Monday, December 20, 2010

Russia and Its Uncertain Future

On the surface Russia would appear to be a healthy country. It is rich in natural resources. It survived a rough stretch after the dissolution of the Soviet  Union, but recovered and has had strong economic growth until the current financial crisis hit. Its economy has been blessed with both strong exports and healthy internal demand. It has its share of political issues to resolve as a legacy from the Soviet Union years, but none appear particularly threatening.

However, if one looks a little more closely and peers past the big picture numbers one sees a completely different image. The image is that of ineffectiveness, greed and corruption. Two recent articles take us deeper into the workings of the Russian state and its economy.

Walter Laqueur has written an article for the November/December 2010 issue of “Foreign Affaires”: Moscow’s Modernization Dilemma. He addresses the question of Russia’s future as a state, and tries to envisage where Russia might be ten or twenty years from now.

Laqueur begins by reminding us of Russia’s population issues. This is a subject we have discussed before.
“Speculation on the future of nations rests both on near certainties and on imponderabilia, which cannot possibly be measured, let alone predicted. Russia's demographics provide some near certainties: over the last two decades, more than 20,000 villages and small towns have ceased to exist, the immigration of Central Asian workers and Chinese traders has continued, and the Russian birthrate of 1.5 children per woman has stayed well below the replacement rate of 2.1 children per woman. A radical reversal of these demographic trends seems quite unlikely. There will be fewer ethnic Russians in the Russia of the future, to be sure. What is less clear is whether Moscow will even be able to hold on to the Russian Far East and all the territories of Russia beyond the Urals.”


A glance at the map of Russia indicates that the majority of the Russian land mass lies east of the Urals. To consider losing control of an area that large has implications on a monumental scale. Perhaps Russia’s biggest threat, or competitor, is China. The two counties share a long border (particularly if you include Mongolia) at which Russia has a declining population and China has a much higher and growing population. How does one lose control of so much land? Do you sell it? Lease it? Give it away? It is hard to see how this might happen at all, let alone happen gracefully.

Laqueur’s concern about Russia’s future centers on its failure to change with the times. Russia’s near-term economic prospects will be determined by the facts that they have a somewhat dysfunctional society, and they have a poorly balanced economy. It is easy to have strong growth if you have a very low starting point. It is good to have a steady flow of income from oil and gas exports, but it is not healthy if that is the overwhelming component of your exports.

Russia is aware of its need to modernize. Some of its actions must be interpreted in the context of their desire to meet this need, but their actions are necessarily constrained by their complex relationship with the developed nations, particularly the United States. The cold war legacy keeps Russia tentative in developing stronger ties with both Western Europe and the United States.

Its societal dynamics seem to hinder large scale changes.
“There is yet more debate over how to pursue modernization. Advocates of top-down modernization argue that the state should act as the main agent, with a minimum amount of political change. This form of authoritarian modernization is what the Putinists call ‘vertical state intervention.’ Russian proponents of this school are certainly aware that Russia acquired nuclear technology, to give one obvious example, without democratization. As they see it, Russia's traditions are not those of the West, and in the country's present labile state, more democracy would be harmful, possibly fatal.”

“Most of those in the more ambitious and daring camp, who favor deep modernization (this camp is comprised of management experts and Russia's economic liberals), do not envisage political democratization along the lines of the European model. But they do want some steps in this general direction: they argue that the modernization of recent years has not worked, partly because it has been limited to certain projects or branches of the economy and carried out without competition. Advanced technology can be bought or borrowed -- or stolen -- but more often than not, Russian industries have been unable to absorb new technologies and make them work. The state bureaucracy is not capable of guiding and directing resources toward innovation, nor have Russian capital markets shown much interest in investing in innovative technologies. In June, Putin told the members of the Russian Academy of Sciences to do more for the modernization of the country; this will not be easy, however, considering that the academy's budget is being cut and many scientists have protested against their dismal working conditions.”
A rapid path to modernization would be to create an environment in which outside interests would want to invest in production capability of goods for the Russian market. The stability Putin has provided is a plus in this context, but the lawlessness and corruption, particularly in the legal system, is not enticing to investors.

Laqueur is pessimistic.
“No matter which camp holds sway -- the more conservative one represented by Putin or the one somewhat more inclined toward reform headed by Medvedev -- modernization is probably inescapable in the long term. But in the short term, its prospects are poor. A change not of policy but of mentality is needed among both rulers and ruled. Such dramatic societal changes do occur, but they usually happen as the result of immediate need and a clear and present danger -- neither of which exists in Russia now. And this leaves Russian policymakers with the temptation to muddle economic modernization with a minimum of political liberalization.”
The second article appeared in the December 9, 2010 edition of “The Economist.” The author looks at the state of Russian society and produces a rather unsavory image.
“The Russian state not only flagrantly flouted the law for its own interests, but also sent a powerful signal to its bureaucracy that this practice was now okay.”

“According to Alexander Oslon, a sociologist who heads the Public Opinion Foundation in Moscow, Mr Putin’s rule ushered in a breed of ‘bureaucrat-entrepreneurs’. They are not as sharp, competitive or successful as the oligarchs of the 1990s, but they are just as possessed by ‘the spirit of money’ in Mr Olson’s phrase, the ideology that has ruled Russia ever since communism collapsed. By the end of the 1990s the commanding heights of the economy had been largely privatised by the oligarchs, so the bureaucrat-entrepreneurs began to privatise an asset which was under-capitalised and weak: the Russian state.”

“Unlike businessmen of Mr Khodorkovsky’s type, who made their first money in the market, the bureaucrat-entrepreneurs have prospered by dividing up budget revenues and by racketeering. ‘Entrepreneurs’ who hire or work for the security services or the police have done especially well, because they have the ultimate competitive advantage: a licence for violence.”

“No one worries about conflicts of interest; the notion does not exist. (Everyone remembers the special privileges given to party officials for serving the Soviet state.) As American diplomats are now revealed to have said, the line between most important businesses and government officials runs from blurry to non-existent.”

“In 1999 the oil price started to climb and petrodollars gushed into Russia, changing the mindset of the political class. Mr Oslon points out that the most frequently used word in Mr Putin’s state-of-the-nation address in 2002 was ‘reform’ and its variants. A few years later the most frequently used word was ‘billion’. Divvying up those billions has become the main business in Russia. Corruption no longer meant breaking the rules of the game; it was the game.”

“Shortly before his arrest Mr Khodorkovsky estimated state corruption at around $30 billion, or 10% of the country’s GDP. By 2005 the bribes market, according to INDEM, a think-tank, had risen to $300 billion, or 20% of GDP. As Mr Khodorkovsky said in a recent interview, most of this was not the bribes paid to traffic police or doctors, but contracts awarded by bureaucrats to their affiliated companies.”
This is not a pretty picture. The author continues on to discuss the implications of these societal characteristics for the Russian economy.
“Unsurprisingly, surveys now show that the young would rather have a job in the government or a state firm than in a private business. Over the past ten years the number of bureaucrats has gone up by 66%, from 527,000 to 878,000, and the cost of maintaining such a state machine has risen from 15% to 20% of GDP.”
The author says that many of the gains made in living standards for the Russian people came at the cost of a massive underinvestment in infrastructure.
“In the late Soviet era capital investment in Russia was 31% of GDP. In the past ten years Russia’s capital investment has been, on average, about 21.3% of GDP. (For comparison, the figure over the same period in China was 41%.)”

“Despite rising oil prices and a construction boom, Mr Inozemtsev says, in the post-Soviet period Russia has built only one cement factory and not a single oil refinery. The Soviet Union used to build 700km of railways a year. Last year, it built 60km. “We have lived by gobbling up our own future,” he argues.”
It would appear that a time of reckoning is not far off.
“Russia’s trade surplus is shrinking. As imports grow, so does pressure on the rouble. The government is now running a budget deficit. Mr Aven says Russia’s budget balances at an oil price of $123 a barrel. Three years ago it balanced at $30. For all the talk of stability, only 6% of the population can imagine their future in more than five years’ time, which may explain why only 2% have private pension plans.”

“To keep up his approval rating, particularly among pensioners and state workers, Mr Putin has had to increase general government spending to nearly 40% of GDP. To pay for this he has raised taxes on businesses, which are already suffocating from corruption and racketeering. While Russia’s peers in the BRIC group of leading emerging economies are coping with an inflow of capital, $21 billion fled out of Russia in the first ten months of the year….Russia’s private firms are too nervous to invest in their own economy.”
The author would agree with Laqueur that the prospect for progress in correcting these defects is minimal. The chosen title: “Frost at the Core: Dmitry Medvedev and Vladimir Putin Are Presiding over a System That Can No longer Change.”

It seems Russia has some interesting times in store.

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