Tag: Oil

The Russian economy under Putin (so far)

Posted on March 15, 2018 | Policy Brief

20180315 The Russian economy under Putin Image 02

Russians are heading to the polling booths on March 18, but where will the economy head after Putin has been elected president again? This brief provides an overview of the economic progress Russia has made since 2000 as well as an economic scorecard of Putin’s first three tenures in the Kremlin and uses this to discuss what can be expected for the coming six years. Although significant growth has been achieved since 2000, all of this came in the first two tenures of Putin in the Kremlin on the back of increasing oil prices. In order to generate growth in his upcoming presidential term, Putin and his team will need to address the significant needs for reforms in the institutions that form the basis for modern market economies. Otherwise, Russia will continue to be hostage to the whims of the international oil market and eventually lose most of its exports and government revenues as the world moves towards a carbon free future. Perhaps this is beyond the scope of Putin as president, but not beyond the horizon of young Russians that will be casting their votes on Sunday and in future elections.

Let’s assume that Putin will be elected president again on March 18 (for once a very realistic assumption made by an economist). What will this mean for the Russian economy in the coming six years given what happened during his previous and current tenures in the Kremlin? To assess the future as well as to understand Putin’s power and popularity, this brief starts by looking back at the economic developments in Russia since Putin first became president.

Although many different factors enter the power and popularity function of Putin, economic developments have a special role in providing the budget constrain within which the president can operate. A higher income level means more resources to devote to any particular sector, project, voting group or power base. This is not unique to Russia, but sometimes forgotten in discussions about Russia, that often instead only focus on military power or control of the security apparatus and media. These are of course highly relevant dimensions to understand power and popularity in Russia, but so is economic development, particularly in the longer run.

Russia’s economy in the world

The economic greatness and progress of a country is usually assessed in terms of the size of the economy, how much growth that has been generated, and how well off the citizens are relative to the citizens of other countries. So, by our common indicator gross domestic product (GDP), has Russia become a greater and more powerful country since Putin first became president? Table 1 shows two things, the absolute level of GDP measured in USD at market exchange rates and the rank this gives a country in a sample of 192 countries in the world that the IMF collects data on (this brief is too short for a long discussion of the most relevant GDP measure, but GDP at market exchange rates makes sense when comparing the economic strength of countries in a global context, Becker 2017 provides a discussion of alternative measures as well). When Putin become president for the first time in 2000, the value of domestic production was estimated at $279 billion, which implied a 19th place in the world rankings of countries’ GDP. In 2016, almost three presidential terms of Putin later, Russia’s GDP had increased by 4½ times to $1281 billion and its ranking improved to 12th place in the world. This clearly is an impressive record by most standards. However, the Russian economy is still the smallest economy of the BRIC countries and corresponds to only 7 percent of the US economy in 2016. In other words, impressive progress by Russia but the country is (still) not a global superpower in the economic arena.

Table 1. Russia in the world (GDP in USD bn)

Source: IMF (2017)

For the average Russian, income per capita is a measure more closely connected to consumption and investment opportunities or ‘welfare’. Progress in this area is also more likely to affect how individuals assess the performance of its political leaders. Of course, progress in terms of overall GDP and GDP per capita is closely linked unless something unusual is happening to population growth. Therefore, it is not surprising that GDP per capita also increased by around 4½ times between 2000 and 2016 (Table 2). This is the first order effect of the economic development in Russia, but in addition, citizens of Russia moved up from a world income rank of 92nd to 71st. This has implications when Russian’s compare themselves with other countries and can in itself provide a boost of national pride.

It also directly affects opportunities and status for Russians visiting other countries. Being at place 71 may not be fully satisfactory to many, but we should remember that due to the rather uneven income distribution in Russia, many of the people that travel abroad are far higher up on the global income ranking than what this table indicate. Nevertheless, Russia is far behind the Western and Asian high-income countries in terms of GDP per capita. And although the picture would look less severe if purchasing power parity measures are used, the basic message is the same; Russia has still a lot of catching up to do before its (average) citizens enjoy the economic standards of high-income countries.

Table 2. Russian’s in the world (GDP/capita)

Source: IMF (2017)

The macro scorecard of Putin

So what generated the impressive 4½ times increase in income in USD terms from 2000 to 2016 and can we expect high growth during Putin’s next six years in office? The short answer to the first question is the rise in international oil prices and to the second question, we don’t know. Table 3 provides a comparison of different economic indicators for Putin’s two first terms in office compared with his current term (where GDP data ends in 2016 so the sample is cut short by a year). It is evident that the impressive growth over the full period is entirely due to the strong growth performance in the first two presidential tenures. Rather than generating growth in the most recent period, the economy has shrunk. This is explained by the evolution of international oil prices, which quadrupled in the first eight years and instead halved in the more recent period. These swings in oil prices have also been accompanied by significant shifts in foreign exchange reserves, the exchange rate, and the value of the stock market.

In Becker (2017) I discuss in more detail the importance of international oil prices in understanding the macro economic development in Russia. In particular, it is important to note that it is changes in oil prices that correlate with GDP growth and other macro variables and that the problems with predicting oil prices makes it very hard to make good predictions of Russian growth.

Table 3. A macro scorecard of Putin in office

Source: Becker (forthcoming)

Policy conclusions

To break the oil dependence and take control of the economic future of Russia, the president will need to implement serious institutional reforms that constitute the basis for a modern, well-functioning market economy in his next term. Otherwise, Russia will continue to be hostage to unpredictable swing in international oil prices and nobody—including the president, the central bank, the IMF and financial markets—will be able to predict where the Russian economy is heading in the next couple of years.

Figure 1. Reforms (still) needed

Source: World Bank (2017)

In the longer run, the prediction is much easier. With the world moving towards a green economy, the price of oil will see a structural decline that will rob Russia (and other oil exporters) of most of its export and government revenues. The reforms which basically every economist agree are needed are related to market institutions and Figure 1 provides a clear illustration of key reform areas. The progress during Putin’s years in office has been modest at best. Swedish institutions in 2016 have been added to the figure as a comparison and it is clear that the institutional gap between Russia and Sweden is significant. Of course, all countries are different, but Russian policy makers that are interested in reforming its economy are most welcome to Sweden for a discussion of what we have done to build our institutions.

References

  • Becker, T. (2017). ‘Macroeconomic Challenges’, in Rosefielde, S., Kuboniwa, M., Mizobata, S. and Haba K. (eds.) The Unwinding of the Globalist Dream: EU, Russia and China, Singapore: World Scientific Publishing.
  • Becker, T. (forthcoming), ‘Russia’s economy under Putin and its impact on the CIS region’, Chapter 2 in T. Becker and S. Oxenstierna (eds.) Perspectives on the Russian Economy under Putin, London: Routledge.
  • IMF (2017), World Economic Outlook database, April 2017 edition available at http://www.imf.org/external/pubs/ft/weo/2017/01/weodata/index.aspx
  • World Bank (2017), Worldwide Governance Indicators (WGI), 2017 update available at http://info.worldbank.org/governance/wgi/index.aspx#home

The Determinants of Renewables Investment

Posted on November 13, 2017 | Policy Brief

20171112 Determinants of Renewables Investment 01

On the 24th of October, SITE held the first of its series of Energy Talks, replacing what for one decade had been known as SITE Energy Day. For this first edition, SITE invited Thomas Sterner, Professor of Environmental Economics at the University of Gothenburg to give a presentation under the headline of “Technological Development, Geopolitical and Environmental Issues in our Energy Future”. To comment on the presentation, Leonid Neganov, Minister of Energy of Moscow Region, and Karl Hallding, Senior Research Fellow at the Stockholm Environment Institute (SEI), had been invited. This policy brief reports on the important subjects presented by our guests as well as the discussion that took place during the event.

From climate change concerns to climate change targets

Thomas Sterner began his presentation by addressing the well-known issue of climate change, a constantly current topic.

Different versions of Figure 1 (below) have been used extensively by those discussing climate change over the last decades, most notably by the previous US President Al Gore in his 2006 documentary “An Inconvenient Truth”. It shows the concentration of CO2 (carbon-dioxide) in the atmosphere over the past 400,000 years. There is wide agreement within the scientific community that the emissions of greenhouse gases (GHG), such as CO2, methane and nitrous oxides, have led to the shifting weather patterns and increased temperature over the past century (NASA, 2017).

Figure 1. Level of CO2 in the Atmosphere

Notes: The vertical red line is the Keeling curve, showing how the concentration has changed since 1958. Source: Allmendinger, 2007.

Predicting the impact of these emissions is far from an exact science: the temperature increases are likely to be unevenly spread across the world as shown in Figure 2. Some areas are likely to be particularly afflicted, especially coastal lowlands susceptible to flooding and semi-arid areas where droughts can become more likely. Unless current emission levels start to decrease, we are likely to observe severe results of climate change within 20 years, such as displacement and increased migration in the wake of extreme weather (NIC, 2016). For instance, adverse health effects in China, or decreasing productivity in South-East Asia, have already become apparent due to current increased temperatures (Kan, 2011; Kjellstrom, 2016).

Figure 2. Predicted Temperature Increase

Source: IPCC, 2013.

To tackle this issue and its negative economic impacts, many policy makers have agreed to replace fossil fuels with renewables. Renewables is the collective term of energy sources that have a neutral or negative net-effect of GHG emissions and are extracted through resources that are continuously replenished, e.g. solar, wind and hydro power, and biomass energy.

As the issue of climate change is a global one, the transition to renewables needs to be global too. International climate agreements have hence long been the accepted norm to approach climate change issues. The Paris Agreement is currently the guiding principle, in spite of the announcement of the Trump administration to withdraw the United States. Though instrumental in creating a momentum in the transition to lower levels of GHG emissions, it comes with many flaws. Its goal of a maximum average temperature increase of 2°C might be considered radical given current levels. However, the policy instruments that the target depends on – the Intended Nationally Determined Commitments (INDCs) – shift the responsibility to individual nations and remove the global responsibility. As Thomas Sterner pointed out, the first three words of this acronym remove indeed any binding force, and elementary game theory tells us that it will be hard, not to say unlikely, for all signatories to remain cooperative in achieving the target of 2°C.

Investing in renewables: from political choice to competitive choice

As stated above, investing in renewables is a necessary condition to achieve climate change targets. Indeed, there are some countries that have pushed the development of renewables with the aim to reduce the fossil fuel dependency to a minimum level in a very near future (see Figure 3). However, most of these investments are currently driven by political will. A natural question is whether renewables technologies can be competitive.

It is a fact that costs of renewables have been severely decreased in the last decade (Timmons et al., 2014). However, as Thomas Sterner mentioned, the cost of renewables and of fossil fuels are still very place and time specific and depends on the scale. Investments in renewables are growing and solar and wind power have both seen production capacities increasing markedly yearly over the last years (GWEC, 2016; IEA, 2017a). However, coming from an initial low level, it will take some time before we will be able to rely on them.

Even with massive investments and decreasing generation costs, the intermittent nature of most renewable energies will still impede the competitiveness of renewables. Solar and wind power are the technologies where most of the development has been centred (Frankfurt School-UNEP Centre/BNEF, 2017). They are highly weather dependent and electricity production from these sources cannot be secured all of the time. This makes countries dependent on backup technologies. In some countries, the obvious answers to these challenges have been hydro and nuclear power. Both technologies have their respective drawbacks though.

Figure 3. World’s Top 10 Investors in Renewable Energy in 2016

Notes: New Investments $BN, Growth on 2015. Source: Frankfurt School-UNEP Centre/BNEF, 2017.

Hydro power requires a geography that allows for dams, which in turn change the nature markedly around them and may not be available during drought periods. Nuclear energy has surrounding safety aspects that most recently came to light with the 2011 Fukushima Daaiichi nuclear disaster, leading Germany to decide to shut down all of its 17 reactors by 2022 (25 % of the country’s electricity production). Moreover, it may also be technically difficult to have nuclear as a backup technology given the associated ramping and start-up constraints.

Two further remarks on the intermittency problem can be made. First, this problem is likely to become more severe when policymakers push for large-scale electrification (c.f. EU Energy Roadmap established in 2011). For example, the full electrification of transport or heating sector will drive up the demand for and consumption of electricity. As this happens, the need for something to secure constant energy access will increase.

Second, only the development of technologies that allow electricity storage could solve this issue permanently. However, the current technological progress regarding batteries’ capacity cannot yet offer the solution (J. Dizard, 2017).

Oil price, a reference price

Another important aspect stressed by Thomas Sterner was to take into account the significant role of fossil fuel prices. Although identifying an optimal oil price for a fossil-free future is not a straightforward procedure, as discussed during the event.

The high price of oil during the late 00s and early 10s stimulated the development of alternative technologies. As awareness of climate change and its effects increased among policy makers and the general public, there was a momentum to push for the development of renewables.

As investments in renewables went up, so did investments in another less green technology: hydraulic fracturing, or fracking. In the 10 years between 2005 and 2015, the United States alone saw the extraction of shale gas and oil to increase six-fold. (EIA, 2016) In part to maintain a market share, OPEC countries exceeded their own set production limits and oil prices tumbled from around $100 per barrel to around $50 (Economist, 2014).

With roughly three years behind us of somewhat stable and low oil prices, the question is what the implications of this are. It makes it more difficult to phase out fossil fuels as demand for them goes up, depressing efforts put into the research and deployment of renewables. Energy efficiency also becomes less important, driving up waste and stopping investments in energy conservation.

On the other hand, with low oil prices, investments in the fossil-fuels industry are also less likely to take place. Keeping resources in the ground becomes more palatable as profit margins are pushed down. This, in turn, is likely to have a positive effect on environment by decreasing the level of GHG emissions.

The invited guests, Leonid Neganov and Karl Hallding spoke more in depth about two central countries that contribute in shaping global environmental policy.

The local conditions, Russia and China examples

As the world’s fourth largest supplier of primary energy and the largest supplier of natural gas to the EU (IEA, 2017b), Russia presents an interesting case to observe as a country supplying fossil fuels. Leonid Neganov, Minister of Energy of Moscow Region, commented on the current policy direction of the country. He explained that non-renewable, GHG emitting energy sources make up a majority, roughly 60% of the Russian energy balance. The rest is provided by more or less equal shares of nuclear and hydro power. New renewable technologies make up a miniscule share of an estimate 0.2% of the current total.

According to Neganov, in the coming 20 years, we should not expect to see too much of a change. Though total output is expected to increase, the share of GHG-neutral energy will remain more or less constant, though the share of renewables are set to increase to 3% according to the current drafts of Russian energy policy. A more pronounced transition to other energy sources are more likely in a longer perspective towards 2050, even though circumstances may naturally change over the coming decades.

Other available information also points to that Russia has decided to tackle the shift in consumption of its major market in Europe by widening its geographic reach. Massive infrastructure investments, such as the Altai and TurkStream gas pipelines, will enable Russia to more easily reach markets that are currently beyond any practical reach.

With the Altai pipeline, Russia will be able to provide China with natural gas at a much greater level than before. China being by far the largest producer of coal sees an opportunity to shift away from the consumption of a resource that during winters causes its major cities to periodically become enveloped in clouds of smog and at the same time also decrease its GHG emissions. The environmental benefits of natural gas as opposed to coal should not be exaggerated though. Thomas Sterner pointed out that methane, the main compound of natural gas, is a considerably more potent GHG than CO2. A total leakage of an estimated 1% negates the environmental benefits, he said.

Karl Hallding, Senior Research Fellow at SEI, particularly stressed the need to look at China. It is the supplier of half of the world’s coal, extraction levels remain high. (BP, 2017) Domestic consumption is decreasing but consumption of Chinese coal is, however, more likely to shift geographic location rather than to be left in the ground, said Hallding. Through massive infrastructure investments, such as the New Silk Road, and in energy production in Sub-Saharan Africa, China spreads its influence (IEA, 2016). By exporting emissions, the impact at the global level will not change.

References

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Russia and Oil — Out of Control

Posted on October 31, 2016 | Policy Brief

Free Policy Brief Image - Russia and Oil — Out of Control

Russia’s dependence on oil and other natural resources is well known, but what does it actually mean for policy makers’ ability to control the economic fate of the country? This brief provides a more precise analysis of the depth of Russia’s oil dependence. This is based on a careful statistical analysis of the immediate correlation between international oil prices — that Russia does not control — and Russian GDP, which policy makers would like to control. I then look at how IMF’s forecast errors in oil prices spillover to forecast errors of Russian GDP. These numerical exercises are striking; over the last 25 years oil price changes explain on average two thirds of the variation in Russian GDP growth and in the last 15 years up to 80 percent of the one-year ahead forecast errors. Instead of controlling the economic fate of the country, the best policy makers can hope for is to dampen the short-run impact of oil price shocks. A flexible exchange rate and fiscal reserves are key volatility dampers, but not sufficient to protect long-term growth. The latter will always require serious structural reforms and the question is what needs to happen for policy makers to take action to get control over the long-term fate of the economy.

In a recent working paper (Becker, 2016), I take a careful look at the statistical relationship between Russian GDP and international oil prices. This brief summarizes this analysis and its policy conclusions.

Russia and oil, the basics

Although Russia’s oil dependence is discussed every time international oil prices drop, it is not uncommon to hear that oil is not really so important for the Russian economy. The argument is that the oil and natural resource sector only accounts for some 10 percent of Russian production. This is indeed consistent with the official sectoral breakdown of GDP that is shown in Figure 1 where the minerals sector indeed only has a 10 percent share.

Figure 1. Structure of GDP in 2015

slide1Source: Federal State Statistics Service, 2016

However, this static picture of production shares does not translate into a dynamic macro economic model that allows us to understand what is driving Russian growth. Instead a careful analysis of the time series of Russian GDP is required to understand how important oil is for growth.

Russian GDP can be measured in many different ways: nominal rubles, real rubles, U.S. dollars, or in purchasing power parity (PPP) terms to mention the most common. Here we focus on GDP measured in real rubles and U.S. dollars since we want to get rid of Russian inflation, which has been quite high for most of the studied time period. The PPP measure generates figures and numerical estimates that are in between the real ruble and U.S. dollar measures and are not included here to conserve space.

The first evidence of the importance of international oil prices as a major determinant of Russian income at the macro level is presented in Figures 2 and 3 where the first figure shows dollar income and the second real ruble income. In both cases it is obvious that there is a strong correlation and that the correlation is higher for income measured in dollars.

Figure 2. U.S. dollar GDP and the oil price

slide2Source: IMF, 2016

Figure 3. Real ruble GDP and the oil price

slide3Source: IMF, 2016

However, it is also clear that all the time series have some type of trends or in econometric language, are non-stationary. This means that simple correlations of the time series shown in Figure 2 and 3 may not be statistically valid (or “spurious” as it is called in the literature). This is not a critical issue but can be handled by regular econometric methods.

Russia and oil, the econometrics

When time series are non-stationary they need to be transformed to some stationary form before we can do regular regressions (in Becker, 2016 I also address the issue of using a framework that allows for co-integration).

Two transformations that make the variables stationary are to use first differences or percent growth rates. Both are used before we run simple regressions of growth or first differences of GDP on growth or first difference in international oil prices. The full sample starts in 1993, but since the early years of transition were subject to many different shocks at the same time, a shorter sample starting in 2000 is also used.

A number of observations come from the estimates that are presented in Table 1: Oil prices are always statistically significant; the adjusted R-squared is higher for dollar income than real rubles (with one exception due to a large outlier in 1993); overall the explanatory power of these simple regressions are very high (42-92 percent) and the explanatory power increases in all specifications when going from the full sample (1993-2015) to the more recent sample (2000-2015). Note that the latter sample perfectly overlaps with the current political leadership so contrary to some wishes; the oil dependence has not been reduced under Putin/Medvedev.

Table 1. Russian macro “models”

slide4Source: Becker 2016

Russia and oil, the forecasts

The strong correlation between international oil prices and Russian GDP provides a very simple econometric model for explaining past variations in Russian GDP. Unfortunately it does not imply that it is easy to forecast Russian GDP since international oil prices are very hard to predict. There are many models that have been used to forecast oil prices, but the IMF and many others now use the market for oil futures to generate its central forecast of oil prices.

The IMF also provides confidence intervals around the central forecast, and the uncertainty surrounding the forecast is substantial: In the latest forecast the 68 percent confidence interval goes from around 20 dollars per barrel to 60 one year ahead, while the 98 percent interval ranges from 10 dollar per barrel to around 85. With oil currently around 45 dollars per barrel, these variations imply that oil prices could either halve or double in the next year, not a very precise prediction to base economic policy on for Russia since the estimates for real ruble growth in the later sample in Table 1 imply that Russian GDP growth in real ruble terms could be anywhere from minus 5 to plus 10 percent, or a fifteen percentage point difference!

If we look at past IMF forecasts of oil prices and Russian GDP and see how much they deviate from actual values a year later we can compute one year ahead forecast errors. We can do this calculation for the last 16 years for which the IMF data is available. Figures 4 and 5 show how the forecast errors in oil prices correlate with the forecast errors for dollar income and real ruble income, respectively. Similar to the regressions presented in Table 1, the correlations are very high for both measures of GDP: 82 percent for dollar GDP, and 65 percent for real ruble GDP.

In other words, a very large share of the uncertainty surrounding Russian GDP forecasts can be directly attributed to variations in international oil prices, a variable that (again) Russia does not control. The fact that the variations in oil prices explain somewhat more of the variation in dollar income compared to real ruble income is a result of a policy change that in later years allowed the exchange rate to depreciate much more rapidly when oil prices fall.

Figure 4. Forecast errors

slide5Source: Becker 2016

Figure 5. Forecast errors

slide6Source: Becker 2016

Policy conclusions

The depth of Russia’s oil dependence is much greater than what casual observers of the mineral sectors share of GDP would suggest. At the macro level, variations in international oil prices explain at least two thirds of actual Russian growth and even more of the one-year ahead forecasts errors.

The experience of the 2008/09 global financial crisis provided an important lesson to Russian policy makers, which is that exchange rate flexibility is required to dampen the real impact of falling oil prices and to protect both international reserves and the fiscal position. In the more recent years, the currency has been allowed to depreciate in tandem with falling oil prices and the drop in real ruble income was therefore less severe in 2015 than in 2009. Income in dollar terms, instead, took a greater hit, but this was a necessary corollary to protecting reserves and the budget. A flexible exchange rate and gradual move to inflation targeting in combination with accumulating fiscal reserves in times of high oil prices are key to Russia’s macro economic stability.

Nevertheless, these policies are not sufficient to remove the long-run impact that low or declining oil prices will have on growth, measured both in real ruble terms or dollar terms. It is nice to have fire insurance when your house burns down, but when you rebuild the house you may want to consider not building another straw house. For Russia to build a strong economy that is not completely hostage to variations in international oil prices, fundamental reforms that encourage the development of alternative, internationally competitive, companies are needed. This includes reforms that initially will reduce policy makers control over the economy and legal system, but over time it will provide the much needed diversification away from exporting oil that puts the fate of the Russian economy squarely in the hands of international oil traders. Losing some control today may provide a lot more control in the future for the country as a whole, but perhaps at the expense of less control for the ruling elite.

References

Natural Resources, Intangible Capital and Sustainable Development in a Small, Oil-Rich Region

Posted on December 3, 2012 | Policy Brief

20121203 Natural Resources, Intangible Capital and Sustainable Development Image 01

“Where scientific enquiry is stunted, the intellectual life of a nation dries up, which means the withering of many possibilities of future development.” – Albert Einstein, 1934 The rampant unemployment rates and the general contraction of economic activity in many western countries rekindled the fear of emigration and brain drain, which for a while seemed to be exclusively a developing-world problem. This brief illustrates a potential new approach to the issue, through a recent experience in a small but oil-rich region of Southern Italy. 

Economic Growth and Brain Drain

Since the times of Solow, economic theory represents growth as the result of a process not unlike some sort of portfolio management. Just like any individual investor, countries own and need to manage certain assets, characterized by different properties and returns: some are exhaustible, others are renewable or living, and ensure a sustained stream of income.  In the original formulations, the economy’s productive assets were identified in land, capital and labor, to which human capital was soon added. In 2006, the World Bank published estimates of 120 countries’ total wealth, in an attempt to introduce a broader view of what these assets really are [1]. The report classified a country’s capital into three main types: natural, produced (physical) and intangible. A striking pattern emerged. While the share of produced assets in total wealth is virtually constant across income groups of countries, the share of natural capital tends to fall with income, and the share of intangible capital rises. This means that rich countries are largely rich because of the skills of their populations and the quality of the institutions supporting economic activity.

There is an important relation between the different types of assets. In order to avoid illusory and temporary growth based on consuming the readily available natural capital, efficient management through saving and investment can transform one type of asset into another, achieving sustainability over time. Although this may sound as no big news, the analysis of the actual savings and rates of growth in the different form of capital reveals far from ideal situations all over the world. In many resource-rich developing countries, savings rates have been negative for many decades, meaning that resource rents have been at best used for consumption. In the worst cases, they have fueled corruption and private enrichment of small elites, as highlighted by the extensive literature on the “resource curse”.

Also, renewable natural resources are often exploited in an unsustainable fashion. One case in point is the thorny issue of fish stocks, but many more examples are discussed in the literature on ecosystem services. Even the intangible capital is under stress in many places. In the wording of the 2006 World Bank report, “intangible assets include the skills and know-how embodied in the labor force; social capital, that is, the trust among people in a society and their ability to work together for a common purpose; all those governance elements that boost the productivity of labor: an efficient judicial system, clear property rights, and an effective government.” Probably the first component in the list, what is traditionally indicated with the term human capital, is the most tangible, observable and relatively controllable part of it.

Controlling the Brain Drain?

Although there are many arguments in favor of international careers and general workforce mobility,[2] some regions experienced negative and prolonged net outflows – emigrants minus immigrants – to the extent that they now face a real risk of hold ups in their economic development. This, due to shortages of vitally needed high-skilled personnel. Even the economic sustainability of many basic services and businesses is in doubt due to the shrinking customer base.

Southern Italy is one of these regions. The net outflow of people with a bachelor or higher degree is negative[3] even at the national level,   -2% over the latest ten years. In southern Italy, with a population of just above 13 million, the net balance of emigrants and immigrants over the same period amounts to -630,000. 70% of these people are aged between 15 and 34, and 25% hold at least a bachelor degree. To this figure, which is based on changes in official residence and therefore grossly underestimates the real size of the phenomenon, must be added the 150,000 that on average every year join the flow of internal migrants or long-distance commuters from the south to Northern Italy. Among these people, 47% are aged between 15 and 34, and almost 30% hold a bachelor or higher degree. The reason for these massive outflows can be identified in the labor market dynamics. If we break down the average 22% decline in job creation for youth between 2008 and 2011, new hires declined by 30% for youth with a bachelor degree and 14% for higher degrees, against 11% decline for youth with only secondary education.[4]

As opposed to physical capital, recent research shows that loss of human capital can have long lasting crippling consequences for economic growth (Waldinger, 2012). Among the policies that have been tried in order to stop or counterbalance the brain drain, a first set targets human capital as embodied in the workforce, i.e. tries to attract highly trained people. Probably the most popular are economic incentives in the form of tax rebates, higher wages or other job-related benefits and amenities. This kind of incentive regime exists in Italy since December 2010, though only targeting Italian nationals. However, for many high-skilled professionals, the important factors are others, such as a generally innovative and creative environment, a network with a critical mass, a transparent and competitive labor market not contaminated by politics, high quality support services, and other conditions that are not as easy and cheap to modify. Some countries have played the card of instead attracting prestigious foreign schools to their national territory to prevent their brilliant youth from leaving in the first place. Many famous western universities have already initiated partnerships with or lent their names to schools and universities in these countries and even built replicas of themselves – mostly in Asia – so as to get a toehold in the world’s largest education market, or in the Gulf States, where financial resources abound. There are successful examples of such partnerships in Italy, too.

A different approach has been taken by the new government, with the realization that the country can benefit from the pool of expatriated talents without moving them permanently back. A program of facilitation for visiting scholars and exchange students was thus launched in September 2012. But a step even further is actually possible. A network of scholars and high-skilled professionals that want to contribute to the development of a particular country or region, for example their place of origin, does not require physical presence on the territory, and not even any formal or institutional bond. The only needed ingredient is the Internet. Not removed from the environment and the conditions where they achieved success, these people can actually contribute even more. This is the idea behind, for example, Innovitalia.net and other smaller independent initiatives inspired by the concept of crowd-sourcing.[5]

The Experience of Basilicata

I recently witnessed (what I hope is) the birth of one such network in the region where I am from. Basilicata, also known as Lucania, is a small, poor region of less than 600,000 inhabitants scattered across 131 different municipalities on a territory of barely 10,000 squared kilometers, between the heel and the toe of the boot that the Italian peninsula resembles. Here, the crisis hit especially hard and migration outflows are since then even stronger, especially among youths.  According to SVIMEZ (a think tank focused on entrepreneurship and economic activity in Southern Italy), Basilicata has lost 10% of its regional GDP since 2007, much more than the national average of -4.6%. Compared to other large European economies, Spain is currently at -2.7, while Germany and France, notwithstanding the low annual growth rates, are now back at the same level as in 2007. The youth employment rate (with the generous definition of 15-34) is alarmingly low at 30%, down by 15% since 2007, and only 24% for women. As a result, the consumption level of 27.5% of families is now below the poverty threshold, compared with 11% of families at the country level.[6]

Enter Europe’s largest onshore oil and gas reservoir; about 150,000 oil barrels are extracted in Basilicata every day, covering 12% of the national oil demand. The exploitation started in the late 1990s, although the reservoir has been known since at least the 1970s. It is expected that these oil fields will be operational until 2022, but at least one more reservoir with about the same estimated capacity remains unexploited. The regional government has for the time being blocked any new concession, hoping perhaps to negotiate better conditions. The truth is, there have been strong concerns – related to lack of transparency and in some cases to alleged corruption – voiced at the actual quantities of extracted oil and what is a fair distribution of revenues. After more than 10 years, it is hard to claim any major social impact of the project:  there is a clear lack of funds to invest in local small and medium size businesses and, as observed above, unemployment in the area remains a problem while the regional population has plummeted.

Is this a case of “resource curse”? Not really. There is no clear evidence of corruption, or elite capture – the problem seems to be mostly poor management and a lack of ideas, mixed with the deeply rooted penchant of local politics for populism and the clientela system (patronage). To give an idea, creativity in using the oil money did not go much beyond the restoration of many of the small town’s pavements and facades. In 2009, in line with the so called “Development Action Plan” of the Berlusconi government, an 80 euro lump sum was distributed to all residents. After the crisis hit harder, the royalties have also been used to cover holes here and there in the current account. Data from the Ministry for Economic Development shows that capital investment in the region went down by 8.5% per year between 2008 and 2011, while current expenditure went up by 3%. Going back to the importance from the growth perspective of savings and investment versus consumption, it is worth remarking that current expenditure is (in most part) consumption.

Can this bounty instead become an answer to Basilicata’s troubles? This was the question driving the first Sustainable Development School, held at the end of October in Viggiano, a small town in the center of the oil field, hosting 23 oil wells. Sponsored by a number of institutions and associations, local or national,[7] the event attracted a group of 45 economists, sociologists, managers and entrepreneurs, engineers and culture sector specialists, in most part born in Basilicata and working or studying abroad. Seven of these participants were instead citizens of various countries in the Middle East and North Africa region, working or studying in Basilicata. This heterogeneous group worked together for two days on concrete proposals to be put on the administrator’s tables, in five main areas: Regional Economy in the new Euro-Mediterranean context, Energy and natural resources, Environmental protection, Infrastructure for environmental protection, Promotion of the historical, cultural and social heritage. Given the context, most projects focused on alternative proposals for how to use the royalties. The keyword was, however, sustainability. Everybody was well aware of the fact that for them to last longer than oil itself, these resources must be saved and earmarked to some productive use that, leveraging on other locally abundant resources, can start off a process of self-sustained development. The projects highlighted the stimulation of local small-scale entrepreneurship and the creation of employment opportunities as necessary ingredients for a fairer sharing of the revenues but most importantly for long-term sustainability.

Many local resources, not fully utilized at present, were brought in as examples: the abundant wood, the underexploited waterways, even the wastewater from bigger agricultural and animal farms, connected to the potential for small-scale generation of energy from renewable sources. On a slightly different note, the list continued with the historical and cultural heritage, natural beauty and the religious and culinary traditions that could support a much more developed tourism industry than what it does today. All of this, in the proposals of the participants, has the potential to support profitable businesses that bring employment to the community. This ingredient is considered crucial, in the perspective that the long-term survival of any (business) initiative requires tying its success to the welfare of the local communities. The focus was thus overwhelmingly on private initiative, with the public confined to the role of investing partner and provider of supportive infrastructure (material and immaterial) and services.

Overarching is undeniably the question of institutional quality, needed as the underlying canvas to support whatever initiative we hope to see blooming.  A proposal that did not make it to the finals, though, involved the creation of a stable watchdog, either on local policies in general (and in particular on the use of the royalties) or more specifically focused on the environmental and health impact of the extractive activity. According to the more politically experienced participants, no administration would agree to finance an independent body with the explicit mandate to criticize them. Never mind that this type of institutions is common in other places. In Italy, the one body that currently operates with a watchdog function on the public administration, although limited to the financial aspect,[8] is facing threats of limitations of its powers. A lot remains to be learned. However, the perhaps most valuable outcome of this experience was, if not yet policy change at least a promising method to produce change, by mobilizing a latent ‘local’ resource and really transform oil rents in durable intangible capital.

References

  • Where Is the Wealth of Nations? Measuring Capital for the 21st Century. Washington, DC: The World Bank, 2006
  • The brain drain in Spain is mainly to Spain’s gain, The Economist, April 2012
  • The Inclusive Wealth Report 2012, Cambridge University Press, 2012
  • Rapporto sull’economia del Mezzogiorno, SVIMEZ, 2012
  • Peer effects in science: evidence from the dismissal of scientists in Nazi Germany, Waldinger, F., The Review of Economic Studies, 2012

[1] Updates on these figures for a subset of 20 countries can be found in the newly released Inclusive Wealth Report 2012 , sponsored by a number of UN agencies, the first of what is intended to be an annual report looking at a broad measure of wealth. From the report: “Wealth is the social worth of an economy’s assets: reproducible capital; human capital; knowledge; natural capital; population; institutions; and time.”

[2] The Economist recently pointed out that “[w]hat some call “brain-drain” may in fact be a win-win situation for Europe’s economies. […I]n the short run, migration takes away pressure from budgets as the unemployed don’t claim benefits but move [abroad] instead. In the long run, there is a pool of highly skilled workers who have not fallen victim to hysteresis effects and can be re-activated for the [home] economy once the crisis is over.”  However, it is not at all obvious that this migration is short-run, i.e. that these high-skilled workers will eventually go back. A survey of Italian scientists working aboard reveals, for instance, that the overwhelming majority excludes ever going back to Italy.

[3] The “import” of such people generally more than compensates the “export” in other big European countries.

[4] Source: SVIMEZ, 2012.

[5] A recent paper analyzing the experience of New Zealand (Davenport, 2040) reviews the waves of brain-drain response policies and calls this latest generation diaspora policies: “Diaspora policies are based on an assumption that many expatriates are not likely to return, at least in the short term, but represent a significant resource wherever they are located. This resource is not just embodied in the individual expatriate but also potentially includes their socio-professional networks. A key advantage of any diaspora option is that such connectivity initiatives do not require a large infrastructural investment in order to potentially mobilize this latent ‘national’ resource.”

[6] Source: ISTAT.

[7] Sponsors and partners included the municipal and regional administration, the Italian Institute for Asia and Mediterranean (ISIAMED) and its local branch, CeBasMed, the Val d’Agri National Park, the Regional Environmental Protection Agency, SVIMEZ and the University of Basilicata.

[8] The Corte dei Conti tribunal.

What Does Modern Political Economics Tell Us About the Fate of Russia’s Reforms?

Posted on September 5, 2011 | Policy Brief

20110905 Policy Brief Image Russia Kremlin Saint Basil Cathedral

After the 2008-09 crisis, Russia is facing a new set of challenges. The pre-crisis sources of growth have been exhausted. In order to implement its growth potential and catch up with OECD countries, Russia must improve its investment and business climate. Although the reform agenda has been repeatedly discussed, it is not being implemented. The explanation is provided by modern political economics: what is good policy (in terms of social welfare and growth) is not necessarily good politics (for a country’s rulers). In this sense, modern Russia is a perfect example of the non-existence of a political Coase theorem. Although everybody understands that the status quo is suboptimal, the most likely outcome is further postponement of reforms.

Whither Russia?

In 2009, the New Economic School joined the Russia Balance Sheet project launched by two DC-based think tanks: the Center for Strategic and International Studies and the Peterson Institute for International Economics. The aim of the project was to assess Russia’s assets and liabilities. Similarly to compiling a company’s balance sheet, the project estimated the potential for long-term development and growth, and the problems that could prevent Russia from realizing this potential.

The main output of the project in 2009-10 was the book “Russia after the Global Economic Crisis”, which was published in English in the Spring 2010 and in Russian in the fall of the same year. The book looked at a broad range of issues that could be classified as Russia’s “assets” and “liabilities”, extending from economic, political and social issues to energy, foreign relations, climate change, innovation and military reform. Interestingly, despite the breadth of the analysis, the authors of the book’s different chapters arrived at similar conclusions, which might be summarized as follows: while Russia came out of the crisis in a reasonably good shape and has nothing to fear in the near term, it has serious long-term problems that need to be addressed as soon as possible; however, it is, unfortunately, the case that Russia is unlikely to implement the required reforms, since they go against the interests of the ruling elite.

This argument is especially clear with respect to Russia’s economic problems – that Aleh Tsyvinski and I analyzed in the first chapter of the book. In the short run the Russian economy is certainly doing quite well. So long as oil prices stay high, the budget remains balanced, the economy grows, and sovereign debt is virtually non-existent (in marked contrast with debt burdens of OECD countries). Contrary to what is claimed by many critics of the government, pre-crisis growth did trickle down to all parts of Russian society, and that has ensured that the government enjoys sufficient political support.

However, in the long run, the situation is very different. The pre-crisis sources of economic growth (rising oil prices, low capacity utilization and an underemployed labor force) have all been exhausted. Oil prices are high, but are unlikely to rise much further. Production capacity and infrastructure are over-utilized. The labor market is very tight. In order to grow at the rates, which Korea and other fast-growing countries achieved when they were at Russia’s level of development, Russia needs new investment. Hence, Russia has to improve the business climate and the investment climate. This, in turn, depends on reducing corruption, improving protection of property rights, building an effective and independent judiciary, and opening the economy to competition (both domestic and international).

Good Policy, Bad Policy

The changes that are needed in order to ensure strong growth are obvious, but they are unlikely to happen. The reason is very simple: the political equilibrium is such that Russia’s political elite is not interested in change. There is nothing unusual about this. As Bueno de Mesquita et al. (2003) have argued: good policy may be bad politics and vice versa. If achievement of economic growth depends on surrendering control over the commanding heights of the economy (through privatization, strengthening the rule of law, deregulation, and encouragement of competition), the ruling elite may fear a weakening of its hold on power and ultimate loss of power as the price of achieving growth. In this case, the ruling elite will prefer to stay in charge of a stagnating economy (and enjoy a big piece of a small cake) rather than risk losing power (and having no piece of a bigger cake).

Can society somehow buy out the vested interests of the rulers? One of the most powerful theoretical results in economics, the Coase theorem, would suggest that the answer is yes. However, the conditions of the Coase theorem are not met in the instance of political economy, which we are considering. In our case the ruling elite does not merely trade goods or even assets: by allowing reforms it would lose the power to expropriate and protection from being expropriated. Unsurprisingly, there is no “political Coase theorem” (see Acemoglu, 2003).

As we discuss in Guriev et al. (2009), this problem is particularly acute in resource-rich transition economies without established political and legal institutions. In such economies, the lack of institutions means that the rulers are less accountable and can therefore appropriate a large share of the resource rents. The resource rents increase the incentives to hold on to power and provide the rulers with the resources which they need in order to maintain the status quo.

In the opening chapter of “Russia After the Global Economic Crisis”, Aleh Tsyvinski and myself argued that this is precisely Russia’s problem. We punningly defined the status quo as a “70-80 scenario”: if the oil price stayed fairly high ($70-80 per barrel) then Russia would be likely to follow the 1970-80s experience of the Soviet Union, when reforms were shelved and the economy stagnated. That period ended with the bankruptcy and disintegration of the Soviet Union.

Certainly, the differences between modern Russia and the 1970-80s Soviet Union are substantial. Although the government controls the commanding heights of the modern Russian economy, the nature of the latter is capitalist and not command. Also, Russian economic policymakers are much more competent and, unlike their Soviet predecessors, they can easily believe that if a country runs out of cash, the government is removed from office: they have seen it happen to those same Soviet predecessors.

This brings us to a conundrum: if it is clear that the status quo is a dead-end, what is the ruling elite hoping for? On the one hand, the elite understands all too well that reforms are risky – everybody remembers the last Soviet government, which initiated change and lost power as a result of that change. On the other hand, it is clear that in order to remain in power the government needs growth and that growth can only come from reforms.

Rational Overconfidence

The solution to this conundrum is to be found, not in modern political economics, but in the realm of behavioral economics and studies of leadership. In recent years, economists have been keen to integrate insights from psychology into their models of markets and organizations.

Psychologists know very well that human beings want to be happy, and are therefore disposed to forget bad news and remember only good news. They also like to persuade themselves that they are good (or at least better than others). This explains why investors always want to believe in more optimistic scenarios (hence bubbles, see Akerlof and Shiller, 2009). Furthermore, a certain degree of over-optimism on the part of leaders is actually “rational” or “optimal” (see Van den Steen, 2005, and Guriev and Suvorov, 2010). Over-optimistic leaders are more resolute, and they attract more capable and enthusiastic followers. In this sense, in an environment with weak political institutions, over-optimistic political leaders always crowd out more realistic leaders (who do not promise as much). Where there are strong political institutions that ensure political accountability (e.g. via political parties), this behavior is not sustainable. But if there is no accountability, over-optimism almost inevitably prevails as a result of political selection.

This may explain why the Russian political leadership hopes for the better. So far the model “whenever we are in trouble, the oil price goes up and saves us” has worked, and it will keep working until the oil price goes down and undermines both macroeconomic and political stability. Once again, resource abundance is important as it helps to feed the over-optimism: the fortunate leaders that rule during the period of high oil prices can easily believe that their luck is permanent and their belief (or, as the leadership literature calls it, “vision”) will be consistent with the evidence – but only until the oil price plunge.

The 70-80 Scenario: Two Years On

We started to write the 70-80 chapter in the fall of 2009, when the oil price was already back from $40 per barrel to the fiscally comfortable range of $70-80 dollars. What has happened since then to the likelihood and sustainability of our scenario?

What we find is that, although the 70-80 pun no longer works, our main argument has been reinforced. First, the oil price is no longer in the range of $70-80 per barrel, but has risen higher due to events in the Middle East and Japan, as well as increased demand for oil as a store of value reflecting diminished confidence in dollar and euro assets. Second, the Arab Spring has made the Russian government suspect that its hold on power is more tenuous than it previously believed, and it has started to spend even more aggressively. Russia’s budget is no longer in surplus at $70 per barrel: it can now only be balanced if the oil price is at $125 per barrel (!). In this sense, $70-80 per barrel is no longer a “high” price – it is both below the current market’s expectations and below the Russian government’s fiscal benchmarks.

However, our main argument has been reconfirmed. High oil prices have encouraged the Russian government to become further entrenched in the status quo scenario. While there has been a substantial increase in rhetoric about privatization, deregulation, competition, rule of law etc., actual change has been lacking. On the contrary, there is increasing reliance on government ownership and increasing probability that Russia will move further down the road to stagnation after the presidential elections of 2012.

Can There Be An Alternative to Stagnation?

In “Russia After the Global Economic Crisis” we also charted an alternative scenario based on reforms that help to realize Russia’s substantial growth potential. Is this scenario feasible? Certainly, the laws of political economy are not deterministic. Even though the status quo path is preferable for the country’s rulers, a leader (or a sub-group in the elite) may emerge who is long-term-oriented and is not over-optimistic. If this leader or group manages to create a critical mass of stakeholders for reforms, there may be a “run” on the status quo. For example, if the oil price decreases and there is fiscal pressure to privatize, then a critical mass of private owners may emerge who are interested in protection of property rights and the rule-of-law.

However, even though a positive scenario is possible, it is not very likely. Investors have already reached this conclusion: Russia has been experiencing large capital flight since the fall of 2010 (net capital outflow is about of 5% of GDP). Investors are not yet ready to bet their money on the good scenario. Nor would political economists recommend them to do so.

References

  • Acemoglu, Daron (2003). “Why Not A Political Coase Theorem? Social Conflict, Commitment, And Politics,” Journal of Comparative Economics, 31: 620-652.
  • Akerlof, George A., and Robert J. Shiller (2009). “Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism”. Princeton University Press.
  • Åslund, Anders, Sergei Guriev and Andrew Kuchins (2010). Russia after the Global Economic Crisis. Peterson Institute for International Economics. Washington, D.C.
  • Bueno de Mesquita, Bruce, Alastair Smith, Randolph M. Siverson, and James D. Morrow (2003). “Logic of Political Survival”. MIT Press.
  • Gilbert, Daniel (2006). “Stumbling on Happiness”. Knopf.
  • Guriev, Sergei, Alexander Plekhanov, and Konstantin Sonin (2009). “Development Based on Commodity Revenues.” European Bank for Reconstruction and Development Working Paper No. 108. Available at SSRN: http://ssrn.com/abstract=1520630 (Also available as Chapter 4 in the Transition Report 2009).
  • Guriev, Sergei, and Anton Suvorov (2010). “Why Less Informed Managers May Be Better Leaders.” Available at SSRN: http://ssrn.com/abstract=1596673
  • Van den Steen, Eric J. (2005). “Organizational Beliefs and Managerial Vision.” Journal of Law, Economics, and Organization, 21: 256-283.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

A Multidimensional Approach to Energy Security in Belarus

Posted on September 5, 2011 | Policy Brief

20110905 Policy Brief Energy Security in Belarus Image 01

Energy security is a complex phenomenon incorporating a variety of economic, social and environmental aspects. This brief outlines fundamental aspects of energy security in Belarus that decision makers, policy analysts and the general public should be aware of when trying to understand the consequences for energy security of existing and suggested policies as well as other domestic and external factors. This brief will pay special attention to the economic dimension of energy security (such as energy intensity of the economy and diversification of energy sources), international and geopolitical dimension (diversification of energy suppliers and use of the hydrocarbon pipeline system), as well as environmental considerations (actual and prospective environmental impact of the energy consumption and production).

Energy security is an issue of primary concern for decision-makers worldwide. This is especially true in many post-Soviet countries, where the current dependency on Russian energy imports is being reinforced by the high energy intensity of these economies – a legacy of the energy inefficient Soviet technologies coupled with a lack of technological modernization over the past two decades. Belarus, a landlocked country with a population of 10 million people, is one of the countries struggling to solve an energy security puzzle in the midst of perturbations of the energy markets and important changes in regional geopolitics.

Belarus’ economy has been growing steadily in the early 2000s with an impressive 7.7% average annual GDP growth – a figure surpassing the economic performance of its closest post-Soviet neighbors, Ukraine (7.6%) and Russia (7.5%). The 2010 economic crisis resulting in substantial downturns in Ukraine (-15.0%) and Russia (-7.9%), had very mild impact on the Belarusian economy, which grew 0.2% in 2010.

Despite the apparent robustness of the Belarusian economy as compared to its neighbors, the crisis revealed a major weakness of the Belarusian economic model, the country’s utmost dependence on economic and political relations with Russia. Belarus is trying to move away from the Russia-centered economic model, in an attempt to diversify the sources of its economic growth. Not surprisingly, Russia is using a number of economic and political levers, of which oil and natural gas are the most important ones, in an attempt to tame a rebellious ex-vassal.

As a result, Belarus recently faced a variety of new energy challenges that must be successfully tackled for the country to preserve its political and economic independence.

The Belarusian Economic Growth Drivers

Belarusian economic growth in the late 1990s-early 2000s was primarily driven by the combination of three main factors: (i) privileged access to Russian markets for Belarusian industrial and agricultural exporters and energy importers; (ii) preferential support of the enterprises and sectors with a large state share, especially those producing for export, and (iii) governmental policies on wage and price control, which resulted in temporary cost advantages for traditional exports (WB 2005). These factors were reinforced by the low capacity utilization that experienced a sudden drop in the early 1990s as the Soviet Union collapsed.

Immediately prior to the 2010 economic downturn, productivity growth was the main driving force of the industrial growth in Belarus (WB 2010a). For most economies in transition, productivity growth is driven by (i) productivity increases within the firms and (ii) labor reallocation. In Belarus, most of the productivity increase occurred due to the former driving force. Recent data show that productivity growth is slowing down – a sign that productivity improvements has so far been gained through “low hanging fruit” type of investments, but these are now coming to an end. (WB 2010a).

Productivity growth in 2004-2008 was reinforced by increasing capacity utilization from approximately 45% in 1996 to 57% in 2004 to almost 70% in 2009. Yet, it is commonly perceived that most of the underused capacities are outdated and need rehabilitation or replacement. Thus, the actual figures of the unused capacities may be well inflated. Therefore, the years of reclaiming unused capacities will soon become history, and Belarus is gradually approaching a point at which output growth would require either costly capacity expansion or increase of capacity-usage efficiency. Of these two alternatives, improvements in energy efficiency are the one that does not show signs of being exhausted in the near future.

Belarusian energy efficiency increased by nearly 50% between 1996 and 2008 as the government began designing and enforcing a comprehensive energy efficiency policy. The measures included among others (i) establishing a Committee for Energy Efficiency in 1993, which evolved into Energy Efficiency Department of the Committee for Standardization with a mandate to develop and implement the energy efficiency improvement strategy; (ii) substantial financing, amounting to USD 4.2 billion in 1996-2008 and USD 1.2 billion in 2008 alone ; (iii) political commitment to energy efficiency, as illustrated by two National Energy Savings Programs approved in 1996 and 2001 respectively and the 1998 Law on Energy Savings (WB 2010b).

Currently, Belarus’ energy intensity is the lowest compared to the neighboring CIS countries (see Figure 1). Specifically, in 2008 Belarus used 1.17 tons of oil equivalents (toe) to produce USD 1,000 of its GDP – a substantial advantage compared to Ukraine’s 2.55, Russia’s 1.60 and Moldova’s 1.50 toe/USD 1,000. Yet, despite substantial recent progress and good standing in its regional sub-group, Belarus is still far from its energy efficiency potential, as showed by comparison with the closest Western neighbors: Poland and Lithuania use respectively 0.41 and 0.46 toe/USD1,000 (IEA 2010). Economic modeling suggests that a baseline scenario of 50% decline in energy intensity within the next decade would be a source of an additional annual GDP growth by 3.5-7%.

Currently, as implicit subsidies from Russia in the form of cheap oil, natural gas and electricity diminish, economic growth induced by the productivity increase, and capacity reclaiming is being exhausted, it becomes apparent that the search for new sources of economic growth must incorporate energy security considerations.

Overview of the Energy Security Dimensions in Belarus

Energy security is a multidimensional issue, which requires considerations with respect to:

  • Primary energy sources distribution
  • International trade and the geopolitical context
  • Impact of energy on the environment

I will review them in turn.

1. Primary Energy Security Dimensions in Belarus

A reasonable diversification of energy sources results in a more sustainable energy model of the economy.
Currently, Belarus’ primary energy source is natural gas, which accounts for 63% of its energy supply (see Figure 2). Natural gas is primarily used for heat production (55% of the total natural gas supply) and electricity production (20%). Over 80% of Belarusian centralized heating stations use natural gas and nearly 95% of electric energy in the country is produced with natural gas as a primary fuel.

Notes to figure 2:

  1. The percentage scores may not add up to unity due to independent rounding, other omitted uses and secondary supply sources.
  2. Net of exports.
  3. Combustible renewables and waste.
  4. Combined heat and power plants.

The second biggest share (29%) is crude oil and petroleum products, mainly used in the transport sector as well as the residential, commercial and public services sectors. All other primary energy sources account for less than 10% of the total primary energy supply. Renewable sources of energy are virtually unused in Belarus.

In sum, the analysis of the Belarusian energy balance reveals a disproportionately large share of natural gas use, especially in electricity and heat generation. It is therefore clear that, in the context of emerging tensions over the imported Russian natural gas, substantial changes in the electricity and heat generation sector will be needed.

2. International Trade Considerations and Geopolitical Context

Belarus produces only 14% (4 Mtoe per year) of its total primary energy demand and nearly 15% of its oil and gas consumption, thus being totally dependent on fossil fuels imports from Russia. Prior to the escalation of the conflict with Russia, almost the entire demand for natural gas and oil was satisfied by Russian imports at discounted prices, which was often viewed as an implicit subsidy of the Belarusian economy. Currently, Russia is reducing these implicit subsidies by narrowing the gap between prices charged to Belarus and to the EU.

An important difference between natural gas imports and oil imports is that while natural gas imports are entirely consumed by the Belarusian domestic market, a large share of crude oil imports is processed and exported as petroleum products (see Table 1). Therefore, while reducing dependency on Russian gas imports may be achieved, to a large extent, by a transition to alternative energy sources and improvements in energy, the same approach is unlikely to work for oil imports, since no transition to other sources of energy is possible for oil refineries and efficiency increase is limited to losses minimization. Thus, the only alternative to reduce dependency on Russian oil imports is diversification of oil suppliers.

In early 2010, the Belarusian government has signed an agreement with Venezuela on continuous supply of crude oil to Belarus. The first delivery was made by a railroad transfer from the Ukrainian sea port of Odessa; the following deliveries were made through the Estonian Muuga seaport and the Lithuanian Klaipeda seaport by railroad. Belarusian government has announced that it expects nearly 4 million tons of Venezuelan oil to be delivered in 2010, and the quantity is expected to grow to 10 million tons (i.e., 42.5% of the current oil imports) in 2011 and onwards. The average price for Venezuelan crude in 2010 was USD645 per ton (compared to USD 402 per ton of Russian oil), according to the national statistics committee.

Land transport of Venezuelan oil from seaports remains the most questionable issue. While railroad transfer proved to be a reasonable intermediate solution, a sustainable and cost-efficient transportation of Venezuelan oil is possible only through pipelines. Although the Lithuanian and Latvian legs of the former Soviet Druzhba pipeline system can be used, they require major investments to allow for reverse transfer from Baltic seaports to Belarus. The Ukrainian Odessa-Brody oil pipeline, in reverse direction, is the most likely route for a large share of Venezuelan oil, as Ukrainian government signed an agreement with Belarus for transfer of 9 million tons of Venezuelan crude in 2011. Yet, the deal is heavily threatened by Russia which was using the Odessa-Brody pipeline in the opposite direction until 2010 and is losing an important lever of influence over Belarus as the country diversifies its oil imports.

Another crucial energy security consideration from the geopolitical perspective for Belarus is its own pipeline systems (see Figure 3 below).

In 2009, nearly 62.2 billion cubic meters of Russian natural gas (36.9% of total Russian natural gas exports to the non-CIS countries) and 89.6 million ton of Russian oil (36.2% of total Russian crude exports) went through Belarusian pipelines. For comparison, Ukraine, another major transfer route for Russian hydrocarbons, transports 95.8 billion cubic meters of Russian gas (56.9% of Russian exports) and nearly 30 million tons of Russian crude (12.1% of Russian exports). Thus, almost the entire (93.8%) Russian natural gas exports as well as a substantial share of Russian oil exports (48.3%) are transported via Ukrainian and Belarusian pipeline systems.

Until recently, Belarusian oil and gas transit capacity has been a powerful lever in its relationships with Moscow. In an attempt to diversify its hydrocarbon export routes, however, Russia has announced the construction of an alternative Nord Stream pipeline system (see Figure 4) in 2005. The two-legged 1,200 km pipeline system will transport natural gas from Russian Vyborg to German Greifswald under the Baltic Sea, thus making it the longest sub-sea pipeline in the world. Each leg has a projected capacity of 27.5 billion cubic meters per year (55 billion cubic meters for the entire system). The first leg is projected to be in full operation by late 2011, the second by late 2012.

Although the Nord Stream transfer capacity is below the annual transfer of natural gas through Belarus, it represents an important strategic instrument in Russian foreign policy to manipulate Belarus and Ukraine as they compete for a residual share of the Russian natural gas transfer. Recent trends in European energy security policy headed towards increase of energy efficiency, diversification of hydrocarbons importers and shale gas revolution will undoubtedly lead to a decrease in the European demand for Russian gas, which, in the worst case scenario, may completely eliminate Belarus from the Russian gas transfer system, as Belarusian and most of the Ukrainian gas pipeline capacity become redundant.

3. Impact of Energy on the Environment

Belarus lies around the average, both in Europe and in the Eastern European region, when it comes to pollution intensity of its energy use, (see Figure 4 below). While there is room for improvements in terms of the impact of energy on the environment, this concern is of second order as compared to the above discussion on energy intensity. Moreover, it is believed that improvement of energy efficiency of the economy through implementation of modern technologies will bring along reduction of pollution intensity as well.

Despite the fact that current environmental implications of energy use are not especially worrisome, Belarus still remains one of the countries that suffered the most severe consequences of the 1986 Chernobyl nuclear power plant accident.

About 20% of Belarusian territory was affected by the accident and nearly 17% of its agricultural land. Costs to the economy are estimated in the order of 32 to 35 times the Belarus state budget in 1985. Nearly 22% of the national budget was spent in 1991 on remediation measures, although the figure has contracted to 6% in 2002 and 3% in 2006%. The total spending of Belarus due to consequences of the Chernobyl disaster over the period 1991-2003 exceeded USD 13 billion.

Besides the direct impacts on health, several social problems followed the worst civil nuclear accident, including the loss of rural livelihoods and outward migration of qualified workforce accompanied by inward migration of unqualified workforce and people who have economic difficulties elsewhere. A significant amount of agricultural land in the area of the radioactive fallout is still unavailable for cultivation. Development of the area remains a challenge, especially in small towns accommodating migrants from outside Eastern Europe, predominantly from Central Asia. Radioactive pollution is still a concern in the affected areas.

Not surprisingly, Belarusian population remains cautious about plans to construct the first nuclear power plant in Astravets, in the Hrodna Voblast, as nuclear power is still considered a source of substantial risks, despite extensive media campaigns and policy assurances on the exceptional nature of the Chernobyl accident.

Concluding remarks

A changing geopolitical context and gradually shifting priorities in the Belarusian foreign policy will undoubtedly affect various dimensions of the energy security of this transitional Eastern European country.

When evaluating consequences of external or internal factors for energy security, it is necessary to keep in mind that this is a complex, multifaceted issue. The main concerns to be considered about Belarusian energy security include primary energy source distribution (diversification of energy sources, especially away from natural gas, and reduction of the economy’s energy intensity), international trade and geopolitical context (with a special focus on diversification of energy suppliers and an optimal use of the country’s gas- and oil- transporting systems) and environmental considerations of the energy use (related to both actual and prospective impact of the energy production and consumption on the environment). Other dimensions of relevance include social impacts of the energy production and consumption, sustainability of the energy use another important elements beyond the scope of this brief.

The main trends that will alter energy security in Belarus within the coming decade most likely will include the shale gas and liquefied natural gas (LNG) revolution, the launch of the Nord Stream, possibly the construction of the Astravets nuclear plant as well as the effort of Belarus to diversify hydrocarbon suppliers.

In the next part of the analysis forthcoming in the FREE policy brief series I will analyze in detail these and other existing trends and will discuss their potential positive effects and challenges as well as potential measures for addressing the adverse effects in the context of energy security of Belarus.

Recommended Further Reading

  • Cherp, A, A. Antypas, V. Cheterian and M. Salnykov. 2006. Environment and security: Transforming risks into cooperation. The case of Eastern Europe: Belarus-Moldova-Ukraine. UNEP/UNDP/UNECE/OSCE/REC/NATO Report.
  • Chester, L. 2010. “Conceptualizing energy security and making explicit its polysemic nature”. Energy Policy, 38(2): 887-95.
  • CIA (Central Intelligence Agency) 2010. CIA World Factbook. (https://www.cia.gov/library/publications/the-world-factbook/fields/2003.html)
  • IEA (International Energy Agency) 2010. “Key World energy statistics”.
  • WB (World Bank) 2005. “Belarus – Window of opportunity to enhance competitiveness and sustain economic growth – a Country Economic Memorandum for the Republic of Belarus”.
  • WB (World Bank) 2010a. “Belarus – Industrial performance before and during the global crisis: Belarus economic policy notes.”
  • WB (World Bank) 2010b. “Lights out? The outlook for energy in Eastern Europe and the former Soviet Union”.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.