Intoxicated by high oil prices: Political Dutch disease afflicting the Kremlin

There were two leaders in Soviet history who were strongly influenced by specific national achievements. For Joseph Stalin, it was the victory over Nazi Germany in 1945 and the first test of a nuclear bomb in 1949. For Nikita Khrushchev, success came with the launch of Sputnik in 1957 and the first human space flight by Yuri Gagarin in 1961.

Encouraged by these accomplishments, both leaders turned a blind eye to the country’s economic weaknesses and brazenly defied the US and its allies. The triumphs also boosted the moods of the ruling elite and the majority of the population. During these periods, the country as a whole enjoyed a heightened level of confidence and a sense of ideological and military superiority over the US.

The euphoria generated by the Soviet army’s victory over Germany explained why, despite Western resistance, Stalin was emboldened to take control of Eastern Europe in 1946-47, triggering the Cold War. The same assertiveness fueled the dangerous Berlin crisis in 1948 when American and Soviet tanks squared off. A few years later in June 1950, Stalin encouraged or at least permitted Kim Il-sung to trigger a “hot war” in Korea.

After Stalin’s death in 1953, members of his Politburo, who had watched helplessly as the country moved toward a major conflict in the last years of Stalin’s rule, signaled to the West that the USSR was willing to coexist peacefully with the US. Then, at the 20th Party Congress, Khrushchev announced that a war between the communist and capitalist worlds was not inevitable. He also criticized Stalin’s obsession with the military industry and his disregard for the miserable state of the Soviet economy and standard of living.

Khrushchev, however, would later follow Stalin’s lead. The launch of Sputnik I, the world’s first artificial satellite, in 1957 explained why, despite Russia’s weak economy, he challenged the US by installing missile bases in Cuba in 1961, setting the world on the brink of nuclear war. As in Stalin’s case, as soon as the members of the Politburo ousted Khrushchev in 1964, they criticized his foreign and economic policies.

There were no major Soviet achievements during Leonid Brezhnev’s regime that could fuel a special sense of national pride and self-confidence. Although Brezhnev’s Kremlin also pursued a risky policy with the invasion of Afghanistan in 1979, it was modest compared with the crises in Berlin and Cuba and did not directly challenge the US military, as in the two previous cases.

Putin’s Kremlin

Until the last 2 years, it appeared that Vladimir Putin’s Kremlin also would have little to boast about in terms of economic achievements. Much of the economic growth during this period was based, not on advancements in technology or industry, as was the case in Soviet Russia, but on the growing world demand for and price of oil.

In 2006, oil and gas made up 71% of Russia’s total exports. All prognoses about the future of the Russian economy were based on forecasts of the price of oil. Experts have ascribed the slackening of economic growth in the last 2 years to the decline in the rate of oil industry growth, which declined to 2.5% in 2006 from 11% in 2003.

What is more, nobody wanted to celebrate the fact that in 2005 the country had finally reached the volume of national income and standard of living that had existed in 1991. There was some growth in real income in the country, but the population was mostly dissatisfied with the standard of living. According to data released in May from Moscow’s nongovernmental public opinion-market research firm Levada Analytical Center, half the population saw “poverty and social inequality” as major national problems, and almost as many did not believe that “the leadership can improve life in the country in the near future.”

Recently “deindustrialization”-the decline of industries based on contemporary technology-became a key subject in the discussion on Russia’s economic future. The term was used by Russian Alliance of Entrepreneurs Chairman Alexander Shokhin and several other major Russian business people, as well as by foreign experts.1

Businesses and individuals increasingly have refused to buy Russian durable goods. As famous Russian economist Nikolai Petrakov suggested in June: “Everything in Russia-roads, communication, and big enterprises-was built in Soviet times.” Petrakov also suggested that the obsolescence of industrial equipment is growing. Roughly 50% of Russia’s air industry equipment is obsolete, as is about 70% of its oil industry infrastructure.

Igor Gorynin, another highly regarded expert and a member of the Russian Academy of Sciences, wrote: “In the sphere of technological innovations, Russia is catastrophically behind developed nations and uncompetitive in international markets.” In addition, the country’s agricultural industry has stagnated, and food imports during 2000-05 more than doubled. And, although the Russian state itself has diminished its foreign debt, corporations, including oil and gas companies, increased their financial obligations to foreigners by more than six times.

By the end of Putin’s first term, the mood in the Kremlin was subdued. Although the Kremlin could boast about some sort of political stabilization-local governors, presidents of non-Russian republics, and oligarchs stopped intervening in national politics-the arbitrariness of officials and the level of crime and corruption increased. Of course, Putin could not praise his achievements in supporting democracy in Russia. With Moscow’s evident shift toward authoritarian rule, Putin tried to persuade the world and his own population to accept labels such as “sovereign democracy” or “special Russian democracy.”

Despite the promise to restore the country’s geopolitical status and the promotion of an ideology that praised the state as a supreme value, as in Soviet times, Putin’s foreign policy was quite modest. While covertly encouraging anti-Americanism, Putin was relatively friendly toward the US, particularly in the period after 9/11. At the same time, with the series of color revolutions; Russian influence in the post-Soviet space fell apart.

Status changer

Then, almost suddenly in late 2005, Putin’s confidence blossomed. The price of oil had been increasing throughout Putin’s presidency, but in 2005 he seemingly concluded that the torrent of petrodollars had reached a level that could radically change Russia’s status in the world. Indeed, in connection with the summit in St. Petersburg, a pro-Kremlin Russian newspaper, Rossiiskie Vesti, proudly noted that Russia has only 3% of the world’s population but controls 34% of the world’s gas and 13% of its oil resources.

Discussing how Putin had used the high price of oil to consolidate his power, former President Boris Yeltsin publicly lamented that oil prices during his presidency had been much lower, suggesting that he could have avoided many problems had the price of oil been higher.

The rise in oil prices is responsible, at least partially, for the Kremlin’s decision to take direct control of the country’s major energy companies. As suggested by a pro-Kremlin journalist, “Vladimir Putin slowly but steadily centralized the key branches of the economy.” Although monopoly gas producer OAO Gasprom remained a state company even at the peak of privatization, the state only recently took over most oil companies. The Kremlin now directly controls one third of the country’s oil production.

The Kremlin’s management over this major asset differs from state ownership in the Soviet past, when most companies were considered units of the Ministry of Fuel. The general secretary could not benefit personally from the Soviet oil industry. Today, however, the sway over this industry essentially represents the semiprivate ownership of a narrow group of people at the top of power. As suggested by authoritative Moscow newspaper Novaya Gazeta, eight people-seven Kremlin officials and the president-control “assets in companies that are equivalent to three Russian national budgets, while the owners of these companies are so loyal that they are ready to give almost everything to the Kremlin.”2

Russia’s “Stability Fund,” which currently contains windfall oil revenues over $27/bbl, accounted for 44% of the national budget, further supporting Putin’s personal optimism. However, despite the appeals of many experts and the public at large, Putin has refused to allocate funds to modernize the economy and infrastructure. Instead, he keeps the money in foreign banks as a strong guarantee against economic or political losses. It was used in part to repay foreign debts in 2006.

As noted by Russian media, an unprecedented combination of developments-the rise in the price of oil and the consolidation of personal control over the fuel industry-has boosted the Russian president’s self-confidence enormously, and his new mood may influence his decisions in domestic and foreign policy.3 On Dec. 22, 2005, at the meeting of the Russian Security Council, Putin proclaimed that Russia is back on top and playing a key role on the world stage.

At that moment, Putin’s oil pride spread to the ruling class. The idea that Russia could now dictate its will to the world, or at least to European countries, to say nothing of former Soviet republics such as Ukraine, Georgia, and Belorussia, became a major slogan in Kremlin’s propaganda, just as victory in war and Sputnik had been the centerpieces of Stalin’s and Khrushchev’s propaganda, respectively. The dynamics of Putin’s terminology in his annual addresses to the Federal Assembly were remarkable. By the time Putin started his second term in 2005, the number of references to energy had increased by three times compared with 2004 and by six times a year later.

With the price of a barrel of oil above $70, Putin suggested that the issue of energy lead the agenda at the G-8 Summit in St. Petersburg July 15-17. As ironically suggested by an independent Russian journalist, Russian television station Ekho Moskvy aired the summit as a show with one actor: the Russian president. Much of the media presented the summit as Putin’s total triumph and the world’s recognition of Russia’s leading role.

Public confidence

The Kremlin’s confidence has spread to the general population. As Russian journalist Elmar Murtazaev noted, “the opinion that oil will remain expensive forever or for a very long time has become more and more popular in Russia.”

And Dmitrii Butrin, in the reputable Russian newspaper Kommersant Daily, suggested that Russia should be compared, not with Nigeria, but with Kuwait. In the near future, Russian oil revenues will allow Moscow to pay for the education of all students in the finest Western universities, increase the salaries of state officials, and give children allowances, he suggested. The author was certain that the Russians would gladly accept the Kuwaiti style of life, even if it brings lower levels of entrepreneurial activity and greater governmental control over information.

Another journalist, Dmitrii Ladygin, promised that in a few years each Russian citizen would receive $1,000/month. Russian media saw the developments in the Middle East as a sign that the price of oil would only increase.

The power of oil became a major source of inspiration for Russian imperial and nationalistic feelings. Dmitry Medvedev, the first deputy prime minister and possible heir to Putin, in a rare political interview in July, devoted two thirds of the interview to describing how oil and gas had strengthened the country. Mikhail Margelov, chairman of the Duma’s foreign committee, plainly declared that “gas, oil, and electricity are diplomatic weapons ... a sword in the scabbard.”

One of the best known ideologues of Russian nationalism, the vice-chairman of the State Duma’s committee on international relations Natalia Narochnitskaia, saw the “energy card” as an instrument that would allow Russia to be a great power again and release it from its inferiority complex. Inspired by the new perspective, Narochnitskaia suggested that Russia could serve as a model for the world.4 The author of an article in Komsomolskaia Pravda declared, “Russia is becoming an energy empire” and said it has returned to “great politics through the pipeline.” Some Russian authors contend that the aggressive policy of the US against Russia is dictated exclusively by the desire to take control of the country’s oil resources.

Obsessed with the restoration of the Russian empire, the notorious nationalist Alexander Prokhanov talked about oil as the main strategic resource of the 21st Century and praised Venezuelan President Hugo Chavez, a “Russian friend,” whose policy is also based on oil.5 As a typical element of the political landscape, a member of the St. Petersburg legislature rudely rejected attempts to criticize the regular murders of nonwhite foreigners in the city by claiming that, with the price of oil at $80/bbl, the Russians can do what they please. Among the 80 legislators, only one publicly denounced those comments.

A content analysis of 50 national newspapers produced remarkable results: Between February and July, 2005, the press mentioned “oil” in 7,285 articles and mentioned “gas” in 8,313 articles, while other important subjects were mentioned less often, including “inflation” (3,565 articles), “corruption” (3,354 articles), and “crime” (1,569 articles).

With the idea that oil has provided them with an advantage over their enemies, Russian nationalists are inebriated with thoughts of revenge. In their dreams, they see the US crawling before the Russian oil giant, begging for a few drops of oil. With almost sadistic pleasure, some Russian journalists, such as Evgenii Anisimov from Komsomol’skaia Pravda, suggested that because of Russia’s new role as a supplier of energy, “Europe is scared,” and “her resources of energy are close to exhaustion.”

It is not surprising that, under the impact of the Kremlin’s “oil propaganda,” the Russians were glad to see Moscow force Ukraine to accept, at the end of 2005, a four-fold increase in the price of gas. The absolute majority of the Russian public-80% in the country as a whole and 94% in Moscow and St. Petersburg-unequivocally supported the Kremlin’s position in the December 2005 gas conflict.

Dutch disease

As suggested by many economists, Dutch disease-a country’s excessive dependence on the export of raw materials-can have serious economic consequences as a country becomes increasingly dependent on that raw materials sector. Other branches of the economy, such as manufacturing, often decline because of the concentration of such resources as oil or gold, as happened in 16th century Spain. A sudden fall in the price of the raw materials could bring an economic collapse.

Seemingly, the Russian leaders, like their colleagues in Venezuela and Iran, see the world through the prism of oil revenues. It goes without saying that one of the first victims of the political Dutch disease is democracy.

However, an even more dangerous consequence of the political Dutch disease is the leader’s loss of a sober assessment of reality. Under the impact of their technological achievements, both Stalin and Khrushchev, with their skewed visions of reality, moved the country closer to a major war. Putin’s euphoria over oil prices may not be as great as his predecessors’ enthusiasm, but his aggressiveness in foreign policy in general, and toward the US and Russia’s neighbors in particular, has clearly increased since 2005. The shift occurred in late 2005 when Moscow brandished its gas weapon against Ukraine and indirectly against Europe. Russia’s foreign policy has hardened (despite some cooperative gestures toward the West) and influenced several international conflicts, including issues surrounding North Korea, Iran, and the Middle East.

The conspicuous demonstrations in July of friendship with Venezuela’s Chavez, another political leader inebriated by oil revenues, and the readiness to sell him weapons despite American protests were clear signals of unfriendliness toward the US. Russian media treated Moscow’s attitudes toward Chavez as an obvious demonstration of disregard toward American concerns.

Dmitry Medvedev’s proposal to make the ruble fully convertible in an attempt to renew the currency’s international status was another result of the country’s oil fever. Medvedev talked contemptuously about “the financial irresponsibility of the United States,” citing the country’s growing national deficit. He also denounced the International Monetary Fund’s attempt to promote market reforms, forgetting that only a few years ago Russia had scrounged for credits from this bank.

Oil fever has not infected all Russians. The level of enthusiasm among the general public and particularly among experts does not match the levels observed after Sputnik and cosmonaut Gagarin were launched into space, to say nothing of the excitement after the 1945 war victory. Among the most persistent critics of the oil frenzy is Egor Gaidar who suggested that the leadership’s oil delirium and its disregard for the instability of oil prices were dangerous to the country. Several independent politicians and journalists have seconded Gaidar’s critique of the Kremlin’s “hydrocarbon doctrine,” demonstrating concern for the “time bomb in our political system.”

Concerned about the Kremlin’s “muddled vision of the world,” some independent minds in Russia, such as Dmitry Muratov, the editor of Novaya Gazeta, insisted: “The intellect of the government changes inversely with the price of oil.”6 Leonid Radzikhovsky, a famous liberal journalist, wrote about the inverse correlation between the level of democracy and the price of oil. What is more, even Vladislav Surkov, until now the Kremlin’s leading ideologue challenging Medvedev, in a struggle for influence over Putin, suggested that, with gas as its only basis, the Russian economy would inevitably reveal its fake prosperity in the “post-hydrocarbon era.”

Russia is not the only country in the world that is obsessed with oil. Every country, in one way or another, is preoccupied with oil. While the US, Europe, China, and India are concerned about fuel supply and the adverse influence of high oil prices on the economy and standard of living, several countries, including Russia, have turned their oil resources into weapons for achieving their domestic and foreign goals. As the experiences of Stalin and Khrushchev showed, Russian leaders sometimes overstretch the potential of their advantages and lose a sober perspective of reality.

Mesmerized by his clout, Putin may accept “the invitation” of the Russians to stay in power after 2008. Today, 51% of the Russians would vote for him if he decided to try for a third term, which he promised not to do. In the foreign arena, Putin has already shown less willingness to cooperate with the West and the US in particular. His foreign policy may harden even more. However, it is unlikely that Moscow will demonstrate direct hostility toward the West in the near future.

The post-Soviet space is another story, however. The idea that oil will allow Russia to take control over Ukraine, Georgia, and Belorussia is deeply engrained in the minds of Kremlin politicians. We can expect an exacerbation of the political developments in the post-Soviet space, which will undoubtedly complicate relations with the West.

Aside from the damage to Russia’s international relations, the oil delirium is more problematic to the country’s long-term national interests. The overconfidence in oil revenues may lead to a decline in the spirit of entrepreneurship, to a refusal to modernize industry, or even to an acceptance of deindustrialization. The obsession with high oil prices explains why the Kremlin sees few obstacles to the country’s continued move toward an authoritative regime. It also explains the Kremlin’s conspicuous disregard for the growing problem of corruption in society. With the vision of the Russian leadership blurred, it may become increasingly insensitive to various destructive tendencies in the country. The impact of the price of oil on political decision-making in Russia is crucially important to the world and should be closely monitored.

Acknowledgment

The author thanks Joshua Woods for his editorial contribution to this article.

References

1. Shokhin’s speech at the XY Congress of the Russian Alliance of Entrepreneurs, Apr. 17, 2006 (http://psdp.ru/news/115856216).
2. Department of Economics, “Kassovyi apparat,” Novaya Gazeta, Mar. 2, 2005; Andrew Kramer and Steven Lee Myers, “Workers’ paradise is rebranded as Kremlin Inc,” The New York Times, Apr. 24, 2006.
3. Interview with Stanislav Kucher on radio station Ekho Moskvy (on the program “A particular opinion”), Aug. 1, 2006.
4. Interview with Natalia Narochnitskaia in Literaturnaia Gazeta, July 18, 2006.
5. Talk with Aleksander Prokhanov on radio program Ekho Moskvy, July 24, 2006.
6. Radio program with Dmitrii Muratov on Ekho Moskvy, July 25, 2006.

For other, Russian-based references, please contact the author.

The author