Oil boom and bust cycles

This is a typological model, which explains the orderly sequence of phenomena in the process of impoverishment, degradation and decline in the living standards of rentier states whose welfare depends on the export of natural resources, when one change inevitably entails another. It was initially formulated in 2008 at the peak of oil prices (when no one expected their fall) and introduced in the following years (when they indeed had sharply dropped) into academic discourse to predict the sequence of cycles of decline in socio-economic indicators of the countries exporting oil, gas and other extractable resources.

General overview

The model was first theoretically described in 2008 by its author in the Contemporary Review (Oxford) journal at the peak of world oil and gas prices, when no one expected their rapid decline, and the subsequent onset of global economic crisis with irreversible consequences for oil-exporting countries. Prior to this event, the effect of rising prices of exported natural resources, rendered to strengthen the real exchange rate of national currencies and economic development of their exporters as a result of an oil boom, was described only by the so-called "Dutch disease" theory -- the term first coined by The Economist (London) magazine in 1977, but introduced into scholarly circulation by the Australian economist Max Corden in his 1982 and subsequent works. The author of this theory took for an example the economy of Holland in its dependence on the growing export of natural gas, because in that country it was easier to trace the influence of this phenomenon on the entire local economy in a classical form, and then he generalized the results of his research as a typological model.

However, the theory of "Dutch disease" could not describe the further course of events after the price of oil on the world market began to fall: what would have turned out for oil-dependent countries after the end of an oil boom in them? And this exactly happened in 2008, when the price of oil collapsed from $147 per barrel in the middle of the year to $38 by its end, i.e. by 75 percent. In oil-exporting countries, panic and economic crisis began -- they had not expected and were not prepared for such a crash. Just at that moment, an article by A.Rasizade appeared in a journal, written in the summer of 2008, when the price of oil reached its peak and nothing foreshadowed its fall. Appearance of the article was so timely that the model of decline, formulated in it, was picked up in scholarly literature. The model did not emerge from scratch, it was a summary of all his previous studies of the 20th century Caspian oil boom. Like the author of the theory of "Dutch disease" M.Corden, who took the example of a small Holland, A.Rasizade also took the example of a small Azerbaijan to illustrate the process, since in that petrostate the dependence of local economy and the income of its population on the influx of petrodollars was expressed directly without any additional factors correcting such a dependence, unlike in the oil exporters with more diversified economies (Russia, Canada, Iran, Mexico).

Ascending cycle of oil boom

The rising course of oil boom is akin to the theory of "Dutch disease", with the only difference that the model does not deal with this phenomenon itself, but describes instead the sequence of natural progression in the reaction of a local economy in free market conditions to the growth of revenue from the export of raw materials -- in other words, how the local economy reacts to the rising inflow of petrodollars. This process is summarized in the model as follows. Due to the fact that the exported crude oil itself is a competitive commodity in the world market and does not need to be processed in the country of its production, there is no need in preserving and modernizing the unprofitable local industry, whose products are not competitive on the market (both world and national) -- it is cheaper to import all the necessary (and of better quality) goods, than produce them locally, for the petrodollars received from export of raw materials. This leads to dismantling of almost all the machinery, consumer, and most of the food industry that existed in the country before the oil boom. On the grounds of demolished plants and factories developers build luxury hotels, shopping malls, entertainment centers and pompous office buildings, which have no production value, let alone leaving thousands of factory workers without jobs. Moreover, because of the cheapness of imported food, local agricultural production becomes unprofitable and farmers rush to big cities where they can find some kind of employment. As a result, the population of cities grows several times, with all the consequent problems.

As a result of this process, the country becomes deprived of its industrial base and an army of unemployed people appears, large part of which departs to work abroad. On the other hand, the oil boom leads to an emergence of local plutocracy (the bureaucracy having access to petrodollars entering the treasury) and to obscene enrichment of the national oligarchy, which circulates the same petrodollars for profit through its banks, retail chains, construction activity and government contracts. A significant part of the petrodollar stream is directly transferred through corruption schemes to offshore accounts of their participants. At the same time, the abundance of petrodollars triggers a hyperinflation, which makes many goods and services unaffordable. As a result, the class stratification of society intensifies with all the ensuing consequences of social tension. Construction and trade become the only types of employment in such countries that have abolished their industries due to the crushing tide of petrodollars. A grandiose construction boom takes place because, in the absence of manufacturing, petrodollars have nowhere to be invested except the construction. Another result of petrodollar influx is the rise in the cost of living, which makes such cities the most expensive in the world and further deepens the gap between the rich and the poor.

To avoid a social explosion, the state begins to pay benefits to the poor. This leads to the emergence of a whole class of dependent population, the welfare of which depends on petrodollar revenues. Nevertheless, the supply of petrodollars to the treasury is sufficient for feeding the plebs, for the arms race, for enriching the plutocracy, which has access to this stream, for the super profits of local oligarchy, for maintaining an army of servants, secret agents and security services guarding the existing system. The government, instead of developing local industries to employ the multitude of unemployed citizens, becomes only a distributor of petrodollars to social benefit recipients, wages of the inflated bureaucratic apparatus and security forces, and an allocator of funds for grandiose construction, prestigious international events and infrastructure projects that cost several times more than their foreign analogues. A substantial part of allocations to such projects gets stolen and transferred to offshore accounts of their enablers. Up to 90% of Azerbaijan's state budget revenues, for example, come directly from the export of crude oil -- although local statistics attribute part of these revenues to taxes and customs fees, the ultimate source of all the money circulating in this country, and of all salaries, taxes, incomes, expenditures, duties and trade profits is the same petrodollar revenue. Thus, the welfare of a classical oil-exporting country falls into complete dependence on the petrodollar revenue, which is the culmination of ascending cycle in this model.

Institutionalisation of corruption

Corruption in such countries, awash in petrodollars, also takes place in a certain mode and becomes an integral part of the local economy and government system, thus leading to its institutionalization as a set order of the direction in which the illegally obtained money flows. For example, if an official (in Azerbaijan) receives a bribe, he leaves himself 25% of it and transfers the remaining amount to his superiors. The chief reserves himself another 25% of the amount received and passes the rest up the chain of command, and so on in the job hierarchy. In turn, the authorities turn a blind eye to the bribery of their subordinates and even require new revenues from them, and consequently a chain of corruption algorithm is established. In such a management system, a negative selection of personnel comes into existence, because honest workers are not needed there. This leads to the next stage of model: such a system (of the plenty of money obtained in this way) generates a shadow economy, where billions of illegal petrodollars revolve and bring profit. The government is well aware of its existence, because its officials are themselves involved, but officially there is not a single millionaire who holds a public office in that country. However, the facts speak something different: for example, the Baku Olympic Stadium, worth more than $600 million, was built for the 2015 European Games without any provision of money from the state budget -- it was not even mentioned there among the appropriations for the games. Nevertheless, the stadium was built on time by unknown developers (for no obvious profit) with murky funds, the origin of which the state prefers not to investigate. By a tacit agreement, it turns a blind eye to the theft of officials on a condition that they plunk down the stolen money should the funds be mobilized for state needs.

This is the practice in almost all oil-producing states, since the vast majority of oil-exporting countries are not distinguished by scrupulous compliance with laws and an independent judiciary, which leads to lawlessness and lack of transparency in the receipt and distribution of petrodollars. The highest profit is taken, of course, by the ruling elite, whose members control the oil export, which appropriates and launders a significant part of the proceeds through fake offshore firms with the acquisition of real estate and other valuables abroad, where it flees in the event of a regime change. The second and third echelons of people close to the authorities are satisfied with various corruption schemes in turnover of petrodollars through trade, construction and expensive government projects, which are also subject to the model. For example, kickbacks to officials for receiving government contracts are given from the amounts allocated by the state for that same project. Government positions are illegally bought, and then the expenses recouped with huge profits by ruthless plundering of the entities controlled from those positions. Issuance of multi-million loans by state banks to oligarchs for fictitious projects is made for kickbacks to bankers and officials, who then write off the debts. The supervising and state security bodies, under various pretexts of violation of the law, extort ransom from local companies, while law enforcement agencies are engaged in racketeering of small and medium-sized businesses. This leads to the so-called "roofing" (protection cover) of large companies and even entire sectors of the economy by government officials who receive regular cuts from their profits.

Descending cycle of oil bust

After a sudden drop in the price of oil (gas, coal, ores and other raw materials) or a decrease in the volume of their exports (as a result of the depletion of deposits), the descending cycle of model is launched. Figuratively speaking, this process is similar to the symptoms of withdrawal, when a drug addict is deprived of his potion. In practice, however, things are much more complicated, because the process unfolds according to the immutable laws of political economy. In principle, this is a chain reaction, where everything is interconnected by thousands of causes and effects, as a result of which one change pulls another. One should note the spiral cyclicity of this model: after a drop in the inflow of petrodollars, which is reflected in diminishing the revenues of treasury and reduction of payments from it (salaries, pensions, allowances, appropriations), the purchasing power of population and, accordingly, the trade turnover (incomes, profits, imports) also falls, which leads to a decrease in the collection of taxes. As a result, the treasury receives even less money and further cuts down its payments (salaries, pensions, allowances), and this further compresses consumer demand and trade turnover, which further reduces the tax base and leads to dismissal of a new detachment of jobless workers, after which the next round of spiral begins. In more detail, the sequence of phenomena and the corresponding government measures in this downward cycle are as follows.

The first thing in such a situation (reduction in the inflow of petrodollars) is the devaluation of local currency: in order to keep the volume of state budget (which is nominated in local currency) on the same level without inflation, it is necessary to reduce the exchange rate of local currency to the dollar so as to receive the previous amount of money to the budget in exchange for a reduced quantity of petrodollars. In other words, the execution of national budget requires now a smaller amount of petrodollars -- most often by the percentage of decline in petrodollar revenue. At the same time, while keeping revenues and expenditures of the budget on the same level, devaluation leads to a slump in salaries, incomes, prices and the general standard of living in dollar terms, which has both positive (lower cost of living in dollars) and negative (appreciation in the cost of imports) effects. This results in a reduction of the inflated real estate prices (for example in Moscow, Luanda or Oslo), in the general fall of prices, wages, profits and living standards in line with the country's real production capacity (without petrodollar pumping), in curtailing the prestigious national projects and in diminishing the overall status of statehood and other pomposity. Thus the balance of payments of a given country now more accurately reflects its true place in the hierarchy of global division of labour without the impact of petrodollars.

Thus, model schematically looks like this: a drop in oil production or in the price of oil translates into the synchronous fall in the inflow of petrodollars, which results in the collapse of treasury's revenues and expenditures, which leads to devaluation of the local currency, which ensues (in a free market) the fall in prices of goods, services and real estate in dollar terms, which squeezes the tax base, which entails the redundancy of government bureaucracy, nationwide layoffs and bankruptcies in the private sector, which further squeezes the tax base, which results in cutting wages and social benefits, which causes mass unemployment and impoverishment of the populace, which triggers a growing dissatisfaction of power elite, which brings about a regime change with redistribution of wealth and property. Then the whole cycle repeats itself on a lower level of revenues and living standards until the final fall of this state into its historically legitimate and economically stable place among the nations without either oil revenues or competitive industries, which have become suppliers of cheap labor to industrialized countries and oil-rich Islamic states that continue the construction of Babel towers. This is the final stage of algorithm, after which an industrial development may (or may not, as experience of the Third World shows) start in a given country -- such a prediction does not lend itself to political or economic calculations and depends on the mentality and traditions of each particular nation.

Further reading

• N.Shaxson. Oil, corruption and the resource curse. = International Affairs (London), November 2007, volume 83, number 6, pages 1123-1140.
• M.L.Ross. The oil curse: how petroleum wealth shapes the development of nations. Princeton University Press, Princeton (USA), 2012, 312 pages.
• Dead ends of transition: rentier economies and protectorates (edited by M.Dauderstädt & A.Schildberg). Campus Verlag, Frankfurt, 2006, 249 pages.
• J.D.Sachs & A.M.Warner. The curse of natural resources. = European Economic Review (Amsterdam), May 2001, volume 45, issues 4–6, pages 827-838.
• F.F.Piven & R.A.Cloward. Poor people’s movements: why they succeed, how they fail. Vintage Books, New York, 1979, 381 pages.
• M.I.Goldman. Petrostate: Putin, power and the new Russia. Oxford University Press, Oxford (England), 2008, 244 pages.
• S.LeVine. The oil and the glory: the pursuit of empire and fortune on the Caspian Sea. Random House, New York, 2007, 470 pages.
• Politics in the age of austerity (edited by A.Schäfer & W.Streeck). Polity Press, Cambridge (England), 2013, 320 pages.
• Escaping the resource curse (edited by M.Humphreys, J.D.Sachs, J.Stiglitz). Columbia University Press, New York, 2007, 432 pages.
• E.R.Sadik-zada. Oil abundance and economic growth. Logos Verlag, Berlin, 2016, 167 pages.
• D.Yergin. The Prize: the epic quest for oil, money and power. Simon & Schuster, New York, 1991, 877 pages.
• M.A.El-Gamal & A.M.Jaffe. Oil, dollars, debt and crises: the global curse of black gold. Cambridge University Press, Cambridge (England), 2010, 217 pages.
• G.Hayes. Regimes of austerity. = Social Movement Studies (London), January 2017, volume 16, issue 1, pages 21-35.
• P.Roberts. The end of oil: on the edge of a perilous new world. Houghton Mifflin, New York, 2004, 389 pages.
• D.O'Sullivan. Petromania: black gold, paper barrels, and oil price bubbles. Harriman House, Petersfield (England), 2009, 306 pages.

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