.643 –3.701 –0.916 –1.024 –1.132 –0.739 –1.696 60.179 –3.006 –0.802




Table 3 Relative change of labour input

Price (%) AGRI HIND LIND PECH CONS TRAN COMM NONM COAL OIL NGAS ELEC

5 –0.012 –0.104 0.063 –0.462 0.004 –0.005 –0.018 0.038 –0.111 8.921 –0.333 0.021

10 –0.023 –0.199 0.115 –0.848 0.009 –0.009 –0.034 0.072 –0.206 16.814 –0.614 0.041

20 –0.042 –0.358 0.193 –1.435 0.024 –0.016 –0.062 0.126 –0.356 29.657 –1.047 0.080

40 –0.067 –0.569 0.280 –2.123 0.048 –0.024 –0.101 0.193 –0.539 44.013 –1.565 0.134

50 –0.074 –0.634 0.304 –2.321 0.057 –0.027 –0.113 0.213 –0.594 50.993 –1.715 0.152

100 –0.092 –0.778 0.354 –2.735 0.078 –0.032 –0.140 0.256 –0.710 61.786 –2.033 0.193

4.2 Effects of low/medium/high technological advances in the crude oil mining sector to resist oil price risk

According to an economic perspective, other factors removing labour and capital from production function can be regarded as the contribution of technology to output; the scale parameter φ i of production function expresses the contribution of technological advancesin sector i (in a broad sense) to output. In the light of literature, we call φ i increasing by2% as low technological advance, φ i increasing by 4% as median technological advanceφ i increasing by 8% as high technological advance (Doroodian and Boyd, 2003).

Figure 14 shows the effect of low/medium/high technological advances in the sectorof crude oil mining on resisting international oil price risk to China’s real GDP and totalinvestment. When there are no technological advances in the sector of crude oil mining,China’s real GDP and total investment suffer negative effects resulting from the crude oil price. From the simulated results, we find that low technological advances in the sector ofcrude oil mining have a significant effect on resisting oil price risk to China’s real GDP,(when oil price has a small rise e.g., 5%, 10%). When international crude oil price rises by 10%, low technological advances in crude oil mining sector can cause China’s real GDP to reduce less: 0.034%; that accounts for 64% of total effect. However, when oil price has a large rise, the effect of low technological advances in the sector of crude oilmining on resisting oil price risk shows a remarkable reduction. When international crudeoil prices rise by 100%, low technological advances in the crude oil mining sector cancause China’s real GDP to reduce only by 0.043%, which accounts for 27% of the totaleffect. Medium technological advances in the crude oil mining sector can resist fully thenegative effect of oil price increases on China’s real GDP, so long as the range of oil price rise does not go beyond 10%. It resists half of the negative effect of oil price onChina’s real GDP, when the oil price rises by 100%. High technological advances in thecrude oil mining sector can fully resist the negative effect of increases in oil price on

China’s real GDP – even if oil price rises 100%.Low technological advances in the crude oil mining sector can fully resist the

negative effect of increases in oil price on China’s total investment, if the range of oil price rise does not go beyond 10%. Medium technological advances can resist fully thenegative effect of oil prices on China’s real GDP if the range of oil price rises does notgo beyond 40%. High technological advances can resist fully the negative effect of oil prices on China’s real GDP, even if the oil prices rise by 100%. From the relative level,low technological advance can resist 46% of total negative effect on total investment;Medium technological advance can resist 89%.




Figure 14 Impact on real GDP (left) and investment (right) with technological advances in crude

oil mining sector

From the above results, we can draw the conclusion that technological advances in thecrude oil mining sector play an important role in resisting the international crude oil pricerisk.

4.3 Effect of low/medium/high technological advances in petroleumand chemical sectors to resist oil price risk

Figure 15 shows the effect of low/medium/high technological advances in the sectors of petroleum and chemicals on resisting international oil price risk to China’s real GDP andtotal investment. Low technological advances can fully resist the negative effect of oil price rise, if the range of the oil price rise does not go beyond 20%, medium/high;technological advance can fully resist the negative effect of oil price on China’s real GDP, even if oil price rises by 100%. Low/medium/high technological advances in thesectors of petroleum and chemicals can fully resist the negative effect of oil price rise onChina’s total investment. From relative level, low technological advance can resist 81%of the total negative effect on real GDP when the oil price rises by 50% and resist

69.8% when oil price rises by 100%.

Figure 15 Impact on real GDP (left) and investment (right) with technological advancesin petroleum and chemical sector

4.4 Effect of low/medium/high technological advances in the transportation

sector to resist oil price risk

Figure 16 shows the effect of low/medium/high technological advances in thetransportation sector on resisting international oil price risk to Chinese real GDP andtotal investment. Low technological advances can fully resist the negative effects of oil price rises, if the range of oil price rise does not go beyond 20%; medium/hightechnological advances can fully resist the negative effect of oil price on Chinese real GDP, even if oil price rise by 100%. Any technological advance in the transportationsector is able to resist fully the negative effect of oil price rise on total investment,and continue the growing tendency. Low technological advance is able to resist 77% of




the impact of oil price rise on real GDP if oil price rises by 50% and resist 66.7% of the

impact if oil price rises 100%.

Figure 16 Impact on real GDP (left) and investment (right) with technological advancesin transportation sector

4.5 Effect of low/medium/high technological advances to resist oil price risk on

residents

Technological advances play a positive effect on resisting the loss of residents’ welfarecaused by oil price increases. Figure 17 shows the results of rural/city residents’ welfarechange when international crude oil prices rise by 5%, 10%, 20%, 40%, 50%, 100%while at the same time, medium technological advances are born in the crude oil miningsector, petroleum and chemical sector and transportation sector. Rural/city residents’welfare loses as oil prices rise, and the loss of rural residents’ welfare is greater. Wheninternational crude oil price rises by 40%, and there are no technological advances in anysector; the rural residents’ welfare loses 0.41%. However city residents’ welfare losesonly 0.37% when the oil price rises by 100%. The speed of rural residents’ welfare losingis faster than that of city residents’ as the range of oil price rising, but the speed of

welfare losing tends to be slower. Compared with no technological advances at all, a fewtechnological advances effectively restrain the loss of residents’ welfare, and the effect inthe transportation sector is a little greater than the petroleum and chemical sectors; theyare both greater than the crude oil mining sector. In addition, the effects on rural/cityresidents are different; such as when there are no technological advances, and thecrude oil price rises by 100%, rural and city residents’ welfare loses by 0.56% and0.37%, respectively. However, when there is medium technological advance in the petroleum and chemical sectors, their welfare loses by 0.37% and 0.18%, respectively.So technological advance makes rural/city residents’ welfare lose less by 33.9% and51.4%. Other scenarios have similar results.

Figure 17 Impact on residents’ welfare with medium technological advances in OIL/PECH/TRANsectors




5 Conclusions

Based on the above simulated results and subsequent discussion, we can draw thefollowing conclusions.

• The direct impact of international crude oil price on the Chinese economy is toreduce real GDP. It is well know that investment, consumption and export are thethree factors contributing to of GDP growth. When oil price rises by 50%, exportreduces by 1.468%, total investment reduces by 0.106%, consumption reduces by0.206%, which leads to a real GDP reduction of 0.137%.

• International crude oil price hikes can upset trade balance. RMB exchange rate isfaced with sliding pressure if the international crude oil price increases. The RMBexchange rate slides by 0.636%, if the international crude oil price rises by 50%.

RMB depreciates, making imported products more expensive, export products become more inexpensive, which will cut down real income, which then deterioratesthe Chinese international payments balance.

• The rise in international crude oil price leads to increases in the input cost forenterprises, as oil is their fuel or raw material. Consequently the pressure of products’ cost has the probability of diffusing along the industrial chain, and in turnincreases inflationary pressure. When the international crude oil price rises by 50%,China’s price level measured by the GDP deflator rises by 0.675%.

• The main indirect impact of international crude oil price on the Chinese economy isthe potential risk of exports decreasing. When the international crude oil price rises by 50%, Chinese exports drop by 1.468%. On the one hand, Chinese products’exports become less competitive due to increased production cost. Conversely,import capacity reduces in countries that import products from China (due to thedifficulty of international balance of payments provoked by oil price increases).

• The effect of technological advances on resisting oil price risk is remarkable.Among them the effects of technological advances in the petroleum and chemicalsector and in the transportation sector are bigger than that in the crude oil miningsector. Low technological advances in the petroleum and chemical sector andtransportation sector can resist, fully, the negative effects of oil price increases onChina’s real GDP when the range of oil price hike does not go beyond 20%; mediumtechnological advances in these two sectors can resist fully the negative effects of anoil price hike on China’s real GDP when the range of oil price does not go beyond50%, high technological advances in these two sectors can fully resist the negativeeffects of oil price increases on China’s real GDP – even if oil prices rise by 100%.

• The impact of an oil price hike on rural/city residents’ welfare is different. Generallyspeaking, oil price increases have negative effects on rural/city residents’ welfare; but rural residents lose much more welfare than do city residents. When the oil pricerises 50%, rural residents’ welfare loses by 0.39%; city residents’ welfare loses by0.23%. Secondly, the speed of rural residents’ welfare reduction is faster. Finally, the positive effect of technological advances brings down city residents’ welfareloss faster than that of rural residents’ welfare. When the oil price rises by 50%,medium technological advance in petroleum and chemical sector can make rural/cityresidents’ welfare less reduced 30.8%/47.8%.




• International crude oil price rise causes energy products’ prices to rise. It causes

resources to move from other sectors to the crude oil mining sector. When the oil price rises by 50%, the demand for capital and labour in the crude oil mining sectorincreases by 49.755% and 50.993% respectively. The increase of input factorsmeans that the scale of production expands, which is beneficial to the developmentof the petroleum industry. Additionally, the hike in international crude oil pricereduces the demand for energy in unit GDP. When oil price rises by 50%, crudeoil demand reduces by 2.093%, natural gas reduces by 1.890%, coal demandreduces by 0.476%, and electricity power demand reduces by 0.132%. So oil priceincrease promotes Chinese energy saving, thereby improving Chinese energyefficiency, which in turn is beneficial in alleviating China’s paradox of oil supplyand demand.

Acknowledgements

The authors gratefully acknowledge the financial support from the National NaturalScience Foundation of China (NSFC) under the grants Nos. 70425001, 70573104and 70371064, the Key Projects from the Ministry of Science and Technology ofChina (grants 2001-BA608B-15, 2001-BA605-01). Yi-Ming Wei truly appreciates thesupport from Professor Michael B. McElroy and Mr. Chris P. Nielsen at HarvardUniversity.

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