Budget Cuts for the Bad Guys: Lower Oil Prices for the Middle East and Russia
Across the Middle East, state budgets are being cut. Bloomberg reports “Saudi Rulers to Curb Wages as Kingdom Confronts Oil Slump“:
Saudi authorities pledged to curb wages and push ahead with investments next year as the world’s largest oil exporter seeks to counter the effect of tumbling crude prices on the economy.
Though this article less than a day later, “Saudi Arabia not cutting wages yet” suggests discord on spending issues. Saudi Arabia has a top-down bureaucratic economy deeply distorted by vast oil revenue, and a big demographic problem:
A hashtag on Twitter about reducing wages has since attracted thousands of comments, reflecting the sensitivity of any discussion of public sector wages — the main source of income for most employed Saudis. The International Monetary Fund says Saudis are primarily employed in the public sector, which is also the leading source of new jobs.
Of the kingdom’s roughly 20 million citizens, 67 percent are under the age of 30. Many youth seeking to marry are struggling to afford housing — a common prerequisite to marriage in the Middle East.
Another recent Bloomberg article: “Age of Plenty Seen Over for Gulf Arabs as Oil Tumbles,” notes:
The sheikdoms have used the oil wealth to remake their region. Landmarks include man-made islands on reclaimed land, as well as financial centers, airports and ports that turned the Arabian desert into a banking and travel hub. The money was also deployed to ward off social unrest that spread through the Middle East during the Arab Spring.
Much of the vast income from selling high-price oil over the last decade, the article claims, went to improve the economies and people of oil-producing Middle East countries:
That year , King Abdullah of Saudi Arabia allocated $130 billion to create jobs, build homes and raise salaries, while Qatar ordered $8.2 billion in to boost pensions and pay for civil servants. When protests broke out in Bahrain, the only GCC country to experience major upheaval, and to a lesser extent in Oman, their Gulf neighbors pledged $20 billion in assistance.
But this claim is misdirection. It’s the action hand the magician has his audience watch while the other hand does the magic. Frédéric Bastiat describes this “magic” of state spending in his essay, “What is Seen and What is Not Seen.” Here is an economic reason the Saudi King was able to announce $130 billion for new jobs in 2011. Oil prices jumped from $70 a barrel to over $100 and Saudi 2011 oil income jumped by $170 billion:
The unseen here is not the same as in Bastiat’s example from the French economy. Usually state spending claiming to create jobs by building roads, ports, and airports (the seen), is balanced or overbalanced by the job-destroying and wealth-reducing effect of higher taxes needed to pay for the jobs and infrastructure. Politicians can stage photo opportunities for media at the shovel-ready job sites but higher taxes reducing consumer and industry spending and delayed expansions go unreported and unrealized by the public.
The Saudi “$130 billion to create jobs,” was earned from similar cutbacks by consumers and industry around the world. Faced with paying higher prices for oil and gas, consumer managed a combination of driving less and spending less for other goods and services. Higher oil and gas prices prolonged the “Great Recession” of 2008-2009 (more on this below).
Also, it is unlikely that the $130 billion allocated “to create jobs” created much long-term employment. Contractors, consultants, and engineers surely consumed most of the money on politically-directed Saudi projects likely similar to Alaska Senator Ted Steven’s famous “Bridge to Nowhere.”
One of the Alaska bridges, dubbed the “Bridge to Nowhere” by its critics, would connect one small town to a tiny island. It received $223 million in the highway bill that Congress passed this summer. …
Later in the day, the Heritage Foundation circulated a paper, “The Bridge to Nowhere: A National Embarrassment,” and noted, “fiscally responsible members of Congress should be eager to zero out its funding.” Even the Sierra Club backed the amendment, noting, “We must fix the nation’s existing infrastructure first.”
The seen is the bridge and the thousands of jobs created building it, even if it goes nowhere and few cars later drive across it. The seen spending in Saudi Arabia is the $130 billion spent on show projects, with each profiles on the evening news to unemployed and underemployed Saudi citizens (though the hardworking guest workers from India and Bangladesh who do most of the actual construction work may not have access to televisions).
Okay… back from Alaskan Bridges to Nowhere to the Age of Plenty Seen Over for Gulf Arabs as Oil Tumbles story. The Saudi government will cut government spending, as will other OPEC countries. Oil prices falling by half is a big financial hit to OPEC and Russian governments. But that is not the same as saying lower oil prices are bad news for the people of these countries. The governments of Saudi Arabia and Russia, the world’s two top oil producing countries in 2013 (13.8% and 13.1% according to this Wikipedia page on 12/19/2014), divert much of their oil revenue to political insiders, plus send significant amounts to fund extremist causes.
Lower oil prices that reduce money for these governments, and for the corrupt leaders of Nigeria, Venezuela, and other oil producing countries in the Middle East, could be good for everyday people in these countries whose lives are made worse by oppressive, incompetent oil-drenched government officials and their friends and family.
U.S. allies in the Persian Gulf have a history of directly supporting or at least allowing private funds to flow to terrorist groups. This phenomenon has its roots in the U.S. and Saudi-backed Afghan insurgency against the Soviet Union, which included aid to the so-called “Arab Afghans” who joined the indigenous insurgency. The impact on Saudi society, and the broader Middle East, was profound.
Following the 9/11 attacks, in which 15 of the 19 hijackers were Saudi, many in the U.S. raised the issue of terrorist financing from wealthy private donors, and perhaps even the government itself, in Saudi Arabia.
With oil revenue cut in half, less money will flow to radical Saudi Islamist organizations, families, and foundations. Much less money should flow out to support Saudi-backed Islamists in other countries. And less for Putin’s Russian government means less to fund military and oligarchic operations in Ukraine and other former Soviet countries.
High Oil Prices and the Slow Recovery from the Great Recession
Commentators have offered many reasons for the slow economic recovery following the “Great Recession” of 2008-2009. Conservatives point to increased economy-distorting government “stimulus,” health care interventions, and general regime uncertainty. Progressives point to “financialization” of the economy, income inequality, war and other military spending, and still not high enough government domestic spending.
But a major factor contributing to the slow economic recovery has been high oil prices. In India and much of the developing world, gas prices are held at below market rates and subsidies absorb a big chunk of government budgets. Attempts to let prices rise lead quickly to riots. Oil prices falling by half is good news for the developing world. (This Reuters finance blogger disagrees, but notes: “India is likely to harvest annual fiscal savings of $12 billion by pruning energy subsidies and by raising taxes on oil products, Reuters reported recently.”)
In the U.S., high oil prices over the last ten years brought billions of dollars of investment in advanced engine and related fuel-saving technologies. New Boeing jets have lighter composite bodies, wingtips, and more efficient engines. And they cost a lot more, as do new diesel, gas, and hybrid engines for trucks and cars. Plus high oil prices added to political pressure from environmental and “energy-independence” groups to further subsidize ethanol, electric cars, and fund myriad wind and solar installations. There are benefits to all these projects and technologies, but there are also costs paid in higher prices for cars, trucks, airplanes, and electricity.
Opportunity cost is key concept for common sense economics. Billions of dollars invested in fuel-saving technologies and alternative energy projects is billions unavailable for other investments. The higher prices paid for gasoline leave people with less to spend on other goods and services, or save for the future. Higher diesel and fuel oil costs add to the prices of goods trucked across the country and shipped around the world.
The interactive EIA chart below shows inflation-adjusted oil prices across time (back to 1968). Note the stable and moderate oil prices over the twenty years of rapid economic growth for the U.S. economy from 1986 to 2005. Tax reform and transportation deregulation played major roles in restoring the U.S. economy after years of high tax, inflation, and interest rates that followed 1960s and 1970s federal spending on the Vietnam war and Great Society. Oil shocks during the Carter years added to the problems of high inflation and unemployment (“stagflation”). President Reagan’s policy reforms (“Reaganomics”) included “eased or eliminated price controls on oil and natural gas…”.
Oil prices begin a rapid rise again in 1998 and again in 2003 as the U.S. economy and economies around the world continue their rapid expansion. But oil prices keep going up after 2003 without production increasing enough. The U.S. invasion of Iraq in 2003 certainly disrupted oil supplies, and added a giant risk premium to oil prices. The long years of U.S.-led trade and investment restrictions of Iraq and Iran slowed or stopped investment in oil production in these countries. In Russia, Putin seized the thriving Yukos company, which had brought in western oil expertise and technology and dramatically increased Russian oil production and exports, and threw its dynamic president Mikhail Khodorkovsky, in jail. Yuko operations fell into state and crony ownership and oil production increases slowed (the numbers are pretty amazing, like flipping a switch). Check out the pre-K, K, and post-K Russian oil production numbers at right. Khodorkovsky is arrested in 2003 and the company gradually seized. Russian oil production had been increasing by around 7% each year since 2000, at nearly 10% in 2003, over 8% in 2004, then a dramatic slowdown to 3% or less ever since.