Putin May Be The Most Effective Economic Reformer Russia Has Ever HadDr. Harry G. Broadman
(Forbes) – Boris Yeltsin was no dummy. He had a secret plan all along to bring lasting economic democracy to Russia: put Vladimir Vladimirovich Putin, a former Lieutenant Colonel of the KGB (now FSB), in control of the Kremlin.
Yeltsin must have known that Putin, a political neophyte, would work unsparingly to centralize control and amass tremendous power—arguably the skills he had honed best over his career. And then, as a result of his comrade’s inability to adhere effectively to Machiavelli’s playbook, Yeltsin surely foresaw that Putin would begin to self-destruct on the world stage, getting Russia booted out of the G8; put the lid on a nascent democracy at home; and instill even greater brittleness to an already hobbling economy.
Over the years, this confluence has given rise to an increasingly effective incubator for a growing share of the Motherland’s citizenry to become seriously fed up and truly question what has happened to their once great country, especially as Russians see firsthand other emerging markets making great strides in development, most notably China.
If history is any guide, it is the bringing of the Russian economy to its knees that is really sowing the seeds for a rupture in the governance of the country—one that ultimately might engender a fundamental economic restructuring that could permit realization of the type of growth that has eluded Russia for decades.
This may well be overly optimistic: having spent a substantial number of years, beginning in the 1990s, as a senior economic advisor to (literally) numerous, successive governments in Moscow—almost all in the pre-Putin era—during my tenure at the World Bank, I no doubt have developed a soft spot for Russia.
The conventional wisdom today about Russia’s economic troubles—the IMF projects the Russian economy will shrink by 3.4 percent this year, on top of minute growth of 0.6 percent in 2014, and it will register only 0.2 percent growth in 2016—tends to focus on the impacts of international sanctions put in place as a result of Putin’s annexation of Crimea and invasion into eastern Ukraine in February 2014 and, of course, the present-day regime of significantly low world oil prices, a decline that began in earnest in June 2014.
To be sure, the sanctions, which were applied in March 2014, are causing real economic pain to some of the most powerful elites in Russia. More importantly, however, they are serving to socialize (pun intended) the costs of Putin’s westward land grab across the entire Russian economy. Indeed, this is a case where international sanctions are doing largely what they are intended to do.
And, yes, the low price of oil is the real kicker for Moscow. After all, when only one or two commodities, especially ones that are highly tradeable and subject to significant global volatility—in this case, oil and gas—have been accounting for more than 51 percent of a country’s budget, it is the rarest of emerging market economies, if any, that can truly develop.
So while the sanctions and low oil prices are certainly major pressure points for Russia today, they are typically viewed as emanating from forces external to Russia. And in any event, they are seen astransitory—phenomena whose time shall pass.
On the first point, to suggest that these developments are actually not direct consequences of Putin’s own doing is hard to swallow. The imposition of sanctions by the international community is, of course, very clear in this regard.
And, surely, the sudden—and sustained–decline in world oil prices ultimately is a result of an imbalance in global supply and demand—stemming perhaps most notably from the decline in Chinesedemand for oil, coupled with the bringing on stream of new supplies from the US, Africa and Latin America. But more important is the anomalous behavior of OPEC, especially Saudi Arabia, that gives rise to notions of a deliberately strategy to discipline the Russians, in particular Putin.
Perhaps after several decades, the Saudis have finally seen the light: that cutting back output to maintain artificially high oil prices is self-defeating in that it only strengthens incentives for their customers to switch to alternative energy sources and/or develop more energy efficient technologies and processes. Or perhaps mindful of wanting to maintain the role of global supplier of last resort and preserve the “brand loyalty” of its bigger purchasers, especially the U.S., the Saudis are now willing to live with low oil prices in the near term order to fight off erosion of market share over the long run.
In the end, however, one cannot help but speculate that the Saudis’ paradoxical conduct is driven, in part, maybe in large part, by the motive—perhaps supported behind the scenes by the U.S. and the EU—to really tighten the screws on Putin where it will hurt him the most as a direct result of his actions.
On the second point, sanctions and low oil prices are no doubt not permanent. In fact, they should properly be seen as external disturbances exacerbating structural distortions that have arisen from the hollowing out of the Russian economy–a process that has been underway steadily throughout Putin’s regime since it began New Year’s Eve in 1999. To wit, Russian economic growth, having been driven for a few years by all-time high oil prices, was already beginning to decelerate before oil prices began to decline.
Indeed, it is the badly frayed underlying fabric, poorly stitched together to support the Russian economy ever since the break-up of the Soviet Union, that lies at the heart of Russia’s travails today. What are the key sources of this fraying?
By far the most publicized is the economy’s undue reliance on energy revenues. Currently 70 percent of Russia’s export earnings stem from the country’s oil and gas sales. (In Saudi Arabia, by comparison, oil and gas revenues account for about 85 percent of export earnings.)
However, most people are surprised to learn that the minimal level of economic diversification of the Russian economy that these numbers reflect actually has not changed appreciably going back to 1997, when I first started very intensive visits back and forth to Moscow.
And even less understood is that the concentration of Russia’s economy in the oil and gas sector has actually increased over time. Last year, for example, 98 percent of total corporate profits earned by the 500 largest Russian firms (which account for 77 percent of the entire economy) was generated by that sector alone.
But there are other less obvious yet more pernicious structural attributes of Russia’s economy that have come into starker relief for at least a decade and a half. Several strands of data will suffice.
Russia’s non-energy sector has become less competitive in world markets: while the volume of the nation’s non-energy merchandise exports grew at an annual rate of 11 percent in 2010, they grew only 7.6 percent in 2014.
In fact, Russia’s overall integration into the global economy is shrinking: whereas the country’s total merchandise exports in 2000 accounted for 58 percent of the country’s GDP, their GDP share in 2013 was only 42 percent (and almost all of this decline was due to a continuous and significant fall in Russia’s total exports of goods and service over the period.)
At the same time, net private capital outflows in 2014 stood at $150 billion, which is equivalent to 8 percent of GDP. This is a record high for Russia, a country well-known over the past couple of decades for its capital flight, owing to an erosion of the population’s confidence of investing at home.
The share of Russia’s population participating in the civilian workforce continues to diminish: in 2005 it was 65 percent and last year it was 52 percent. In part, this is due to the fact that by law the country’s retirement age is comparatively low. And if that disincentive to remain in the workforce isn’t strong enough, average wages in real terms have been falling in Russia since 2002.
Meanwhile, Moscow’s military expenditures—already the third highest in the world—have steadily grown, from 3.6 percent of GDP in 2000 to 4.5 percent in 2014.
Finally a factor that few focus on: the still-in-place trade, foreign investment, and remittance linkages between Russia and much of the former Soviet Union. While in some cases these have weakened somewhat since the early 1990s, most of the countries in the Commonwealth of Independent States, and to some extent the Baltics and of course portions of Ukraine, largely remain within Moscow’s sphere of economic (as well as political and security) sphere of influence. As a result, they are being swept into the (continued) downdraft of the handicapped Russian economy. Given the inflexibility of the ‘mutual support’ system these linkages represent, the chances the current vicious cycle of low growth that they perpetuate will be transformed into a virtuous circle of prosperity—as aspired by Putin and his regional allies—are as low as they ever have been.
So what is needed? In a nutshell, huge capital investments that actually diversify, modernize and rejuvenate the Russian economy as one might have hoped would have begun two decades ago, coupled with an overhaul of the policy apparatus commensurate with those goals. If only it were so easy.
For one thing, gross capital formation as a share of GDP in Russia has remained essentially flat (around 23 percent) since 2001. But mind you, it is not just the quantity of capital investment that is important; rather it is the composition of such activity that is really critical.
The rub is where will the financing for such investment come from?
For starters, the fact is that Russians tend to save far more than they invest; moreover, they have learned the hard way not to put their savings in banks, which in turn deprives the economy of intermediation. Under the circumstances in which they live, can you blame them?
But far more important is that the ‘usual’ and generally largest source of funds for such an undertaking—a country’s corporate sector—is a non-starter in the case of Russia. After all, how does one convince the one industry that generates the overwhelming bulk of a country’s corporate profits that it is they who should provide financing for the economy to reduce its reliance on them?
Alas, this is the core of the ‘Russian dilemma’—one that the current regime is quite happy to live with.
But something has to give. Russians have strong stomachs and they can put up with a lot. This is an admirable trait to be sure. But even Russians have a tipping point, and reaching it could well give life to the true irony of Putin’s program. When might there be a political rupture?
A cue might be taken from the December 2011 events in Moscow, when, in reaction to the Duma elections, which were widely believed to have been rigged, there were the largest public demonstrations since the end of the Soviet Union, estimated to have included as many as 120,000 protesters. Of course this was prior to the Ukrainian crisis, the steep fall in oil prices, this year’s sharp devaluation of the ruble and Russia falling into deep recession.
The next Duma elections are in mid-September 2016. While it takes someone with far more courage—and insights—than I can muster to make such predictions, it would seem highly plausible that the stars may be aligned late next year for another chapter of Boris Yeltsin’s plan for Putin to be opened.