Trade Theory: The Case of Russia as Oil Exporter

Background

            The oil industry of Russia is undoubtedly one of the largest in the world. Russia is relatively the largest exporter of natural gas, a position that was once held by Saudi Arabia. Today, the country is expected to outrank Saudi Arabia as the leading exporter of oil (considering its position as the largest non-OPEC exporter of oil). Overall, Russia provides about 13% of the world supply of oil. In 2006, the production of crude oil in the country reached to about 10 million barrels per day. Domestic demand for crude oil is about 2.6 million barrels per day. The excess quantity of crude oil is used for export.

Issues

            There are two overriding issues here. First, there is the problem of investment. Potential production of crude oil (about 2.3 times the current crude oil production) can be reached if investment to the oil industry is increased by about 89%. This poses a problem to the Russian government. Only few capitalists are willing to invest their money to the Russian oil industry. Perhaps, the main reason lies in the relatively risky nature of the oil industry. The second issue is the about trade surplus. As Russia increases its oil export, the value of imports becomes relatively lower than the value of exports. This situation seems very attractive. However, it posits several problems. The Russian currency will appreciate relative to the value of other currency. In the long run, the appreciation will hurt the exporting sector. The government will be forced either to subsidize the exporting sector or limit its production of crude oil. The latter will cause another strain on the oil producers. The potential gap between investment and ROI (return to investment) increases. Incentives to invest become lower. If the nominal wage of workers in the oil industry is not fixed, then real wage falls.

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Analysis

            Using the Heckscher-Ohlin model, we can draw up a simplified economy of Russia (importing and exporting sectors). Suppose we have only two sectors of the Russian economy: importing and exporting sectors. There are two general goods: oil and import goods. Factors of production (labor, capital) are perfectly mobile between industries but immobile between countries (Dunn and Mutti, 2004). The oil industry is relatively capital intensive than import goods. There is a constant return to technology for both goods (Dunn and Mutti, 2004).

            If Russia is to increase its export of oil, it must also increase its import of goods (labor-intensive). Russia gains trade balance, that is, it has neither trade surplus nor deficit. Russia also increases its social indifference curve; that is, there is an increase in the quantity and variety of goods consumed by the Russian population (Dunn and Mutti, 2004). Here, Russia can avoid an appreciation of the Russian currency and a possible decrease in the incentive to invest. The shift of the social indifference curve (a higher social indifference curve) implies higher utility for the Russian population (Dunn and Mutti, 2004). The price of oil, however, in the world market is lower since the supply of oil is also increased (world supply of oil increases).

Conclusion

            An indefinite increase in the quantity of Russian oil exported will definitely lead to an indefinite appreciation of the Russian currency. This is not good since it will indefinitely hurt the exporting sector of the country. The remedy is achieved by finding a desired level of exports relative to imports in order to achieve maximum social utility. The effect though is a lower price of oil and an increase of the world supply for oil. Russia though can import more goods from countries, increasing domestic consumption.

Reference

Dunn, Robert and John Mutti. 2004. International Economics. London: Routledge.

 

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