The crash of the oil price is a bonus to most of the world and especially to the largest oil importer, China. But for oil producers in general, and for one country in particular, it is a disaster. That country is Russia. Oil matters to Russia, in some ways even more than it does to the Middle East oil producers, the largest of which is Saudi Arabia. That is partly because if you add oil and gas together, Russia is the No 1 producer, but it is also because it has a much larger population to support. It has less fat to trim.
It is the oddity in the BRICs group of nations. The other three – Brazil, India and China – are all true developing countries, with diversified economies, making the same transition towards developed countries’ levels of wealth. Brazil is furthest along the path, having achieved middle-income status. China follows in terms of GDP per head, and last comes India (though actually China was poorer than India on that basis in the 1970s).
But Russia is quite different. In some ways it is a fully developed economy, able to produce advanced weaponry and with a still large, if antiquated, industrial capacity. For example, it is the third-largest generator of nuclear power in the world. So, unlike the others, it is a high-income economy. But it achieves this status by being a primary producer, dependent on digging or pumping stuff out of the ground to give its 142 million people a reasonable lifestyle.
Thus, oil and gas alone produce 68 per cent of its export earnings and give the government half of its tax revenues. Other commodities supply much of the rest. The energy and commodity boom of the past few years has enabled the country to boost overall living standards, though the benefits have been unevenly distributed. But quite suddenly, in the past few weeks, that great wealth machine has gone into reverse.
It has been under pressure for most of this year, pressure increased to some extent by Western economic sanctions. But the coup de grâce was last week’s decision by the Organisation of Petroleum Exporting Countries not to respond to softer oil prices by cutting production. The oil price plunged, the rouble plunged, and a country probably already in recession is now in serious economic trouble. It turns out that we need not have bothered with sanctions, for their impact has been marginal. What has really hit Russia is the growth of US oil production, itself a result of fracking. Unsurprisingly, it seems that Russia is financing anti-fracking protests in eastern Europe.
However, do not expect Russia to collapse. It is able to respond, indeed has responded, by devaluing its currency. Oil is priced in dollars. The rouble has fallen by about 35 per cent against the dollar since June, a similar order of magnitude as the fall in the oil price. So, in rouble terms, Russian government revenues are pretty much where they were. It has been calculated that the country needs an oil price of around $100 a barrel to balance the budget, but if it devalues by enough, it could get by at the present level of about $70. If the price goes on falling, well, it can devalue some more.
Devaluation does, however, carry costs, and these costs spread across the economy in a number of ways. One immediate hit is to living standards, as the price of imported goods climbs pretty much in line with the decline of the currency. Importers will be squeezed, as indeed will countries that export to Russia: Germany does badly here and you can pick up German concern in weak forward indicators for its manufacturing sector, released this week. One further cost is the possibility of the fall in the currency getting out of control. We are not through this yet by any means. Today, the head of the country’s second-largest bank acknowledged that there was “some panic” at the banks. Last week, official interest rates were increased from 8 per cent to 9.5 per cent to try to halt the collapse.
I think we just have to wait and see how stability will be restored. Russia still has large reserves of hard currency, though these were depleted by attempts earlier this year to curb the decline of the rouble, before it was allowed to float (or you might say, sink). And the country as a whole is under-borrowed – it has the lowest proportion of total debt relative to GDP of any of the BRICs – and far below that of the West.
Economic crises come and go. What is happening in Russia is not so different from what happened in Britain in 1976, when we had to turn to the International Monetary Fund for an emergency loan – though our principal sin then was incompetence, rather than a mixture of bad luck and misbehaviour. But thanks to that misbehaviour, Russia now has few friends to help it out. It cannot go to the IMF for a bridging loan, as some Middle Eastern oil producers may have to do. It is inherently a rich country, a natural partner to a resource-poor western Europe. Maybe the real lesson of the past few days is that, if Russia wants to remain rich, it must learn to get along with its neighbours.
The enviable economics of the lingerie industry
One of the great examination questions for potential Oxbridge economics students is “why do fashions change?” It is great because it makes students think about the nature of consumption: why do we want to buy, or be sold, different things that perform exactly the same function as the old ones? Now let me propose another related one: it is “why is the price of a garment inversely related to the amount of material used to make it?”
This applies, as I was assured by a friend, to bikinis as well as lingerie. But the thought was spurred by the show, actually two shows, of Victoria’s Secret Angels, the first time this transatlantic extravaganza has come to London. It is of course in business terms classic clever – mid-market presented as top end. But the wider point is that the manufacturing cost is exceptionally low relative to the sales price. That huge margin makes possible clever devices such as a plethora of “free” items to boost interest, limited-time coupons, “bargain” sales and incremental incentives. (There is a blog called Quality Logo Products that explains all this.)
But this is just brilliant retailing applied to what might otherwise be a utilitarian product. From an economic perspective, the key thing is the intangible added value to the product that design and marketing can bring. It is precisely because the manufacturing cost is such a tiny fraction of the selling price you not only use clever conventional marketing but can add intangible value by association. You are not selling a product; you are selling a dream. All fashion retailing does this; Victoria’s Secret is the most extreme current example of how to make more out of less.
And on a dull December day, ahead of our Chancellor about to make less out of more, what is wrong with that?