And 20 Years After

The Soviet Union officially ended 20 years ago today.  There are two good articles in New York Times and Financial Times providing a retrospective of the past two decades.  Both are worth reading.  The Economist has provided a personal essay on this day.

An addendum to the Financial Times article is particularly interesting.  Having spent some of my youth in the Middle East, I am fully aware of the Oil Curse and its consequences.  It appears that current-day, oil-rich Russia is having to live with the same issue.

Role of resources: How the balance tilted when energy-abundant Russia ‘became too rich’ 

Among the biggest factors holding back the development of democracy in the former Soviet Union have been two three-letter words: oil and gas. 

Of the six post-Soviet republics deemed authoritarian by the Economist Intelligence Unit, three – Kazakhstan, Turkmenistan and Azerbaijan – have big hydrocarbon reserves. Russia, with the largest reserves, is a “hybrid” state, showing authoritarian features. 

All have to some extent suffered classic symptoms of the “oil curse”. Oil and gas revenues have enabled cronyist leaderships to establish or maintain firm rule, while buying off opposition by raising wages and pensions. Apart from Kazakhstan, which has carried out some market-friendly reforms, energy wealth has also stunted the growth of other sectors. 

Russia is perhaps the starkest example. Throughout the 1990s, when oil prices were low, Russia was a democracy, albeit a highly imperfect one. For the first three years of the last decade, under president Vladimir Putin, liberal reforms continued. “But finally oil prices rose and Russia became too rich,” says Nikolay Petrov of the Moscow Carnegie Center, a think-tank, “and the leadership decided there was no longer a need to undertake new reforms, as they enjoyed huge revenues coming from nowhere.” 

Oil and gas have played an important role not just in countries that possess them, but also as leverage Russia has used to maintain influence over neighbours that lack them. 

Ukraine, the biggest ex-Soviet republic by population after Russia, relies on cheap Russian natural gas to fuel its heavy industry. Twice since 2006, Russia has cut supplies in winter amid pricing disputes. In Belarus, smallest of the three Slavic republics, energy subsidies from Russia have sustained the autocratic Alexander Lukashenko in power. They have compelled him, too, despite a poor personal relationship with Mr Putin and Dmitry Medvedev, his successor as Russian president, to remain essentially a vassal of Moscow. 

Belarusian industry, like Ukraine’s, benefits from cheap Russian gas. Belarus also receives cheap Russian oil, refines it in two Soviet-built refineries and sells the products to western Europe for a fat profit. “Who knows how Ukraine or Belarus might have developed if Russia had not exerted such an influence using oil and gas,” says Mr Petrov. 

By the same token, however, the lack of energy revenues has prevented Ukraine’s leaders from establishing as heavy-handed rule as Moscow. Local analysts cite this as a key limiting factor on Ukrainian president Viktor Yanukovich’s attempts to create a Putin-style system. 

In Russia, meanwhile, parts of the political and business elite have realised that without modernisation to nurture other sectors, it risks the kind of economic stagnation it suffered in Soviet times. Mr Medvedev portrays himself as a reformer who will try to help Russia escape the oil curse if granted a second term as president next year. But oil revenues may yet help propel Mr Putin, currently prime minister, back to the Kremlin.

Economics is not Accounting

In the economics sphere, a common misconception is “my loss is someone else’s gain” and vice versa.  While this conception is true in competitive situations involving pecuniary exchange, it does not hold when it comes to the wealth of nations.  As such, populist remarks like “rich people are getting richer on poor people’s back” is basic rubbish. 

Unlike accounting, economics is not a zero-sum game; that is, someone else’s loss does not necessarily translate to your gain.  Generally, when wealth is generated, it lifts all boats (the question of equitable distribution is a legitimate one – but that is a whole other topic).  Likewise, when wealth is destroyed, it generally hits everyone across the board (and it does hurt the less wealthy proportionally harder).

The same is true for international wealth of nations.  In today’s highly interconnected financial markets, a single nation’s economic faltering (unless it is North Korea or a similarly disintegrated locale) is indicative of a larger contagion that has the potential of affecting other nations.  And, if the contagion is in a large center like US, EU, or China, it has a high probability of making everyone sick. 

In October 2008 while I was in the US, I received more than one call from Russia where my contact gleefully lamented the “American crisis,” the undertone of the conversation being “America had it coming” and “Russia is rising again.”  While the crisis was American-made, it became the world’s crisis; in turn, it affected Russia more severely than it did its American epicenter. 

The brief period of gleeful lament came about again this year when (the American) Standard and Poor’s rating agency downgraded America’s credit rating from AAA to AA+.  In the early periods of market gyration, a few Russian acquaintances indicated that they lamented the latest difficulty in America while hardly containing their giddiness.  It was not before long before the Russian ruble declined some 10% against the American dollar as the greenback was spiraling downwards against other major currencies.  Their moods changed quickly.

The fall of the Russian ruble against the dollar deserves a quick explanation:  Russia has an oil-driven economy.  Oil markets are priced in US dollars.  A slowing American economy signals less consumer demand, which implies less production and hence less energy usage.  Because America has the largest world economy and the world’s largest importer of foreign goods, a slowing American economy slows the world economy.  Oil is the source of a good portion of the world energy.  Hence, a slower world economy means less demand for oil, therefore falling oil prices denominated in dollars, and therefore more pressure on the Russian economy and currency as measured against the dollar.

Let’s get back to the difference between accounting and economics.  The emotional kick that comes from a competitive situation between two parties involving money exchange is understandable.  These are gaming situations where there could be a clear winner and loser.  The same emotional sensations are misplaced, if not stupid, in the broader economic sense.  In the short run – that is in a timespan that matters for the individual – the poor do not get richer when the rich get poorer; in fact the poor are likely to get poorer under these circumstances.  Likewise, and country X does not benefit when country Y declines.  Countries X and Y tend to rise and fall together.

Very unfortunately, populist political rhetoric – often purposefully – confuses the differences between economics and accounting.  Elections can become battles between the haves and the have-nots instead of about policies that benefit everyone.  And nationalistic feelings lead to a brief satisfying tinge once a former enemy declines; it is also those feelings that very often get in the way of effective national policy for economic diversification (away from oil in Russia’s case), better integration with world markets, and a more sustainable, predictable prosperity engine that lifts everyone’s boat.