10.08.2004
The Unbearable Lightness of Petrodollars
№3 2004 July/September

The second term of Vladimir Putin’s presidency began under very
favorable economic conditions. High oil and gas prices, both key
assets of the Russian export industry, permit his government to
boost Russian living standards with direct money transfers and
engage in structural reforms at the same time. However, as the
experience of other countries suggests, governments do not hurry to
introduce reforms when the economic climate is looking good. In
other words, why toil too much if everything is alright? Political
leaders rest on their laurels, while the voters (if we are speaking
about democracies) do not try to wake them up, since they see no
reason for concern. In such situations the authorities pay little
attention to expert warnings about the dangers of chasing
short-term advantages and postponing reforms. Harvard University
economists Jeffrey Sachs and Andrew Warner attribute this to the
public’s false sense of security that emerges during periods of
affluence.

The ‘contentment-with-prosperity’ effect can be observed both in
imperfect democracies and in truly authoritarian states. No
dictator will conduct painful reforms if the population does not
demand them.

And vice versa: as soon as a period of austerity arrives, reform
expectations grow in the society alongside a desire to replace its
leaders. Prof. Danny Roderick from Harvard University states that
as a crisis emerges, the advantages and losses of any policy
acquire a new dimension. Democratic leaders react to such problems
faster and refrain from any overly radical moves. However, the less
democratic a country is, the later its leaders will respond to the
situation. As a result, their reactions are usually quite
harsh.

What are the obstacles to growth?

There is a standard set of reasons why the abundance of natural
wealth impedes economic growth (which is a widespread trend). These
include the struggle for natural rent between different groups.
Next, there is what is known as ‘Dutch disease’ when the value of a
country’s currency rises, thus making manufactured goods less
competitive with other nations. Finally, there is the inherent
volatility of the world commodities markets, which especially hurts
economies with non-diversified exports. All these factors are
greatly conditioned by government policies.

Savings and investment surveys show that countries rich in
natural resources are unable to sacrifice short-term political
gains for long-term economic efficiency. They prefer to channel
revenues into wage increases instead of investing in education or
new technologies.

The records of many countries prove that a sudden emergence of
an additional income source lets the government postpone
long-pending reforms. Many such examples are discouraging – Sudan,
Nigeria, Venezuela, Algeria, Libya and Azerbaijan. Oil revenues in
those countries enabled their governments to protect the local
industries from foreign competitors far longer than the rules of
economic efficiency required. In resource-rich Central African
countries, such as Niger, Mali and Chad, the main problem was a
very low level of savings and, therefore, investment. The quality
of investment left much to be desired, too. In Nigeria, for
example, the government funneled oil export revenues into
industrial development, but it did it so inefficiently that, even
despite an annual six-percent growth rate of investment during two
decades, the national industry remained stagnant. In Saudi Arabia,
the ineffective application of oil export revenues brought about a
serious imbalance on the job market: in 1998, almost 90 percent of
the local population was employed in the state sector.

There is a positive example, however. Norway invested surplus
oil export revenues in education and a stabilization fund. Yet,
Oslo, too, has problems that are related to its oil market
orientation. Norwegian exports have become frozen at about 40
percent of the country’s gross domestic product. This is a very
good figure by international standards, but it was attained before
oil revenues started pouring into the economy. It means that oil
has not increased the rate of exports, but has only replaced some
of the traditional export items.

Postponed transformations

Russia can learn a lot from the example of Mexico, which has a
similar political system. It is a big federal state with a single
megalopolis that concentrates the financial wealth of the country.
For almost 60 years the country was ruled by one party, although
some principles of elective democracy were still observed. For
example, neither presidents nor congressmen, elected in a
non-competitive environment, were allowed to remain in office for
longer than a fixed term.

In the 1950s, the Mexican economy grew at a very fast pace, but
after the import substitution policy had exhausted its potential,
the country felt the need for reforms. At that very time, there
arose a favorable situation on the world commodity markets. After
the oil price hikes of 1973, Mexico found that exporting oil (which
had previously been almost completely consumed on the domestic
markets) was the simplest and quickest way of enriching the
nation.

As former president Josй Lуpez Portillo, who ruled at this time,
stated: “Oil is what secures our independence and compensates for
our drawbacks.” The inflow of petrodollars brought cheap foreign
bank loans with it. In the period from 1976 to 1979, more than half
of all loans given to the developing world went to five countries,
including three oil exporters. Obviously, any country which is
suddenly inundated with wealth must not indulge in borrowing
sprees, but rather save money or pay back its previous debts. But
is there any politician who would dare tell his fellow citizens
that the feast will end some day?
In the early 1980s, a global economic slump was followed by a
drastic dive in the price of oil. In 1982, a new candidate from
Mexico’s ruling party, Miguel de la Madrid, ran for the presidency
under a slogan for change. His program of reforms was aimed at
reducing state interference in the economy, liberalizing trade, and
carrying out privatization and deregulation. The reforms, which
should have been carried out ten years before, were successful,
although very painful.

Russia also experienced periods when a sudden emergence of
additional revenue sources let it postpone long-awaited reforms.
The most vivid examples are the reforms that were proposed by
Soviet Prime Minister Alexei Kosygin. Launched in the mid-1960s,
after a new team of Soviet leaders came to power, the reforms were
actually a reaction to a decrease in living standards which had
triggered strikes and protests in the country a few years before.
The reforms were intended to increase the effectiveness of the
centrally planned economy by stimulating economic agents. Among
other measures, the industrial enterprises were anticipated to
independently manage part of their profits. However, in the late
1960s, rich oil and gas fields were discovered in Western Siberia.
As a result, the much-needed reforms were stopped and later
shelved, as the Soviet economy was flooded with petrodollars. The
consequences of stalling the reforms were felt soon enough, with
Soviet agriculture hit the hardest. As the country was now able to
purchase grain from abroad, there was no need to reform the
national system of collective and state farms (kolkhozes and
sovkhozes). As a result, in 1974-1985, the agricultural growth rate
in the Soviet Union was far below the figures of the developed
countries, and almost three times below the world’s average. By the
mid-1980s, the Soviet Union ranked 90th in the world in grain
production and 71st in potato production.

A new attempt to reform the country was made 15 years after the
beginning of Kosygin’s reforms, in the first few years of Mikhail
Gorbachev’s perestroika (restructuring) policy. By that time, the
crisis of the Soviet economy had become all too evident, especially
after oil prices plummeted in the early 1980s. A top official at
the Soviet State Planning Committee said in 1988 that “if we had
not discovered the Samotlor [oil field], we would have been forced
to start perestroika 10 or 15 years before.” Meanwhile, it can be
debated what would have become of the country had the Kosygin
reforms continued. Could they have saved the Soviet Union? Most
likely, the Kosygin government would have been forced to face the
fundamental issue of ownership, in much the same way as Gorbachev
did. Yet, there is the possibility that the Soviet economy would
have entered the period of radical reforms in a far less decrepit
state than it did in the late 1980s.

The international community has a very limited ability to
influence the oil-exporting countries and encourage radical reforms
there.

Generally speaking, the international community has a very
limited ability to influence the oil-exporting countries and
encourage radical reforms there. Experts of the Carnegie Endowment
for International Peace pointed out that the international
community, as a rule, avoids pressuring the oil producers. Such a
policy was pursued vis-а-vis Iraq until Saddam challenged the world
in 1991 by occupying Kuwait. Saudi Arabia is still free from any
excessive Western pressure. In Sudan, the government received the
right to extract oil only after it concluded an agreement with the
opposition forces operating in the country’s oil-rich regions.
According to the agreement, Khartoum cannot use oil revenues to
beef up its military potential, that is, to increase allocations
for the struggle against the opposition. Nevertheless, the
country’s defense spending soon doubled, and the international
organizations that were the guarantors of the agreement preferred
not to interfere, although they had long viewed Sudan as a
potential ‘rogue nation.’

Oil and democracy

Moisйs Naнm, Editor of the Foreign Policy magazine and
Venezuela’s former minister of trade and industry, knows very well
the specificity of the development of the naturally rich countries.
He asserts that not a single ‘petrostate’ has been able to make oil
into a source of prosperity for the majority of its population.
“When oil revenues flood a nation that has a weak system of
democratic checks and balances, dysfunctional politics and
economics ensue,” Naнm wrote in The New York Times (December 4,
2003). “A lot of oil, combined with weak public institutions, fuels
poverty, inequality and corruption. It also undermines
democracy.”

The government of a country where the budget is mainly formed by
oil revenues feels no need to actively collect taxes from numerous
small and medium-sized businesses and, therefore, no need to
stimulate their growth and heed their political demands. This
situation provokes growing inequality, which is the curse of all
naturally rich countries, and hampers the political activity of the
middle class, the basis of democracy.

Leonard Wantchekon of New York University discovered the
following correlation: “A one percent increase in [a country’s]
resource dependence as measured by the ratio of primary exports to
GDP leads to a nearly 8 percent increase in the probability of
authoritarianism.”

Even in democratic countries, reliance on oil revenues bolsters
centralized power, since oil, as a strategic resource, often falls
into the hands of one state-owned company. In weak democracies, it
may lead to the establishment of a truly authoritarian regime, as
happened in Nigeria where the share of oil in the GDP grew from one
percent in the 1960s to 90 percent in the 1990s. Only
well-developed democracies with strong civil and political
institutions are protected against such a scenario.

In Norway, for example, the growth of oil revenues produced a
totally opposite effect. For the previous five decades it had been
ruled by one (Social Democratic) party; since 1981 it has been
alternately run by Social Democrats and Conservatives.

Dependence on the export of natural resources may have grave
economic consequences; the higher the dependence, the higher the
risks. Likewise, failures of economic policies in the authoritarian
states are far more catastrophic than in democratic countries.

Windfall incomes and the strengthening of the state (similar to
the processes that are under way in Russia now) are prone to one
more danger – the flagging responsiveness of the political system
to the demands of the citizens. The situation may arise where the
citizens feel the need for reforms, but the imperfections of the
political mechanism bar them from exerting sufficient pressure on
the politicians.

The above considerations suggest an unfavorable conclusion for
Russia: resource-rich countries have less chance to become
full-fledged democracies than other states. On the other hand, the
experience of other resource-rich countries does not allow one to
measure the probability of Russia becoming an authoritarian
state.

Russia is a “normal country,” as Andrei Shleifer and Daniel
Treisman described it in Foreign Affairs (March/April 2004). It is
normal in a sense that its crime level, media independence, and
life expectancy are almost the same as in other states at a similar
level of development. The trouble is that, from the point of view
of its democratic stability and the ability of its political system
to correct its own flaws, Russia is a borderline state. It is too
rich for a Chinese or Korean-style modernization – and too poor to
resist politicians’ attempts to embark on that path.