The Day After Russia Attacks
What War in Ukraine Would Look Like—and How America Should Respond
For the last five years the world has been trying to cope with a set of problems triggered by the sudden oil price explosion of late 1973: the availability of oil to cover future energy demand, the economic and financial upheaval attending the jump in oil prices, and the utilization of a flood of petrodollars by OPEC countries for their national development and other purposes. These three issues are intimately interrelated and interact on each other; they can thus be properly assessed only in conjunction with each other.
The relationship between oil supply and oil demand has always depended not only on trends in world oil discovery and consumption - including the impact of conservation and the progress made in developing additional energy sources - but on the price and production policies of major oil-producing countries, based in turn on calculations of their political and economic interests. The post-1974 upheaval in the economic and financial structures of the Western industrialized countries, and of the world as a whole, has been kept within controllable limits in part by an economic slowdown and the resourcefulness of Western public and private financial institutions - but certainly also because the principal OPEC countries were not then able or willing to cut production and to press their undoubted bargaining leverage to the utmost. Price advances by OPEC have not kept pace with the overall rate of inflation and the decline of the dollar since the fourfold price increases of 1974, and the real price of oil has dropped substantially. Meanwhile, the great bulk of the new oil money, or petrodollars, flowing to the OPEC countries has been soaked up, often through prodigious spending by these countries in the West. As a result, the shock to the industrialized economies has been cushioned, and the flow of petrodollars directly into the financial system - while itself enormously increased and the source of continuing major problems - has not turned out to be the nightmare many had feared in 1974.
The American public's sense of urgency has thus tended to dissipate - as the limited energy legislation just passed by Congress attests. At the same time, responsible officials throughout the world have clearly felt that neither the West nor the United States in particular has yet faced up to the long-term scope of the energy crisis, especially the oil situation. Are the factors that have operated in these past four years lasting or temporary? Have we not, in fact, paid a far steeper price, even in these years - in the form of a recession, unemployment and inflation - than we have lately been prepared to recognize? May we not be headed, within the next decade at most, for far more serious upheavals, in which the OPEC producing countries can - and may, if for no other reason than to protect their vital self-interest - completely reassess their present internal development policies, which, in turn, may drastically affect their policies on the supply and price of oil? And what should we do about the serious possibility of interlocking adverse developments?
Let us deal first with the energy-oil balance. The present situation is one of oil surplus, stagnating OPEC production and declining real prices for oil. What has brought this about? On the demand side, there has been a substantial slowdown in the use of oil since 1974, especially for industrial purposes, partly because of the slow rate of world economic development and partly because of the higher cost of oil. Whereas energy consumption in the major industrial countries increased more rapidly than Gross Domestic Product in the years preceding 1974, the ratio between the two rates of increase - or the "energy coefficient," as it has come to be called - fell substantially in the years following.
On the supply side, the earlier discoveries in Alaska and the North Sea have now come to fruition and are making a substantial contribution. To this have lately been added increases in Mexican production based on recent prolific discoveries. At the moment, therefore, the oil crisis appears to be invisible.
But what about the prospects for the future? Every estimate for future oil demand shows at least some quantitative increases in world oil requirements for some time to come. For instance, taking into account the most likely availability and full utilization of all non-oil-based energy resources, a conservative assessment would project non-communist world oil consumption as likely to advance from 51 million barrels daily in 1977 to 62 million barrels per day in 1985.
With domestic production of non-OPEC countries estimated for 1985 at 25 million barrels per day, including some 8 million barrels daily of non-OPEC developing countries - about twice their current output - required OPEC production would be 37 million barrels per day as against 32 million in 1977 (which includes OPEC's internal requirements). This assumes that there will be no call, in terms of net oil trade, on OPEC resources by the communist-bloc nations. Present OPEC productive capacity has been estimated at about 39 million barrels per day, of which Saudi Arabia would account for some 11 million.
The above figures would represent an increase in oil consumption of 2.5 percent per annum between 1977 and 1985 - versus a rate of 7.5 percent between 1965 and 1973. This is predicated on an OECD economic growth rate of 3.6 percent per year from 1977 to 1985 - versus 4.7 percent from 1965 to 1973 - and an "energy coefficient" of 0.81 between 1977 and 1985, as compared with 1.13 between 1965 and 1973. This assessment points to a tight margin of oil availability in spite of what we believe are relatively moderate estimates of oil and energy demand. If OECD energy needs were to increase by only one-half of one percent per year more rapidly than our estimate, requirements by 1985 would be almost four million barrels a day higher - a precarious balance indeed between energy demand and available supply.
We might also refer to a much more pessimistic recent report of the International Energy Agency in Paris. Based on a "realistic assessment" of each IEA member country with energy policies as now in place, it assumes a 4.3 percent economic growth rate, 0.7 percent higher than the conservative assessment above. Taking account of the estimated energy balances for non-IEA countries, the IEA projects requirements from OPEC in 1985 at 42 to 48 million barrels per day, as compared with estimated available OPEC production of 36 to 38 million. This gap between supply and demand of 4 to 12 million barrels per day is, as the IEA points out, "a notional gap because in the long term the market will see to it that supply and demand would reach equilibrium. This situation, however, would imply strong upward pressure on prices and adverse consequences for economic growth."
In cruder but all-too-plausible terms, consuming nations would be bidding against each other not only in terms of price, but also in terms of political actions. Some would have to accept a severe reduction in the supply of oil that would be available at prices they could afford to pay. All would suffer individually, and the strain on the cohesion of the key Western allied nations could be very grave indeed, not to mention the friction between rich and poor countries.
In each of these projections of future balance, the estimates of available future OPEC production - and of worldwide production generally - involve considerable uncertainties, especially for the post-1985 period. It takes time to discover, develop and bring substantial quantities of new oil to markets. But may not the new discoveries now being emphasized - in China two years ago, more recently in Mexico and in the Arctic - confound those who argue that the world must expect oil to diminish steadily as a component of total energy supplies?
Conceivably, if the highest hopes of every prospecting organization in the world were to be realized, the discovery of new reserves might keep pace with levels of consumption that are increasing more slowly than in the past. But, neither history nor recent experience provides dependable assurance for any such hypothesis. Even at a conservative rate of estimated demand for oil, cumulative consumption from 1978 through 1990 would amount to nearly 300 billion barrels, or about one-half of the total existing proven reserves. The 1978 ratio of production to proven reserves is currently 32 years; the break-even rate of discovery to maintain this ratio must start at 18 billion barrels a year and rise steadily to some 23 billion barrels a year by 1985.
As against such needs, it has recently been estimated by Exxon, on the basis of geological assessments and probability analysis, that the finding rate during the next decade will fall within an average range of 12-18 billion barrels a year - more than in the past except during the initial boom period in the Middle East. Even if one takes a slightly higher estimate of the rate of discovery - say, 18-20 billion barrels of new proven reserves a year until 1985 - the production-to-reserves ratio would decline from 32 years in 1978 to 25 years in 1985. The ratios would be higher than the average for Saudi Arabia and a very few more producing nations, but much less for most of the other oil countries, thus setting an effective physical limit on their level of output. There would then be little room, if any, for many of the producing countries to expand or even maintain their production on the basis of extant reserves.
The large new discoveries in Mexico and the potential elsewhere, such as in the Arctic and East Asia, will of course be most welcome and may ultimately stretch the lifespan of reserves by a number of years. But nothing now in sight changes the basic prognosis of declining physical availability of oil. This does not mean, of course, that reserves would actually run out by the dates that present arithmetic would suggest, for producing countries would tend to cut back production along the way in the face of impending declines in their reserves, while importing countries would be scrambling for other energy sources. The point is that the kind of pressures on production and pricing policies already predicted by the International Energy Agency for the 1985 time frame can only get worse thereafter as the implications of declining physical availability take hold.
Moreover, the new or enlarged producing areas will certainly not operate without regard to the supply/demand and physical availability factors that will be conditioning the policies of the present members of OPEC. On the contrary, it must be assumed that new production will be integrated sooner or later into the OPEC supply and pricing pattern as that pattern itself evolves. Not in the medium term - nor even in the long term - is new production likely to cause a meaningful break in oil prices for any sustained period that would substantially reduce the financial burden of the importing countries.
These are the facts of life in the world of oil; they are as well known in the sophisticated circles that guide present OPEC policies as they are in the consuming countries. In formulating an energy policy, we must thus assume that the period available to us for transition from an oil-based economy to one founded substantially on new energy resources will probably not exceed 20 to 25 years. The need to provide for the world's medium- and longer-term future is clear, but not the means of getting from here to there.
Coal will certainly make a substantially increased contribution, but only in the few countries with an extensive resource base. It is unlikely that within a relatively short time span, the environmental compromises would be reached and facilities could be put into place that would permit the production, internal transportation, exports, and utilization of large additional quantities of coal from the few richly endowed countries. Moreover, shale oil, tar sands and very heavy oils will become a significant factor only if there are technical breakthroughs, such as in situ production. The prospects for solar, wind and wave power, and for energy from biomass, must presently be evaluated as relatively marginal within the foreseeable future.
Atomic energy is the one technically and economically feasible source that could make a major contribution to supply, but its development is stymied by the problems of potential weapons proliferation, waste disposal, and political and public opposition. Whereas only two years ago it was predicted that by the year 1985 the member nations of the OECD would have in excess of 300,000 megawatts of nuclear capacity in operation, the Department of Energy, in its "1977 Annual Report to Congress," now assumes that by the mid-1980s there will be no more than about 200,000 megawatts of nuclear power on line. As far as the United States is concerned, the Department of Energy currently estimates that by the mid-1980s nuclear capacity will be slightly less than 100,000 megawatts or about one-half of the OECD figure. This compares with U.S. government targets for 1985, set only a few years earlier, of more than 200,000 megawatts. Further delays or cutbacks can only intensify the crunch.
Against this background and aggravated by the decline in the value of the dollar, we must expect that during 1979 OPEC prices will increase more or less in line with inflation and the fall of the dollar - perhaps by eight to ten percent for the year, possibly in installments. This would increase the cost of OPEC's oil exports by more than $12 billion in the coming year alone. If the Iranian oil industry has not resumed reasonably full-scale operations by the end of this year, the cost of oil will most probably advance much more steeply.
After 1979, assuming continued increases in demand, the rate of price increases - probably by the early to mid-1980s - might accelerate, not only to make up for past "losses," but also to reduce or eliminate the current account deficits of many OPEC countries, which in 1977 already had borrowed over $11 billion in the international market. Moreover, around the mid-1980s or early 1990s, when the specter of imminent oil shortages begins to haunt the world, the opportunities and pressures for large advances in the real price of oil are almost certain to become decisive from the standpoint of oil-balance factors alone.
We have already experienced the economic consequences of the 1974 oil price explosion; and since 1974, the progress of the world economy has become dangerously sensitive and vulnerable to the economic and political effects of any future sizable advances in the cost of oil. The impact of the 1974 price rise has not been uniform among nations, but has shifted over time among developing as well as developed countries, including the United States, and often unpredictably. Between the end of 1973 and early 1978, the total foreign debt of non-OPEC Third World countries, partly as a result of the high cost of their oil imports, has increased from an estimated $95 billion - of which $30 billion was owed to commercial banks - to $210 billion, of which $90 billion was obtained from private financial institutions. At present, the United States is struggling with a persistent, huge oil trade deficit, and with uncertainties affecting the dollar exchange rate, aggravated by potentially volatile dollar holdings abroad.
The pace of economic progress of a large number of countries has been sluggish and unemployment has remained high. Likewise, inflation is still rampant; at the same time, however, inflation is, to a significant extent, the reason that the international debt service burden remains, in general, within manageable limits as compared to inflated current export receipts of many of the debtor countries.
In this connection, it must be emphasized that even the halting recovery we have experienced since 1974 would have been virtually impossible had world oil prices increased between 1976 and 1978 with inflation and the fall of the dollar; instead, the cost of oil in real terms has declined by perhaps 20 to 25 percent during this period - mainly because of the restraint exercised by Saudi Arabia with the support of Iran and of a few other OPEC members. Only because of this substantial reduction have we been able up to now to avoid a serious and long-lasting recession and to handle effectively the enormous problem of financing world oil imports and the so-called recycling of petrodollars.
In short, the period of declining real prices for oil is coming to an end, and may, within the not too distant future, be followed by an accelerating increase in real prices, with the timing dependent on the oil supply/demand relationship. As far as the importing countries are concerned, the only leverage they have is related to the level of their oil requirements as compared with oil availability. The former depends on their rate of economic growth and the success of their oil conservation measures. They find themselves between the Scylla and Charybdis of a slow rate of development with the risk of a recession and political instability, or a policy of sustained growth entailing the danger of an early oil shortage accompanied by high oil prices. Either course might bring about economic and financial turmoil with ensuing political instability.
Thus it would be dangerous to base future policy on the illusion that the financial issues centering around the oil problem have been successfully resolved, or to assume that because there has been no real catastrophe in the past there might not be extremely dangerous situations facing us in the future. In spite of our past successes in making the necessary financial adjustments - assisted by slow economic growth, high unemployment and excessive inflation in most of the importing countries and wasteful expenditure of part of their revenues by producing countries - the problems have not faded away like the Cheshire Cat in Alice in Wonderland, with only a grin remaining until that, too, vanished.
Up to this point, we have been giving a current assessment of the central "market" factors for at least the past five years. The picture that emerges is disturbing enough, but our disquiet is bound to be intensified if we turn to a serious examination of the internal economic situations of the major producing countries in OPEC. Now, with five years of experience to judge from, it is high time for us to take this element of the situation into much greater account than we have heretofore. For, in the last analysis, the availability of oil from OPEC countries will depend not only on their judgment of supply/demand factors and of the state of their proven oil reserves, but also on their economic policies and on overall political considerations.
In particular, we will now review the progress and prospects of the economic development program of OPEC countries; and, because of the extreme relevance of this assessment for their future welfare, we will not dwell on other factors - such as inflationary pressures on their economy or political decisions related to, say, Arab-Israeli developments - which might also affect their future oil production policy. Nor will we deal with the ever-present contingency of a political upheaval in any one of the major producing nations, or a protracted oil workers' strike, or a serious accident or sabotage that would put essential oil facilities out of operation for a long time. Any of these events could upset the world's oil supply/demand balance practically overnight with potentially very harmful consequences for the prosperity of virtually every one of the oil-importing nations.
We must expect that sooner or later many producing countries will seriously question the value of much of their development program in terms of its potential contribution to their economic progress, political stability, employment, budgetary receipts, and foreign exchange income. Many of them will painfully realize that their industrial efforts could not possibly begin to replace the government and foreign exchange revenues that they have become accustomed to receiving from their oil production, nor provide them with a prosperous non-oil-based economy.
When confronted with a sudden huge influx of oil money, most countries immediately set out to prepare a program on how to make the best possible use of their newfound riches. They began to formulate an economic development plan, build up an infrastructure, provide exchange for imports for current consumption, improve the welfare of their citizens and allocate more funds for military purposes. They also had to decide how much they wanted to retain for foreign investments and savings.
The challenge they face may perhaps most simply be described this way: during the relatively short period when they can count on a large flow of oil revenues, they have to develop an economy that can provide them with sufficient government revenues, foreign exchange income and employment for the period when the oil bonanza begins to peter out.
The preparation of a plan - and even more so its implementation - requires a great deal of time, and its feasibility and real value to the country depend on its ability to draw on the advice of competent experts. The magnitude of the problem OPEC has to cope with has been without precedent. Many of the countries are confronted with a very unfriendly environment for the creation of a modern economy: a hostile climate; lack of arable land, water, power and other resources; a high degree of illiteracy; a scarcity of managerial talent or experience; at best, a very small skilled labor force and, likewise, a shortage of available or socially adjusted unskilled labor. Inevitably, and in the best of circumstances, there was bound to be a lot of confusion, mismanagement, waste, lack of coordination within a country - and even more so within an area - and thus substantial duplication of effort.
Development programs were rapidly formulated, involving sometimes very costly projects of a prestige character but of dubious immediate value to the country, such as a huge atomic energy development program - apparently now being cut back - in one of the nations possessing enormous natural gas resources on which it could draw for a very long time. Coordination of industrial development, manpower needs, housing requirements, and water, power and transport availability was often - as one might expect during this chaotic period - by no means perfect.
The most immediate issue facing the producing countries in 1974 was to build up the port and transportation facilities in order to accommodate the vast increases in consumption and in imports for development purposes that were triggered by the oil bonanza. This has more or less been accomplished - albeit at a very high cost - resulting partly from the speed with which these projects were undertaken. There was some large overexpansion of port facilities and airports both because of lack of coordination and national prestige considerations. Certainly inexperience and other cost-increasing factors also contributed, but this was almost inevitable considering the amount of money available and the rate at which it was spent. At the same time, educational, training and health facilities were ordered, frequently without regard to the staffing problems, level of possible utilization or future cost of operation.
We do not intend to go into a country-by-country review or a specific project analysis. Much went right and much went wrong, and there is no point in presenting a catalogue of specific successes and failures. Many of the difficulties and dilemmas posed could not have easily - or sometimes even possibly - been avoided, given the unprecedented nature of the problem, and the political and social circumstances as they exist in the separate countries. These observations apply, of course, in varying degrees to the different OPEC nations.
Three fields of special interest to the producing countries are forward integration from crude oil production into refining, producing at least commodity petrochemicals for export, and tanker transportation. Even though the investments are large, the value added is relatively small, and the employment provided is somewhat limited. In addition, there is a locational and transport disadvantage for exporting refined products in comparatively small tankers versus crude oil in supertankers. Just as the number of citizens directly and indirectly engaged in their country's oil operations is relatively small, the part of the population that would benefit directly from the oil bonanza as employees or as providers of equipment and services for the oil industry is relatively limited. And the creation of a specially privileged class of those connected with the industry would of course create other problems, such as setting wage or profit standards for other economic or agricultural activities that such undertakings could not possibly sustain.
Between 1973 and 1977, OPEC's growth in refining capacity has been less than the increase in domestic demand; and, excluding Venezuela, exports of refined products are only about five percent of crude exports. However, by 1985 another 3.5 million barrels per day of refining capacity has been scheduled for completion. Likewise, the buildup of large new petrochemical facilities is underway or contemplated. In addition, obvious fields for investment that are being pursued are energy-intensive industries such as aluminum and steel.
The main problem confronting OPEC here is, of course, the current surplus refining and petrochemical capacity in many of its markets, coupled with the need to overcome the construction, operating cost and transport disadvantage of OPEC's new facilities by below-market pricing of crude or feedstocks and by cheap financing. The OPEC tanker fleet - still relatively small - will undoubtedly increase substantially, but it faces the problem of a world surplus tanker capacity. At the moment it requires heavy subsidies. However, the desire of the producing countries to upgrade at least some of their crude oil themselves is perfectly obvious and understandable. As the Kuwaiti Oil Minister put it, "Investment should be considered not purely from the commercial point of view, but from that of the economic and social profitability for the nation, especially in the long run - and also as part of the social costs as a means of filling the technological gap and widening the industrial base." Accordingly, OPEC, as the world's major crude supplier, will somehow be able to export refined products and petrochemicals, and also to utilize its tanker fleet. But this can most likely be done only at some financial cost either to OPEC or to the importing countries or to both, and presupposes constructive cooperation between the two parties.
The problem of launching an effective economic development program has been immensely aggravated by the inevitable and huge pressures on the governments to improve the economic well-being of their citizens almost immediately after the dramatic increase in the flow of oil revenues. A policy of gradual change in accordance with the rate of economic progress would - in the light of the high expectations raised - be politically and socially very dangerous, if not impossible. But rapid movement toward a welfare state would in due course have equally destabilizing and harmful effects.
As the government owns all of the oil revenues, it is the public sector that would have to provide the financing, not only in the proper field of governmental activities - such as for the build-up of an infrastructure - but also for most of the development projects. These would then either be government-owned or in some form or fashion be made available, fully or in part, to private owners - usually on favorable terms and frequently only to a small select group. At the same time, the government has to engage in activities that would improve the welfare of its citizens at large. This would be achieved by direct or indirect transfer payments to its nationals - such as paying for their education, their health services, subsidization of housing, food and other necessities of life.
In some instances, in order to "spread the wealth," the government in fact made land available cheaply or without cost to its citizens, land which would either increase substantially in value or which the government would buy back at higher prices. In all these circumstances, it was inevitable that most of the countries would be plagued by rampant inflation, further increasing the cost of the government's welfare and development program.
There has also been an explosive increase in the employment - amounting in the millions - of foreign skilled and unskilled labor, needed in practically all phases of economic activity, which has not only brought social and political problems, but has also involved large remittances of several billions of dollars per year to the expatriates' home countries.
It should surprise nobody that, during this period of hectic chaos, there was a mass movement to the main cities from the outlying areas and villages; that agricultural production could not keep pace with increases in demand, and frequently even declined; that many traditional industries suffered; and that imports of all kinds of consumer goods expanded at explosive rates.
All this was accompanied by a building spree of unheard-of dimensions, frequently uncoordinated with available water, power, and sewage facilities and often providing luxury or high-rent accommodations. In many urban areas, there is still a huge shortage of housing for the poor - with the large original slum population swollen by the new inflow of people in search of the "good life" in the cities. Rental costs have often reached fantastic levels.
Equally, with billions of dollars spent on the establishment of educational and health facilities and on the buildup of a modern military force, the government must be prepared to maintain and operate them after their completion. And the annual operating and maintenance costs may well amount, for an indefinite future, to one-quarter to one-third of the initial construction cost. Already, some of the countries have to cope with budgetary and foreign exchange deficits.
The point at which individual oil-producing countries will be confronted by a decline in oil production and revenues differs, of course, among the various oil producers, depending on their level of production and the richness of their hydrocarbon resources. Saudi Arabia and a few other producers have sufficient reserves to give them ample time for slow adjustments to this post-oil period, and they can absorb a large amount of an at least partially inevitable waste of their financial endowments. Many others are not in such a fortunate position.
But all of them have to cope with the political and social problems that have been posed by this vast inflow of money: the feverish rate of development; the negative impact on agriculture and traditional industries; their increasing dependence on subsidies for imports, or for industries providing domestic substitutions; the unhealthy urbanization; the excesses of a building boom; the large influx of foreign labor; inflation; the lopsided distribution of wealth; and many other politically and socially destabilizing factors. They will all realize that rapid and forced development tends to weaken, if not destroy, established social and cultural values, and mostly without replacing them by new ones. Sooner or later there may be a wave of disappointment, frustration and resentment, most likely directed largely against the foreigner and the producing countries' national governments and their institutions. The present turmoil in Iran is indicative of what may lie ahead.
To sum up, since 1974 OPEC government revenues, which coincide with most if not all of its foreign exchange income, have amounted to some $550 billion. An estimated $400 billion may have been spent on goods, services, military expenditures, and so on. The value received on an OECD cost basis would appear not to have been more than perhaps some $200 to $300 billion.
For example, the capital projects of the oil-producing countries cost - for a number of reasons - around two to three times as much as competing facilities located in developed countries. They involve, as of 1976, an estimated "locational premium" for a project in Arabia as against the Texas Gulf Coast ranging from 2.1 times for industrial construction to 2.8 times for military establishments; the ratios for electrical power generation, housing and hospital construction costs are estimated in the same range. These figures take into account factors related to ensuring comparable performance, as well as transportation costs, delays due to bottlenecks, extra service fees, expenditures for housing, sewage, and procurement of expensive foreign labor and management. Many enterprises are also burdened with a substantial additional accommodation or, if you will, "under the table charge," which may vary roughly between five and 20 percent of the amount of the contract, depending on the "political" situation and the nature of the project. Likewise, the operating costs for such projects - because of locational disadvantages, lack of supporting services, foreign labor, etc. - are substantially higher than those incurred in OECD countries.
However, even after the oil age has passed, many of the OPEC countries will still have to depend on substantial government revenues and foreign exchange income. This poses another problem inherent in the character of the large rent on crude oil that the countries are able to command as a result of the OPEC pricing policy. For each one billion dollars received by OPEC for its crude oil exports, perhaps $900 million accrue to the country as government revenue, and are obtained, moreover, in the form of free foreign exchange.
In contrast, for a usual industrial development project with an output of one billion dollars, the government tax authorities - provided that an effective tax system is in place - might collect in direct taxes on the industry no more than $50 million. The foreign exchange income to the country depends on its receipts from exports which, in turn, are contingent on its competitiveness in world markets, and its cost for foreign raw materials, semi-finished products, and part of the expense of any foreign labor that might be needed. However, as we have mentioned, quite a number of projects - because of the high level of construction and operating costs, and the expenses of transportation to more distant markets - are most likely noncompetitive in world economic terms and might be unable to operate profitably, once a continued flow of oil money or a below-market-price supply of energy or feed-stocks is no longer available to subsidize operations. Under such conditions export revenues could, at best, be only a small fraction of that obtained previously from oil exports.
At the same time, the operation and maintenance of ports, transportation, health and educational facilities, the upkeep of a modern military force, and the support of a welfare economy in quite a number of these countries will become an ever-increasing budgetary drain on a prospectively much lower level of government revenues.
According to a recent survey of the London-based Economist Intelligence Unit, of all the Persian Gulf countries, only Iran, Iraq, Oman, Bahrein and Dubai might potentially be able to build up credible non-oil-based economies - and, except perhaps for the last two, only if there is a massive shift in their development philosophy and policy.
The odds at this time are that when the oil revenues begin to peter out, a number of the OPEC countries will find themselves not too much better off than before - like Spain, after it had been inundated by gold and silver from its Latin American empire in the late sixteenth and early seventeenth centuries. As the Controller General of Venezuela pointed out in December 1975, "In many countries, being rich is a consequence of the efforts and work of the people. When you make something you can manage it. The creation of wealth and its management are part of a process. We have never had such a process. The wealth came out of the earth. We have a consequence without a cause."
It should be noted that not only oil-rich developing countries, but also those few developed nations that have been suddenly endowed with an oil or gas El Dorado - such as the U.K., Norway and Holland - might be easily tempted to dissipate their oil revenues. In this vein, the head of the Dutch Central Bank has described the economic effects of his country's income from natural gas as "a curse in disguise."
What does all this imply for future OPEC oil exports and prices? Confronted sometime in the future with declining oil production and revenues, producing countries will realize that the rate at which they exploit their oil resources and the allocation of their oil earnings will become increasingly critical - as, for example, among welfare, development of agriculture and internal industries, production for exports, and foreign investments. Many of them will question whether they can really establish a self-sustaining non-oil-based economy and inevitably consider the alternative of slowing down their development program, as well as possibly "welfare" expenditures and military purchases. This would enable them to stretch their oil reserves by producing less, and to sustain the future viability of their economy as much as feasible through an increased flow of revenues from foreign investments. Kuwait has in fact been doing this by putting a ceiling on its production and establishing a "Fund for Future Generations" derived from 10 percent of all its government receipts. The present unstated policy of providing adequate production for the world's needs at manageable prices would then be replaced by one of lower production at higher prices.
In such a situation the importing countries - at least during the adjustment period - would have no choice but to continue essential oil imports at high prices, rather than curb their receipts drastically with a sudden crippling effect on their countries' economies. The continuous stringency of oil supplies and their high cost would be bound to cause most serious economic and political problems for developed as well as developing countries. Moreover, for the industrialized nations - which have greatly benefited from the vast expenditures on development projects and military equipment by OPEC countries - a reduction in the purchase of goods and services and an increase in the funds allocated to foreign investments would be very harmful; during a period of sluggish economic growth and high unemployment, it would further impede their chances for recovery.
In addition, the outflow of interest and dividends on much higher OPEC foreign investments in importing countries could, within a number of years, approach and even exceed the inflow of new OPEC funds. The early relief for the balance of payments of oil-importing countries would thus become increasingly less.
For many OPEC countries, such a change in current development policy might not be possible without economic and political upheavals. And for some of the poorest non-OPEC LDCs - which in 1977 provided Middle Eastern oil countries with a labor force of some 2.5 to 3 million foreign workers, transmitting nearly $5.5 billion to their homelands - a severe reduction in emigrant remittances coupled with the higher cost of oil imports and a general slowdown of economic growth would be a devastating blow.
A change such as indicated here in OPEC's oil production, development and foreign investment policy, would obviously take place gradually and also would not apply with equal force to all of the OPEC countries. The damage to their own economic systems and political stability, and the effect on the prospects of importing countries and their cooperative relationships with each other and with the OPEC nations, makes it imperative for them to proceed with caution and concern for the future well-being of all parties concerned.
In spite of the huge inflow of oil money, only three or four years after the start of the oil bonanza, some OPEC countries have already incurred an increasing foreign exchange deficit on their current account and are unable to balance their internal budgets. This will inevitably force them to take a hard look at the level and effectiveness of their expenditures for development and possibly for military purposes, and also to calculate the potential optimum level of their oil revenues. They might well decide that they cannot afford to ignore their more urgent interests even though it would detrimentally affect the prosperity of their Western customers - and would, of course, also be harmful to them.
It is not easy to formulate, in light of all these factors, a rational policy for the industrial democracies that would also take account of the legitimate vital interests of the OPEC countries.
An energy policy for importing countries must be based on realistic assumptions somewhat weighted on the prudent side. The price for being too optimistic about the availability of oil supply, and thus facing a serious shortage at an early period, would be economically and politically destabilizing. The cost of being too pessimistic, on the other hand, would at its worst involve the misdirection of some resources, or a loss of interest on capital spent earlier than necessary. It would thus be much better to pay the smaller additional expense of doing too much too early than risk the enormous cost of doing too little too late.
What seems clear is that we have not as yet succeeded in establishing an effective energy policy for the oil-importing countries to cope with the supply and economic-financial problems with which they are likely to be confronted, nor have we succeeded in making a constructive contribution to what presently appears to be, at least in part, an ineffective development effort of the oil-producing nations. What is needed is a common major endeavor, that would include the oil-importing and exporting countries to engage in a critical evaluation of what went wrong and why, and then attempt to formulate a constructive national and international policy and an agreement on its subsequent implementation.
Oil is a finite resource whose depletion is in sight. In spite of temporary current surpluses, it is vital that a maximum effort be made to provide as early as possible for its gradual replacement. The consuming countries, with the United States in the lead, must thus set as their most important goals the further improvement of the energy-GDP ratio, establishment of optimum conditions for the expansion of traditional sources, and the development of large dependable new energy supplies. Taking for granted a relatively high and increasing energy cost at least during a transition, there is, I believe, a reasonable prospect that in due course we will be able to bring production costs down or, perhaps, stabilize them. Such a development may be achievable through concentrating on conventional atomic, breeder and - perhaps later - fusion energy. This whole effort should involve a more effective coordination than has yet materialized with the Europeans, Japanese, and others.
The question must also be asked whether it is really in the interest of the oil-importing countries to put undue emphasis on the availability of ample supplies of oil at low prices, as this would inevitably, within a relatively narrow time span, be followed by shortages of oil with a price explosion. Any freeze of current oil prices, or even more so their reduction, would particularly affect all endeavors to develop non-OPEC-based energy resources, be they oil or non-oil-based, as such efforts will be very costly.
We have a wider national and international interest in an energy price that is high enough to encourage the optimum development of new traditional as well as nontraditional energy resources - even though this could and does in fact represent very serious financial and balance-of-payments burdens, as well as a troublesome impediment to economic growth worldwide.
We also need to rethink our policies toward the developing OPEC countries. Up to now we have mostly accepted without question, even when wasteful, their desire for rapid development and large military expenditures. After all, this has been of great economic benefit to the developed world and has enabled it to cope with the petrodollar problem. But the balance of factors is moving in the direction of change, based on the declining physical availability of oil and an incipient realization on the part of producing countries that they need to revamp their development programs, the awareness that they might have to stretch their oil resources and revenues, and that they could in the post-oil future become substantially dependent on revenues obtained from their foreign investments. None of this is, of course, absolutely certain to happen, but no responsible nation can afford not to plan for such a contingency.
What is needed, therefore, is a candid exchange of views with OPEC on the goals and practicability of their development programs, even though we may run the risk that they would interpret any advice or guidance we offer as another manifestation of neocolonialism. In particular, we must try to engage them in serious discussions as to which enterprises make sense, and must be willing to assist them constructively in developing as many industries offering the prospect of economic viability as they can handle, by providing them with technology, managerial talent and access to markets. Obviously, such an effort can only be pursued with any chance of success on the basis of a consensus among OECD countries and a coordination of their policies which, because of the intense competition among the developed nations for Middle Eastern business, might be very difficult indeed to achieve. But it is absolutely essential that selfish national interests not be allowed to undermine a common and balanced approach to the range of problems that confront us.
Any such policy would have its costs and would undoubtedly involve a substantial throttling back of OPEC programs. It would result in a slower but more sensible development program, which would ultimately be in everyone's interest. We cannot afford to ignore the fact that political unrest, labor strife, and social and cultural disintegration would be as threatening to the stability of OPEC nations as they would be to a secure and uninterrupted flow of OPEC's oil to importing countries.
There are undoubtedly very difficult times ahead. Up to now we have not fully evaluated our own and OPEC's vital concerns, nor have we resolved various conflicts of interest inherent in the issues we face. In any case it seems certain that we must adjust ourselves to a period of slower economic growth, which we hope will provide us with the time and opportunity to develop an energy base for the future without endangering in the meantime the non-communist world's economic and political system.
We cannot much longer afford a situation in which the importing countries waste a substantial part of their energy while the producing countries waste a substantial part of their oil revenues. In the past we have too often been stymied in our efforts to cope with these problems by entrenched national or private interests on all sides. If we should ultimately fail, this period in our history could truly be characterized as "the years that the locust hath eaten."