April 16, 2005

Did OPEC destroy the USSR?

Paul Roberts' The End of Oil gets really fascinating when he starts talking about the geopolitics of oil: i.e. the gritty power plays made by OPEC, the political ramifications of oil price swings, that sort of thing. One point he hints at very, very briefly, but never states outright, is the possible role of oil in the decline of the Soviet Union. So perhaps a bit of follow-through on Roberts' little hint is in order.

The usual explanation for the decline and fall of Communist Russia involve economic reasons. The basic story as I've learned it sounds like this: At some point in the '80s the Soviet bloc hit a "post-industrialization" phase of economic development, wherein further growth depended on a good deal technological innovation. (Up until that point, communist countries were perfectly well-suited to industrialization, since they could always just steal the necessary technology from abroad.) Sadly, the Soviet system was particularly bad at stocking up capital for investment towards this sort of thing, and a planned economy is never good for entrepreneurship, and thus no innovation was forthcoming. The resulting economic stall-out led to anger, anger led to glasnost, that led to more grumbling, and the dark side came in 1991 when the whole system finally collapsed.

But one question I've always wondered: Why did the wipe-out occur exactly when it did? Why not ten years later? Or twenty? The big Republican theory has it that Reagan's military buildup in the 1980s (along with the war in Afghanistan) was the ten-ton weight that crippled the Soviet system, forcing the country into a costly arms race that crowded out much-needed capital for economic growth, and really kicked the already-weak communist economy right in its bright red teeth. As this story goes, that's what induced Gorbachev to undertake market-based reforms, etc. Oh, and Reagan was God, y'know? Okay, now we're getting somewhere, but this still seems weak. (For instance, if this was the jackboot on Russia's throat, then why did Gorbachev go in for glasnost instead of just cutting back on military spending?)

So now oil. As Roberts notes in his book, OPEC ironically shot itself in the foot with its oil embargoes during the 1970s. Oil prices surged, true, and the OPEC countries all got rich, rich, rich, but after awhile the West adapted, both by weaning itself partially off oil and by finding incentive to drill in new and uncharted territories (the northern cliffs of Alaska, for instance). As a result, OPEC got hit hard, and its share of the global oil market plummeted from 50 percent to 29 percent by 1986. At this point, Saudi Arabia tried to shore up prices by demanding that other OPEC countries limit their production and keep under quota. But those other OPEC countries were now panicking and flooded the market with oil in order to reduce prices and recapture their market share.

Finally, in 1985, the House of Saud decided to do a little "capacity cleansing", unleashing their spigots and flooding the market with cheap oil from their reserves. Prices plummeted, and other OPEC countries were devastated. They realized, at last, how powerful Saudi Arabia could be with all its excess capacity, and decided to fall into line with this "quota" business. More importantly, though, with the fall in prices, the West no longer found it profitable to drill in places like the North Sea and Alaska. So they started buying OPEC oil once more.

Unnoticed by many, though, the Saudi flood devastated the Soviet Union. With oil prices tumbling downwards, not only did Russia lose much of its income, but it was also no longer profitable for Russia to operate many of its expensive pumps in Siberia, etc. (Saudi Arabian crude costs around $1.50 a barrel to find, drill, and pump; in Russia it's about $15 a barrel. So if prices fall too low, oil companies will close up shop in Siberia.) As Roberts tells it, Moscow's hard-currency income was cut in half by 1986, and "the Soviet oil industry was knocked out for years." Two long knives to the gut.

Now it seems that this can help explain why both the Soviet Union and the Eastern European satellite states started breaking down exactly when they did. The drop in Soviet oil production, obviously, led to serious shortages. And as bad as that experience was for the West back in the 1970s (global recession!), it was even worse when it hit the Soviet Union in the late '80s. For one, the ability to wean oneself off oil requires very, very clever technological innovation: something that, as pointed out above, the communist states were spectacularly bad at. Western countries could design more fuel-efficient cars, etc. in the '70s and somewhat weather the oil shocks. The Soviet Union simply couldn't, not without the sort of glasnost reforms that Gorbachev was forced to undertake in the late '80s. Which... just happened to be the precise period that Soviet oil production was plummeting. Eerie coincidence? Dunno. Doesn't seem like it. But I think we're latching onto an explanation here.

Obviously this isn't a rigorous analysis by any means; it was just something dumb I started musing over while riding the bus back home tonight. The really interesting corollary, of course, is what future oil shocks could do to China's semi-communist economy...
-- Brad Plumer 5:02 AM || ||