Cyclopedia Of Economics 1st edition

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Russia, Economy of

Contrary to recent impressions, Russia's Western (American-German) orientation is at least as old as Gorbachev's reign. It was vigorously pursued by Yeltsin. Still, 2002 marks the year in which Russia became merely another satellite of the United States - though one armed with an ageing nuclear arsenal.

Russia's economy has revived remarkably after the 1998 crisis, but it is still addicted to Western investments, aid and credits. Encircled by NATO to its West and US troops stationed in its central Asian hinterland, Russia's capitulation is complete. In the aftermath of conflicts to be engineered by the United States in Afghanistan, Iraq, North Korea, Iran, Syria and, potentially, Cuba - Russia may feel threatened geopolitically as well as economically. Both Iran and Iraq, for instance, are large trading partners and leading export destinations of the Russian Federation.

If anything can undo the hitherto impressive personality cult of Russia's new "strong man", Vladimir Putin, it is this injured pride among the more penumbral ranks of the country's security services. Russia's history is littered with the bloodied remains of upheavals wrought by violent ideological minorities and by assorted conspirators.

Hence Putin's tentative - and reluctant - attempts to team up with China and India to establish a multi-polar world and his closer military cooperation with Kyrgyzstan and Armenia - both intended to counter nationalistic opposition at home.

Luckily, the sense of decline is by no means prevalent.

Russians polled by the American Pew Research Center admitted that they feel much better in a world dominated by the United States as a single superpower. The KGB and its successors - Putin's former long-term employers - actually engineered Russia's opening to the West and the president's meteoric ascendancy. And no one in the army seriously disputes the need for reform, professionalization and merciless trimming of the bloated corps.

Reforms - of the military, Russia's decrepit utilities, dilapidated infrastructure and housing, inflated and venal bureaucracy, corrupt judiciary and civil service, choking monopolies and pernicious banking sector - depend on the price of oil. Russia benefited mightily from the surge in the value of the "black gold". But the windfall has helped mask pressing problems and allowed timid legislators and officials to postpone much needed - and fiercely resisted - changes.

Russia's "economic miracle" - oft-touted by the "experts" that brought you "shock therapy" and by egregiously self-interested, Moscow-based, investment bankers - is mostly prestidigitation. As the European Bank for Reconstruction and Development (EBRD) correctly noted in November, Russia's 20 percent growth in the last three years merely reflects enhanced usage of capacity idled by the ruination of 1998.

Neutering the positive externality of rising oil prices, one is left with no increase in productivity since 1999. Industrial production - outside the oil sector - actually slumped. As metropolitan incomes rise, Russians revert to imports rather than consume shoddy and shabby local products.

This, in turn, adversely affects the current account balance and the viability of local enterprises, some of which are sincerely attempting to restructure. According to Trud, a Russian business publication, two fifths of the country's businesses are in the red. Russia's number of small and medium enterprises peaked at 1 million in 1995-6. They employ less than one fifth of the workforce (compared to two thirds in the European Union and in many other countries in transition).

Thus, falling oil prices - though detrimental to Russia's ability to repay its external debt and balance its budget - are a blessing in disguise. Such declines will force the hand of the Putin administration to engage in some serious structural reform - even in the face of parliamentary elections in 2003 and presidential ones the year after.

Russians - wrongly - feel that their standard of living has stagnated. claims that 39 million people are below the poverty line. Many pensioners survive on $1 a day. In truth, real income per capita is actually up by more than 8 percent this year alone. Income inequality, though, has, indeed, gaped.

Responding to these concerns, though, in a "coattails" effect, the president is expected to carry pro-Kremlin parties back into power in 2003 - a modicum of elections-inspired bribing is inevitable. State wages and pensions will outpace inflation. The energy behemoths - major sources of campaign financing - will be rewarded with rises in tariffs to match cost of living increases.

Russia faces more than merely a skewed wealth distribution or dependence on mineral wealth. Its difficulties are myriad. On cue from Washington, it is again being hyped in the Western press as a sure-fire investment destination and a pair of safe geostrategic hands. But the dismal truth is that it is a third world country with first world pretensions (and nuclear weapons). It exhibits all the risks attendant to other medium-sized developing countries and emerging economies.

External debt repayments next year will exceed $15 billion. It can easily afford them with oil prices anywhere above $20 and foreign exchange reserves the highest since 1991. Russia even prepaid some of its debt mountain this year. But if its export proceeds were to decline by 40 percent in the forthcoming 3-4 years, Russia will, yet again, be forced to reschedule or default. Every $1 dollar decline in Ural crude prices translates to more than $1 billion lost income to the government.

Russia's population is both contracting and ageing. A ruinous pension crisis is in the cards unless both the run-down health system and the abysmally low birthrate recover. Immigration of ethnic Russians from the former republics of the USSR to the Russian Federation has largely run its course. According to, more than 7 million people emigrated from the Federation in the last decade.

Russia's informal sector is a vital, though crime-tainted, engine of growth. Laundered money coupled with reinvested profits - from both legitimate and illicit businesses - drive a lot of the private sector and underlie the emergence of an affluent elite, especially in Moscow and other urban centers. According to the Economist Intelligence Unit, Goskomstat - the State Statistics Committee - regularly adjusts the formal figures up by 25 percent to incorporate estimates of the black economy.

Russia faces a dilemma: to quash the economic underground and thus enhance both tax receipts and Russia's image as an orderly polity - or to let the pent-up entrepreneurial forces of the "gray sectors" work their magic?

Russia is slated to join the World Trade Organization in 2004. This happy occasion would mean deregulation, liberalization and opening up to competition - all agonizing moves. Russian industry and agriculture are not up to the task. It took a massive devaluation and a debilitating financial crisis in 1998 to resurrect consumer appetite for indigenous goods.

Farming is mostly state-owned, or state-sponsored. Monopolies, duopolies and cartels make up the bulk of the manufacturing and mining sectors - especially in the wake of the recent tsunami of mergers and acquisitions. The Economist Intelligence Unit quotes estimates that 20 conglomerates account for up to 70 percent of the country's $330 billion GDP. The oligarchs are still there, lurking. The banks are still paralyzed and compromised, though their retail sector is reviving.

Russians are still ambivalent about foreigners. Paranoid xenophobia was replaced by guarded wariness. Recently, Russia revoked the fast track work permit applications hitherto put to good use by managers, scholars and experts from the West. Foreign minority shareholders still complain of being ripped-off by powerful, well-connected - and minacious - business interests.

With the bloody exception of Chechnya, Putin's compelling personality has helped subdue the classic tensions between center and regions. But, as Putin himself admitted in a radio Q-and-A session on December 19, this peaceful co-existence is fraying at the edges.

The president will try to reach a top-down political settlement in the renegade province prior to the 2004 elections, but will fail. Reform is anathema to many suborned governors of the periphery and the Kremlin's miserly handouts are insufficient to grant it a decisive voice in matters provincial. Devolution - a pet Putin project - is more about accepting an unsavory reality than about re-defining the Russian state.

The economic disparity between rural and urban is striking. The Economist Intelligence Unit describes this chasm thus:

"The processing industry is concentrated in the cities of Moscow, St Petersburg, Yekaterinburg and Nizhny Novgorod. These larger cities have managed the transition relatively well, as size has tended to bring with it industrial diversity; smaller industrial centers have fared far worse. The Soviet regime created new industrial centers such as Tomsk and Novosibirsk, but Siberia and the Russian Far Eastern regions remain largely unindustrialised, having traditionally served as a raw materials and energy base. Owing to the boundless faith of Soviet planners in the benefits of scale, one massive enterprise, or a small group of related enterprises, often formed the basis for the entire local economy of a substantial city or region. This factor, compounded by the absence of unemployment benefits, makes the closure of bankrupt enterprises a politically difficult decision."

The politically incorrect truth is that Russia's old power-structure is largely intact, having altered only its ideological label. It is as avaricious, nefarious and obstructive as ever. Nor does the Russian state sport any checks and balances. Its institutions are suspect, its executive untouchable, its law enforcement agencies delinquent.

Russians still hanker after "men of iron" and seek tradition rather than innovation, prefer unity to pluralism, and appreciate authority more than individualism. Russia - a ramshackle amalgamation of competing turfs - is still ill-suited for capitalism or for liberal democracy, though far less than it was only ten years ago.

Conspicuous consumption of imported products by vulgar parvenus is no substitute to true modernity and a functioning economy. Russia is frequently praised by expats with vested interests and by international financial institutions, the long arms of its newfound ally, the United States.

But, in truth, "modern", "stable", Russia is merely a glittering veneer beneath which lurk, festering, the old ills of authoritarianism, lawlessness, oligarchy, aggression, ignorance, superstition, and repression mingled with extremes of poverty and disease. Here is one safe prediction: none of these will diminish next year.

Russian President Vladimir Putin warned on Tuesday, in an interview he granted to TF1, a French television channel, that unilateral American-British military action against Iraq would be a "grave mistake" and an "unreasonable use of force". Russia might veto it in the Security Council, he averred. In a joint declaration with France and Germany, issued the same day, he called to enhance the number of arms inspectors in Iraq as an alternative to war.

Only weeks ago Russia was written off, not least by myself, as a satellite of the United States. This newfound assertiveness has confounded analysts and experts everywhere. Yet, appearances aside, it does not signal a fundamental shift in Russian policy or worldview.

Russia could not resist the temptation of playing once more the Leninist game of "inter-imperialist contradictions". It has long masterfully exploited chinks in NATO's armor to further its own economic, if not geopolitical, goals. Its convenient geographic sprawl - part Europe, part Asia - allows it to pose as both a continental power and a global one with interests akin to those of the United States. Hence the verve with which it delved into the war against terrorism, recasting internal oppression and meddling abroad as its elements.

As Vladimir Lukin, deputy speaker of the Duma observed recently, Britain having swerved too far towards America - Russia may yet become an intermediary between a bitterly disenchanted USA and an irked Europe and between the rich, industrialized West and developing countries in Asia. Publicly, the USA has only mildly disagreed with Russia's reluctance to countenance a military endgame in Iraq - while showering France and Germany with vitriol for saying, essentially, the same things.

The United States knows that Russia will not jeopardize the relevance of the Security Council - one of the few remaining hallmarks of past Soviet grandeur - by vetoing an American-sponsored resolution. But Russia cannot be seen to be abandoning a traditional ally and a major customer (Iraq) and newfound friends (France and Germany) too expediently.

Nor can Putin risk further antagonizing Moscow hardliners who already regard his perceived "Gorbachev-like" obsequiousness and far reaching concessions to the USA as treasonous. The scrapping of the Anti Ballistic Missile treaty, the expansion of NATO to Russia's borders, America's presence in central Asia and the Caucasus, Russia's "near abroad" - are traumatic reversals of fortune.

An agreed consultative procedure with the crumbling NATO hardly qualifies as ample compensation. There are troubling rumblings of discontent in the army. A few weeks ago, a Russian general in Chechnya refused Putin's orders publicly - and with impunity. Additionally, according to numerous opinion polls, the vast majority of Russians oppose an Iraqi campaign.

By aligning itself with the fickle France and the brooding and somnolent Germany, Russia is warning the USA that it should not be taken for granted and that there is a price to pay for its allegiance and good services. But Putin is not Boris Yeltsin, his inebriated predecessor who over-played his hand in opposing NATO's operation in Kosovo in 1999 - only to be sidelined, ignored and humiliated in the postwar arrangements.

Russia wants a free hand in Chechnya and to be heard on international issues. It aspires to secure its oil contracts in Iraq - worth tens of billions of dollars - and the repayment of $9 billion in old debts by the postbellum government. It seeks pledges that the oil market will not be flooded by a penurious Iraq. It desires a free hand in Ukraine, Armenia and Uzbekistan, among others. Russia wants to continue to sell $4 billion a year in arms to China, India, Iran, Syria and other pariahs unhindered.

Only the United States, the sole superpower, can guarantee that these demands are met. Moreover, with a major oil producer such as Iraq as a US protectorate, Russia becomes a hostage to American goodwill. Yet, hitherto, all Russia received were expression of sympathy, claimed Valeri Fyodorov, director of Political Friends, an independent Russian think-tank, in an interview in the Canadian daily, National Post.

These are not trivial concerns. Russia's is a primitive economy, based on commodities - especially energy products - and an over-developed weapons industry. Its fortunes fluctuate with the price of oil, of agricultural produce and with the need for arms, driven by regional conflicts.

Should the price of oil collapse, Russia may again be forced to resort to multilateral financing, a virtual monopoly of the long arms of US foreign policy, such as the International Monetary Fund (IMF). The USA also has a decisive voice in the World Trade Organization (WTO), membership thereof being a Russian strategic goal.

It was the United States which sponsored Russia's seat at table of the G8 - the Group of Eight industrialized states - a much coveted reassertion of the Russian Federation's global weight. According to Rossiiskaya Gazeta, a Russian paper, the USA already announced a week ago that it is considering cutting Russia off American financial aid - probably to remind the former empire who is holding the purse strings.

But siding with America risks alienating the all-important core of Europe: Germany and France. Europe - especially Germany - is Russia's largest export destination and foreign investor. Russia is not oblivious to that. It would like to be compensated generously by the United States for assuming such a hazard.

Still, Europe is a captive of geography and history. It has few feasible alternatives to Russian gas, for instance. As the recent $7 billion investment by British Petroleum proves, Russia - and, by extension, central and east Europe - is Europe's growth zone and natural economic hinterland.

Yet, it is America that captures the imagination of Russian oligarchs and lesser businesses.

Russia aims to become the world's largest oil producer within the decade. With this in mind, it is retooling its infrastructure and investing in new pipelines and ports. The United States is aggressively courted by Russian officials and "oiligarchs" - the energy tycoons. With the Gulf states cast in the role of anti-American Islamic militants, Russia emerges as a sane and safe - i.e., rationally driven by self-interest - alternative supplier and a useful counterweight to an increasingly assertive and federated Europe.

Russia's affinity with the United States runs deeper that the confluence of commercial interests.

Russian capitalism is far more "Anglo-Saxon" than Old Europe's. The Federation has an educated but cheap and abundant labor force, a patchy welfare state, exportable natural endowments, a low tax burden and a pressing need for unhindered inflows of foreign investment.

Russia's only hope of steady economic growth is the expansion of its energy behemoths abroad. Last year it has become a net foreign direct investor. It has a vested interest in globalization and world order which coincide with America's. China, for instance, is as much Russia's potential adversary as it is the United State's.

Russia welcomed the demise of the Taliban and is content with regime changes in Iraq and North Korea - all American exploits. It can - and does - contribute to America's global priorities. Collaboration between the two countries' intelligence services has never been closer. Hence also the thaw in Russia's relations with its erstwhile foe, Israel.

Russia's population is hungry and abrasively materialistic. Its robber barons are more American in spirit than any British or French entrepreneur. Russia's business ethos is reminiscent of 19th century frontier America, not of 20th century staid Germany.

Russia is driven by kaleidoscopically shifting coalitions within a narrow elite, not by its masses - and the elite wants money, a lot of it and now. In Russia's unbreakable cycle,  money yields power which leads to more money. The country is a functioning democracy but elections there do not revolve around the economy. Most taxes are evaded by most taxpayers and half the gross national product is anyhow underground. Ordinary people crave law and order - or, at least a semblance thereof.

Hence Putin's rock idol popularity. He caters to the needs of the elite by cozying up to the West and, in particular, to America - even as he provides the lower classes with a sense of direction and security they lacked since 1985. But Putin is a serendipitous president. He enjoys the aftereffects of a sharply devalued, export-enhancing, imports-depressing ruble and the vertiginous tripling of oil prices, Russia's main foreign exchange generator.

The last years of Yeltsin have been so traumatic that the bickering cogs and wheels of Russia's establishment united behind the only vote-getter they could lay their hands on: Putin, an obscure politician and former KGB officer. To a large extent, he proved to be an agreeable puppet, concerned mostly with self-preservation and the imaginary projection of illusory power.

Putin's great asset is his pragmatism and realistic assessment of the shambles that Russia has become and of his own limitations. He has turned himself into a kind of benevolent and enlightened arbiter among feuding interests - and as the merciless and diligent executioner of the decisions of the inner cabals of power.

Hitherto he kept everyone satisfied. But Iraq is his first real test. Everyone demands commitments backed by actions. Both the Europeans and the Americans want him to put his vote at the Security Council where his mouth is. The armed services want him to oppose war in Iraq. The intelligence services are divided. The Moslem population inside Russia - and surrounding it on all sides - is restive and virulently anti-American.

The oil industry is terrified of America' domination of the world's second largest proven reserves - but also craves to do business in the United States. Intellectuals and Russian diplomats worry about America's apparent disregard for the world order spawned by the horrors of World War II. The average Russian regards the Iraqi stalemate as an internal American affair. "It is not our war", is a common refrain, growing commoner.

Putin has played it admirably nimbly. Whether he ultimately succeeds in this impossible act of balancing remains to be seen. The smart money says he would. But if the last three years have taught us anything it is that the smart money is often disastrously wrong.

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