The most significant defense development of the past six months has been the meteoric rise and sudden fall of oil prices. When prices rose to over $150 per barrel, it seemed that measures as
extraordinary as applying nuclear power to large amphibious ships might be justified. It also appeared inevitable that a wide range of alternative energy programs would become viable. Internationally, high oil prices seemed to fuel Russian and Venezuelan ambitions. Whatever its intentions, the Iranian government looked like its oil resources were limitless. The U.S. economy appeared to be dragged down by the vast capital outflow associated with our national addiction to oil. Suggestions that high oil prices were a classic bubble were dismissed as naive.
Now the bubble has burst, with a vengeance. Governments of oil-producing countries that based their budgets on $90-per-barrel oil are in deep trouble, particularly if they believe their stability depends on what they can offer their populations. Reportedly, neither Iran nor Venezuela can make any substantial profit at the current price of oil. OPEC is trying to restore the high price by cutting production. However, since Russia relies on oil sales for almost its entire budget (not having had much success converting military production to anything saleable), it is unlikely that it will follow suit. The problem of every oil producer is that there is a single oil market: what any one producer holds back, another can replace. Recession in the West is further depressing demand, so it is unlikely that prices will shoot up again very quickly.
Boom and Bust
Historically, this is not a unique situation. Countries that depend on single commodities for their income have had to live with boom-and-bust economics. A boom in any commodity spurs attempts to increase production, but at some point the market saturates. Speculators push the price beyond what the market can or will support. If the commodity can be stored, supplies pile up. At some point the bubble bursts.
The lesson, for an oil state, is that oil money can support the sort of national development that can outlast a boom in prices. Governments and economies can diversify. That takes discipline, because it is easier to spend ready money on more immediate needs. In Russia, for example, the oil boom ended the economic depression that followed the collapse of the Soviet Union. It was the only reason Vladimir Putin could begin to rebuild his armed forces. It did not help that Mr. Putin and the old Communist Party and military complex on which he depends had little or no concept of economics, let alone the structure of the Russian economy.
The Russians still have no idea how much they spent on their military during the Soviet period; some estimate that it may have been as much as half or even two-thirds of their gross national product. Despite a great deal of talk about converting the vast Soviet-era military development and production machine to other purposes, that has not been done. Mr. Putin and his supporters apparently had no idea that oil was merely buying them time, not solving their underlying problems.
Worse, from a Russian point of view, is that individual Soviet-era military enterprises are now competing, with much less of a central apparatus, to decide how to allocate resources. Competition is almost completely political. The Russian press has carried charges that the current Bulava submarine strategic missile was chosen for development (in favor of developments of earlier weapons) only thanks to the influence of the head of its design organization, the Moscow Thermal Institute.
Post-Soviet governments have been unable to cope with the gross design and production overcapacity they inherited from the Soviet Union. The result is that the overhead to maintain this machine is charged to whatever customers they can attract. The export prices of Russian weaponry are now far above those of the Soviet period, to the point where they have precluded some important sales.
Overcapacity is not, of course, only a Russian problem. It is also a major problem in Western Europe. A few years ago several of the European missile producers amalgamated into a company called MBDA. In theory it would rationalize production, replacing numerous more or less equivalent missiles with single products whose lower prices would make them more competitive on the world market. That has not happened. For example, MBDA is currently responsible for two parallel antiship missiles, Exocet and Otomat, and it participates in development of two more, the Norwegian NSM and the Swedish RBS 15. Each has its own virtues, but of the four only Exocet is enjoying much export success. It seems unlikely that the political will exists in any of the four producing countries to kill off its missile industry in the name of European integration (or better economics). The problem in Europe is infinitely less serious than in Russia, because military production was a much smaller fraction of Western European economies.
If the Russians are about to suffer an economic crash, Putin will need something other than payments to military industry to stay in office. Perhaps Georgia was the first taste of a newly assertive policy that will make use of increased military muscle before it wilts.
The Saudi Factor
Oil money has also been a major problem for the United States. Al Qaeda has been financed, apparently in large part, by some wealthy Saudis. They may have been motivated by piety, or they may have been in effect paying blackmail, hoping that al Qaeda would direct its energies away from an early goal of overthrowing the Saudi government. Similar payments were once made to the Palestine Liberation Organization, for much the same purpose. From a Saudi national point of view, supporting al Qaeda's operations in Iraq would be a good way of reducing the direct threat at home, both by directing al Qaeda energies elsewhere and by focusing its more energetic operatives on killing Americans.
Many supporters of the Saudi monarchy may also see U.S. support for a more or less democratic Iraqi government as an indirect attack on that absolute monarchy. At home, oil money helps support Saudi stability by providing enormous social benefits for a rapidly growing population. But it also causes problems, because it supports a large class of semi-educated, semi-unemployed youths who may have too much time on their hands to ask whether the Saudi monarchy lives up to its religious ideals. The problem is that oil money has also paid for what some Saudis see as a corrupt upper-class lifestyle.
All this means that a dramatic shrinkage of Saudi income would also bring serious problems. It is unlikely that those at the top who have been enjoying the fruits of high oil income will happily sacrifice to keep the wider population content. The Saudi government is in a difficult position. Its claim to legitimacy is that, thanks to its particularly pious (and, nominally, ascetic) view of Islam, it is the appropriate guardian of the holiest sites in that religion. At the same time, as money has flowed in, the Saudi government has also offered its population many of the material benefits of the modern world.
What happens when the benefits are drastically reduced (as they have been recently) but the population feels that some at the top are hypocritically enjoying a corrupt existence? Some might see the seeds of something unpleasant like the European Reformation in this kind of dilemma. If that is true, then Saudi Arabia is in for a major internal religious war that will drastically affect the kingdom's ability to pump oil. If that kind of disaster is coming, perhaps our policy ought to be to buy as much as we can from Saudi Arabia before the crash.
The oil price crash could also mean the demise of current Venezuelan policy; Hugo Chavez may have already overspent his oil income, which he likely calculated based on the past high prices. He does not yet have the military muscle he wants, and now he may not be able to afford it. However, he does have an enlarged army, and he could just decide that he can solve his problems by seizing resources from his neighbors.
As for the Western meltdown, one wonders what happens to China in a recession caused by a crash among the trading partners. After the 1989 Tiananmen Square massacre, the Chinese Communist Party based its legitimacy on a combination of nationalism (we got Hong Kong back) and economic success. If it is reduced to nationalism, does that mean an attack on Taiwan is more likely?