If Geology Is Destiny, Then Russia Is in Trouble

By MOISÉS NAÍM

ASHINGTON — Russia's future will be defined as much by geology as by ideology. Unfortunately, while leaders can pick their ideology, they don't have much of a choice when it comes to geology.

Russia has a lot of oil, and this inescapable geological fact will determine many of the policy choices available to it. Oil and gas now account for roughly 20 percent of Russia's economy, 55 percent of all its export earnings and 40 percent of its total tax revenues. Russia is the world's second largest oil exporter after Saudi Arabia, and its subsoil contains about 30 percent of the world's gas reserves. It already supplies 30 percent of Europe's gas needs. And Russia's oil and gas industry will only become more important. No other sector has the potential to be as internationally competitive, or as profitable.

Yet such growth is also dangerous. Russia risks becoming, and in many respects may already be, a "petrostate." In the debate set off by the arrest of Mikhail Khodorkovsky, the former chief executive of Yukos Oil and Russia's richest man, over what kind of country Russia is becoming, its characteristics as a petrostate deserve as much attention as the Kremlin's factional struggles.

Petrostates are oil-rich countries plagued by weak institutions, a poorly functioning public sector, and a high concentration of power and wealth. The gulf between a petrostate's rich natural resources and the chronic poverty of its citizens often leads to political unrest and frustration. Nigeria and Venezuela are good examples.

That Russia is rich in oil is old news. What's new are the changes in politics, technology and markets in the petroleum sector. Throughout the 1990's, privatization and innovations in exploration and drilling brought into production oil fields that had hitherto been underperforming or off limits. To energy companies worried about growing domestic instability among the major oil exporters of the Middle East, Russia became an attractive hedge.

Regardless of its political turmoil, Russia will continue to appeal to oil companies. They know how to operate profitably in countries with weak property rights and unstable politics, and sooner or later Russia's beguiling geology will attract companies that cannot afford to be left out of some of the world's richest oil reservoirs.

But what's good for the energy markets is not necessarily good for Russia. When oil revenues flood a nation that has a weak system of democratic checks and balances, dysfunctional politics and economics ensue. A strong democracy and an effective public sector help explain why oil has not distorted Norway the way it has Nigeria or Venezuela. A lot of oil, combined with weak public institutions, fuels poverty, inequality and corruption. It also undermines democracy.

The economic effects are more noticeable. A country whose economy relies mostly on oil exports inevitably has an exchange rate that encourages imports and hinders exports. Such an imbalance favors oil at the expense of other sectors, like agriculture and manufacturing, as their products become more expensive abroad.

And while oil generates export revenues and taxes for the government, it creates few jobs. Despite its enormous economic weight, Russia's oil and gas industry employs just two million workers out of an economically active population of 67 million. Also, since the price of oil is volatile, petrostates suffer constantly from boom-bust cycles. The busts leave in their trail banking crises and public budget cuts that hurt the poor disproportionately.

Even the tax revenue generated by oil is a mixed blessing. Petrostates commonly suffer from a narrow tax base. In Russia, for example, the 10 largest companies account for about half of total tax revenues.

The political consequences of all this are corrosive. Thanks to the inevitable concentration of the industry into a few large firms, owners and managers acquire enormous political clout. In turn, corruption often thrives, as a handful of politicians and government regulators make decisions that are worth millions to these companies.

Nationalizing the oil industry fails to solve these problems: state-owned oil companies often become relatively independent and are rife with corruption, inefficiency and politicization. Privatizing the industry without strong regulatory and tax agencies is also not a solution, as private monopolists are no better than public ones.

In petrostates, bitter fights over the control and distribution of the nation's oil revenues become the gravitational center of political life. It is no accident that the current crisis in Russia hinges on control of the country's largest oil company and the political uses of its profits.

But Russia is not Nigeria. It is a large, complex country with a highly educated population, a relatively strong technological base and an economy that is still somewhat diversified. A strong and independent public sector, tempered by the checks and balances of a truly democratic system, will help Russia to compensate for the economic and political weaknesses that plague all countries where oil is the biggest industry and the most potent political force. Such institutions are essential if Russia is to overcome the crippling effects of its ideological past and its geological present.

Moisés Naím is editor of Foreign Policy magazine.