Since the end of World War II and the birth of the modern global economy, business leaders have come to accept an iron law: International trade always expands faster than economic growth. Between the late 1940s and 2013, that assumption held true. Trade grew roughly twice as fast as the world economy annually, as fresh markets opened up, governments signed free-trade pacts, new industries and consumers emerged, and technological advances made international trade cheaper and faster.
Now this iron law may be crumbling. Over the past two years, international trade has grown so slowly that it has fallen behind the growth of the world economy, which itself is hardly humming. Major potential trade deals, such as the proposed Transatlantic Trade and Investment Partnership between Europe and North America, are at risk of falling through. At an early December meeting in Bali, representatives of the 159 members of the World Trade Organization agreed to move forward with basic trade facilitation measures but failed to reach any consensus on what should be on the table for the next WTO round, instead just deferring action on substantial items.
Despite such worrying trends, many economists and trade specialists seem unfazed. In its latest research report, HSBC (HSBC) predicted that global trade will continue expanding by about 8 percent annually for the next two decades, outstripping the world’s economic expansion.
Such optimism is misplaced. Expectations that emerging markets could boom for decades haven’t come true. Advances in technology over the past five years have facilitated the rise of state capitalism and made it easier for companies to stay in their borders. And unlike at just about any time in the past six decades, the political leadership of almost every major economy is weak, making it easier for protectionism to flourish. The era of free trade as the world has known it is dangerously close to coming to an end.
The belief that trade flows would inevitably increase was based on two assumptions: Emerging markets still had huge space to expand, and new technologies would make businesses more interconnected. These ideas still power reports such as HSBC’s forecast. But they appear to be wrong. Today’s technological advances don’t necessarily lead to economic integration. The latest breakthrough in manufacturing, 3D printing, makes it easier for companies to keep their design and initial production work in-house and cut out suppliers—which reduces trade, because it removes incentives to outsource later rounds of manufacturing overseas. The coming breakthrough in many science-based industries—such as synthetic biology, in which living forms are created from strands of DNA—will similarly create pressure for companies to keep operations in-house. Already, many corporations are coming home: Cross-border investment inflows fell by 18 percent in 2012 and probably will drop again in 2013.
Far from creating a long tail, globalization and the Internet have instead made economies of scale more important to companies’ survival. That has prompted consolidation in industries from telecommunications to oil to mining, allowing many of these industries to become dominated by giant state-owned companies from countries such as China, Russia, and Brazil. These state-owned enterprises are hardly forces for free trade: They often crush entrepreneurs in their own societies, and they often push for protectionist barriers, not against them.
As for the big emerging markets, they aren’t proving as resilient as expected, despite their huge consumer classes. China’s economy has slowed only marginally, but every other major emerging economy, from India to Brazil, has seen its growth drop precipitously the past two years. (When all the figures were finally in and calculated this summer, it turned out that Brazil’s economy grew by only 0.9 percent in 2012, far less than Brazilian leaders and economists had forecast.)
Many of these, such as India, have based their hopes for growth on services, not the export-oriented manufacturing that enriched Japan and the Asian tiger economies—and before them Britain, the U.S., and other countries. As economists Amartya Sen and Jean Drèze note, services not only employ fewer people than manufacturing, but they also face far more trade barriers by developed nations than manufactured exports.
These challenges might be surmountable if a stronger international consensus in favor of free trade existed. Over the past 60 years, at least one major economy was able to take the lead in advancing the global trade agenda. Today, however, every prominent trading economy is too consumed by problems at home. Weakened by the shaky rollout of health-care reform, President Obama faces a hostile Congress that has little inclination to support either the administration’s proposed free-trade agreement with Asia, called the Trans-Pacific Partnership (TPP), or a U.S.-European trade pact. China’s top leaders are still trying to consolidate power and address domestic challenges such as land reform.
Britain is consumed with austerity, Japan is embarking on contentious economic reforms, and Germany is constrained by its history and Berlin’s consensual politics. Reports of U.S. spying on top European leaders have caused politicians across the European Union—already skeptical of a trans-Atlantic trade zone because of concerns that many European industries would be swamped—to call for trade negotiations with the U.S. to be cut off. As of early December, negotiations have resumed, but the prospects for a deal remain highly uncertain.
The absence of political leadership has benefited populist forces and companies willing to flout trade rules. The Center for Economic Policy Research, a U.K.-based economic think tank, recently published a comprehensive analysis of trade-related legislation and other measures implemented by the Group of 20 countries over the past five years. Last year, G-20 countries passed 23 percent more protectionist measures than they had in 2009, while midsize trading nations—those slightly smaller than the G-20 economies—also have seen increases in protectionist measures. Major trading economies have turned to regional trade agreements, particularly in Asia, yet it remains unclear whether these deals foster global trade or simply discriminate against countries that are not signatories.
Getting the global trade agenda back on track won’t be easy. Although it’s debatable whether regional agreements promote multilateral trade, the White House needs to get the TPP finalized by the time the president heads to Asia next spring, so he can show America’s partners that the U.S. still has some credibility on trade. In addition, the U.S. should offer European allies concessions on surveillance issues, if that’s what it takes to get the Transatlantic Trade and Investment Partnership off life support. And leaders of the major economies should make clear that Roberto Azevêdo, the director-general of the WTO, has their backing in pushing to restart talks on a new global trade round, even after the failed negotiations on the round in 2009 and 2011.
An era of shrinking trade would be disastrous. The past 200 years show that trade makes the world economy more dynamic. It brings people from different countries together and links economies to each other, fostering interdependence. Leaps in scientific progress usually occur during times of growing trade and migration, because these types of exchanges create intellectual ferment. And although conflict between states can still occur, enmeshing nations in webs of trade does create incentives for countries not to fight wars against their trading partners. Restoring faith in free trade isn’t just an act of economic self-interest. It’s essential to building a more prosperous and peaceful world.
If you’re a cable TV subscriber who grumbles about paying for dozens of channels your family never watches, a media analyst has a message: That cable bundle carries all sorts of unseen benefits. In a report that attempts to quantify the costs of an à la carte pricing for cable television, Needham & Co.’s Laura Martin estimates that $45 billion of TV advertising would be at risk under such a change, along with 1.4 million jobs, $20 billion in taxes paid by such cable operators as Comcast (CMCSA) and Time Warner Cable (TWC), and $117 billion in market capitalization. And maybe you wouldn’t miss the Christian-themed Smile of a Child channel or Jewelry Television, but if you love any of those niche networks you could almost certainly kiss them goodbye for lack of financial support.
The notion of “unbundling” cable television packages and allowing consumers to choose only those channels they want has long tantalized frustrated subscribers, who pay about $720 per year in the U.S. for an average of 180 channels. The average viewer watches somewhere from 16 to 20 of those, according to Needham, and the gap infuriates millions as they write monthly checks to cable companies.
Martin argues in her report this week that à la carte pricing would lead to higher TV bills: “The notion of creating value through unbundling may be a laudable goal from a public policy point of view, but the world this premise describes can never exist.” That’s mainly because for every $1 of subscriber revenue, advertisers pay $1.24. Those payments totaled $101 billion last year, and $56 billion came from advertisers.
To keep the average cable roster of 180 channels, U.S. households would need to pay $1,260 yearly—or 75 percent more than they do now. But, wait, you say, the entire goal would be to pare that 180 drastically, down to the 15 or 20 I care to watch. Unfortunately, this is where the economics of the industry wallop an unbundler’s best-laid plans: The average annual cost to program a cable channel is $280 million, according to Needham’s math, and it’s way more for those that carry sports. Consumers tend to name an ideal price of $30 per month for just those few channels they want, according to Needham’s surveys. Across the 104 million U.S. homes with cable, that amounts to $37 billion per year.
Only 28 percent of current channels would survive in such a world—or about 50 channels in total. “Worst case,” Martin writes, “if distributors (who collect all the money) kept the first $30 billion (as they did in 2012), that would leave only $7 billion for content, implying only 7 percent of channels would survive and 173 channels would disappear.”
What about advertising? That revenue would still exist but only for the most-watched channels, such as Fox News (FOXA), AMC (AMCX) and A&E, where Duck Dynasty has ruled cable-TV ratings. What Martin calls “passion channels” like Discovery’s (DISCA)Military Channel would, in all likelihood, not have meaningful advertising funds and would disappear, taking the massive bundle paradigm with them.
This math exercise doesn’t translate to any kind of real-world channel bundles a cable TV company would ever try to sell, given their enormous cost structures and the fact that ESPN (DIS) alone has some nine permutations. (So far.) Yet the overall “ecosystem” of Big Cable remains a lucrative market for both content creators and distributors, their periodic fighting over money notwithstanding. While unbundling cable may not work economically, the Needham report does suggest one solution for people disenchanted over paying for all those unwatched channels: Cut the cord, keep your modem, and stream the shows you like from Hulu, Amazon (AMZN), or Netflix (NFLX). Says Martin: “That’s how capitalism works.”
Bachman is an associate editor for Businessweek.com.
Less than a decade ago, Miami's inner city was mangy. The tropical city could have become the next Detroit.
When businesses, law firms, and government offices downtown closed, few people remained in its seedy core, fleeing to suburban Miami-Dade and Broward counties for their gated, manicured subdivisions and soccer fields, or to the glamorous nightlife across the causeway in sleek South Beach.
But that's all changed. Miami is booming again. Construction cranes dot the skyline as a new wave of baby boomers, international residents, and businesses converge on the city.
Call it the tale of two cities: Detroit sought to fix its urban blight with high taxes, heavy regulation, and big salaries and pensions for government employees.
Much of the credit for the transformation of Miami falls to the city's mayor, Tomas Regalado, who decided to take his city on the opposite path, one of lower taxes and economic growth.
Regalado, a Republican born in Havana, Cuba, was elected mayor in 2009 and soon after, set out on an ambitious path of improving city finances, cutting taxes, and welcoming new businesses with a regulation overhaul.
He is running for re-election this November.
"This coming budget, we are proposing to reduce taxes, maintain the level of services, and hire more police officers. Why? Because property values are coming back," Regalado told Newsmax TV.
After forcing concessions from city workers, there is room in the budget for tax cuts, he said. And following a series of lawsuits from public unions that ended in the city's favor, Regalado was also able to trim Miami's budget without eliminating jobs.
City employees making more than $40,000 saw salary cuts, but those earning less did not have to share the pain. The plan kept all city workers employed as the city implemented tough reforms.
"I didn't want to kill a city to save a government," Regalado said, defending his choices, which included slicing his own salary by 36 percent.
"We broke all the contracts with the union, created [new] contracts with salary reductions, and capped the pensions at $100,000, because in the city of Miami, you had [young] people retiring with $150,000, $140,000 per year for life. [In Miami] ... firefighters and police officers retired young," Regalado, a former broadcast journalist, says of the bitter fight and lawsuit he weathered.
He said topping pensions at $100,000 helped to "reduce the deficit and taxes. The reason I proposed to reduce taxes was because the foreclosures were affecting Miami. Miami was ground zero," Regalado said.
"I thought that by reducing taxes, you would bring new investment into the city of Miami and it happened. People are moving back. The message is very clear: You reduce taxes, people will come because it's a good investment."
Regalado also cited tax enterprise zones and Business Improvement Districts — where business people in a geographic area tax themselves and decide which projects to fund — as programs that helped turn the city around.
Today, the city once known for its "vice" in a hit TV show now reflects Regalado's opportunistic message: chic high-rise condos, an emerging crop of world-class restaurants, high-end hotels, a growing expanse of luxury retail stores, and a burgeoning cultural scene.
"I've been in this position for five years now. When I first got here, the condos were 62 percent occupied," says Alyce Robertson, executive director of the Miami Downtown Development Authority. "We are at 95 to 97 percent occupancy now."
The inner city, she adds, has become "its own destination," making it an easier sales pitch for civic leaders seeking jobs for the city beyond those created by a service and tourism industry.
The city vigorously courted financial services companies from New York and Connecticut, tech industry jobs for the city's South American Internet hub, and art groups seeking a friendly home.
"By the year 2025, we envision in our master plan a very vibrant, culturally diverse, walkable, livable downtown," Robertson said.
After being hit hard by a foreclosure crisis that still lingers — about 41 percent of mortgages are still underwater in the Miami-Dade County region — real-estate experts say trendy areas like Miami Beach and Regalado's downtown are flourishing with housing prices reaching levels last seen during the 2000 boom. Miami Beach is a separate municipality from the city of Miami.
The Miami arts scene is also in full tilt. In November, the world-class Perez Art Museum is set to open its doors alongside the premier Patricia and Phillip Frost Museum of Science.
Other chic construction projects in the works for the Downtown-Biscayne corridor include an architecturally spectacular convention center and Marriott hotel with 1,800 rooms on the site of the old Miami Arena, adding to a changing landscape that also includes the elegant Adrienne Arsht Center for the Performing Arts, the state's largest facility of its kind.
Miami still has its share of urban problems such as homelessness, income inequity and, according to National Science Foundation data, the lowest science and engineering workforce for major cities in the nation.
But a coalition of business and education leaders is focused on changing that.
"I think there is a renewed spark of energy and it is palpable in this community," says Robin Reiter, the interim president of Miami's The Beacon Council, a public-private nonprofit organization that helps increase economic development and facilitates job creation.
"I think you see it in the day life as well as the nightlife. I think you see it in the vibrancy of all our downtown communities," Reiter said. Other Miami-Dade County cities like Aventura, Coral Gables and South Miami have their own booming downtown areas.
"I think the real estate market is recovering," Reiter adds. "The pendulum here swings once again. The price of housing is going up. There is a thrust to build more rental units to accommodate those who don't want home ownership … Yes, we're still seeing a high level of homes in foreclosure, but we're seeing them move off the market very quickly."
Broader international interest in Miami is also heating up the market, Reiter says.
"We have folks from all over the world buying property here," she said, noting that delegations from China and Taiwan have recently visited to examine possibilities in the area.
"We have a huge influx of businesses from across the globe who view Miami as the gateway to the Americas and as such, our business is booming," said Reiter.
Reiter points to the metro area's thriving Miami International Airport and its bustling seaport and cruise ships as crucial economic touchstones that are driving growth.
"There isn't a locale around the world that anyone can travel to and from that, you can't get to and out of Miami with great ease. That has been a tremendous bonus."
Seth Gordon, who runs Seth Gordon Initiatives, which advises global businesses on how to become productive in Miami, praises new inner-city projects as giving the area "a heartbeat."
When he moved to Miami in the 1970s, the city "had no life, no pulse." Now restaurants and businesses are leaving the beaches for the Brickell Avenue corridor, where the new energy is pushing development.
"It's become like a horse race to see how quickly you can buy up empty lots and fill them with very expensive buildings," he said of the growth.
The area's international cache, Gordon adds, is growing. "You see people from Argentina, Brazil, Colombia, Venezuela, and also Russia, even New York. A lot of them don't live here year-round, but this is one of their homes. They just want to have a place here," and are willing to spend $2 million to $3 million on a pricey vacation spot.
For the wealthy, "it's become one of their checkpoints," Gordon observes.
But the challenge remains on how to create an economy that supports jobs for those who aren't ultra-wealthy.
In terms of space, even as the city center explodes, Gordon said, "we've got another 95 percent of the county not exploited or built out yet: inland. We've got room to do whatever we want to do if people ever want to do it."
Gordon adds, "There's a huge opportunity for expansion, maturity and for growth — and all that comes with that. The last 10 years have been a good peek into the future of just what we can do. We're on the right track now. We just have to keep doing more."
Regalado Makes Case for Second Term
In the interview with Newsmax TV's John Bachman, Mayor Regalado makes a strong case for re-election on Nov. 5, saying he helped bring the city back from a feared fiscal collapse.
"Miami is the poster child of what happens if you reduce taxes, reduce expenses, if you live like any other family in the United States," says Regalado. "In bad times, you don't spend what you don't earn. In good times, you only spend what you have."
"People will understand that this is the model for any city," he says.
Story continues below video. Regalado has done what many of the nation's other big-city mayors have not had the courage to do: push back against costly union deals to stave off fiscal collapse and create a business climate favorable to private investment.
"I know that politicians always, always are really scared of unions because the unions do have great power, political power. They have the resources to go out and help you or hurt you," Regalado says.
After a market boom from 2004 to 2006, property values were hot in the tropical mecca. But by 2008, the bottom dropped out of the housing market and foreclosures skyrocketed, leaving revenues sagging and city leaders searching for new ways to close the gap.
"The combination of having a lot of unemployed people, property values going down — which is [lost] taxes — and the fact that we overspent by giving unions huge increases in 2007 made us almost bankrupt," said Regalado, describing the situation he says he inherited when he took office in 2009.
Regalado says Miami wasn't fully into a fiscal emergency like Detroit, but the city was headed on a road to "fiscal urgency." Thus, his need to make some difficult choices put him at odds with police and firefighters, whose union pension costs were cutting large slices of city funds.
Regalado said the growing pains of Miami can be an example to cities like Chicago, where mayors must wage similar union fights over pension and healthcare costs after years of fiscal malfeasance and high taxes.
"They only need the courage to do it," Regalado tells Newsmax. "I know it's difficult to fight unions. And in my case, I became persona non grata with the unions."
Regalado said winning the battle with the unions was the key to the city being able to stave off a tax increase, instead allowing for tax cuts.
"We would have made people leave Miami because of high taxes. And I thought that by reducing taxes, you would bring new investment into the city of Miami and it happened," Regalado said. "The idea that you have to increase taxes to keep services is wrong."
Such successful reforms will likely bolster the political future of Regalado, who until late August faced a serious challenge in his re-election bid from Francis Suarez, who was well-financed but dropped out of the race amid a series of miscues by his staff. He said the campaign was creating too much stress on his pregnant wife.
In his own life, Regalado was married for 37 years to Raquel Ferreiro, who died in 2008. He is the father of three and the grandfather of four, and lives in the city's Little Havana neighborhood.
Regalado said that when he was elected mayor in 2009, "[it] was the worst economic time for the United States and for the city of Miami, especially."
"Unemployment was like 13 percent," Regalado said. "The construction boom had ended but we had 20,520 empty condo units in the downtown corridor, which is five, six miles. All these buildings, they were empty."
Regalado recalled "at the time, you looked at the skyline at downtown at night and it was dark. Today we have 98 percent occupation. People are buying, people are renting, people are moving back, and that has helped the revival of downtown."
With new restaurants in places far from South Beach, many are reconnecting with the new lively downtown area.
Regalado praised the growth in other areas of the city as well. In Overtown, once the site of riots, a new wing of the University of Miami has brought an improved landscape and 500 new jobs.
"They're doing medical research, [with] doctors that specialize in care," Regalado said.
In Wynwood, the center of the city's arts district renewal, technology has been invited as an emerging partner to bolster the growth.
"We have a lot of technology companies in old warehouses that house hundreds of small companies ... Technology, it is the future of Miami," he said.
Soon, search engine powerhouse Google will announce a partnership with the city's parks, he said. "We believe that if we train children after school in programming and in computers, more companies will come to Miami," Regalado says.
Tourism and the potential of new citizens and foreign investors are an important part of the success equation, Regalado added.
"We have more than 20 flights a day from Miami direct to Europe directly feeding tourism, but there are [also] a lot of business people coming to invest here," he said.
He said the city has applied to the Department of Homeland Security to be "certified as an investor visa regional center," where a foreign national who invests $1 million in certain businesses can obtain for themselves and some family members a "permanent green card if they create 10 jobs."
Tax enterprise zones and a healthy Business Improvement District also have played a role in allowing private enterprise drive the economy of the city, Regalado says.
"They decide how to spend that money, either in lighting, more police presence, or in infrastructure, and it's working spectacularly because the fact is, these people know better," Regalado said. "Usually government doesn't know better."
Study results released in late August revealed a startling disconnect between
marketing and technology at most U.S. businesses. According to Accenture, the
research firm that conducted the survey of chief marketing and technology
officers, only 10 percent of CMOs and CIOs believe collaboration between the two
disciplines is sufficient at their organizations.
ABSTRACTS:
The Accenture study shows that only 10 percent of CMOs and CIOs believe
collaboration between the two positions is sufficient at their organizations...
While 77 percent of technology executives in the Accenture study agreed
that alignment between marketing and technology is important, only 45 percent
said that marketing is near the top of their priorities...
The study shows overwhelming agreement among marketing and technology
executives that technology is essential to marketing, and that its primary
purpose is to gain insight and intelligence about customers...
The Accenture study responses show the disconnect between marketing and
technology professionals most clearly in these responses: 36 percent of
marketers said IT deliverables fall short of the desired outcome, and 46 percent
of IT executives said marketing does not provide an adequate level of detail to
meet business requirements...
The marketing guys are not specifically wired at the detail level – that is why
the two departments must be entrenched in the day-to-day operations of the
business in order to succeed. The marketing team has to involve the IT team when
developing a project or customer request, the IT guys have to understand the
business better...
When I grew up the Russians were the Soviets and they were the bad guys. We were told we were about 20 minutes or so from mutually-assured destruction and that the Russians (er, Soviets) hated us for our freedoms.
Eventually, things changed. The Soviet Union fell but many of the old guard remained in power. Vladimir Vladimirovich Putin is a good example. He spent 16 years in the KGB, mustering out with the title of Lieutenant Colonel (the same rank Ollie North had when he was playing games with Iran and the Contras).
While Ollie never became leader of a great nation, Vlad-Vlad certainly did. In fact, the Putinator has been either President or Prime Minister of today's Russia since 1998. Suffice it to say, not much goes on in Russia today without the Putin stamp of approval.
That's why my attention was so quickly drawn to what seems like a normal little marketing gimmick on the part of RT.com. You might know RT.com as a news site. After all, Alexa shows it has a ranking 553 in terms of American visitors to its Web site. 20 percent of its visitors come from the United States (compared to only 5.8 percent who visit from Russia).
What was that marketing gimmick? Nothing big really. Just an extension you can install in Chrome to keep up with RT's news. Or is it something more... devious?
Image courtesy RT.com
Let's explore RT.com for just a minute. RT.com is Russia Today. Yeah, it's a Russian-owned and Russian-operated propaganda vehicle aimed squarely at Americans. It is funded directly by the Russian Government through Rospechat, the former Ministry of Communications and Mass Media, now known as the Federal Agency on Press and Mass Communications of the Russian Federation.
RT is Putin's house organ. Of course, because most people don't bother to investigate where their news comes from, RT.com is regularly quoted and Liked and tweated all around the blogosphere. I wonder how many people who think they're good Americans don't realize they're furthering Putinganda all across the U.S.?
So here's what baffles me. Everyone is all up in arms about this NSA spying thing, where activities being done are being done under carefully defined legal conditions, and where most of it is for Americans' protection. And yet there are constant stories of outrage.
But when a foreign frenemy power wants to install a toolbar right in your browser, a toolbar that can do pretty much anything (no, I haven't disassembled it, but that's not the point), no one whines and no one cries.
Of course, we're also depending on Eugene Kaspersky for much of our anti-malware protection. Kaspersky was trained by the KGB and his anti-malware software "protects" about a third of America's PCs.
Americans and the press are all freaking out because America's premier signals intelligence agency is gathering signals intelligence for the purpose of protecting America, but then they turn around and open up their computers and their privacy completely to a foreign power who most definitely does not have their best interests at heart.
Sometimes I just don't understand folks out there.
Oh, and if you want to know more about Putin and his antics, read this briefing paper I wrote last year. That one will give you nightmares for a week.
For Russian leaders, sticking it to the Americans has long been a source of both personal satisfaction and political gain. By that standard, President Vladimir Putin is riding high.
He’s enraged Washington officialdom by supporting Syrian President Bashar al-Assad—despite his apparent use of chemical weapons against civilians—and obstructing efforts to rein in Iran’s nuclear ambitions.
Activists in the U.S. and Europe have called for a boycott of the 2014 Winter Olympics in Sochi over the country’s harsh new antigay law.
The Kremlin’s decision to shelter National Security Agency contractor Edward Snowden, wanted on espionage charges in the U.S., prompted President Obama to nix a one-on-one meeting ahead of the Group of 20 summit in St. Petersburg, Russia, on Sept. 5 and 6.
Since reclaiming the presidency in May 2012, Putin has become the biggest impediment to the Obama administration’s foreign policy aims. That’s undoubtedly played well with Russians yearning for the days when the country was a superpower. Yet beneath Putin’s swagger lie weaknesses at the core of the economy that threaten Russia’s future—and with it, his power base. And for that, he can blame a familiar nemesis: the U.S.
His difficulty has nothing to do with intercontinental ballistic nuclear missiles—and everything to do with natural gas that’s cooled to -260F at normal pressure, condensed into liquid form, and transported on special tankers to markets around the world. America’s surprising return as an energy superpower is complicating life for the Russian petro state. The rise of a vibrant, global, and pipeline-free liquefied natural gas (LNG) market is a direct threat to Russia’s interests in Europe, where Gazprom (GAZP:RU), the state-owned energy giant, supplies about 25 percent of the gas. So is the shift in pricing power from suppliers to consumers as a result of the huge supply shock emanating from North America.
Russia is still the world’s biggest overall energy exporter: It’s the No. 1 oil producer and No. 2 in gas after the U.S. However, the country’s known oil reserves—primarily between the Ural Mountains and the Central Siberian Plateau—are enough to sustain current production levels for just 20 years, according to a study in December by the European Bank for Reconstruction and Development (EBRD), vs. 70 years for Saudi Arabia and 90 years for the United Arab Emirates. Untapped oil and gas reserves in eastern Siberia and the Arctic will take massive investments to explore.
Putin’s aware of the problem. “For many years we have had a situation when prices for our main export goods rose fast and almost without interruption, and this made it possible for Russian companies and for the government to cover high expenses,” he told global executives at the St. Petersburg International Economic Forum on June 21. “But this situation has changed now. There are no simple solutions and no magic wand we can wave to change things overnight.”
That may be true, but the country has little time to waste. Many Russians, and in particular members of the president’s inner circle, have benefited hugely from the country’s energy-export windfall. Now that foundation is slipping away. The question is whether Putin’s power will, too.
When he took over at the start of the last decade (he served as president from 2000 to 2008 and premier for four years after that), the global economy was in the early stages of a commodities supercycle. Accelerating global demand, led by a China growing at about 10 percent annually, coincided with rising prices for oil, gas, copper, coal, and other natural resources. Political instability in Venezuela, the start of the Second Gulf War, and Hurricane Katrina all constrained supply and refining capacity, sending energy markets into overdrive.
Through 2008, Putin oversaw an average of 7 percent growth in gross domestic product and a huge expansion in Russia’s middle class. At its 2007 annual meeting, Gazprom, the world’s largest gas producer, served red and black caviar. Management Committee Chairman Alexey Miller said the company, whose market value at the time was $360 billion, would someday be worth $1 trillion.
Russia’s phenomenal run of prosperity would have been an ideal time to diversify the economy beyond energy, a goal that harks back to the days of Soviet leader Leonid Brezhnev. Instead, energy’s share of the economy actually increased; as of late 2012, oil and gas accounted for about 70 percent of exports, compared with less than 50 percent in the mid-1990s, providing half of the government’s revenue and roughly 17 percent of GDP, according to the EBRD. Gazprom alone represents 14 percent of the Russian stock market’s total capitalization. “It has been an issue since the late 1970s and early 1980s, and it has gotten worse,” says Alexei Kokin, an energy analyst with UralSib Financial. “I don’t see that changing.”
Russia’s energy dependency problem became impossible to ignore in 2009 as the global recession crushed oil prices, which fell to $34 a barrel from a precrisis high of $147. Russia’s economy contracted almost 8 percent, the steepest drop among the G-20 industrialized nations that year. Since 2010, the economy hasn’t come close to hitting the 5 percent to 6 percent mark that Putin has said it needs to close the gap with leading developed nations. On Aug. 9 the government said the roughly $2 trillion economy unexpectedly slowed in the second quarter, growing a below-expected 1.2 percent from the previous year, the sixth consecutive quarterly deceleration. As for Gazprom, it’s worth all of $94 billion, down 74 percent in six years.
Photo illustration by Crash!; Putin: www.kremlin.ru
Putin, 60, has long viewed the nation’s natural resources as a foreign policy lever. He learned about the economics of scarcity growing up in the 1950s in a decrepit communal apartment complex in postwar Leningrad (now St. Petersburg). “There were hordes of rats in the front entryway,” Putin said in an autobiographical compilation of interviews, First Person, published in 2000.
“My friends and I used to chase them around with sticks.” In a 2012 interview he said that his elder brother died from diphtheria during the Nazi siege of Leningrad; his father barely survived his combat tour with the Soviet army.
Many years later, as deputy mayor of St. Petersburg, Putin wrote an academic thesis advocating that Russia flex its energy muscles.
Once in power, he did just that: In price disputes, Russia turned the taps off on its gas pipelines to Ukraine in 2006 and 2009 in the dead of winter, causing shortages elsewhere in Europe. Gazprom has been able to extract high prices, particularly in former Soviet states, by indexing its long-term contracts to the price of oil.
Putin renationalized the oil industry and dialed back the involvement of Western oil companies. Authorities arrested and later convicted Yukos Chief Executive Officer Mikhail Khodorkovsky in 2003 on tax charges just as the company entertained selling stakes to ExxonMobil (XOM) and Chevron (CVX). Approximately $27 billion in state tax claims bankrupted Yukos, whose assets were sold off to other companies. After pressure from Moscow, Shell (RDSA) gave up part of its stake in an LNG venture in Sakhalin to local interests. British Petroleum (BP) sold its stake in an Anglo-Russian joint energy venture called TNK-BP to Rosneft (ROSN:RU) after a dispute with investors in the country.
At the same time, Putin placed loyalists throughout most of the oil industry or secured the allegiance of executives. In December a report by Yevgeny Minchenko and Kirill Petrov for Moscow-based consulting firm Minchenko Consulting Communication Group portrayed Putin as an energy czar with direct control over “long-term gas contracts, management of the gas industry, and, basically, Gazprom, as well as the control over backbone Russian banks” such as VEB, VTB, and Sberbank.
Taxes on the energy industry are vital to the Kremlin patronage system. They give Putin the means to woo key constituencies such as the military, security, and political elites; to improve government pensions; and to spend in poorer regions in the Muslim North Caucasus and other rural areas. During his 2012 campaign, he promised to improve wages for doctors and teachers, increase retirement checks, and invest in Russia’s military arsenal. The former KGB career officer is unlikely to loosen his grip on the state-owned energy sector, because that would endanger his grip on power, says one economic adviser who declined to be identified for fear of offending the president.
Five years ago, peak oil theorists predicted that global production would soon hit its high-water mark and then decline inexorably, with the U.S. growing even more dependent on overseas energy imports. Those trends seemed to play into Putin’s hands. What he didn’t anticipate was that U.S. oil production—thanks to horizontal drilling and hydraulic fracturing technology, in which pressurized water and chemicals are blasted into rocks to release energy—would increase 46 percent. That equals the entire output of Nigeria, estimates Daniel Yergin, vice chairman of consulting firm IHS. “Think of it like a non-OPEC country appearing in North Dakota or southern Texas,” Yergin told executives at the St. Petersburg forum in June.
Between now and 2018, North America will provide 40 percent of new supplies through the development of light, tight oil and oil sands, while the contribution from the Organization of Petroleum Exporting Countries will slip to 30 percent, according to the International Energy Agency, which also sees the U.S. emerging as the biggest oil producer by 2020 and a net exporter of oil by about 2030. Meanwhile, the agency trimmed global fuel demand estimates for the next four years.
The U.S. is also on pace to add 2 trillion cubic feet per year of natural gas once three just-approved LNG projects start operating, an 8 percent increase in total U.S. capacity based on 2012 production levels. More LNG facilities are coming onstream in Australia, South Korea, Mozambique, and Tanzania. Yergin predicts natural gas, both conventional and liquefied, will be the No. 1 energy source by the end of 2030.
Russia’s worry is twofold: An expanding supply of affordable LNG, which is transported by ship, is forcing Gazprom to either cut prices or lose share. (Weird and surprising fact: As American utilities shift to gas, displaced U.S. coal is flooding into European markets. The U.S. may supplant Russia as the world’s No. 3 coal exporter by yearend, according to Goldman Sachs (GS).) Second, the Russian gas giant is under pressure to adopt spot-market pricing instead of tying its prices to oil.
In June, Gazprom agreed to revise its gas contracts with German utility RWE after losing an arbitration case; it’s renegotiating supply contracts with other utilities, including Eni (ENI:IM) and EconGas. The European Union is also drafting an antitrust complaint against Gazprom for abusing its dominant position, say three people familiar with the probe who asked not to be named. The company declined to comment. Longer term, the Russians may even have to contend with shale energy assets being developed by Western oil majors in Poland, Ukraine, and Lithuania, all Gazprom profit sanctuaries.
With the LNG trade expected to almost double to 450 million tonnes a year, according to Bloomberg New Energy Finance, the Russian government is expected to take up legislation that would for the first time allow companies other than Gazprom, which has been slow to respond to big industry changes over the last decade, to export LNG. Energy Minister Alexander Novak said in June the country is also committed to building out its LNG capacity—Russia has just one plant up and running in Sakhalin—and more than doubling Russia’s share of the LNG trade from 4 percent to about 10 percent by 2020. With Gazprom’s traditional gas business facing pricing and demand pressure in Europe, Russian companies need to be bigger players in faster-growing Asian markets. “We are really behind the curve and need to accelerate,” says Ildar Davletshin, an oil and gas analyst with Renaissance Capital.
The challenge for Putin is to simultaneously revive the country’s colossal energy sector—and then place Russia on a track to break free of its hydrocarbon dependency. The country needs to make huge infrastructure investments in the east and to expand nonenergy sectors where Russia has real potential, such as information technology, airplanes, helicopters, engines, turbines, and industrial pumps and compressors.
The country’s recent entry into the World Trade Organization could be an opportunity to reduce or eliminate import tariffs and trim domestic subsidies. Putin’s near-total control of Russia’s political apparatus—he’s marginalized, intimidated, or silenced any potential opposition—gives him the space to push through painful reforms. It would require not only the kind of tough-mindedness the bare-chested outdoorsman and YouTube sensation is known for but also a fair amount of business savvy and strategic vision. Failing to reform risks condemning Russia to a future of middling growth, declining standards of living, and diminished stature abroad. If Putin truly wants to restore the country to economic greatness, Russia will need a 12-step program for its energy-addicted economy.
