404

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

The impact of rising international crude oil price

on Chinas economy: an empirical analysis
with CGE model
Ying Fan
Center for Energy and Environmental Policy Research,
Institute of Policy and Management,
Chinese Academy of Sciences, Beijing 100080, China
E-mail: ying_fan@263.net

Jian-Ling Jiao
Hefei University of Technology, Hefei 230009, China
E-mail: jianljiao@126.com

Qiao-Mei Liang
Center for Energy and Environmental Policy Research,
Institute of Policy and Management,
Chinese Academy of Sciences, Beijing 100080, China
E-mail: lqmhl@hotmail.com

Zhi-Yong Han
National Natural Science Foundation of China,
Beijing 100085, China
E-mail: zhy.han@gmail.com

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: ymwei@deas.harvard.edu
E-mail: ymwei@263.net
*Corresponding author
Abstract: Many studies, as well as historical events, indicate that oil price
shocks affect the macro economy of a country. In this paper we build a Chinese
Computable General Equilibrium (CGE) model, with which we simulate the
impact on the Chinese economy of international crude oil price when it rises by
5%, 10%, 20%, 40%, 50% and 100%. Simulation also identifies the effects of
low/medium/high technological advances in the crude oil mining, petroleum
and chemical and transportation sectors on fighting the risk of oil price shocks.
Copyright 2007 Inderscience Enterprises Ltd.

The impact of rising international crude oil price on Chinas economy

405

The results indicate that international crude oil price has negative effects on
Chinese real GDP, investment, consumption, import and export, amongst a
range of economic indices. Technological advances have positive effects on
fighting back the risk of oil price shocks, especially the technological advances
in petroleum and chemicals, whilst the transportation sector has a greater
effect on resisting oil price risk. An international oil price hike holds more
disadvantages for rural residents welfare. These results would be valuable
reference 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 rising
international crude oil price on Chinas economy: an empirical analysis with
CGE model, Int. J. Global Energy Issues, Vol. 27, No. 4, pp.404424.
Biographical notes: Ying Fan is a Professor at the Institute of Policy and
Management, Chinese Academy of Sciences, China. In 2004, she was a visiting
scholar 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 and
Management of the Chinese Academy of Sciences, China. His research
interests focus on energy environment and energy issues, modelling and
analysis.
Zhi-Yong Han is a research assistant at the National Natural Science
Foundation of China, China.
Yi-Ming Wei is a Professor at the Institute of Policy and Management of the
Chinese Academy of Sciences. In 2005, he was a visiting scholar at Harvard
University, USA.

Introduction

After the two big oil crises in the 1970s and 1980s, it is generally believed that increase
in crude oil prices contributes to inflation, at the same time bringing down demand for
consumption, 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 the
year 2004; moreover, the problem of fiscal impact of oil price fluctuation in every
countrys 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 that
there is a strong relationship between oil price fluctuation and the US real GDP. Other
studies have found that the relationship was asymmetric and that the impact of oil price
fluctuation on an economy when price goes up has greater economic effects than when

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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 was
caused by high oil prices; that different overarching monetary policies may cause
different results. The notion of the causal relationship between monetary policy and the
depression after high oil prices has attracted keen academic interest (Rasche and Tatom
2001; 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 economy
was 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 price
fluctuation as nonlinear. Hence, oil price fluctuation and its specific relationship to GDP
has 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 the
economic impact induced by oil price fluctuation is different at differing periods,
or on different countries. The impact on Germany and USAs economy (they are both
dependent on oil imports), caused by oil price fluctuation in the 1970s and 1980s
is an interesting example. The negative impact on the USA is greater than that on
Germany; likewise, export dependent UK and Norway each have differing consequences:
the impact on UKs economy is negative, but on Norways 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 the
magnitude experienced in the 1970s will have a fairly severe effect on such things as
gasoline and refinery prices, the aggregate price changes will be largely dissipated over
time at the aggregate level. Furthermore, the aggregate level of prices (CPI and PPI) will
fall over time as the level of technological advances rise. Uri (1997) used a CGE model
to simulate the impact of the gasoline and electricity price-shock on the Mexico
economy.
China became a crude oil net import country in 1996. The overall tendency
for crude oil imports, and its level of dependence on international oil markets, gradually
increased year by year; the only exception being during the Asian Financial
Crisis in 1998. Chinas crude oil imports totalled 120 million ton in 2004 causing its
dependence on international oil to be at around 42%. It has been estimated that the
import of oil by China will reach 230 million tons; increasing its dependence on
international oil by some 60%. The Chinese crude oil price has basically realised
co-movement with international crude oil price after the reform and adoption the
oil pricing mechanism in 1998. Any fluctuation in crude oil prices in international
markets will inevitably influence Chinese domestic prices; and in turn, will influence the
Chinese economy. Such relational pricing mechanisms and impacts can be represented
using a CGE model that reflects a dynamic Chinese economy. Figure 1 represents the
trends of Chinese oil consumption, net import and dependence on international oil
markets from 1993 to 2002.

The impact of rising international crude oil price on Chinas economy

Figure 1

407

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

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 theoretical
model of General Equilibrium. Subsequently, the existence, uniqueness, and stabilisation
of the models 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 Scarfs work that made the
General Equilibrium model a practical application model from its pure theoretical
framework.
The basic idea of General Equilibrium theory is: according to the principle of
maximising profit or minimising cost, producers make input decisions under resource
constraints. Producers then determine optimal supply; according to the principle of
maximising utility. Consumers make optimal expenditure decisions under budget
constraints; this ultimately, determines optimal demand. Equilibrium price makes optimal
supply 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 the
two-sectors CGE model; Shoven and Whalley (1973, 1974) built a CGE model on Tax
Reform for developed countries. Global Trade CGE models have also been developed
(Shoven and Whalley, 1992; McFarland et al., 2004). Almost all countries now have
various CGE models to explore relevant policy development (Bye and vitsland, 2003;
Dellink et al., 2004; Willenbockel, 2004; Das et al., 2005; Mustafa, 2005). The merit of
the CGE model is that it embodies market mechanisms and policy instruments which
play an important role in identifying price incentive mechanisms. Moreover, they can
describe inter-dependence factors that exist in production, demand and international
trade. When an economy suffers an unexpected shock, we can study the impact of the
shock on gross economics, economic structure, relative prices, and so forth. The CGE
model is an appropriate tool for studying various impacts when an economy suffers
unexpected international oil price shocks.
Literature on Chinese CGE models has increased in recent years. CGE models
specifically using Chinese characters include: DRCCGE developed by The Development
Research 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 CGE
Model for China (Wu and Xuan, 2002); and applied research on analysing CO2 control in

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

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-Tax
or CO2 tax). Hou and Xuan (2003) developed a one sector CGE model to analyse the
impact 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 on
the Chinese economy.
In this paper we discuss the building of our CGE model that was developed by
drawing upon the above literatures. Application of the model allowed simulation of the
impact of international crude oil price occurring with differing shocks on several Chinese
economic indices together with the impact on import/export/value added at the industry
level. We also simulated the action of crude oil mining, petroleum and chemical, and the
transportation sectors occurring at low/medium/high technological advances on resistive
effects of oil price risk.

CGE model based on simulating the impacts of international crude oil

price 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 balance
and model closure module. For emphasising energy and energy related sectors, we
consider 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 not
contribute to a final solution, it was possible to compute residents welfare (upon final
execution of the model).
Table 1

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

Sectors in model
01
Agriculture
02
Heavy industry
03
Light industry
04
Petroleum and chemical
05
Construction
06
Transportation
07
Commerce
08
Nonmaterial
09
Coal mining
10
Oil mining
11
Natural gas mining
12
Electricity

40 sectors
01
04~05, 13~26
06~10
11~12
27
28~29
30~31
32~40
02
03
03
24

124 sectors
001~005
009~013, 048~085, 087~089
014~035
036~047
090
091~099
100~101
102~124
006
007
008
086

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409

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 that
Chinese international trade contribution to the global trade is small enough; and Chinese
production and the domestic price does not influence international price; and that China
only 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 indicates
that consumers minimise their expenditure, and that producers maximise their profit.
Value added price is a compound commodity price that is taken off indirect taxes and
median inputs. The price index is defined by the GDP deflator, calculated by nominal
GDP divided by real GDP.
Production module
In our model a 2-nested production function is employed. First, every sector uses labour
and 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, according
to the Leontief function. Technologies are taken into account by production functions
which exhibit constant elasticity of substitution. Technological progress (both embodied
and 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 can
vary between zero and infinity. Hence, we have
Vi = i [ L Li

( i 1) / i

+ K Ki

( i 1) / i i /( i 1)

where Vi is the value added in sector i; i is elasticity of input substitution in sector i,

i is an output scaling parameter which can allow technological change, Li is labour at
sector i; Ki is capital at sector i; and s are share parameters defined so that

L , K > 0
and

L + K = 1.
The outputs of the other manufacturing goods industries also enter the
production-function specifications as fixed-factor components of the national
inputoutput 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 output
and input prices as parameters, profit maximisation, based on the production technology,
yields output supply and factor demands for each production sector and factor market in
the model.

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Figure 2

Y. Fan, J-L. Jiao, Q-M. Liang, Z-Y. Han and Y-M. Wei
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 from
the government, enterprise and rest of the world to the residents. It represents disposable
income, after taking off income tax. Residents savings are residents disposable income
multiplied by marginal propensity to save; the consumption by residents of commodities
is described by the Extended Linear Expenditure System (ELES). Government income
comes from enterprises direct taxes and indirect taxes, residents income taxes, import
taxes, etc. Total saving is composed of residents savings, governments savings,
enterprise savings and foreign net savings.
Trade module
Producers and consumers select a group of compound commodities compounded by
imports and domestic products according to the Armington assumption. The import
demand function is obtained by minimising CES cost function; the export demand
function is obtained by maximising CET profit function.
Investment module
Total investment equals total savings. This supposes that every sectors investment is a
fixed proportion of the total investment.
Macro balance and model closure module
Model closure conditions include market equilibrium and macro equilibrium. There are
four market equilibriums in the model; they are commodity market equilibrium,
factor markets equilibrium, capital market equilibrium and foreign exchange market
equilibrium.
Commodity market equilibrium indicates that every kind of compound commodities
supply equals the domestic demand for this kind of commodity. Domestic aggregate
supply comes from domestic enterprise production and import. Domestic aggregate
demand is divided into two parts: one is the other sectors median input demand; another
is the government and residents final demand and investment (see Figure 3).

The impact of rising international crude oil price on Chinas economy

Figure 3

411

Commodities flow

Factor market equilibrium means that the aggregate demand for every kind of factor
equals its aggregate supply. We suppose that the factor market can make full adjustment
for the factors relative price in every sector when it suffers an external shock such as in
the labour market where labour aggregate supply is a given exogenous variable, every
sectors relative wage is an endogenous variable, and labour supply allocation in every
sector 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 receipts
are composed of export receipts, the transfer from the rest of the world to residents, to
government, 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 commoditys 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 after
the change of international crude oil price, on the basis of commoditys price before the
oil price rise.
EVh = PZ i CDhihs PZ ib CDhihb .
b

Here EVh is the variation of the residents welfare. CDhihb and CDhihs 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 of
sources. Data on the following were obtained: income and expenditures for each of the
income categories; the amount of imports and exports in each of the traded sectors;

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

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 data
mainly come from the Chinese Input-Output Table (1997), Chinese Statistical Yearbook
(1998, 1999, 2000) and Almanac of Chinas Finance and Banking (1999), amongst other
sources.
Apart from a large amount of original data, many parameters are also used
in 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 aspects
of the model. Some of them are estimated using traditional statistical inference; some
are collected from the existing literatures (Wu and Xuan, 2002; Zhang, 2001).
All parameters, however, have been calibrated to a 1997 base. A number of data
adjustments 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 actual
1997 data (Ballard et al., 1985).

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 be
affected when international crude oil price rises by 5%, 10%, 20%, 40%, 50%, 100%,
respectively. Figures 413 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 reduces
the 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 by
10% and 50%, respectively.

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413

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 of
rural residents consumption is bigger than that of city residents. The reason for the
result is that rural residents real income reduces much more than that of city residents
as 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 RMB
exchange 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 sliding
when 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 Chinas foreign exchange payment. However, the
range of the RMB exchange rate sliding is moderate, so the impact of an oil price hike on
the Chinese economy is not serious.
Figure 5

Impact on consumption

Figure 6

Impact on residents real income

414
Figure 7

Y. Fan, J-L. Jiao, Q-M. Liang, Z-Y. Han and Y-M. Wei
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 level
measured by a GDP deflator as oil price rises. The results show that Chinese price
levels 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 international
crude oil price shows a small rise, the speed of price level rise will accelerate; when the
range of international crude oil price rises beyond 50%, the speed of price level rise will
slow 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 reason
is that the RMB exchange rate depreciates if oil price rises, which makes Chinese exports
more competitive, and subsequently weakens Chinese import capacity.
Figure 8

Impact on import/export

Figures 911 show the results of import, export and value added variation in Primary
Industry, Secondary Industry, Tertiary Industry. Import reduces by 1.941%, export
reduces by 1.763% in Primary Industry if crude oil price rises by 50%. The reason for
this 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

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415

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 of
agricultural 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 price
rises, 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 in
the 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 if
international crude oil price rises by 50%. The reason lay in the rising of domestic
crude oil prices as international crude oil prices rose; also oil prices risk diffusion
along with the industry chain. This is due to crude oil being a primary energy; its
downstream is very long with almost all sectors, far and near, suffering its price
fluctuations. 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 enterprises
are integrated upstream-downstream enterprises. About 80% of the crude oil used by
their downstream products are supplied by only 20% of the enterprises upstream;
(Chinese degree of dependence on international oil is 20.17%). When there are rises in
international crude oil price, these enterprises upstream products (crude oil) prices also
go up; but the price range is greater. Combined with these factors, the profit of the
Chinese petroleum enterprises does not reduce but, in fact, increases; which is consistent
with 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

416

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

Figure 11 Impact on value added based on industry level

In the Tertiary Industry, imports reduce as oil price rises. However, value-added
increases when the range of oil price rising does not go beyond 40%. Moreover, if the
range 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 is
cheap), so countries importing from China do not reduce their imports. However, when
the 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 import
reduction 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 much
smaller than that of the Primary and Secondary Industry.
The hike in international crude oil price brings about a rise in Chinas domestic crude
oil 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% and
50%. The prices of all sectors prices go up. The price of petroleum and that in the
chemical sector has greatest range, when compared with heavy industry. The agricultural
sector has the smallest range. When international crude oil price rises by 50%, the range
in petroleum and chemicals is 1.670%, in the heavy industry it is 1.084%, in the
electricity sector it is 0.898%, in construction it is 0.814%, and in agriculture it is
0.263%. The results show that prices go up the most when there is a strong relationship
with crude oil. Since prices go up in all sectors, the level of cost-push inflation will be
raised.
Figure 12 Impact on supply prices

The impact of rising international crude oil price on Chinas economy

417

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 is
natural 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 electricity
reduces by 0.083%. The results indicate that Chinas energy efficiency still has a long
way to go on one hand; on the other hand, the rise in oil price will lead to a change in the
Chinese energy structure, that is to say, expanding the current tendency of substituting
crude oil and natural gas with coal and electricity.
The increase in international crude oil price will stimulate investment in the crude oil
mining sector, and expansion production. Tables 2 and 3 show capital input increases of
16.497%; 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 input
demand in the natural gas mining, petroleum and chemical sectors than in the heavy
industry and coal mining sectors. Our simulated results are under the hypotheses that
labour and capital markets are able to reach full equilibrium state when the Chinese
economy suffers oil price shocks. Therefore, increased labour and capital inputs are
transferred from other sectors- which are mainly the natural gas mining, petroleum and
chemical, 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

0.156 0.247 0.080 0.605 0.140 0.149 0.161 0.105 0.254

8.765 0.476 0.123

10

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

418
Table 3

Y. Fan, J-L. Jiao, Q-M. Liang, Z-Y. Han and Y-M. Wei
Relative change of labour input

Price (%)

AGRI

0.012 0.104 0.063 0.462 0.004 0.005 0.018

HIND LIND PECH CONS TRAN COMM NONM COAL

0.038 0.111

OIL

NGAS ELEC

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

8.921 0.333 0.021

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 i of production function expresses the contribution of technological advances
in sector i (in a broad sense) to output. In the light of literature, we call i increasing by
2% as low technological advance, i increasing by 4% as median technological advance
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 sector
of crude oil mining on resisting international oil price risk to Chinas real GDP and total
investment. When there are no technological advances in the sector of crude oil mining,
Chinas 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 of
crude oil mining have a significant effect on resisting oil price risk to Chinas 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 Chinas 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 oil
mining on resisting oil price risk shows a remarkable reduction. When international crude
oil prices rise by 100%, low technological advances in the crude oil mining sector can
cause Chinas real GDP to reduce only by 0.043%, which accounts for 27% of the total
effect. Medium technological advances in the crude oil mining sector can resist fully the
negative effect of oil price increases on Chinas 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 on
Chinas real GDP, when the oil price rises by 100%. High technological advances in the
crude oil mining sector can fully resist the negative effect of increases in oil price on
Chinas 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 Chinas total investment, if the range of oil
price rise does not go beyond 10%. Medium technological advances can resist fully the
negative effect of oil prices on Chinas real GDP if the range of oil price rises does not
go beyond 40%. High technological advances can resist fully the negative effect of oil
prices on Chinas 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%.

The impact of rising international crude oil price on Chinas economy

419

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 the
crude oil mining sector play an important role in resisting the international crude oil price
risk.

4.3 Effect of low/medium/high technological advances in petroleum

and 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 Chinas real GDP and
total 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 Chinas real
GDP, even if oil price rises by 100%. Low/medium/high technological advances in the
sectors of petroleum and chemicals can fully resist the negative effect of oil price rise on
Chinas 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 advances
in 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 the
transportation sector on resisting international oil price risk to Chinese real GDP and
total 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/high
technological 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 transportation
sector 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

420

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

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 advances
in 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 welfare
caused by oil price increases. Figure 17 shows the results of rural/city residents welfare
change 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 mining
sector, 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. When
international crude oil price rises by 40%, and there are no technological advances in any
sector; the rural residents welfare loses 0.41%. However city residents welfare loses
only 0.37% when the oil price rises by 100%. The speed of rural residents welfare losing
is 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 few
technological advances effectively restrain the loss of residents welfare, and the effect in
the transportation sector is a little greater than the petroleum and chemical sectors; they
are both greater than the crude oil mining sector. In addition, the effects on rural/city
residents are different; such as when there are no technological advances, and the
crude oil price rises by 100%, rural and city residents welfare loses by 0.56% and
0.37%, 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% and
51.4%. Other scenarios have similar results.
Figure 17 Impact on residents welfare with medium technological advances in OIL/PECH/TRAN
sectors

The impact of rising international crude oil price on Chinas economy

421

Conclusions

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

The direct impact of international crude oil price on the Chinese economy is to
reduce real GDP. It is well know that investment, consumption and export are the
three factors contributing to of GDP growth. When oil price rises by 50%, export
reduces by 1.468%, total investment reduces by 0.106%, consumption reduces by
0.206%, which leads to a real GDP reduction of 0.137%.

International crude oil price hikes can upset trade balance. RMB exchange rate is
faced with sliding pressure if the international crude oil price increases. The RMB
exchange 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 deteriorates
the Chinese international payments balance.

The rise in international crude oil price leads to increases in the input cost for
enterprises, 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 turn
increases inflationary pressure. When the international crude oil price rises by 50%,
Chinas price level measured by the GDP deflator rises by 0.675%.

The main indirect impact of international crude oil price on the Chinese economy is
the 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 the
difficulty 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 chemical
sector and in the transportation sector are bigger than that in the crude oil mining
sector. Low technological advances in the petroleum and chemical sector and
transportation sector can resist, fully, the negative effects of oil price increases on
Chinas real GDP when the range of oil price hike does not go beyond 20%; medium
technological advances in these two sectors can resist fully the negative effects of an
oil price hike on Chinas real GDP when the range of oil price does not go beyond
50%, high technological advances in these two sectors can fully resist the negative
effects of oil price increases on Chinas real GDP even if oil prices rise by 100%.

The impact of an oil price hike on rural/city residents welfare is different. Generally
speaking, 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 price
rises 50%, rural residents welfare loses by 0.39%; city residents welfare loses by
0.23%. Secondly, the speed of rural residents welfare reduction is faster. Finally, the
positive effect of technological advances brings down city residents welfare
loss 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/city
residents welfare less reduced 30.8%/47.8%.

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Y. Fan, J-L. Jiao, Q-M. Liang, Z-Y. Han and Y-M. Wei
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 sector
increases by 49.755% and 50.993% respectively. The increase of input factors
means that the scale of production expands, which is beneficial to the development
of the petroleum industry. Additionally, the hike in international crude oil price
reduces the demand for energy in unit GDP. When oil price rises by 50%, crude
oil demand reduces by 2.093%, natural gas reduces by 1.890%, coal demand
reduces by 0.476%, and electricity power demand reduces by 0.132%. So oil price
increase promotes Chinese energy saving, thereby improving Chinese energy
efficiency, which in turn is beneficial in alleviating Chinas paradox of oil supply
and demand.

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

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