Introduction
Russia’s deplorable invasion of Ukraine raises profound questions about the West’s energy policy. The West is directly funding this war by buying Russian hydrocarbons. But this is just one example of a wider trend. Dependence on fossil fuels creates geopolitical instability, allowing autocratic nations to survive and encouraging conflict. Fossil fuels are not just unsustainable in environmental terms, but in social and economic terms too.
In recent days Western countries, plus some others, have imposed unprecedented sanctions on Russian companies and the central bank, in an attempt to stop the war. But Russia continues to accumulate vast amounts of foreign exchange thanks to its exports of oil and gas, allowing it to pay for military equipment and other supplies. In January 2022, the latest available data, Russia’s current-account surplus — a measure of what it earns from abroad — reached its highest-ever level.1 Oil prices are high, and Europe is in a cold winter. The European Union currently relies on Russia for almost 40% of its gas consumption.2
Russia-Ukraine is just one example of how the global addiction to hydrocarbons contributes to economic and political instability. Political scientists sometimes refer to this as the “resource curse”. As we at Generation Investment Management see it, there are two parts to this argument. Countries that are reliant on hydrocarbons tend to be weaker economically. That, in turn, makes the emergence of repressive political systems more likely.
Hypothesis 1
Take the economy first. Using World Bank data, we divide all countries into “oil-dependent” and “non-oil dependent” states, using a simple threshold: a country is oil-dependent if profits from oil account for more than 5% of GDP.3 Our analysis finds that in the past decade the economies of oil-dependent states have grown considerably more slowly (1.8% a year on average) than others (2.6% a year on average).
These states are also more likely to be “one-track economies”, where oil earnings are the only true source of foreign earnings. In the Republic of the Congo, for instance, where oil profits account for nearly half of registered GDP, there is not much else to sustain the economy. These countries tend to be subject to boom-and-bust cycles because commodity prices tend to be quite volatile.
Oil-dependent countries also tend to be more unequal. Recent research on Iran, for instance, has found a compelling link between oil booms and higher inequality.4 Russia has some of the world’s highest levels of inequality of income and wealth.5
Why does a reliance on hydrocarbons lead to such poor economic outcomes? One reason relates to “Dutch disease”. This is a phenomenon whereby high levels of exports result in currency appreciation, which ends up making non-resource sectors uncompetitive on international markets.6 Well-paid jobs in oil and gas draw the smartest people in, depriving other parts of the economy of their expertise. Oil-and-gas production is a highly monopolistic industry: only a small number of people control the industry at any one time, contributing to high inequality.
Another reason relates to corruption. Corrupt societies tend to have weaker economic growth.7 In part this is because weak property rights dissuade investment; in part this is because getting stuff done is just more difficult. A huge range of evidence shows that oil-dependent states tend to be more corrupt. One paper by two IMF researchers, for instance, found that an “increase in oil rents significantly increases corruption”.8 This is in large part because the potential payoffs to corruption — in the form of access to huge reserves of liquid gold — are high.
Hypothesis 2
For similar reasons oil-rich states are also more likely to be politically unstable—the second part of our argument. In part this is a direct result of the fact that their economies are weaker. But there is something inherently unstable about a country that relies heavily on fossil fuels. Whoever is in charge of oil rents has a licence to print money: beyond maintenance, pumping oil neither requires much particular expertise nor new ideas. Control is all that matters. As such, political violence has very high rewards. “Strongmen” political leaders are more likely to emerge. Might is right.
Fossil-fuel-rich states are, indeed, more likely to be autocratic. A recent paper in World Politics, an academic journal, found convincing evidence that “oil exports are strongly associated with authoritarian rule [and] that this effect is not limited to the Middle East”.9
Generation’s analysis of data from Freedom House10, a research organisation, backs up this point. Oil-dependent countries, we estimate, are approximately 40% less free than other countries (as measured on a one-to-seven scale).11 In addition, oil-dependent countries have become considerably less free over the past 30 years (other countries have become somewhat more free over the same period). Oil, in sum, is the enemy of democracy.
Conclusion
It is important to acknowledge that the West’s continued reliance on oil and gas perpetuates the “resource curse”. By using fossil fuels, we are not simply cooking the planet, as bad as that may be. We are also consigning a huge chunk of the world’s population to weak economic growth, political violence and undemocratic government.
There are good reasons to believe that renewable-energy generation, operated at scale, will not have these same pernicious effects. For one, a large body of research suggests that renewable energy is more labour-intensive: this helps spread the economic rewards around more widely, reducing inequality.12 The geographical distribution of renewable-energy generation — both within countries and between them — is also wider. Few countries can produce oil; but very few countries cannot produce renewable energy. Most people cannot dig an oil well in their garden, but most people can put a solar panel on their roof. The political dynamics are thus completely different.
Russia’s invasion of Ukraine has focused minds on the consequences of Western energy dependence. It is, however, also important to cast the net wider. Hydrocarbons are not just environmentally unsustainable: they weaken the social, political and economic fabric too. We can only hope that this crisis will accelerate the transition away from fossil fuels and towards a cleaner future.
- https://twitter.com/RobinBrooksIIF/status/1499438042280517640
- https://ec.europa.eu/commission/presscorner/detail/en/ip_22_1511
- https://data.worldbank.org/indicator/NY.GDP.PETR.RT.ZS
- https://onlinelibrary.wiley.com/doi/abs/10.1111/rode.12569
- https://www.europarl.europa.eu/RegData/etudes/ATAG/2018/620225/EPRS_ATA(2018)620225_EN.pdf
- This probably has disproportionate effects on women. Indeed some researchers have argued that oil production “reduces the participation of women in the labour force by crowding out the economic sectors that tend to employ women. Since fewer women work outside the home, they are less able to organise politically, less likely to lobby for expanded rights, and less likely to gain representation in government”. Countries with big oil reserves are thus worse places for women. Ross, Michael L. "Oil, Islam, and women." American Political Science Review 102, no. 1 (2008): 107-123.
- Mo, Pak Hung. "Corruption and economic growth." Journal of Comparative Economics 29, no. 1 (2001): 66-79.
- https://www.elibrary.imf.org/view/journals/001/2009/267/article-A001-en.xml
- https://www.cambridge.org/core/journals/world-politics/article/abs/does-oil-hinder-democracy/67665D8D240C8F43CD4A2DCB35894071
- https://freedomhouse.org/report/freedom-world
- The scale measures both political rights and civil liberties.
- Fragkos, Panagiotis, and Leonidas Paroussos. "Employment creation in EU related to renewables expansion." Applied Energy 230 (2018): 935-945.
Important Information
The ‘Insights 10: Fossil Fuels, the Economy and Instability: Why the world’s dependence on fossil fuels hurts the economy and creates instability' is a report prepared by Generation Investment Management LLP (“Generation”) for discussion purposes only. It reflects the views of Generation as at March 2022. It is not to be reproduced or copied or made available to others without the consent of Generation. The information presented herein is intended to reflect Generation’s present thoughts on sustainable investment and related topics and should not be construed as investment research, advice or the making of any recommendation in respect of any particular company. It is not marketing material or a financial promotion. Certain companies may be referenced as illustrative of a particular field of economic endeavour and will not have been subject to Generation’s investment process. References to any companies must not be construed as a recommendation to buy or sell securities of such companies. To the extent such companies are investments undertaken by Generation, they will form part of a broader portfolio of companies and are discussed solely to be illustrative of Generation’s broader investment thesis. There is no warranty investment in these companies have been profitable or will be profitable. While the data is from sources Generation believes to be reliable, Generation makes no representation as to the completeness or accuracy of the data. We shall not be responsible for amending, correcting, or updating any information or opinions contained herein, and we accept no liability for loss arising from the use of the material.