30.07.2005
A Long-Term Project for Russia
№3 2005 July/September



 

The
prospects for long-term investment in Russia will take definite
shape only when the country succeeds in the so-called
entrepreneurial project. The successful development of business is
the only format in which Russia can develop as a civilized and
successful country. A failure to embrace the entrepreneurial
project means that from a strategic point of view Russia is
doomed.

 

RUSSIA’S
CURRENT SITUATION: 
THE OBVERSE

 

Russia is
experiencing its seventh year of economic growth. Since 1998, the
nation’s Gross Domestic Product has increased by almost 50 percent;
over the last six years the per capita GDP has increased 52
percent, with an annual growth rate of 7.2 percent. This rate
ensures the doubling of the per capita GDP (a goal set forth by the
Russian president) over a period of 10 years. Last year, some
industrial sectors – primarily the oil, gas and ferrous
metallurgical industries – overcame the slump they had experienced
during the 1990s and reached the output volumes they had enjoyed
before December 1991, the period which ushered in the
disintegration of the Soviet Union. Although this advance does not
embrace the entire economy, it signifies the overtaking of an
important psychological barrier, as whole industries – not just
individually successful corporations – have outpaced pre-crisis
production volumes.

 

Investment
continues to increase. Over the past 6 years, investment has grown
79 percent, which means an average annual growth rate of 10.2
percent. The result is clearly positive, although some observers
believe Russia still lacks a sufficient amount of investment. The
past few years have seen a considerable growth of foreign direct
investment, which trebled over the past six years and stood at $11
billion in 2004.

 

Russia’s
financial situation is more stable now than at any time in the past
several decades. The national budget has enjoyed a surplus for six
years running; the foreign exchange/gold reserves stand at
approximately $140 billion, with around $30 billion of that amount
accumulated in the stabilization fund. Since 1998, Russia’s foreign
debt has shrunk to $110 billion from $154 billion, while it no
longer faces the economic challenge of repaying its foreign debt –
once an economic and political problem; it is now a purely
technical one. If Russia continues to pursue a prudent fiscal
policy, it will be able to pay off its entire foreign debt in the
coming few years.

 

The income
and consumption rates of the Russian population have increased
sizably in recent years. Private per capita consumption was 32
percent higher in 2004 than in 1990, the most affluent year in
Soviet history (although disparities in consumption, income and
property became more pronounced amongst the Russian people).
Millions of Russians have significantly improved their living
standards. For example, the number of private cars trebled and the
total floor space of private housing quadrupled, while the
construction of private country houses that people build in
addition to their city apartments is thriving in the suburbs of any
big Russian city, although official statistics may take an
incomplete account of this phenomenon.

The list
of tangible and important achievements can be continued, and yet it
has a reverse side, too.

 

RUSSIA’S
CURRENT SITUATION: 
THE REVERSE

 

By
international standards, Russia’s achievements look quite modest.
While in 1975 the per capita GDP – which is the main economic
indicator measured as consumer demand parity – stood at 43 percent
of the U.S. level, it dropped to 18 percent by 1998; it recovered
slightly to reach 24 percent in 2004. By modern standards of
wellbeing Russia remains a fundamentally impoverished
country.

 

The
problem of fundamental poverty has never been and cannot be solved
through distribution and/or redistribution of existing resources.
Poverty in Russia can be eliminated only by generating new wealth
and accelerating economic growth.

 

However,
the economic growth rate has been consistently reducing in Russia.
In 2004, with regard to this indicator, the country sank to the
bottom of the list among the ten countries of the Commonwealth of
Independent States, and is presently sharing that position with
Kyrgyzstan. The other economies of the CIS, like many countries of
the world, are developing at a faster pace than the Russian economy
whose growth rate reduced by a third at the beginning of 2005 as
compared with the same period in 2004.

 

Russia’s
achievements are not steady enough, and each of the trends
mentioned above may easily head in the reverse direction.

How did
Russia attain those achievements in recent years? Basically, it
drew on three major resources, or backbone elements that provided
for this country’s relatively successful development. Exploiting
each of those three resources, however, involved serious
problems.

 

The first factor involves the
development of private enterprise. After all, it was Russian
businessmen who produced economic growth, gradually bringing Russia
into a different condition. They succeeded due to their energy,
persistence, enterprising spirit, readiness to assume risks, and
ability to rebuff the pressure of ruthless criminals and
bureaucrats. It cannot be denied, however, that the Russian
business community remains weak.

 

Factor number two is the activity of
government agencies that witnessed serious fluctuations during the
past 15 years. In the beginning, there was the start of economic
reforms in 1991 and 1992 and a breakthrough in reformation in 1993.
There was also a period between 2000 and 2002 when the authorities
enacted a sizable package of economic reforms that sent the
country’s credit ratings up, attracted new investments and bred the
hopes that Russia had opted for a path of civilized social,
economic, and political development.

 

But there were also other significant
periods. From 1995 through to 1998, the economy was unnaturally
stifled by the policy known as the ‘currency corridor.’
This  resulted in Russia’s default on
debts in August 1998 and a devaluation of the Russian ruble as the
government confiscated many billions of dollars worth of assets
belonging to Russian and foreign companies. Then there was a period
between 2003 and 2004 when the government’s actions aroused doubts
both inside and outside Russia as to what direction the country was
moving and what should be expected next.

 

Recently, Russia sent signals that the
government was taking some steps toward reducing the damage that
had occurred in 2003 and 2004. However, the Russian business
community, as well as other sectors of the population, is not
convinced that the steps taken are sufficient enough to declare
that the damage inflicted on the entrepreneurial climate in 2003
and 2004 has been fully removed.

 

The third element involves the outside
impact on Russia. There is no country in the world that can exist
in international isolation, especially a country that seeks to
advance its economy, attain high growth rates, and become a
respected member of the global community. Russia’s integration into
the global economy means that the performance of its economic and
political entities, as well as the very nature of the Russian
government’s activities, heavily depend on the situation on the
global markets.

 

The favorable situation on the global
markets in recent years has opened up an unprecedented inflow of
finance to Russia. Furthermore, it has raised the degree of freedom
of economic and political structures in implementing various
projects. In some years, benefits from the market situation
comprised 6 to 9 percentage points of the GDP. As for 2004, they
clearly accounted for the entire actual growth of the GDP.

 

RUSSIA’S ECONOMIC ILLS

 

An inflow of hard currency from abroad
plays a dual role: it builds up resources for economic growth on
the one hand, but aggravates the conditions for the Dutch disease
on the other. Today, this economic disease presents one of the
biggest challenges for the Russian economy, political system and
society. The Dutch disease occurs when currency flows into the
country, inflation remains high, the real exchange rates rise,
economic growth slows down, and structural imbalances become more
pronounced.

 

An exacerbation of the Dutch disease
promotes corruption, impairs the quality of policies, including
those of an economic nature, and demoralizes essential federal and
public institutions. The flow of revenues not earned through the
hard labor of the government or economic entities has a degrading
effect, thus encouraging the emergence of a “rent-oriented”
government and a “rent-oriented” society. As a result, the idea of
business through creative endeavors gives way to an aggressive
ideology of redistribution.

 

In Russia, the Dutch disease is
gradually turning into the Venezuelan disease, i.e. a policy based
on increasingly stringent tax and bureaucratic controls over
finances (above all, in the oil and gas industry), nationalization
of the largest and most successful corporations, the continued
government monopoly over infrastructure facilities, a ban on
private ownership of mineral resources, exclusion of foreign
investors from the development of the most promising natural
resource deposits, and protectionism that creeps into all branches
of the economy.

 

This was the same path that Venezuela
chose for itself in 1957. Prior to that date, the development of
oil deposits by local oligarchs and “imperialist sharks” had
propelled the South American nation to record high positions in
terms of economic growth within a period of four decades.
Unprecedented economic growth increased the per capita GDP by a
factor of ten. By the beginning of the 1950s Venezuela became one
of the world’s richest nations. Its per capita incomes and
consumption levels stood a notch below those of the U.S. and
Switzerland. Its capital, Caracas, turned into one of the most
modern, beautiful and safe cities in the world.

 

A turnaround occurred in 1957, however,
when the government launched a nationalization campaign. Efforts to
nationalize the fuel industry, pipelines, seaports, steel
processing plants, and other facilities, completed 20 years later,
drove the country to stagnation. The average per capita GDP growth
rate fell by a factor of 13 then – from 7.6 to 0.6 percent.

 

The year 1977 marked the triumph of
state capitalism in Venezuela. At this time, the government
controlled the commanding positions in the economy and took an
active part in managing the global crude oil market as OPEC’s
leading member. The “patriotically motivated” economic policy
proved devastating as Venezuela slid into its deepest economic
crisis. By 2004 its per capita GDP was 37 percent lower than half a
century before that. The degrading impact of state command in the
economy spread beyond government institutions – it caused the
degeneration of Venezuelan society, affecting two generations of
people who grew up during state capitalism. Today, Venezuela has no
political forces capable of leading it out of the historical
deadlock.

 

A part of the Russian elite is obviously
tempted to follow the Venezuelan path. It dreams of imposing state
control over money flows in the fuel sector, nationalizing it,
putting under control its infrastructure, keeping up infrastructure
monopolies, and managing energy resource flows inside and outside
the country. If Russia continues to move in this direction, the
prospects of it being hit with the Venezuelan disease – with all of
its economic and political complications – will become a very real
possibility.

 

THREE CHALLENGES

 

What are the options for Russia? The
success of the Russian national project depends to a great degree
on whether the Russian government, business community and society
at large will be able to appropriately respond to three dramatic
challenges.

 

Challenge number one is to choose a
national formula of economic and social vision. Society has not
made that choice yet, and the need for nationwide debate on that
issue is hard to overestimate. It is critical for Russia to breed
immunity against destructive ideas, which are occasionally imported
from countries generally viewed as advanced and developed.

 

There are two extreme viewpoints as
regards the ideas coming to us from the West. One of them suggests
that all the ideas generating in the West are correct, progressive,
and deserving immediate implementation. The other viewpoint
dismisses all Western ideas as dangerous and hazardous; Russia must
vigorously prevent them from entering the country.

 

But real life is much more complex than
this. Ideas that have been entering Russia for centuries from the
West were typically those related to the ideas of freedom, market
economy, democratic development and the observance of human rights.
Like people from many other countries, the Russians are thankful to
the West for its contribution to the international wealth of human
thought. But let us remember, however, that inhumane and
destructive ideas like Marxism, Communism, Socialism, and
contemporary Kyotoism were also generated in the West.

 

On the one hand, Russia must learn how
to assimilate the ideas of freedom, development, and creativity
from a broad array of concepts offered by the world; on the other
hand, it must learn to avoid those concepts that demand dependence,
degradation and redistribution.

 

Challenge number two is to find the best
formula for a relationship between the business community and
Russian government, to design a model enabling the country’s
development over the long term. In the middle to late 1990s, big
business unconditionally dominated the government, but society was
opposed to that model. In recent years, Russia turned to the
opposite extremity, which is the absolute domination of government
over business. But this model has no promise for the future. Thus,
neither the past nor present model can ensure Russia progress over
the long term.

 

A look at the economic models offered by
the developed nations suggests there are two options available. The
first is the U.S.-Hong Kong model which has a more or less
equitable – although far from idyllic – relationship between
business and government; this model offers the broadest
opportunities for creativity and development. The second option is
the Continental-Japanese model, where government dominates over
business, yet strives to create lucrative conditions for the
redistribution of resources and protracted stagnation.

 

A comparison between the actual economic
growth rates in the U.S. and Hong Kong, on the one hand, and
Continental Europe or Japan, on the other, provides a good example
of the efficiency of a long-term relationship between business and
government. As for Russia, it has yet to make a choice between
these two models, although a part of its political elite has
already made its decision.

 

Challenge number three seems to pose the
biggest problem for the success of Russia’s long-term national
project – finding the best formula for a relationship between the
business community and the rest of Russian society, as that
relationship is now in a state of latent conflict.

 

In previous years, Russian business
offered a model of de facto bribing or ‘buying up’ of society. The
majority of ordinary people rejected those overtures. At the same
time, the government proposed a model of social responsibility for
business. This is ridiculous, of course, since the main
responsibility that the business community has for society is to
ensure efficient business, that is, produce the commodities and
services that would enjoy demand on the market. Neither the
previous nor the existing model of relations between society and
business can ensure Russia’s efficient development over the long
term.

 

A response to that challenge – that is,
devising a model of equitable partnership between business and
society without bribery or violence on either side – will be
critical for the success of the Russian entrepreneurial project and
guarantee its very survival. Russian and foreign businesses in this
country must also find equitable, decent and respectful methods of
cooperation with society. It would make the business community
understandable to society which would begin supporting and
defending businesspeople. Only then would Russian businessmen get a
chance to overcome or at least reduce the hostile attitude now
visible in some sections of society. It would then avoid the
possibility of becoming hostage to the mob or the whims of
government agencies. It would then be able to turn into an
inalienable, respected, and genuinely treasured part of Russian
society. The lessons of what happened to Russia in 1917, in China
in 1949, or in Iran in 1979 must finally be learned.

 

If Russia’s business community,
government and society at large are able to find appropriate
responses to these many challenges, then the Russian national
project is destined to enjoy long-term success.