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Do Oil Exports Fuel Defense Spending?

Authored by Dr. Clayton K. S. Chun. | February 2010

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Many national security analysts have viewed oil-exporting countries with some trepidation. Although these exporting nations supply a vital energy source to the United States and her allies, it comes at a price. A great wealth transfer occurs in this process from oil importers to exporters. In some cases, oil importers face economic woes if energy prices rise sharply. Additionally, some critics might argue that oil exporters now have the financial wherewithal to acquire a military capability that could threaten neighbors or create intra-regional instability with global implications. If oil revenues are the major factor that determines defense spending levels, then an oil- exporting nation’s neighbors or other powers need to become more vigilant during times of great energy demand or price increases. Conversely, decreases in oil revenue might presage a reduction in defense spending and a corresponding lessening of tensions. Could oil prices be a significant factor in determining defense spending? If so, then the level of oil revenue may become an important predictor for future defense budgets. But what if nations decide their defense spending will be independent of oil revenues? A more serious situation might ensue if defense spending rises independently of any oil price increase or decrease.

During the summer of 2008, oil exporters received record oil profits. Oil importers suffered greatly due to the high energy prices. As the world economy retreated in early 2009, some national security analysts believed that the United States might face fewer problems from oil exporters that bankrolled their defense spending through petroleum sales. Although the premise that falling oil prices would cause a reduction of government expenditures seems attractive, perhaps it might not be valid.

Nations that depend on oil sales or raw materials for their major source of government revenue might act much differently from industrialized or developed countries. States that rely on rents from the sale of their raw materials, leases from firms extracting raw materials, royalties, and other payments have motives to control these raw materials. Such rentier economies may have few options to develop wealth other than from raw materials extraction. The governments that oversee these economies could use these revenues to placate or silence critics, create a society that depends on government largesse, or divert profits for the personal enrichment of government officials. If the economy is not fully developed, then the government might be the major source of economic strength and power in the state. The national leadership may feel the need to control the sale of raw materials, like oil, to maintain its position in society. Government officials who control all aspects of the economy, politics, and society may employ this wealth to underwrite large defense budgets to enhance their own security or to create a capability to counter a national security threat.

Oil revenues and wealth serve as means to finance current and future defense spending. One method to indicate how defense spending changes with different amounts of oil revenue is simply to measure elasticity of demand. This metric describes the sensitivity of defense spending to changes in oil revenue in a given period. If, during a given period, a nation’s defense spending rises or falls by a greater percentage than the percentage rise or fall respectively of oil revenue receipts, then defense spending is said to be elastic. Conversely, if during the same period a nation’s defense spending rises or falls by a lower percentage than the percentage rise or fall respectively of oil revenue receipts, then defense spending is said to be insensitive to oil revenues, or inelastic. The most extreme and threatening form of defense spending inelasticity in a potential aggressor nation occurs, of course, during a period when the percentage rate of defense spending is trending upward at the same time that the percentage rate of oil revenues is trending downward. That could be a very troubling sign in regions afflicted by rivalries.

This monograph examines five countries that relied on oil exportation for a large portion of their Gross Domestic Product (GDP)—Venezuela, Iran, Saudi Arabia, Kuwait, and Nigeria. Each nation exhibited a mainly inelastic demand for defense spending vis-à-vis oil exporting revenues. This suggests that oil revenue is only one factor in determining why nations might have a high rate of defense spending. These countries increased defense spending even during times of declining oil revenues.

Each nation experienced situations where annual oil revenue decreases failed to slow defense spending, and there were years when defense expenditures actually increased. Additionally, in countries that did not decrease defense budgets at the same rate of oil revenue reductions, military expenditures fared better. However, in some instances, worldwide economic slowdowns did cause reductions in defense spending, but this condition was temporary and not universal to all oil exporters.

If oil revenue is not the major determinant of defense spending, then what other factors could affect such spending? Nations might rely on many years of oil revenue accumulation to disburse during lean times. Long-term defense systems like aircraft or ballistic missiles might require many years to acquire. Security-conscious countries might fear the growth of a regional rival, domestic opposition, terrorism, or other threats that require military forces regardless of the level of oil revenues. To explain why defense spending increases or decreases, analysts would need to consider country-specific rationales rather than concentrating solely on oil revenue measures. Policies that attempt to limit oil revenues for nations that potentially endanger national interests may not significantly affect defense spending. Thus, a one-size-fits-all policy would probably fail; instead, mitigating regional threats or pursuing other options to reduce the defense spending of the target state might be more successful.