The threats to social peace from a reduction in current spending are too obvious to merit discussion.
An oversized, unbalanced budget, especially in a relatively poor country, is a clear sign of irresponsible populism. Norway, which ended 2015 with a 6 percent budget surplus, stands out as a rare example of an oil-rich country that has pursued prudent economic policies. By contrast, a clear majority of petrostates are running a budget deficit, as the oil windfall has encouraged their populist leaders to forego sound fiscal constraints. The deficit is biggest in Venezuela (24.4 percent of GDP in 2015), Algeria (13.7 percent), Azerbaijan (7.6 percent), Russia (5.7 percent) and Ecuador (5.1 percent), all of which are already feeling the pinch. But even the affluent Persian Gulf states, particularly Saudi Arabia where government spending exceeded 50 percent of GDP and the budget deficit hit 21.6 percent of GDP in 2015, will have to radically revise their fiscal policies in the coming years. This revision will have far-reaching consequences not only for their own peoples but for the whole world.
What Oil Did to the Soviet Union
The last thirty years of the Soviet Union's existence are an excellent case study in how oil and gas dependence can shape the destiny of a country and the world.
In the early 1960s, the Soviet Union was not yet a petrostate, selling less than $1 billion in oil to capitalist countries and earning just above a fourth of its export revenue from commodities.
The country was then in the catch-up growth stage. In fact, "catch up and overtake capitalists" was a slogan that formed a lynchpin of Soviet ideology. This goal was starting to look elusive by the 1960s. The economies of leading Western nations, especially war-ravaged Western Germany and Japan, had been expanding at a tremendous rate since the end of World War II. What’s more, growth had been steadily accelerating in the U.S., which doubled its growth rate between the mid-50s and the mid-60s. The Soviet economy, on the other hand, was slowing down.
Estimates of Soviet growth rates provided by official government statistics, Soviet economists and their Western counterparts vary widely, but they all point to deceleration setting in around the mid-1950s. By that time industrialization had nearly run its course and the central planning system, which had been reasonably well suited to industrialization needs, was beginning to show its inability to cope with an increasingly complex, postindustrial economy. Urbanization, too, had already occurred, with urban population exceeding 50 percent in 1962. A cheap rural workforce could no longer be counted on as a source of rent.
Disappointed by the failure to catch up with the West, the Soviet elite was also frustrated by the inability to materially to improve its own living standards. The country simply lacked the resources. Change, therefore, was imperative. Nikita Khrushchev was removed from power and a radical reform program was drafted. It became known as the Kosygin reform, after the country's long-serving prime minister.
Had the reform been implemented, it might have set the Soviet Union on a path of gradual change, roughly along the lines that China experienced. Deng Xiaoping's China and the USSR of the initial Brezhnev years differed greatly, however, first and foremost in urbanization levels. Once oil was found in West Siberia in the early 1960s, opening up a new source of revenue, the reform was shunted aside. The last hope of change vanished with the Prague Spring of 1968, which taught the Soviet leadership one thing: even a small concession to liberalism could have tremendous, unpredictable consequences.
Major oil discoveries in West Siberia continued through the 1960s. As crude production in the region rocketed from 1 million tonnes per year in 1965 to 365 million tonnes per year in 1985, Soviet oil exports jumped from 75 million to 193 million tonnes per year. This came against the backdrop of a sustained rally in oil prices, which saw the year-average Brent price climb from $7.7/bbl in 1971 to $66.3/bbl in 1980 (in 2000 dollar terms).
As a result, Soviet oil-export earnings quadrupled between 1975 and 1985. The government no longer had to worry where to find food for its people or machinery for industrial modernization. Living standards rose, as did the wherewithal to support both friendly socialist regimes around the world and the Warsaw Pact member states' armed forces.
But prosperity came at a price. With the share of oil, gas and petroleum products in export revenue topping 50 percent by the 1980s, the Soviet Union developed a strong dependence on crude prices. When prices dropped in 1986, the government was caught unprepared.
It reacted by scrapping a few megaprojects that could no longer be financed. Fortunately, one of the first to go was the one that involved diverting part of the flow of Russia's northern rivers (the Ob and the Yenisei) to arid lands in Central Asia. However, while the obviously unsustainable expenditure was abandoned, the government was making little progress on general fiscal consolidation.
This was due to the opposition from several political and industry interest groups that had sprung up during the fat years. They had come to expect their share of the oil rent and had learned to fight for it. The most powerful of these lobbies represented water utilities and agriculture, the military and defense industry and the apparatchiks responsible for supporting the ”international socialist system”.
Mikhail Gorbachev's cautious attempts to reduce funding to these groups met fierce resistance. Cuts had to be spread across the board and were clearly inadequate. Beginning in 1985, the country started running a budget deficit which widened to 10 percent of GDP in 1990. The gap in the balance of payments increased fivefold in just eight years. Ramping up exports to capitalist countries brought little relief. The only way out appeared to be foreign borrowing, which was made quite easy at first by the Soviet Union's traditionally high credit rating.
But as foreign debt surged from $28 billion in 1988 to about $100 billion in 1992 while government finances unraveled, borrowing grew increasingly difficult and costly. Politically motivated credits were raised but could not ultimately save the country..
By autumn 1991 the Soviet Union was going bankrupt, with no international reserves to speak of, no means to avert default and no money to buy vital imports, let alone support “friendly” regimes. The living standards of a population that depended on government aid plummeted. The end of 1991 marked the end of the USSR.
To be sure, the Soviet Union's main economic problem was not oil dependence. Oil or no oil, the Soviet planning system was doomed to collapse one day. But it was oil price swings that determined the timing of its demise. Expensive crude stalled economic reform and then a sharp drop in oil prices exacerbated the pain of the country's transition to democracy and a free market. But for this drop, the Soviet Union could have survived for another couple of decades.
Low Oil Prices: What is in Store?
The effect of a long-term slump in oil prices on any given country is difficult to forecast. Too much depends on the state of the country's economy and its future economic policies. But some of the global consequences can be guessed.
First, the populist regimes in Venezuela, Ecuador and Algeria, which are the most financially vulnerable today, are going to be hit hard. Indeed, Latin America as a whole is certain to veer to the right. The rulers in Ecuador and Venezuela, as well as in Venezuela-sponsored Cuba, have already been scared by the triumph of right-wing forces in Argentina. While liberal reforms will hardly bring about an immediate improvement in people's lives, left-wing populism is certain to start losing its grip on the continent.
Second, the post-Soviet space is in for a major shift in the balance of power. Until now, economic integration within it has been underpinned by Russia's oil and gas revenues, the trade breaks that Russia offered and its vast labor market where millions of Central Asian migrants could earn enough money to support their families back home. This cooperation model is on the way out. A new one must be established if Russia doesn’t want to lose its regional leadership once again. Unless much-needed domestic reform occurs in Russia, Azerbaijan and Kazakhstan (which is the only one of the three to have made half-hearted reform noises), the countries that depend on their own or Russian oil revenues will face social and economic upheaval. The repercussions may transcend borders, as hundreds of thousands, if not millions, of people flee their homes.
Third, the Middle East will see its balance of power recast. Iran, Turkey and Israel are well placed to increase their influence as Saudi Arabia's dominance wanes due to its declining oil wealth. There is a chance of political liberalization in Iran. Falling oil prices may also serve as a trigger for a major redrawing of borders and the emergence of monoethnic or monoreligious states. In this context, a break-up of Syria and Iraq appears probable. Violent conflicts are most likely in the near term, as regional governments seek to divert popular attention from domestic problems and to solve them by getting their hands on their neighbors' resources. It is hardly a coincidence that the last time Iraq's oil revenue shrank the country invaded Kuwait. In the longer term, however, violence will subside if prices stay low. The belligerents will run out of the funds necessary to finance war efforts.