Thursday, December 04, 2008

Revisiting Parting with Illusions

At the beginning of 2008, I wrote an analysis on U.S. policy toward Russia for the Cato Institute (Parting with Illusions).

One of my overall conclusions for the report was that "Washington lacks sufficient leverage to its policy preferences" and in footnote 43, which is attached to the section on Russia's economic recovery giving the Kremlin greater confidence to project power, I noted:

"The World Bank estimates that the oil and gas sector accounts for about 20 percent of Russia's GDP but generates some 60 percent of the country's export revenues. Approximately 50 percent of the government's revenue is derived from the energy sector. Given rising global demand for energy, plus continued unrest in the Middle East and West Africa, energy prices are likely to remain high for the foreseeable future."

Oil prices are now at January 2005 levels (around $44/barrel). This obviously deprives Russia of a good deal of its windfall income. It also raises the question as to whether this changes any of the conclusions I came to in that report.

Yes and no. A collapse of the oil price definitely hurts Russia, hurts its economy, and deprives it of the extra income it was counting on. It reduces the attractiveness of the Russian economy and reduces the country's soft power in Eurasia.

But the collapse of the oil price comes at a time of global recession when all economies are hurting. The United States is also coping with a reduction in what it can do around the world. Oil prices are falling because demand has collapsed--not because there is a glut of supply. If demand revives, the price goes back up.

I have heard from some colleagues who have suggested to me that the collapse in the oil price "finishes" Russia as a major power. Perhaps, but the U.S. is also dealing with negative ramifications of its own economic crisis. I found this piece from the WSJ on the fall in university endowments. Russia's fall is not taking place amidst the rise of others; instead, we are in a race to the bottom, it seems.

And so Russia's leverage is reduced but ours hasn't increased--so I think the initial conclusion I reached is still sound.

Makes sense. The fall in oil prices that was supposed to hurt Russia, Iran and Venezuela was not supposed to come as a result of a U.S. financial crisis.
US no longer has any finanical leverage (carrots or sticks). Her credit is shot and cash is king; her financed-based carrots and sticks are no longer viable.

Don't you see that almost all banks in US are insolvent?
I don't think Russia is close to running down its foreign exchange reserves of recent years, so short-term the fall in the price of oil should be manageable.

The real question is longer-term, whether Russia can reduce its dependence on energy revenues. It doesn't have forever to diversify its economy.
Mr. Billington,

I expect that the prospects for diversifying Russia's economy are better than they have been for years, and it will be the Russian government that sees to it. The mistake to this point has been to invest the surplus from energy sales in the West, like foreign acquisitions for the Oligarchs and Treasuries/Agencies for the RF government. Now that it can be seen that investing the energy surplus outside Russia is folly, you can expect serious investment in Russia, for the first time in about 35 years.
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