Can the Caspian Region Survive Life After Oil?

RWI economist Andrew Bauer (fourth from left) works with Eurasia hub attendees to improve resource revenue management.
Country: Eurasia
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The Caspian region is one of the world’s most oil-rich. The five countries that border the Caspian Sea — Azerbaijan, Kazakhstan, Iran, Russia, and Turkmenistan — produced 21.5 percent of the world’s oil and 26 percent of its natural gas last year. Crude oil alone generated approximately $630 billion in gross revenue for these governments and the companies, many state-owned, that operate there.

Yet these five countries are also some of the most authoritarian and least economically diversified. This is no accident. In 2010, U.S. State Department cables released by WikiLeaks referred to one Caspian nation as “run in a manner similar to the feudalism found in Europe during the Middle Ages: a handful of well-connected families control certain geographic areas, as well as certain sectors of the economy.” These systems are fueled almost exclusively by oil revenues. Given the interests of these families, the vast sums making their way to government coffers and into private hands are spent less on health, education and useful infrastructure and more on grandiose monuments, conference centers, museums, and, in one case, a brand new city.

Last week, a regional roundtable of diplomats, government officials, international financial institution representatives and academics gathered in Baku, Azerbaijan, to examine this misallocation of oil resources, concluding that it has left the Caspian region woefully ill-prepared for life after oil. In most Caspian countries, the tax base is weak, non-oil growth is stagnant and governments are wholly dependent on natural resource revenues for survival. For example, unless there are large new discoveries, Azerbaijan’s oil and gas revenue will start declining permanently in 2016. In just 12 years, government oil revenue collection will be half of the $19 billion it is today. For a country where over 60 percent of the state budget and nearly 90 percent of exports come from oil revenues, this decline could be disastrous for the economy and Azerbaijan’s 9 million citizens.

The political and social consequences could be as severe. The state apparatus is built on patronage financed by oil revenues. Once these resources dry up and there is no other source of revenue to replace them, how will political stability be maintained?

Kazakhstan’s fate may be slightly different but equally concerning. It has approximately 70 years of oil and gas remaining and revenues are increasing. However, it suffers from the same poor spending decisions as Azerbaijan, not just by the public sector but also the private sector. When oil revenues are high, new buildings pop up everywhere, often half-empty. When oil revenues decline, the government stops spending and the broader economy suffers as companies reliant on government contracts shed jobs or go bankrupt.

Meruert Makhmutova, Director of the Kazakhstan-based Public Policy Research Center, blames poor planning and white elephants on short-sightedness and denial. “The Government doesn’t want to accept that poverty is a reality in our country. After all, we are an oil-rich country.”

The question is: what to do? Participants, including Erling Skjønsberg, HM Norwegian Ambassador to Azerbaijan, representatives from the World Bank and Azerbaijan State Oil Fund (SOFAZ), government officials, academics and former politicians, mentioned a number of specific policy options. First, Caspian countries could enact fiscal rules – permanent constraints on government finances – that limit spending or “smooth expenditures” over time to mitigate boom-bust cycles. Second, governments can build public consensus on medium- to long-term public investment plans. Third, countries can diversify their economies by investing in agriculture and breaking monopolies.

The big challenge remains convincing governments that it is in their best interest to reform. Oligarchs and leaders in the region personally benefit from existing systems, in some cases using oil revenues to acquire billions of dollars of assets for their families. What’s more, state agencies are often designed to reward loyalty rather than promote the public interest or encourage speaking truth to power. It may therefore be incumbent on civil society, notable experts and the international community to work with reform-minded officials to improve the transparency, accountability and effectiveness of revenue management policy.

Andrew Bauer is RWI Economic Analyst.

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