Vladimir Mau, Doctor of Science (Economics), Professor, is Director of the Academy of the National Economy under the Government of the Russian Federation.

If we were to make a brief summary of the year 2003 for Russia, here is what it would entail: an overall favorable economic situation; general economic growth; changes in the political atmosphere which were manifest in the campaign against the YUKOS oil company and parliamentary election results; preparations for the presidential election and debates over what political and economic policies Vladimir Putin may pursue during his second presidency. Last year’s results are worthy of an in-depth analysis, as many of those events will clearly mark out a course for the coming years.

The economic policies were influenced by three main factors. First, the economic growth rate was up for the first time since 2000, accompanied by the growth of investment. Second, the market situation remained favorable, with energy prices remaining high, despite political ups and downs around the globe. Developments in the forex market were also positive: while the U.S. dollar rate substantially weakened against the ruble (both in its real and nominal value), the ruble’s real exchange rate only slightly strengthened against the euro – the main currency for Russian importers – thus moderating pressure on Russian producers which in turn allowed them to keep competitive prices. This situation gives the impression of high stability, but actually it is fraught with additional risks. The feeling that economic threats have been averted can provoke eccentric economic and populist budgetary solutions, and decisions of property redistribution. Such moves will inevitably lead to political destabilization.

Third, political rivalries escalated against the backdrop of a favorable economic situation. The main political clashes, rather than being associated with the electoral cycle, were in line with the logic of post-revolutionary stabilization that occurs in a split society which has begun moving toward accord on basic values and priorities.

Finally, no technological or monetary catastrophe was registered, even though they had been predicted for 2003 throughout the preceding decade. An evolutionary approach was chosen to deal with technological obsolescence, which resulted in high investment levels. The government had resolved the debt problem due to proper debt management policies pursued during the preceding three years.

Russia’s Socio-Economic Development in 2000 through 2003

(% change on previous year, unless otherwise stated)

PRE-ELECTION YEAR

The approaching parliamentary and presidential elections were an important background factor for last year’s economic policies. But the influence of the election campaigns was essentially different from what one could expect while relying on traditional ideas about political and business cycles.¹ There were no clear signs on budgetary populist policies, let alone the loosening of monetary policies. Populism, if it emerged at all, was of a political, rather than fiscal nature.

Last year, some events arose owing to the pre-election year. Most importantly, there was a slowdown of economic reform and an increase of political infighting over the results of the past decade. There were also disagreements over the righteousness of the ownership and power systems that had formed in Russia. Strictly speaking, those issues are only partially associated with the elections – to the effect that election campaigns bring certain problems to the foreground, while overshadowing other problems, even though those problems as such are not created by the elections (unlike standard variations in monetary and budgetary policies that are pegged to the electoral cycle).

The government moved ahead in certain important spheres toward making the Russian economy more efficient. It launched major reforms of Russia’s Unified Energy Systems and railways, the pension system, local government, and adopted liberal forex legislation. A search was initiated for new approaches to administrative reform, reform in the sectors on the government’s payroll (primarily education and public health), the creation of a mortgage system and modern migration legislation.

Most probably, the main obstacles to progression in the aforementioned spheres stemmed from the government’s inner problems, rather than from the approaching elections. A certain amount of fatigue began to show, along with a burden of commitments and compromises. Furthermore, there was an obvious scarcity of practical suggestions. Since a pro-government majority has emerged in the State Duma, bills will be able to pass through parliament much faster; the executive’s analytical resources, together with its ability to elaborate legislation, have now become the only bottleneck in the process.

Only in certain cases were delays in taking the required measures caused by the pre-election situation. The reform of Gazprom, the last natural monopoly still unchanged since its inception not long before the Soviet Union’s collapse, seems to be such a case. The government commission worked out a concept for the monopoly’s reform and put the proposals on the cabinet’s agenda twice, however, both times they were canceled.

The situation was similar to migration legislation. The adopted populist version cannot effectively regulate migration flows – it greatly complicates the inflow of citizens of the CIS member states into Russia, while it does not correspond to the state’s ability to combat illegal immigration. True, soon after the law was adopted, the Russian president proposed a list of amendments to it. There is little doubt that the amendments will be approved, but that has been delayed until after the elections.

So, it was not the government’s policy that was particularly influenced by the election campaigns. The election year’s biggest effect was a steep rise in the authorities’ populist rhetoric and populist political actions. Such moves will have direct and, most likely, long-term effects on the activities of economic agents and, therefore, on the country’s economic developmental prospects. In this connection, it is worth singling out new and important phenomena.

POWERS THAT BE AND BUSINESS IN 2003

The situation around YUKOS was the brightest event of the election campaign period. Its president Mikhail Khodorkovsky had openly stated his political ambitions, giving the authorities an excuse for intensifying their attempts to forcibly separate business and politics and show business its proper place – out of politics and under the authorities’ control.

The event will have a long-term mixed effect on economic processes.

In particular, the direct effect of the YUKOS case has been the escalation of capital flight from Russia. This figure reached $8.6 billion in the third quarter of 2003.² However, this cannot be unequivocally interpreted as a negative development. Under the current macroeconomic conditions, the outflow of portfolio capital is a positive factor, as it slows down any further strengthening of the ruble. But the reaction from the business world associated with direct foreign investment will be predictably different. Presently, it is hard to draw unequivocal conclusions. On the one hand, foreign investors who are putting their money into new markets are used to working with strong-arm (authoritarian) regimes; actually, they often give them preference over weak democracies. On the other hand, the situation in Russia is still uncertain and it is difficult to say with any level of certainty if it tends toward authoritarianism or democracy – it is uncertainty that strategic investors find particularly unpleasant.

Some of the reports on foreign investment in Russia are quite worrying. First, on the whole, capital flight in 2003 substantially declined (from $8.3 billion in 2002 to $2.7 billion) due to loans to the banking sector. This seems to be a rather natural development considering the current energy prices and the weakening dollar. But in the corporate sector capital flight grew from $10.8 billion to $12.3 billion – $5 billion worth occurred in the fourth quarter. Second, foreign direct investment went down to $2.5 billion – the lowest amount since 1994 when it was first estimated. The reasons behind that reversal have yet to be identified more accurately, though. Perhaps, this was only partially caused by political factors, as the amount of foreign direct investment in Russia is so small that even changes in the course of action of one or two investors can lead to dramatic changes in the overall situation.

The Russian business community’s reaction has been a nervous one. The main problem is that it has lost its bearings about the ‘rules of the game’ in terms of its relationships with the state. The hitch is that virtually any assurances by the authorities will at best go unheard or, at worst, put businesses on the alert. It is the practical steps that matter most in the world of business, and it has to understand them and get used to them. And business will now closely watch – watch and wait – for practical steps on the part of the authorities.

Procedural considerations will be quite important in this respect, not to mention the threat of being kept in custody during  an investigation. The personal immunity of an individual is a key problem, and earlier stages of economic growth provide enough evidence of that.³

Reaction on the part of the Russian business community is also critical for economic development since foreign capital only arrives if domestic businesses are actively investing as well. This is particularly important in Russia where a substantial amount of capital has been taken abroad and, as a rule, returns in the form of foreign capital.

The business community’s future structure is yet another problem. The current political campaign may have a two-pronged effect. On the one hand, the escalation of anti-oligarch rhetoric and moves by the law-enforcement agencies weaken (politically as well as economically) the biggest corporations and strengthen the positions of small and mid-sized businesses. On the other hand, the campaign may be perceived as a signal for fighting local (regional) businesses, which would incur grave consequences for entrepreneurial activities at all levels. Both trends were obvious at the end of last year; which one will prevail is hard to predict at the moment.

Finally, the recent developments surrounding the YUKOS oil company have given a new turn to theoretical debates in Western economic publications, which discuss institutional problems related to the development of the Russian economy.  I mean the so called ‘state capture,’ which refers to actions by certain businesses to influence the state’s decisions to their own advantage.⁴ It is now clear that the gravity of the problem was strongly overstated and the ‘business capture’ problem is no less important.⁵

POPULISM ON THE RISE

Populist rhetoric has intensified and populist parties have become much stronger. This can be witnessed in the bitter disputes in Russian society over the results and prospects of the economic policy, as well as in the list of parties represented in the State Duma. The clearly populist parties are the Communists of the Russian Federation, the Motherland bloc and the Liberal Democratic Party of Russia (LDPR). These either do not have any economic program or they have a program that is definitely aimed at property redistribution. In fact, United Russia members have also engaged in populist rhetoric, although to a much lesser extent. As for the anti-populist Union of Right Forces (SPS), it has failed to surpass the 5-percent threshold of the vote in order to secure seats in the Duma.

There are clear signs of the strengthening of economic and political populism, together with nationalist rhetoric, and of the glorification of poverty. There have been calls for imprisoning certain politicians and business people, as well as demands that the results of privatization be revised, and taxes and government expenditures increased. These claims were pronounced in the heat of the election campaign, but one cannot fail to notice that the electorate has clearly shifted toward leftist and “restoration” ideologies.

Restoration here means the sweeping victory of those forces appealing to the Soviet Union’s past record and success as a superpower able to wage a war against the whole world. All parties that have won seats in the Duma have energetically capitalized on this sort of nostalgia. As for leftist economic ideology, there are grounds for speaking about this idea in connection with two important issues in the election polemics.

First, a revision of the privatization results was clearly put on the agenda. Even though a large-scale revision is unlikely, the voters have shown a large interest in this issue – including Muscovites. It looks like this possibility has made the Moscow city authorities greatly worried; it made Moscow’s Mayor Yuri Luzhkov publicly regret that the SPS and Yabloko have not made it into the Duma, even though the Mayor’s relations with the SPS leaders are rather complicated. Actually, the results of Russia’s controversial privatization equally concern the business tycoons and politician-tycoons, Mayor Luzhkov being an illustrative example of the latter – any revision of privatization in Moscow would be fraught with grave consequences.

Second, the forces favoring higher taxes enthusiastically expressed their views for the first time. Whenever the Communists insisted on increasing government expenditures, they failed to mention the particular mechanisms for attaining such a goal. The Motherland bloc has openly called for an alteration of the tax system, together with higher taxation. If successfully enacted, this would waive an important achievement of President Vladimir Putin’s first term as president – the flat income tax rate. Time will tell how serious these demands are, but the very fact that they have been forwarded says quite a lot.

In a way, the success of populist rhetoric was a reaction to the crises and hardships of the last decade. In the past, when the threat of an economic catastrophe was great, the bulk of voters backed the more prudent political forces. But now that the economy has been growing for five years running, it is easy to get the illusion that it is possible to relax and play populism by supporting those who promise “a lot and quickly.”⁶

With respect to Russia it would be premature to say that this course has been chosen. Even though populist parties were successful in the parliamentary election, United Russia has won a majority in the State Duma, while it claims to be in the right-center of the political spectrum. Presently, there is not enough evidence to draw the conclusion that it will be a right-center party, but its very intention to be guided by rightist values gives the country a chance to avoid Latin American-style ups and downs.

NEW POLITICAL SYSTEM

For the first time in Russian history, one party enjoys an absolute majority in parliament, while not being the only party there. No matter what is said about this party and the reasons behind its electoral success, it cannot be denied that a fundamentally new situation has emerged, unprecedented in Russian politics. This factor requires a thorough analysis since it may have an ambiguous effect on the country’s economic and political development.

Above all, the constitutional history of modern Russia has made a new turn. The main responsibility for decision-making and drafting legislation now moves to the executive (the president and the cabinet). The Duma majority will automatically stamp submitted bills, without analyzing them in detail – the latter is only possible in political debates, when a coalition majority has to be formed for the adoption of each draft law. The adoption of the 2004 budget clearly showed new mechanisms for passing bills through parliament: even before the draft budget was submitted to the Duma, a ‘zero reading’ had been held by those factions that jointly formed parliamentary majority. Following this, the Duma approved the draft budget with hardly any amendments.

The emerging constitutional situation may develop according to either of three possible scenarios, as follows from the history of parliamentarianism.

First, Russia may establish a one-and-a-half party system similar to those installed in Japan and Italy after World War II. After a period of acute parliamentary struggle in those countries there emerged much larger parties which were ideologically inconsistent and were comprised of incoherent hostile factions. Yet, they were united by two main goals: that of retaining power, and preventing leftist forces from coming to power. Ideological principles are of secondary importance in this case. This model has a certain internal dynamic which may ensure successful economic development, as well as a relatively sustainable political development. Political crises may occur, but they are usually isolated events within the party and are resolved through the redistribution of posts amongst the various factions. However, the model has a serious drawback: it instigates corruption. This is a rather natural occurrence when a party stays in power for a long time and cannot be replaced by an alternative political force.

Another option is based on the British parliamentary model. As a parliamentary majority is formed, the executive power concentrates virtually all decision-making levers, automatically having its initiatives approved by parliament. The prime minister has extensive real powers and can take virtually any decision (including the dissolution of parliament). True, in today’s Russia that power is mostly vested in the president, but the prime minister can also play an important role. Naturally, this course of events is only potentially possible for the time being. For the model to be realized there should be an alternative political force which the electorate can vest with authority during a general election. Unless there is an alternative, it is the same one-and-a-half party system.⁷

Finally, it cannot be ruled out that unfavorable developments may lead to authoritarianism with the existing Constitution remaining in effect.

In general, the attitude to the Constitution will be one of the main criteria for estimating the nature and prospects of the political and economic models in Russia. Making sure that the Constitution remains unchanged is a most important condition for the gradual formation of a stable democracy. Really, the process rests not so much on the letter of the Constitution as on the inviolability of the ‘rules of the game’ (naturally, if they are democratic in principle). The strengthening of democracy in Russia requires that it develop corresponding traditions. The present Constitution provides such a foundation for this.

ECONOMIC POLICY AND ECONOMIC GROWTH

Economic growth was the focus of economic and political debates in the country throughout last year. In his address to the Federal Assembly, the president set the objective of doubling the country’s GDP over 10 years, provoking debates on whether that goal can and needs to be attained.

Alteration of the growth model. The main news was a reverted trend in economic growth. Throughout 2000-2002, the growth rate had been declining, as well as the investment rate, instigating the sharp criticism that the policies of the government were inefficient. The government was accused of being unable to take advantage of a favorable situation in foreign trade.⁸

Last year’s results allow us to cautiously suggest that a shift has begun toward a new economic growth model. The GDP growth rate was up to 6.7 percent in 2003 from 4 percent in 2002, while the investment volume grew by 12 percent; this number stood at a mere 2.5 percent in 2002. The machine-building sector’s output was up 8.5 percent, the second highest figure after the fuel industry. Imports of machinery substantially increased, contributing to the technological renovation of the economy. But it is still premature to draw the conclusion that a new growth model has been formed.

First, the structural effects of the investment boom are not obvious or, in other words, it is not absolutely clear whether this boom reflects the growth potential of all sectors of the national economy, or is mostly the result of a favorable situation in foreign trade. Last year the fuel industry continued to dominate in the overall investment volume – its share was 21-22 percent, as in 2001 and 2002. It was followed by investment in transport (17 percent), public utilities (15 percent), power engineering (5 percent), the food industry and communications (4 percent each), ferrous metallurgy and machine-building (more than 3 percent each). The fuel and energy sector’s dominance cannot be described simply as a negative factor, however, as it can become a driving force for other sectors.

Second, the stability of any new trend that may lead to investment growth depends on many factors, most importantly on the authorities’ ability to create favorable conditions for domestic and foreign investors. This factor is still open to question, and the political events in the second half of 2003 certainly did very little to clear up the situation. Presently, it suffices to say that Russia is at the initial stage of transition to a new phase of economic growth that is based on attracting new investment.

This transition is very vulnerable in political terms, due to two trends. On the one hand, the consolidation of power is underway, and the government direly needs economic growth from which it needs – and is in position – to derive maximum dividends. On the other hand, deep-rooted political stability is lacking, and there is a high degree of distrust among the main parties of the economic and political establishments – the state, owners and employees (they are all lacking the necessary ‘credit history,’ both in economic and political terms). On the surface, it seems that stabilization is in place and the political situation is favorable for business activities. But there is a conflict between the authorities, who are looking to secure immediate economic dividends, and the business community. The authorities start looking for a guilty party in the business or political community, thus further aggravating the situation by creating obstacles to economic growth.⁹

Under modern conditions, general attitudes of discontent with politics are supplemented by the situation on the global markets, which adds to the illusion of stability. Yet, external economic factors under these conditions are not so much a source of stability as additional threats to a positive shift in growth. On the one hand, the situation with export prices adds uncertainty, as price dynamics are unpredictable for the time required for making economic and political decisions. On the other hand, a favorable price situation tempts the government to shift from cautious economic (primarily budgetary) policies to populist solutions. It is not surprising that populist rhetoric steadily intensified throughout last year.

Debates on growth policies. Against this backdrop, heated debates were opened on the nature and prospects of economic growth. Since the issue of economic growth is an opportunity for various political forces to lay their claims to power, last year’s increase in the growth rate from 2002 certainly did little to dampen the enthusiasm of the parties involved.

The debate focused around growth rates, structural changes, the prevalence of raw materials in exports, and the development of new sectors. The objective of doubling the GDP in ten years encouraged debates on the various ways for attaining this goal. The question was asked if such a jump was compatible with economic restructuring, and what was the role of particular instruments in ensuring this accelerated growth. Moreover, a concept for accelerated growth was on last year’s agenda as one of the most pressing issues.

The government proposed its view of the problem which was in line with the logic it had adhered to during the past three years. In fact, it outlined a set of macroeconomic, institutional and sector-specific measures constituting an extensive plan of action.

In the macroeconomic sphere, it proposed pursuing a cautious policy aimed at ensuring monetary and financial stability, including a balanced budget and a floating exchange rate. Actually, the government’s budgetary policy has been sharply criticized by those favoring populist solutions and demanding that budgetary funds (and even the Central Bank’s reserves) be implemented to speed up growth and achieve economic restructuring. But even when high growth rates are successfully fulfilled, government leaders are accused of impeding the growth of a country’s economic might.¹⁰  It is true that every government that pursues a conservative policy inevitably faces this type of criticism.

Institutional policy last year was in line with the course of the previous years. Certain progress was made in the reform of the natural monopolies (with the exception of Gazprom) and pensions. There was a general improvement in budgetary legislation (first and foremost, with the formation of a stabilization fund), as the formation of a guaranteed system for bank deposits of private individuals, the liberalization of currency legislation, the adoption of laws regulating foreign economic activities, etc., went into effect. In other spheres involving administrative and budgetary reform, the reform of social welfare, and military reform, the preparation of basic concepts and the required legislative foundation were intensified. In general, much of the necessary groundwork for progress has been laid, but several more years will be required to realize the plans in their entirety.

Sector-specific problems are the most complex issues of modern economic policy. While the government is proceeding with the course outlined in its Strategic Program adopted in 2000, it decided not to define priorities for particular sectors with the purpose of translating them into budgetary subsidies. This policy is in line with the specifics at this stage of technological development, when it is virtually impossible to a priori define promising sectors and allocate financial resources to them in a centralized manner. Therefore, traditional measures of industrial policy that were typical of the first half of the 20th century – such as ‘handpicking the winners’ and fixing sectors that would receive priority financing from the budget – look unacceptable.¹¹

Meanwhile, the diversification of production and exports, together with the accelerated development of ‘new economy’ sectors, tend to become the key issues. In this connection, it has been proposed that sector-specific measures, different from the general (macroeconomic and political) instruments used to ensure an investor-friendly climate, be applied. This does not mean special support for particular sectors and enterprises. An example of this approach would be the creation of special economic zones where businesses are offered particularly favorable terms for investment and production (a simplified administrative regime, tax breaks). It is a specific feature of this approach that priority enterprises are not defined, and incentives are offered to any enterprise meeting a set of certain criteria.

The application of special mechanisms for encouraging growth and diversification is a hot issue inside the government. Clearly, the fiscal and tax agencies are skeptical about such ideas, fearing that they could lead to numerous financial offenses typical of Russia in the 1990s. Naturally, the possibility for such offenses should not be overlooked when related decisions are made. But it should also be taken into account that during the past several years, the state’s administrative resources have grown, thereby increasing its abilities for promoting economic growth. It is necessary at this point to discard the practice of ‘handpicking the winners’ in advance.

So the government’s economic policy concept has focused on creating the required institutional preconditions and ensuring macroeconomic stability as a foundation for economic growth. This approach is expected to ensure sustained long-term growth targeted at real, rather than artificial (imposed by state officials or lobbyists from particular sectors) priorities. But the model is politically vulnerable. It is not devised to impress the public. Rather, it calls for lengthy, painstaking and the rather tedious job of ‘cultivating’ institutions. Furthermore, the model depends on a relatively stable situation in the external markets. High oil prices, for example, will significantly slow down positive structural changes.

An alternative view of mechanisms for instigating economic growth and restructuring – an approach upheld by the leftist forces – has been expressed most consistently by the Motherland bloc. The bloc’s program includes a range of standard macroeconomic steps that are typical of left-leaning populist parties and governments in Latin America in the 1930-1950s. Its main provisions are:

• redistribution of property and revenues (to “ensure justice”);
• higher taxes (the Motherland bloc has focused on the need to return to progressive taxation for the income tax and royalties first and foremost);
• an energetic industrial policy, the defining of priorities (sectors of “national pride”), and their support from the budget and tax breaks;
• the withdrawal of extravagant profits from the “compradora bourgeoisie,” in fact, from all of the export sectors, and using them in the priority sectors. Levying of natural resource rent (particularly in the fuel and energy sector) and using it for “national interests;”
• macroeconomic destabilization, which would include waiving the federal budget surplus and allowing a deficit of up to 3 percent of the GDP with funds allocated for increasing the state’s demand; it has also been proposed that the Central Bank’s reserves be used for economic enhancement purposes; 
• a partial revival of the state-supervised regulation of prices.

Latin America’s past record shows that this policy is extremely dangerous, even at the industrial development phase. Nations that have followed such a formula failed to even partially close the gap and catch up with the economically developed nations, while several fell behind even more than was previously the case (e.g., Argentina). A brief period of economic growth (which was registered in only some countries) was followed by grave economic and political crises. Solving crises that were initiated by populist policies was always painful, and in most cases was accomplished only through a military coup.¹²

Such arguments give me serious reservations that this sort of policy can be efficient in modern Russia.

In the event that this course is pursued, the choice of priorities will inevitably be a result of interaction of corrupt government officials and lobbyists from traditional sectors which are the wealthiest ones and have the resources for imposing their will on the state. But even if a totally transparent system for choosing priorities was in place, picking priority sectors would be impossible for the primary reasons mentioned above.    

The rejection of the flat tax rate would mean a radical review of the tax policy consistently pursued during the past several years, that is, a policy aimed at streamlining the tax system, shifting from progressive to flat tax rates, and annulling tax breaks. The reasons for following this course of action was not so much due to the government’s liberal ideological guidelines, as to its intention to bring its economic (including tax) policy into line with the state’s ability to ensure the observance of law. Above all, this inability to use intricate tax instruments – in particular, to collect progressive taxes – prompted the government to adopt flat tax rates. The positive effects that this move has had on the budget surpassed all expectations. A rejection of those principles would mean a return to the situation when the state’s demands failed to correspond to its ability to collect taxes, with fiscal efficiency sacrificed to leftist ideas of ‘social justice.’

Any proposals that the natural resource rent be withdrawn and redistributed are also quite dubious. It is not that the idea of the government receiving higher revenues from those sectors producing and exporting natural resources is wrong – under the current prices in the global markets, this is quite possible. But there are certain questions that demand answers. Unless they are adequately answered, it is impossible to prudently discuss higher taxes in these sectors.

First, revenues from natural resource rent depend on whether world prices are high. But how the state is supposed to receive the necessary funds after global resource prices drop is open to question. This would prove to be particularly important should the price situation worsen after a certain time period during which the Russian economy had become strongly dependent on oil revenues – much more dependent than it is today. Actually, that is why the Soviet Union collapsed – in the 1970s, the leaders believed that the prices of natural resources would indefinitely remain at very high levels, and they adjusted the economy to that price level. But when the prices suddenly dropped, that system collapsed.

Second, it is particularly important to consider how those extra revenues are used. Should higher taxes on the export sectors be accompanied by a reduction of the overall tax burden? Or is the move only aimed at increasing state revenues?

Third, there should be clarity about the mechanisms used for the withdrawal of windfall revenues from sectors producing natural resources. In this case, windfall tax differentiation is required to accommodate the terms for businesses which should get a tax return that corresponds to the costs of extracting natural resources. Such an approach would mean the return to the days when a bureaucrat decides what tax rate is fair in each particular case, i.e. it can instigate corruptive practices of state policy with respect to natural resource producing sectors. This would be one of the most obvious and dangerous effects of the rejection of the unified mineral production tax in its current form.

The above considerations are not absolute arguments against applying higher taxes to the producers of natural resources. When a selling price is favorable, this can be an expedient move, but it should be carried out in a manner that would not aggravate corruption nor make the state budget more dependent on fluctuations of energy prices. It is quite possible to get higher revenues from the fuel and energy sector, while at the same time adhering to a common approach: by marking up the unified mineral production tax rate and export tariff rates, together with an institutional reform of Gazprom.

Finally, the debate on windfall earnings from natural resources has mostly been a political debate and has had little to do with real actions by the politicians. This became evident last June when the State Duma voted on the government’s proposal to mark up the rate of the unified mineral production tax, which would have leveled off the profitability for the producers of mineral resources and other sectors. Both left and center factions voted against the proposal, including those whose political campaigning is based on calls for taxing windfalls.

Administrative reform. Improving the efficiency of decision-making by the authorities is a priority for making their economic policy more efficient. The state’s inability to attain its goals and ensure the observance of the law has seriously limited its choice of economic policy instruments. Last year the government attempted to focus on this problem.

Administrative reform is among its top priorities. The potential for ensuring sustainable growth through economic levers proper has been virtually exhausted. The efficiency of economic legislation has been declining in a sense that each new improvement of the legislative base regulating economic life will have increasingly less effect under the current system of political institutions. One can endlessly perfect banking legislation, engage in deregulation or fine-tune labor legislation, but this will be senseless unless the situation improves in spheres like public administration, the judicial and law-enforcement systems, not to mention military reform.

This entire issue has been pressing for some time already. There was a provision devoted to the different ways for improving the performance of the government agencies in the strategic program that was adopted in 2000, but it was decided instead that the government’s program should focus on economic issues. In late 2002, the government started paying more attention to administrative reform, and in the second half of last year a commission headed by deputy prime minister Boris Alyoshin was formed. His group began analyzing in detail the functions of various government agencies with the purpose of streamlining and optimizing them.

The progress of administrative reform has been significantly complicated by two specific features. First, this reform will take a lot of time. It will produce effects, but gradually, as the ‘rules of the game’ change in the state machine, together with all of its traditions, customs and even generations of employees, which is by far more important than just an alteration of a legislative base. Unlike tax reform, administrative reform cannot quickly yield visible results, and a government implementing such reform has to be able to see far and wide.

Second, administrative reform is being carried out by government officials, i.e. by those it concerns most of all. This is at odds with the general principle of any reform: players should not establish and enforce the rules, nor should they be the arbiters when assessing their own performance. Clearly, army generals should not carry out military reform, but it would be wrong to draw an analogy and say that administrative reform has to be performed by other public servants; in this situation, there really is no other choice. But this puts a serious brake on reform, and the country’s top leadership has to clearly express its political will for administrative reform to be accomplished.

It would be wrong to reduce administrative reform to simply reforming the structure of the executive and the number of ministries and agencies. This reform is a complex problem with a whole range of serious objectives, including the following main ones:

• reform of public service sector with the goal of increasing the efficiency and responsibility of public officers;
• refining, streamlining and elaborating the functions of the different ministries and agencies. This would include a separation of political and control functions, and services;
• reform of budgetary spending as a structural (not fiscal) reform, with the purpose of increasing its efficiency by modifying the allocation rules and procedures, as well as restructuring the budgetary expenditure pattern;
• job cuts in the public sectors; despite market reform, the number of public employees has been steadily growing.

Last year, the commission for administrative reform mostly focused on the analysis of those functions performed by government bodies. During the past two or three years, reform of state service and public spending has also been conducted.

Having focused on functions, Alyoshin’s commission has declined to deal with the formation of a new, ‘optimal’ structure of ministries and agencies. Really, this would have been rather senseless, even if for the reason that in a democratic society, an optimal number of agencies and interrelation of their functions is not a problem¹³– there should be as many as required to ensure stable support for a cabinet in parliament. In an extreme case, a special agency can be created to perform each particular function or, on the contrary, all functions can be concentrated in one agency (a super ministry). A practical solution actually lies somewhere in between.

What must be achieved now is agreeing on a concept for an efficient state administration system, together with an understanding of its functions. An important step at the conceptual level agreed that one body should not combine such functions as the drafting of a policy, the implementation of rules and norms, and control and inspection. This is the right approach, otherwise a conflict of interests arises that works along a well-known scheme: first an agency adopts particular rules that are impossible to be observed, and then it fines (or takes bribes from) the offenders. The private sector should be assigned the functions it can perform. For instance, it has been decided that the inventory of real estate can be performed as a service in the market (that function has been performed by the notorious BTI state-controlled inventory bureaus). Similar proposals have been made about vehicle inspection – the Interior Ministry has monopolized this market with quite grave consequences. In principle, it would be important to strip control agencies of the right to suspend the functioning of businesses without a court verdict.

The following steps in the administrative reform framework would be important. They would limit – and increase –- the efficiency of the state’s interference in the economy:

• the drawing up and introduction of a system of budgeting based on past results, i.e. appropriation of funds from the budget for clearly defined goals;
• ensuring open access to information on the activities of state government bodies;
• the introduction of a system requiring that government agencies proposing new forms of state interference in the economy should publicly substantiate the need for it;
• the introduction of procedures for periodic efficiency assessments of state regulatory measures. This would include the rejection of certain measures of regulation on the results of those audits;
• increasing the efficiency of state property management;
• total rejection of the overlapping of functions between government agencies and business entities;
• the drawing of a legislative base for the activities of self-regulating organizations which should take over part of the functions now performed by the state.

Finally, an analysis of the state-performed functions will have to be followed by huge efforts aimed at updating a vast number of legislative measures now regulating the state machinery’s functioning. There are many such documents – from federal laws to endless departmental instructions. One of the main purposes of these myriad documents was, in fact, to provide certain grandeur to a particular agency (or its head).

Administrative reform has just started and a lot more has to be done. One thing is certain: it will be a laborious effort, both in technical terms (a vast amount of documents will have to be analyzed) and political terms (too many interests are involved).

PRIORITIES FOR THE UPCOMING PERIOD

The summing up of last year’s results requires that priorities should be defined for this year and into the future, that is, for the whole of the next political cycle.

Those issues have been actively debated in the presidential administration, the cabinet, and among economists close to the cabinet since last summer. In particular, the following panels were involved in debates:

the cabinet proper and its experts who drafted law-making priorities for 2004 and beyond; the Commission for Administrative Reform has played a special role;

a working group led by the president’s deputy chief of staff Igor Shuvalov; initially it was comprised of representatives of the various political forces and social groups in order to identify and elaborate on the most important socio-economic development issues which could enjoy wide public support and, therefore, be put on the list of priorities for the next four years. Five priorities were laid out during the preliminary discussions – reform of education, public health, developing a mortgage market and private housing construction, military reform (primarily in terms of resolving social problems of the military), and resolving the Kaliningrad region’s problems. Leading analysts and government officials have started their intense elaboration.

Russia’s Ministry for Economic Development and the Center for Strategic Research (CSR) which are closely associated. As in 2000, the CSR has become one of the main organizations for initiating broad public debate on economic policy issues. Work has been started there on a number of important regulatory documents that may be submitted to the Duma after the presidential election.

Importantly, the above groups have close interaction and they cannot be regarded as alternative groups. They rather supplement each other.

The following issues are among the top priorities for advancing economic reform in the mid-term run:

1. Administrative reform as a precondition for increasing the efficiency of state administration, including the realization of the economic policy proper.

2. Completing the elaboration of a sound economic plan and launching a large-scale reform in the budget sphere. Decision-making procedures should be revised in that sphere. It is necessary to develop budgeting based on results, modify allocation procedures and the expenditure pattern (the list and status of organizations and their functioning principles). It would be essential to gradually shift to mid-term budget planning. Reform of public spending was supposed to follow tax reform, yet no progress has been registered during the past two years.

3. Elaboration of a concept for overcoming the Russian economy’s dependence on natural resources and its transformation into a package plan.

4. In pursuance of the above two points (reform of budget spending and diversification), work should start on making the public health sector more efficient. That sector, along with the humanitarian effects, can generate a significant boost and promote the development of other sectors of the Russian economy: it would create a demand chain in many other sectors and industries, and that demand would be real. A shift to personal insurance plans is a key direction here.

5. Substantial progress has to be made in military reform, primarily in terms of recruitment to the armed forces. This is important from the political and military standpoint, but also in economic terms: accomplishing a post-industrial breakthrough is hardly compatible with diverting young people from energetic creative activities for a long period. Discussions conducted in 2002, combined with more openness concerning defense spending in the 2003 budget, provide a basis for more resolute steps toward a professional army.

6. Continuation of reform of the natural monopolies.

7. The completion of negotiations on WTO accession and adopting the required legislation. Delaying the negotiations threatens an indefinite delay in joining the organization in connection with plans to reform the WTO.

8. Perfecting the legislative and regulatory base, and making the functioning of financial institutions more efficient. The banking sector’s reform with the goal of making it more reliable. However, the issue can only be resolved in full measure as the bulk of economic players (companies, banks, citizens, and the state) gradually receive a credit history.

9. Refining Russia’s policy vis-?-vis the EU as its main trading partner. Last year it became clear that in the foreseeable future the EU will be bogged down in its own problems (expansion, common currency) and will be unlikely to be able to actively deal with Common Economic Space issues. This makes it even more important for Russia to decide what European legislation is acceptable and proceed with its law-making accordingly.

Finally, protecting what has already been achieved and formed has grown increasingly relevant. This concerns both the general principles for the country’s functioning and within its institutions. In the political sphere, preserving a democratic system and the 1993 Constitution are top priorities. In the economic sphere, keeping the tax system that emerged in 2000-2003 – with low flat tax rates and minimal exemptions – ranks as one of the most critical problems.

¹ See: Alesina A. Political Models of Macroeconomic Policy and Fiscal Reform. Washington D.C.: The World Bank, 1992.

² Compared with a net inflow of $3.6 billion in the second quarter.

³  The adoption of the Habeus Corpus Act in England at the end of the 17th century, which guaranteed immunity to an individual, is often mentioned among the main factors behind the start of modern economic growth – even though political rights remained a minority’s privilege for another two ages. A similar case has been cited about the New Economic Policy period in Soviet Russia: A lawyer asked an entrepreneur if business people would take their money to banks after the adoption of a decree guaranteeing the protection of money in bank accounts. The answer was negative, because no one guaranteed “the account owner’s immunity.” (Mau V. Reforms and Dogmas. Moscow: Delo, 1993, p. 120 – Russ. Ed.)

⁴ Hellman J., Janes G., Kaufmann D. Seize the State, Size the Day: State Capture, Corruption, and Influence in Transition. The World Bank. Policy research working paper – 2444. Washington D.C.: IBRD and EBRD, 2000.

⁵ In many respects, the debate reminds discussions of a virtual economy concept, which was extremely popular in Western literature between 1997-1999. It looked like a universal theory was discovered, explaining all problems of the Russian economy for a long period. But after the 1998 crisis it turned out that those conjectures were not based on reality – the ruble’s devaluation alone smashed the theory to pieces.

⁶ This reaction is well known in Latin America. When people are sick and tired of political forces that have stabilized the economy and ensured economic growth, they elect left populists. The latter bring the country to an economic crisis and new problems make people bring right liberals back to power.

⁷ For comparison of constitutional systems of modern Russia and Britain see: Mau V. The 1993 Constitution and Economic Reforms in Russia // Constitutional Law: Vostochnoyevropeiskoye obozrenie, No. 3, 2003 – Russ. Ed.

⁸ There was another explanation for the declining dynamics. It was based on the analysis of the so-called recovery growth. (The Russian Economy in 2002: Tendencies and Prospects. Moscow: IEPP, 2003, pp. 10-13 – Russ. Ed.) In line with that logic, after a deep slump and lengthy recession, the first growth phase is related exclusively with political stabilization, recovery in demand and the commissioning of idle capacities. Naturally, as available resources are used up, the growth rate inevitably declines. A new rate increase occurs later and is based on intensified investment activities, that is, when a transition takes place from growth based on available capacities to growth based on new investment. No one can predict when this transition can be accomplished, as it depends on a whole range of factors determining a country’s investment climate.

⁹ This was the course of events at the end of the 1920s. The Soviet political leadership was displeased at a slowdown of economic growth rates. It charged private businesses with intrigues and accused many prominent economists and government officials of sabotage. This meant an end to the New Economic Policy and a shift to coercive industrialization, which resulted in huge casualties.

1¹⁰ A typical example in Russian history was a policy pursued by the then Minister of Finance and later Prime Minister Vladimir Kokovtsov between 1909-1913 – he was accused of having focused too much on financial and monetary stability to the detriment of economic growth, whose rate was around 6 percent a year at the time. (See: Kahan A. Government Policies and Industrialization of Russia // Kahan A. Russian Economic History. The Nineteenth Century. Chicago and London: The University of Chicago Press, 1989).

¹¹ For more detail on the issue see: Mau V. Post-Communist Russia in the Post-Industrial World. Voprosy Ekonomiki, No. 7, 2002 – Russ. Ed.; Breach A. Broadening Horizons: Russia’s Road to Prosperity in the Post-Industrial World. Brunswick UBS Warburg. Global Equity Research. January 31, 2003.

¹² Classical criticism of populist economic policies can be found in: Dornbusch R., Edwards S. (eds). The Macroeconomics of Populism in Latin America. Chicago and London: The University of Chicago Press, 1991.

¹³ An ‘optimal’ number of ministries can only exist in a totalitarian system. It was not accidental that the Soviet Constitution of 1936 contained a special article with a whole list of people’s commissariats (ministries). As soon as the first gleam of democratization emerged, the article was dropped.