Netherlands contracted in the 1960s. Around that time, the Netherlands was becoming a major natural gas exporter. As the new gas wealth flowed into the country, the rest of the Dutch economy suffered. The national currency became overvalued and exports became relatively more expensive—and, thus, declined. Domestic businesses became less competitive in the face of the rising tide of cheaper imports and increasingly embedded inflation. Jobs were lost and businesses couldn’t survive. All of this came to be known as Dutch disease.
A partial cure for the disease is to segregate some of these earnings. The sovereign wealth funds that are now such important features of the global economy were invented, in part, as preventative medicine—to absorb this sudden and/or large flow of revenues and prevent it from flooding into the economy and thus, by so doing, insulate the country from the Dutch disease.
The second, even more debilitating ailment of the petro-state is a seemingly incurable fiscal rigidity, which leads to more and more government spending—what has been called “the reversed Midas touch.” This is the result of the variability of government revenues, owing to the volatility of oil prices. When prices soar, governments are forced by society’s rapidly–rising expectations to increase their spending as fast as they can—more subsidies to hand out, more programs to launch, more big new projects to promote. While the oil can generate a great deal of revenues, it is a capital-intensive industry. This means it creates relatively few jobs, adding further to the pressure on governments to spend on projects and welfare and entitlements.
But when world oil prices go down and the nations’ revenues fall, governments dare not cut back on spending. Budgets have been funded, programs have been launched, contracts have been let, institutions are in place, jobs have been created, people have been hired. Governments are locked into ever-increasing spending. Otherwise they face political backlash and social explosions. The governments are also locked in to providing very cheap oil and natural gas to their citizens as an entitlement for living in an energy-exporting country. (In 2008 gasoline in Venezuela went for about eight cents a gallon.) This leads to wasteful and inefficient use of energy, as well as reducing supplies for export. A government that resists the pressures to spend—and increase spending—puts its very survival at risk.
There are easier ways than cutting spending to alleviate the “reversed Midas touch.” But they work well only in the short term. One way is by printing money, which leads to high inflation. Another is by international borrowing, which keeps the money flowing. But that debt needs to be serviced and repaid, and as the debt balloons, so do the interest payments, leading of potential debt crises.
In the petro-state, no constituency is in favor of adjusting spending downward to the lower levels of income—except for a few economists who understandably become very unpopular. On the contrary, across society most hold the conviction that oil can solve all problems, that the tide of oil money will rise forever, that the spigot from the finance ministry should be kept wide open, and that the government’s job is to spend the oil revenues as fast as possible even when more and more of those revenues have become a mirage.
As Ngozi Okonjo-Iweala, former finance minister and foreign minister of Nigeria, summed it up: “If you depend on oil and gas for 80 percent of government revenues, over 90 percent of exports are one commodity, oil, if that is what drives the growth of your economy, if your economy moves up and down with the price of oil, if you have volatility of expenditures and of GDP, then you’re a petro- state. You get corruption, inflation, Dutch disease, you name it.”4
While these are the general characteristics that define a petro-state, there are wide variations. The dependence on oil and gas of a small Persian Gulf country is obvious, but its population is also small, which reduces pressures. And it can insulate itself from volatile oil prices through the diversified portfolio of its sovereign wealth fund. A large country like Nigeria that depends heavily on oil and natural gas for government revenues and for its GDP has much less flexibility. Spending is very difficult to rein in.
There is also a matter of degree. With 139 million people and a highly developed educational system, Russia possesses a large, diversified industrial economy. Yet it does depend upon oil and natural gas for 70 percent of its export revenues, almost 50 percent of government revenues, and