REP Roundtable Summary

Russias Economy: Are We Returning to the Soviet Model?

Sergei Guriev
New Economic School, Moscow

16 February 2010

The views expressed in this document are the sole responsibility of the author and do not necessarily reflect the view of Chatham House, its staff, associates or Council. Chatham House is independent and owes no allegiance to any government or to any political body. It does not take institutional positions on policy issues. This document is issued on the understanding that if any extract is used, the speaker and Chatham House should be credited, preferably with the date and details of the event. Where this document refers to or reports statements made by speakers at an event every effort has been made to provide a fair representation of their views and opinions, but the ultimate responsibility for accuracy lies with this documents author. The published text of speeches and presentations may differ from delivery.

REP Roundtable Summary: Model?

Russias Economy: Are We Returning to the Soviet

The dynamics of the Russia economy are not a cause for concern in the short term, but they should worry us over the longer term. It is not accurate to say that the period of high growth in the last decade was down to high energy prices alone. The hydrocarbon boom was an important factor, and example from one third to one half of the growth during 1999-2008 decade. But there was also real growth in other areas which cannot just be attributed to oil revenues. However, this period of growth did not resolve some systemic weaknesses which continue to undermine the Russian economy. Looking at the short term, the economic picture is actually rather bright. Together with Renaissance Capital, the New Economic School constructs a leading indicator in order to predict the current and forthcoming quarter. These suggest the fourth quarter of 2009 and first quarter of 2010 are strong. We expect the recovery to slow down in the second quarter. It is feasible that there will be growth of 3-4 per cent in 2010. However, predicting growth in Russia is risky as it depends heavily on the oil price. The bottom-line, however, is that the Russian economy is recovering. The fiscal situation is acceptable. It is true that the Reserve Fund is falling. At the same time, however, thanks to fiscal rules devised by Finance Minister Alexei Kudrin, the National Wealth Fund is growing. During the crisis it has risen from $30 billion to $100 billion. On the other hand, there are various ways to withdraw money from this Fund as well and it is likely to happen in 2011 after the Reserve Fund is completely exhausted. Russia is planning to borrow 1.5-2 per cent of GDP abroad. Russian sovereign debt is still very low and will not be a cause for concern for the next few years. We should, however, be concerned about the long-term picture. If one were to plot the per capita GDP of Russia over the last ten years, and compare it with that of South Korea for the period eleven years before that, the charts would be virtually identical. Even the dip in growth in 2009 mirrors that of South Korea in 1998. However, it is highly unlikely that in ten years time we could make a similar comparison. Russian is unlikely to continue to grow at 67 per cent a year. Yes, there has been real growth in the last decade. Wages have more than tripled in real terms, poverty has fallen by half and unemployment fell by half. Indicators like housing, mobile phone penetration, car ownership and even levels of self-assessed life satisfaction have all gone up along with the rise in incomes. A domestic financial system has developed. There have been few major reforms in the last five years, but there has been legislation to enable the development of deposit insurance and credit histories. One could write off the domestic credit system as a bubble, but it has financed a real growth in consumption. Mortgages as a percentage of
www.chathamhouse.org.uk 2

REP Roundtable Summary: Model?

Russias Economy: Are We Returning to the Soviet

GDP have risen from zero to 2 per cent. This is still small, but it is not trivial. Russias human capital also remains high. There are, however, three major problems which the decade of growth has not solved: institutional corruption, a failure to diversify the economy, and inequality. On the latter, the quality of data available is very poor. Russia officially has a Gini coefficient of 0.4, the same as the US. However, Rosstat has little information on the very poor and the rich including the upper middle class. The poor institutions and the fact that they are not improving are exactly the reason for being rather pessimistic about Russias prospect to catch with OECD countries in the next 10 years. Vice versa, Russia is more likely to follow the 70s-80s scenario, by which is meant that the price of oil hovers around $70-$80 a barrel, political leaders approval ratings are at 70-80 per cent, and the country increasingly resembles the stagnation of the 1970s and 1980s. In order for Russia to grow in the next ten years, it needs to reform its institutions. Government rhetoric acknowledges the problem, but there are few deeds to match. The reason is that while every government should be interested in increasing growth, in a country like Russia if institutions are reformed the overall share of resource rents for the elite and the probability to hold on to power to enjoy these rents will be lower. Also, the high level of inequality means there will always be a demand for populist redistribution rather than for pro-growth policies. There is no strong constituency to lobby for reform. Non-resource businesses do not have the political clout. At the Krasnoyarsk Forum, Deputy Prime-Minister Igor Shuvalov made it clear that the government wanted modernisation but not at the price of political instability. Russia is not the USSR. Free discussion can be held in Moscow. Private business exists. However, whereas five to seven years ago one would have said that Russia is moving towards a market-based democracy, the situation now is very different. The trend is unclear. There are indications that the governments role in the economy is actually increasing. Some companies profit from a lack of reform, and Russias economy lacks sufficient competition. The appetites of the elite are also growing. Even if the oil price remains where it is now, one has to wonder if the government will be able to maintain stability. The government has concluded from the economic crisis that even when times get tough it can bet on the oil price rebounding to bail it out. If the government runs out of money, we will see a return to the late 1980s. The difference is that no one imagined the USSR could run out of cash. Now this

www.chathamhouse.org.uk

REP Roundtable Summary: Model?

Russias Economy: Are We Returning to the Soviet

scenario is envisioned by a lot of people as all have seen it happening. This is good news. However, the Russian government is also well aware of the fate of the Politburo. No one wants to follow their path . This is a disincentive for reform. Therefore it is possible that Russia will go the route of the USSR, resisting reform until it runs out of cash. The Russian government has already borrowed from the Sovereign Wealth Fund to give cash to banks and inefficient firms, including through lending to VEB. But if VEBs investments fail, the bank will have to be bailed out by the government. What would happen after the government runs out of cash is hard to say. There is a positive scenario, whereby a critical mass of bureaucrats start to worry about the countrys prospects and seriously discuss the need for change. The Prime Minister needs to start talking about it. The good news is that there is already a blueprint for what action to take: the Gref Program, written in 1999 and 2000 under the very same then-Prime Minister Putin. The Centre for Strategic Research estimates that approximately 40 per cent of the reforms proposed by the Gref plan have been implemented. There are a large number of proposals still waiting to be enacted. Indeed, in some areas the government has acted at cross-purposes to the Gref plan by nationalising industries. There is a need to privatise and de-regulate decisively, which in turn will create a constituency for further reforms. The country must be opened up to competition, and seek to join the WTO and OECD. It has been argued that this will undermine social stability. However, there are some reforms which will gain a large measure of public support, such as overhauling the police and conscription, which would be relatively inexpensive and create support for further reform in other areas. If the political will existed, this package of proposals would be eminently feasible. Many people around the elite are pushing for this to be done. Some are extremely dissatisfied with the speeches of the elites. Many attendees at the Krasnoyarsk Economic Forum said (and it was supported by the audiences vote) that the modernisation agenda was not going well, and the institutions of state were not functioning properly.

Questions and Discussion

Gazprom is experiencing unprecedented pressure as energy markets in the EU are liberalised, demand has fallen due to the economic crisis, and LNG and shale gas have created greater competition. Are these factors sufficient incentive for Gazprom to reform?

www.chathamhouse.org.uk

REP Roundtable Summary: Model?

Russias Economy: Are We Returning to the Soviet

The investment banks are still surprisingly optimistic assessment of Gazproms prospects. However, were it not for the support of the Russian government, many experts would already advise against buying Gazprom stock. Gazprom has high debts and demand is falling. Were it a private company I would be very worried. But the current government has hinted that Russian taxpayers will pick up the bill. Gazprom will be the last state company to go.

Is there a possibility that the modernisation agenda launched by Medvedev may run out of his control, as happened during Perestroika? The powers-that-be say they want controlled modernisation, but impatience is increasing. Things could get out of control without Russia running out of cash. However, the government is adept at crisis management. The government was wise not respond too aggressively to the protests in Kaliningrad and Vladivostok. The reaction is generally to talk to governors, mayors and get them to tell central government where the money is needed. However, the idea that Russia is in need of major reform is being discussed with increasing regularity.

The government drew important lessons from the 1998 crisis about fiscal discipline. Will lessons be drawn from the latest crisis? Is the modernisation debate entirely cynical? The government has drawn two lessons: that we can believe in our luck and bet on oil prices, and that the system works under strain. The elites still believe they are capable of managing a crisis. Also, the decision to pile up reserves for the rainy day paid off. After Lehman Brothers went bust, former Deputy Finance Minister Sergei Storchak was released from prison. This is an indication that Putin knows Aleksei Kudrin was right to create the Reserve Fund. It is difficult to say if the debate is cynical but Medvedevs speeches about modernisation dont differ greatly from Putins about competitiveness and diversification ten years ago.

How do you read the Putin-Medvedev relationship? Are they in sync, or are there substantive policy differences between them? What do you make of disagreements over WTO accession?

www.chathamhouse.org.uk

REP Roundtable Summary: Model?

Russias Economy: Are We Returning to the Soviet

Medvedev certainly has a different style. He tends to fire people in response to scandals. He has fired police and prison chiefs. Putin tends to resist pressure to remove cadre. His attitude seems to be that he will not be forced into any personnel decisions. On fundamental policy issues the President and the Prime Minister essentially act in the same way. However, differences have been evident in, for example, the Magnitsky case, where Putin did not want to act, and Medvedev did. The WTO issue showed who eventually runs the country. Putin decided to postpone accession indefinitely and this is what happened. Interestingly, the WTO accession issue was put to a vote in Krasnoyarsk Economic Forum and there was a 49/51 split. Society is divided on the issue. WTO membership has always been just over the horizon. In 2001 we were told by Putin that Russia would join in 2003. In 2006 it was to be 2008. The Customs Union with Kazakhstan and Belarus has pushed it back again.

You argue that the Gref plan is a blueprint for the reforms necessary to renew the Russian economy. But Russia has reached a tough stage in its development. Pushing incomes up into the upper middle bracket is extremely difficult. Breaking-up Gazprom would be an easy win, but the rest of the reform package is complex, long-winded, with rewards which will only become evident some time later. Reforms are difficult to push through. Deregulation is generally easier. Building up a functional court system takes much longer. The important thing is to move in the right direction. The problem is not so much underinvestment as poor management. These reforms have been on the table for ten years.

It has been suggested that one of the problems with the current elite is that there are not enough talented people working there. In general, Russia is suffering a loss of human capital. There are certainly some professionals in positions of power who lack relevant skills. We need to encourage the bureaucrats to engage more with the outside world, to go abroad, to study in foreign universities. Russian academia also remains provincial; think tanks are not keeping up with international debates. There is a post-imperial syndrome at work here. The debate is nationalist and isolationist. In public, the elite insist that Russian universities are best in the world, but send their own children abroad, of course.

www.chathamhouse.org.uk