Did an Oil Crisis Cause the Transition in the Soviet Union?
If Marxist-Leninist Communism was so inefficient, then why did it last in one form or another for over 70 years in Russia and the Soviet Union before it finally died. Did it last so long because inherently it provides a good economic system or did it last so long because inherently it was not as inefficient as we are made to believe, but that some other circumstances caused its demise? We believe the latter. The Soviet system was not spectacularly inefficient and was an adequate, though far below average, system for running an economy. As long as there were plenty of resources, the Soviet economy could continue running. However, rather like a gas-guzzling car, the planned economies became spectacularly inefficient in the face of resource scarcity, particularly oil scarcity. A planned economy is not flexible enough to reallocate quickly scarce resources that suddenly decline in production.
We believe it is no coincidence that Soviet oil production declined by 30% from 1988 to 1992, BP (1996), precisely during the time when the break up and capitalist transformation was occurring. Furthermore since 1992, Russian oil production has declined an additional 20% or more and during that time Russia's recession has worsened. Most analysts see cause and effect during the Soviet transition as being one of the transition of the economy causing the oil production decline. We however believe it is the opposite. It was the oil production decline that caused the final break down of the Soviet economy. The collapsing Soviet economy then caused the break up and political change of the Soviet System. Certainly, there were many factors that played a role in the fall of the Soviet Union. However, there is no bigger fly capable of breaking a camel's back than oil.
In 1973 and 1980 when the West went through huge economic problems due to oil price shocks, the Soviet Union did not appear to have nearly as large of problems. The West went through an incredible oil crisis, which was discussed and analyzed to incredible lengths, yet the Soviet Union continued relatively unfazed. This was because the Soviets had plenty of oil at that time to fulfill their own needs and even enough surplus to export. Even during the so called Soviet "oil crises" of 1977-1982 and 1982-1988, Gustafson (1989), the Soviet Union did not have decreasing oil production except for a slight decrease in 1984. During both periods the Soviet Union could cover consumption and exports and the economy was not greatly affected. However, by 1989 that had changed. Finally the Soviet Union faced the same economic crisis that the West had already endured in order to allocate its oil more efficiently.
In 1989, official Soviet oil consumption was higher than the former Soviet Union's entire oil production of 1993 (BP 1996). Also in 1989, the Soviet Union officially exported 30% of its oil, and much of that export was to the Eastern European satellites. Together the Soviet Union and Eastern Europe consumed roughly 20% more oil in 1988 than they produced in 1993. The only way that the Soviet Union could have possibly survived such an oil production decline crisis, not to mention a complete loss of oil export revenue for hard currency, as well as cut its internal consumption, and cut off Eastern European exports, would be to shift to a market economy. The Soviet Union did exactly that. First, the Soviet's cut off Eastern Europe from receiving cheap Soviet oil and forced them to pay in hard currency prices. Then when that was not enough the Soviets themselves had to allow internal oil prices to rise. This forced the Soviets to follow the same transition that Eastern Europe did. Indeed, Soviet and post Soviet oil consumption declined a staggering 50% from 1985 to 1995. However, the transition was not by choice but by brute economic force.
In this paper will be shown first the theories for the fall of the Soviet Union, then why oil is important to an economy, and then how oil affects economic growth. Specific facts about the Soviet oil crisis and Soviet and Eastern Europe economic decline will be shown. Finally, the paper will explain why Soviet oil production declined, which was not because of inefficient Soviet planning, but rather because of scarcity.
THE COMPETING THEORIES
The classic economic explanation for the decline and break up of the Soviet Union is given by Kotz and Weir (1997). They argue that it was economic stagnation that precipitated political changes towards democracy. We agree with their analysis but add one more element to the economic sequence of events, which is an oil crisis. Other variations of the economics of the Soviet transition can be found from Krueger (1993), Kafouros (1996), Ellman and Kontorovich (1992), and Osband (1992). The sequence of events is as follows:
An alternative theory of the collapse of the Soviet Union has to do with military buildups, see Brown (1992). In this model, we have the same economic stagnation as before, but it is made worse due to more and more resources being poured into the defense industry. As defense gets a bigger piece of the Soviet pie, there is less investment in capital. The total pie gets smaller, leading to economic and then political collapse. America's own defense industry has made claim that President Reagan's military expansion helped caused this. The theory suggests that the US military buildup induced a Soviet escalation of its own military power. The Soviets, trying to keep up with the West, starved their economy of needed investment, speeding up their economic decline.
These general explanations however do not explain why the break up occurred exactly in the late 1980's and early 1990's. The idea that wages were allowed to rise but prices were kept constant does not take into account the thriving black market that occurred during this time. See FBIS (1990). Nor does the theory explain why it was that the Soviet authorities started the process of glasnost in the first place and choose to raise wages all of a sudden in the late 1980's. The reasoning becomes circular: Soviet mismanagement caused Soviet mismanagement. At any rate, since a black market existed throughout the Soviet economy, we cannot use Soviet planning as the singular cause for its monumental decline. Black markets are powerful economic structures that can overcome the most fool hardy of policies. Furthermore, the Soviet and Eastern European economic decline did not start in earnest until right at 1989, and all factors mentioned existed before 1989. For example the Soviet military had always taken a larger percent of GDP than the United States did for defense expenditures, even as far back as the Russian revolution. Furthermore, the Soviet military was always behind the West technologically, so they knew they could never gain an advantage nor even close the gap. Hence, we are left searching for an alternative reason for the events of 1989 to 1991. There must be a more definitive cause and effect scenario for how and why the collapse of the Soviet Empire happened at the exact time that it did.
THE ROLE OF OIL
We believe a more fundamental problem in the economies of Eastern Europe and the Soviet Union was the decline in Russian oil production. Russia was the main oil producer for the communist countries, and its production decline pushed the Soviet and Eastern economies over the brink of disaster, causing the collapse. What is more, the oil production decline did not stop with the break up but has continued to this day, exacerbating the economic problems of Russia and the former states. Certainly much of the economic stagnation in the 1970's and 1980's was caused by the end of industrialization and the lack of innovation. Possibly military defense spending did play a role in further economic collapse, and as Dallin has said, Gorbechev and his policy of glasnost were a big factor in changing Soviet society since this allowed people to feel freer to react politically and express their desire to change communist rule. However, like Weir and Kotz, we believe the final cause of the break up was economic decline. In addition we believe the final decisive economic event-the final straw that broke Soviet economics-was the decline in oil production.
Consider first how valuable oil is as an input into production. Gisser and Goodwin (1986) show that the price of oil significantly affected the growth rate of the US economy. Boyd and Caporale (1996) show that not only oil prices affect economic growth but even the uncertainty of oil prices can affect growth. Trying to make a transition from using oil, to using alternative energy resources such as coal or gas, there is bound to be a price rise for oil and such a price rise would have to create economic problems. It did so for the West. It would also have to be true for the Soviet Empire.
In order for the Soviet Union and Eastern Europe to overcome the loss of oil, their economies would need new technology, more innovation, and greater allocation efficiency for their oil resources; and only a rise in prices could make that happen. In the final years of the Soviet Empire, exactly from 1988 to 1992, the command economies were being forced either to use less oil, to switch to alternative energy sources, or to do both, and in a very short amount of time. This was a fast sudden collapse. The price of oil had been artificially set much lower than the world price and much lower than its scarcity value within the communist system (Balabanov and Deitz 1991). This low price coupled with virtually unlimited supplies up to the 1980's, subsidized the Soviet and Eastern European economies. However, once the oil became scarce, both due to continued small economic growth and due to languishing supplies, internal oil price had to go up. This created an oil crisis.
Consider the history of the Soviet economy all the way up to and past its break up. In particular compare the Soviet and US economies in relation to oil consumption. We look at oil consumption statistics rather than price statistics because the Soviet Union kept internal oil prices artificially low and constant. In addition, oil consumption statistics within the Soviet Union are generally correct but not necessarily very accurate due to the desire to show high growth in every sector of the economy. It is therefore not possible to econometrically relate oil statistics to economic growth, especially since other changes in the economy were occurring simultaneously. Never the less according to the CIA, Soviet oil consumption was increasing at roughly a 7% per year rate and oil production at roughly an 8% per year rate from 1960 to 1975 (CIA 1985). During that time the CIA estimates that the Soviet Union had a roughly 6% rate of economic growth. From 1975 to 1980, the Soviet Union had a much lower 4% per year increase in use of oil and only a 3.5% increase in yearly production. This is the time when Soviet growth fell to 2.6%. From 1980 to 1985, the Soviet Union had no increase in oil consumption and a slight decline in oil production. At that time economic growth fell to 1.8% per year according to CIA estimates. See CIA Directorate of Intelligence (1988). Finally, from 1988 to 1992, Soviet and post Soviet oil production collapsed, as did consumption. At that time both Eastern Europe and the Soviet Union and the Former Soviet Union went into severe economic decline. What is striking about this period is that production declined first then consumption not the other way around. If one was to expect an economic crisis causing an oil production decline, then the reverse would happen.
In fact growth and decline of an economy and the growth and decline of oil consumption go hand in hand. Consider the US. From 1960 to 1973, the US had a 7% growth in oil consumption and a 5% economic growth rate. From 1973 to 1975 the US consumed roughly 6% less oil and had a recession with a 6% economic decline due to the oil price shocks. From 1975 to 1979 the US oil consumption rate increased at about 6% per year while there was simultaneously a 5.5% per year growth rate. Then starting in 1979 another set of oil price shocks started more oil conservation. From 1979 to 1982, US oil consumption declined at an incredible 5% per year, with no growth in the economy during that period, and a major recession (EIA and Economic Report to the President various years).
The US experience as well as Western Europe's points directly to a link between oil availability and growth especially in the short run. In western economies, availability of a resource is determined by price. In planned economies, only quantity determines availability. High oil prices definitely affected the US and other free economies. The same must have been true for the Soviets. In the West, oil scarcity was visible due to the skyrocketing oil prices. This induced oil conservation, at the expense of going through two major recessions and lower overall growth rates since 1973. However, the Soviet Union had to make the same kind of adjustment. They had to have a similar short run shock in order to more efficiently use oil. They had to have an oil crisis. Their oil crisis though was much less visible due to regulated prices, the confusing price structure put on everything, and the hyperinflation that the government resorted to during the transition. Still the Soviet's had to go through the same oil conservation transition that the rest of the world had already made in the 1970's and early 1980's, only they had even less flexibility than the US for adjusting to input scarcities. Designs for fuel efficient capital and transportation as well as the implementation of fuel efficient methods of production and transportation could not possibly be developed and implemented as fast in a planned economy as it could in a free market economy. This is why many of the Soviet party elite in the final days pushed ever harder for more openness and especially freer markets.
This brings up the peculiar dichotomy that existed between East and West during the tumultuous 1970's and 1980's. In the mid 1970's from 1973 to 1975, almost the entire world was having severe economic troubles due to the oil price shock. The Soviet Union and Eastern Europe though seemed relatively well off all be it with some stagnation during this time. Their economies appeared less traumatized. There was no rioting or policies to reduce military outlays drastically. By contrast, the West was full of energy talk and was grasping for ways to overcome energy shortages. The US even hints at a military strike against Saudi Arabia in order to occupy the oil fields, TIME (1975). No such ideas were coming from Russia. Then in the late 1970'as the Western economies seem to be back on track, the Soviet Union staggers a bit economically.
In the early 1980's, the West again went into disruption with another round of oil price shocks. All the leading countries endured a recession. Yet the Soviet Union, while somewhat staggered, seemed to ride through the 1980's price shocks with no serious disruptions. In fact, they were helped by the oil price increases so that they could trade oil to the West for Western goods and technology. Only Poland and maybe some other eastern European countries were affected at this time. Finally, the end of the 1980's came with most western economies flying high, but with Eastern Europe and the Soviet Union experiencing economic and political collapse. We are left to wonder why the East was insulated from the same oil troubles that the West had experienced, only to collapse so suddenly out of thin air when the western economies were doing so well.
The differences are much clearer when we consider oil consumption patterns. Every time the West went into a recession during this period, it was because it was forced to consume less oil due to high oil prices. However, the communist planned economies had enough oil during those times. Finally, however, the Soviet Union and Eastern Europe were forced to use less oil at the end of the 1980's. Their oil crisis finally erupted. Now we can understand the dichotomy between East and West. The Western recessions occurred during times of decreased oil use. The same was true for the East. However, the Western periods of transition were at different times then the Eastern periods because the two sets of economies were virtually cut off from one another. The East was dependent on Soviet oil while the West was dependent on Middle Eastern Oil. The oil scarcity of East and West happened at different times and this is why the growth rates were affected at different times. The most severe decrease in oil production in the East started in 1989, which undoubtedly had a huge stagflationary affect on the Eastern economies.
If we consider the time period of the mid-1980's to the mid-1990's, Soviet and former Soviet oil production declined from a high of 12.66 million barrels per day in 1987 to a low of about 7 million barrels per day in 1995 (BP 1996). Eastern Europe and the Soviet Union combined consumed about 10 million barrels of oil per day or more in 1987. Today they have managed to cut consumption to roughly 5.5 million barrels of oil per day. That is almost a 50% cut in ten years. If, however, the command economies had continued to depend exclusively on Soviet oil, then they would have either had to import oil at the rate of about 3 million barrels per day or make their economies more oil efficient by 30%. Could they have managed that? The Eastern economies had virtually nothing of value to export to pay for so much oil. On the other hand, even the Western economies during the height of the second oil crisis could only manage a 20% reduction in oil usage while they became more oil efficient. Yet that 20% reduction caused monumental problems for the West. How could planned economies have faired better? The planned economies would have had to experience an even more painful transition than the West. In fact, they did. They freed their economies, however, it was virtually impossible-not to mention hypocritical-to follow the tenets of any communist ideology with government ownership of everything and then suddenly change to a free market economy.
Therefore, in order for the Soviet Union and Eastern Europe to become more oil efficient, as quickly as possible, they were forced to change to a market economy and then democracy. Furthermore, intense discontent of the population due to the oil crisis and economic downturn, as well as a lack of military resources for internal control, made it virtually impossible to hold on to power. To summarize, the period 1988 to 1992 was the world's third oil crisis in 20 years. This one brought down the powerful Soviet Empire.
Unfortunately, for the communist party, the free market push did not go fast enough. From 1988 until 1992, Soviet oil production fell an astounding 9% per year. These were the exact years of the fall of most of the communist governments in the Soviet sphere as well as the break up of the Soviet Union itself and the fall from power of the Soviet communist party: the economy of the Soviet Union, the post-Soviet states and Eastern Europe crashed by the same magnitude of force as the oil production crash. The exact level of economic decline in the Soviet and post-Soviet world is difficult to say, given the inexact statistics and currency changes. Never the less, it would be difficult to refute the fact that these two incredible events of economic decline and oil production decline occurring at exactly the same time were not related. Furthermore, given the magnitude by which the Western economies were affected by their oil crisis, the Eastern economies would have been even more affected since they could not adapt as easily as the West had and because they had to reduce oil consumption even more.
The most startling aspect of the oil crisis in the Soviet Union after 1988 is that it is oil production that declines first and then oil consumption. If one were to have expected oil production to decline due to an economic crisis, then the economic crisis would first cut consumption significantly long before it would have affected production. This did not happen. First Soviet production began declining then oil shortages appeared and then came an economic crisis finally followed by huge consumption declines. If the Soviet Union had transformed itself in 1980 or 1975, then there would have been consumption declines but no production declines. It was opposite of this in the transition of the early 1990's.
We believe the cause and effect of the Soviet transition is politics reacting to oil production, not oil production reacting to politics. In the west, all the evidence suggests that politics reacted to oil prices. It had to be the same in the East. The Soviet economy was not flexible enough to cope with diminishing oil supply and higher oil prices. In the closed Soviet system, the price of oil was set artificially low relative to the outside world and to the true value of oil. When the supply production declined, oil prices had to go up inside the closed system. It was, however, hopeless to try to save a planned economy since it could never adjust to the strain. The economic problems of reducing the use of so much oil were enormous. If we acknowledge that there was indeed an oil crisis in the Soviet Empire at the time of its break up, then we must reexamine the sequence of events as outlined in the competing theories section above. We believe that point 3 of the classical model of the Soviet decline should be changed, or at least a new point should be added between points 3 and 4. The new point would explain how the economy had to adjust to an oil crisis brought on by the decline in Soviet oil production. This decline was the final and decisive push that broke up the Soviet Union and dismantled the Soviet Communist party.
THE CAUSE OF THE SOVIET DECLINE IN OIL PRODUCTION
Most analysts claim that the cause of the Soviet oil production decline was a combination of old technology, a lack of investment into the oil industry, and poor management. In addition, the break up of the Soviet Union itself and the problems of the economic transformation are also considered important factors. See Reinsch et. al. (1992). However, there is evidence to suggest that the Soviet oil production decline was natural and would have happened no matter what the Soviet Union did.
Consider first the idea of technology. It is suggested that because the Soviet Union had out-of-date oil technology that production decreased. However over time, even in a closed system such as the Soviet Union, information about technology and technology itself must increase. Soviet technology, although behind the West, was always getting better, not worse. So, consistently better technology of and by itself cannot cause lower production. Even the US since 1970 has had consistently better oil production technology and stable real prices; yet oil production has never the less declined.
Another possible cause of oil production decline is mismanagement. Again, however, the only way for mismanagement to cause oil production decline is if the level of management efficiency declines over time. There is no reason to believe that management was much better in the 1960's when oil production skyrocketed then in the 1980's when it stagnated. There is always incentive to produce more oil with a given set of inputs, whether under a communist or capitalist system. The incentive in a command system was to climb the party ladder or to become a manager or even to get paid more since the Soviets did have incentive pay systems. So incentive was always there to manage the resources the best way possible and to produce as much oil as possible. Unfortunately with oil, it is possible to produce too much. If managers over-produce oil when oil fields are initially put into production, which is suspected in Russia, then production can decline faster in later periods. In other words, Russia may have tried to produce oil too fast in the 1970's and 1980's. The over-production caused a sever decline in later oil production in the late 1980's and early 1990's. This point could be a factor in Soviet oil decline; but it cannot explain everything. It is a long run phenomenon. It did not occur over-night.
Consider, if the decision to extract too much oil in the 1970's and 1980's was the cause of the 1990's decline in production, then it cannot be the transition problems of the late 1980's that caused the oil production decline. In other words, we cannot blame the oil production decline that started in 1988 on a few years in the late 1980's. In addition, extracting oil more slowly in early periods cannot prevent an eventual oil production decline; it can only delay it. What is more, if the Soviets had extracted oil more slowly in the 1970's and 1980's, then they would have had their oil crisis earlier. Gustafson (1989) points out that two "oil crises" occurred in the late 1970's and mid 1980's. However, neither of these so called crises caused reductions in oil production except in 1984 and neither caused economic problems. It was only the decline after 1988 that caused economic problems and was a true crisis. The fact remains, scarcity caused the Soviet oil production decline, just like it caused the US oil production decline. Whether it was Soviet mismanagement or not that caused the oil production decline, oil production did decline. There was oil scarcity. The economy had to adjust to less oil, which induced economic stagflation.
Another suspected cause for the production decline is a lack of investment. However, the level of investment in new and developmental drilling according to the CIA was increasing in the late 1970's and early 1980's. Gustafson says the number of exploration wells completed increased by 6.5% from 1965 to 1975, and capital spending on oil and gas exploration increased by 27% from 1980 to 1985 with even greater increases in investment in other oil and gas infrastructure needs. Certainly if any new giant oil fields existed, they could easily have been found. Furthermore, now that the Soviet Union has collapsed and the oil industry is more privatized, no one believes that substantial increases in investment now will create greater oil production then was attained in 1988 or even 1995. Some may claim that the reign of confusion in the industry during the Soviet break up may also have caused less investment during those years and even a loss of control of management. Again however, it is impossible to believe that a very few years of less than average incentives or management or investment can cause a 50% reduction in the production of oil when before and after there is plenty of incentive, management and investment. If such a situation could happen then why did it not happen in Iran during its revolution in 1979. In Iran, the whole oil industry collapsed, but then a year later was back up to its former production level and under a new highly economically restrictive regime. Russia went from a restrictive economic regime to a more open free market regime. How can such openness create such a severe oil production decline?
Unlike other industries the demand for oil is strong due to high export prices. So unlike other industries, the Russians can sell as much oil as they produce, and if they could produce the oil in the archaic Soviet period, then there is no reason except scarcity for them not to be able to produce as much now. Also if the Soviet Union was able to transport its oil in and around Eastern Europe and export it, then there was certainly the export infrastructure to sell its oil after the collapse. The decline in production cannot be due to a decline in demand or a lack of export infrastructure alone.
However, the same arguments about the Soviet oil industry could also be heard in the US oil industry in the 1970's and 1980's: There was too much regulation, no incentive for new technology and so on. Yet the US and the USSR both had production declines, and the US endured this despite its comparatively freer market system and better property rights. Clearly since the US and the USSR had different economic systems, they should have produced oil in different patterns, but in fact they both show the exact same pattern of oil production.
Compare the Soviet oil experience to the US experience. In figure 1 is the US oil production as a function of cumulative production. Dates for important events are added. Notice that the US encountered a steep decline in oil production even though prices were very high. It cannot be the case that low oil prices or a lack of investment caused US oil production to decline. During the 1970's and early 1980's investments in US oil production and new wells increased dramatically. Yet with higher oil prices and increased investment, oil production fell. During the 1970's and 1980's there was constant talk in the US about regulations or mismanagement causing the US production decline, yet even after deregulation in 1980 and freer markets, the US production continued to decline.
Now look at Figure 2. This is Soviet oil production as a function of cumulative production. It shows the exact same pattern as in the US. There is no reason to believe that the cause of this pattern is any different than the US. The USSR had incentive to find oil just like the US. It's just that Soviet natural resources are subject to the same laws of geology and supply that the US is. Incentives such as career advancement or even selling oil on the black market all combined to induce the Soviets to find and produce as much oil as possible and it did. The technology, the incentive, and the investment existed in the Soviet Union to find oil especially after production stagnated. The cause of the Soviet and Post Soviet oil decline then has to be for a similar reason as the US, namely scarcity. The US and Russia simply have less oil. Both are mature oil producing regions.
It has also been argued that if the Soviet's had invested more into Kazakstan's Tengiz oil field or the off shore oil fields of the Caspian Sea that they could have stopped the decline in production. However at a reserve production ratio of 20 or so, the Tengiz can produce about 1 to 2 million barrels of oil a day and the Caspian may be able to double that. That is still not enough oil to compensate for the huge decline in Russian oil during the Soviet collapse. What is more, as in the case of Alaskan oil in the 1970's, these oil sources are remote and require huge new investments that will take time to get on line. Even if the Soviets had started in the 1970's to exploit these resources using western technology, it would have required a much higher internal price for oil before they could have been accomplished. In other words, there would had to have been an oil price shock within the USSR in order to start developing these resources. Such a price shock would have pushed the Soviet Union into a collapse earlier than it did.
Russia, like the US, has to be considered a mature oil-producing region. Even if some Russian arctic or offshore regions have not yet been explored, neither has some arctic and off-shore regions been explored in the US, yet no one believes that the US or Canada will have increasing oil production. Even the development of Prudhoe Bay itself did not stop US oil production decline after 1970. So what chance does a new giant oil field discovery in Russia have of increasing Russian oil production above 1988 levels, especially since Russia's oil production decline after 1988 was greater than the US's after 1970? The fact of the matter is the Soviets would have easily found a Prudhoe Bay size oil field if one existed. The technology to find such a large field is as old as the early 1900s. The Soviets, unlike the Americans in northern Alaska, were looking long and hard near the arctic coasts, and would have found something if it existed.
Since the collapse of the Soviet Union, Russian oil production did manage to increase slightly in 1997 undoubtedly due to new and better technology, new investment and better management. However in 1998 and the forecast for 1999, oil production is going down again probably due to lower prices. Still, slight changes in current production are incidental compared to the monumental decline suffered after 1988. Even if Russia were to find a Prudhoe Bay or two tomorrow, they could not climb back to their peak.
The fact of the matter is, a high price for oil implies scarcity. Scarcity caused the USSR to free market prices especially oil prices. The only way that the Soviets could do this was to free up their economy since energy and especially petroleum energy is the foundation of an economy. While we can certainly speculate that Russia's decline in oil production may have gone down faster than it needed to during the Soviet break up, it was bound to decline just like US production did. This created an oil price shock. Then just like the US had major economic recessions after the oil price shocks, so did Russia. The former communist countries both before and after their market transitions are still coping with higher oil prices.
THE CRUCIAL EVENTS FROM 1988 to 1992
In order to analyze what really happened in Eastern Europe and the Soviet Union during the crucial break up period, it would be necessary to have hard data on oil consumption and allocation. Unfortunately, official statistics during this period cannot be trusted since they were produced to pacify the public and quell the party managers. Still there are some interesting facts that can shed light on the period.
In the 1970's and 1980's the Soviet Union was trying to get Eastern Europe to cut its reliance on oil especially from the Soviet Union so that it could export more oil for foreign hard currency (CIA, 1985). Before 1989, the Soviets provided as much oil as Eastern Europe needed using a bartering system (FBIS, 1989). In reality the oil was given away at well below world prices (Balabanov and Deitz 1991). The Soviet Union was practically giving away its oil to Eastern Europe, Cuba and North Korea in order to hold up their economies and Soviet influence. As oil production waned, those exports declined and the subsidy was cut causing those economies to fall one by one alongside the Soviet economy. Already the Soviets had a severe credit crunch due to lower oil prices on their oil exports in 1986. The Soviets compensated by cutting foreign imports that year. Unfortunately exporting less lead to greater foreign currency problems, and so the Soviets started borrowing money to pay for imports. Eventually the Soviet and Eastern European economies were forced to cut oil consumption in order for the Soviet Union to be able to export oil for needed revenue to pay interest on foreign debts and buy essential Western technology.
Finally in 1989, the Soviets announced that trade to Eastern European Countries in CMEA (the Council for Mutual Economic Assistance) would be conducted in hard currencies and that oil exports to CEMA would be cut by 10% in 1990 (Balabanov and Deitz 1991). During that year and after, the Soviet Union undoubtedly cut oil exports, although exact figures are hard to come by. The Soviets probably went more quickly to selling their oil for hard currency than official accounts and undoubtedly cut exports to those who could not pay. Thus from 1989 to 1990, Eastern Europe was going through an oil crisis. With less virtually free oil from the Soviet Union, Eastern European countries had to adapt their economies to the new market. They had to become more oil efficient overnight. The only way was with freer markets. The Soviet Union could see that the only way to cut exports of free oil to Eastern Europe was by simply cutting off from the established trading system and let Eastern Europe sink or swim. In 1989 then, Gorbechev initiated total glasnost in Eastern Europe and stood back hoping it would simply stay in the Soviet sphere.
It was clear soon thereafter that with Eastern European economies in decline and with discontent rising, the Soviet Union had to decide between letting Eastern European countries leave the Soviet empire or controlling them militarily and giving them virtually free oil. Since Soviet oil was becoming a precious commodity, the Soviets had no choice but to let go of Eastern Europe. Without the free oil, the Eastern European economies went into a tailspin. Subsequent discontent pushed them toward democracy. The Soviet Union was left trying to simply keep NATO troops out of Eastern Europe but still letting the Eastern Europeans become democracies. CMEA was dismantled, (BW 1989a). No longer did the Soviet Union appear to have the will to push its communist ideal.
But the changes were not yet over. The Soviet Union itself was in decline. In the fall of 1989, with prices still fixed, a curious phenomenon occurred. Soviet wheat and other agriculture crops were rotting in the fields (BW 1989b). How could that have happened? We know that Soviet oil production was already declining and that oil prices inside the Soviet Union were still set well below world prices. Yet free markets were not introduced in the Soviet Union until early 1991. At first one might suspect rotting crops were due to a low artificial price that gave no incentive to harvest them. However, there were in fact black markets all over the country at that time. Harvested crops could have easily been sold if they could simply be transported to a black market. Ellman (1992) suggests that it was changes in administrations with continuous reorganization of the agricultural complex that caused it. However, again, black markets give incentives that can overcome poor government planning.
The problem was more likely a lack of petrol. Gasoline or oil sold on international markets would have provided a tempting source of hard currency reserves for the government in order to import needed food and technology. Undoubtedly much Soviet oil was being sold by the Soviet authorities or by black marketers on spot world markets. It would have been especially tempting for the government itself to sell on the world markets in order to pay interest payments on loans. With more oil sold abroad, there would be oil shortages in agriculture. And since agriculture is a highly petroleum-intensive industry, it is no wonder crops were left to rot on farms. No one had petrol to harvest the crops and transport them to market.
Eventually in 1991, all prices were allowed to go to market levels, but it takes time for an economy to adjust. So the economy fell into a deeper and deeper recession. Note too that even though prices were free, oil prices were kept low and the economy was not allowed to allocate the oil to its most productive uses, i.e. to its highest bidder. This meant that oil was sold on world markets, creating shortages at home. Inefficient factories and producers were allowed to continue to receive wages even though they produced nothing that the economy demanded. It was this lack of flexibility in Eastern Europe and the Soviet Union that helped their economies spiral downward. However, the initiating event was an oil crisis. Even in 1997, after ten years of Parastroika and seven years of free market prices, many factories and business were still being supported artificially by the state. Many firms were still receiving low-priced oil. Former Soviet oil companies have been required to sell fuel at prices below world market prices. This has prolonged the inefficiencies of the Eastern economies. However, even with freer market prices, oil production continues to decline, with only the slight increase in 1997.
During the transition period then, not only were Soviet industries having a hard time coping with higher oil prices, but also the economy as a whole had less oil to export. Low oil exports contributed to a balance of payment and international debt problem that Russia still faces today. The internal oil price shock, bankrupted Soviet industry. All of these crushing economic problems were brought about mainly by a shortage of oil. Eastern Europe and the Soviet Union really had only one course of action: free the markets. However it was impossible to free their markets without also opening up their political systems too-since the state owned everything.
To suggest that the break of the Soviet Union caused the decline in oil production would be like saying the energy crises in the US caused the US oil production decline. Incentive to produce oil, even if on the black market, always existed. Most likely within the conflicting statistics, the period of the break of the Soviet Union was an oil crisis period. We know that the West went through two severe oil crises, which the Soviet Union and Eastern Europe never felt. It was only a matter of time for them finally to have their own oil crisis. They simply insulated themselves from it for awhile. The fact remains that former Soviet oil production by 1992 was 20% less than Soviet and Eastern Europe oil consumption in 1988. Furthermore, incredibly, oil production in the Soviet Union declined before consumption, which makes a cause and effect scenario of an economic crisis causing an oil production decline impossible. The more likely cause and effect scenario is an oil crisis caused by scarcity leading to an economic down turn and eventual consumption reduction. This means that these economies were forced into an oil crisis. They had to reduce oil use. However, with vastly higher oil prices, actual former Soviet and Eastern European oil consumption declined by about 50% from 1988 to 1995.
When the West cut its oil consumption in 1974 and 1981, there were two major recessions. However, neither of those recessions and energy efficiency periods saw a 50% reduction in oil usage in the West. Considering the West's experience, there would be no way for the planned economies of Eastern Europe and the former Soviet Union not to have had even bigger recessions during the period 1988 to 1995-when they saw an even bigger reduction of their oil supply-than the west had in the 1970's and 1980's. Logically, this means an oil crisis pushed these planned economies towards a more efficient system, namely free markets and democracy.
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