Oil crisis: can short-term pain lead to economic gain for Russia?

The recent crash in oil prices is causing much anxiety in oil-producing states. From Iran to Venezuela, many have come to rely on elevated oil prices to fuel economic growth and support government spending.

One country that is perhaps worrying more than others is Russia. Oil and gas production and exports account for nearly three quarters of Russia’s total exports and around half of federal government revenue. Movements in oil prices are also correlated with the rouble exchange rate: when prices rise, the rouble appreciates, making imports for Russians cheaper. But when prices decline, imports become more expensive, squeezing living standards for the population.

In each of the past three decades, a precipitous drop in oil prices has unleashed powerful forces that have affected not just the performance of the Russian economy, but also the trajectory of politics within the country. 

First, during the last Soviet period, the expansion of Saudi production caused a steep decline in oil prices in 1986. Initially, the effects were not severe: the Soviet economy – in those days more isolated from the global economy – did not slip immediately into recession. But politically the effects were more profound. 

The Soviet leadership, led by the newly appointed Mikhail Gorbachev, decided that the Soviet economy was in urgent need of modernisation if it was to wean itself off oil and compete with the US economy. Gorbachev’s policy of perestroika (reconstruction) followed, promising greater freedom for Soviet citizens. Events quickly spiralled beyond Gorbachev’s control, resulting not in economic modernisation but instead the collapse of the Soviet Union.

Later, in 1997, oil prices dropped as the effects of the Asian financial crisis spread across the world. Russia had, at this point, been through nearly a decade of painful economic reforms, first under Gorbachev, then under the Russian President, Boris Yeltsin. However, after a severe economic depression that plunged much of the population into poverty, the economy looked to have turned a corner.

Unfortunately the drop in oil prices exposed the poor state of public finances in Russia, leading to a full-blown financial crisis in August 1998. A severe recession ensued, and the prospects for the nascent market economy appeared bleak.

Surprisingly, however, the leadership in Moscow responded to the drop in oil revenues not by rolling back market reforms but instead by pursuing another round of vigorous economic reform.

Most recently, the Russian economy was sent into a severe recession in the aftermath of the 2008 global financial crisis. The trigger was again a sharp decline in the price of oil. And, as in the previous episodes, the Kremlin responded by reinvigorating efforts to diversify the economy beyond oil and gas. The young tech-savvy President, Dmitri Medvedev, pushed forward a new modernisation agenda. Plans were made to create a new high-tech hub at Skolkovo, just outside Moscow, along with other initiatives to restore Russia’s competitiveness in science and technology.

What these three episodes show us is that while falling oil prices usually result in short-term economic pain for Russia, they also tend to stimulate positive economic reform.

For Russia, the problem has been that the reformist urge in the Kremlin tends to wear off as soon as oil prices rise again. As soon as this complacency sets in, reforms are left unfinished and the familiar ailments that afflict the Russian economy become more acute.

Will the recent decline in oil prices lead to a similar surge in liberal economic reform in Russia today?

Unfortunately, tensions with the West threaten to change the trajectory of political and economic development in Russia for the worse. By boosting factions within Russia’s elite who favour increased state control over the economy and a reassessment of Russia’s integration with the global economy, poor relations with the West threaten to reduce the prospects for a liberal, market-oriented turn in economic policy in Russia.

Put simply, the modernisers have been the group most weakened by tensions with the West. As a result, instead of responding to adversity through openness and reform, as it did in the past, Russia may instead use the spectre of a threatening international environment to justify even greater political centralisation and international isolation to solidify the ruling elite’s grip on power.

Dr Richard Connolly
Senior Lecturer in Political Economy, University of Birmingham