Any crisis, especially one as complex as the current
financial crisis, creates uncertainty that inseparably links
opportunities with dangers. For Russia, which has been searching
for a development strategy for a long time, it is particularly
important to conduct an adequate assessment of the situation’s
potential and the ongoing processes.
DISTINGUISHING FEATURES OF THE 2009 ECONOMIC
ORDER
The rearrangement of the global economic order, which
began spontaneously in the autumn of 2008, entered a sluggish phase
in the winter of 2009-2010. It can be characterized by three
factors.
First, the low liquidity of major
banks in countries with a stable trade deficit (Great Britain and
the United States) paralyzed the world financial system in
September and October 2008. Balance of payments is based on the
double counting principle, therefore an increase in the deficit on
the current balance of goods and services is supposed to occur
simultaneously with an increase in operations with financial
instruments. This was the case until 2008, when U.S. banks had been
investing incoming capital in long-term assets (U.S. mortgage loans
for example, which seemed attractive at the time).
Investors closed their positions as the value of
these funds fell. This resulted in an outflow of money from those
U.S. banks that had been reinvesting on the security of mortgage
loans. Trying to normalize liquidity, the loss-making banks began
to sell their foreign assets, thereby rocking the banking systems
of other countries. In order to avoid the financial chaos caused by
the spontaneous re-distribution of liquidity, governments – above
all, the U.S. administration – had to resort to providing massive
loans to national banking systems.
This yielded certain results. By November 2009, the
liquidity of the trans-Atlantic banking system was as good as
restored, as shown by the decreasing difference between interest
rates on inter-bank loans in London and rates on Treasury bills in
Washington (TED spread), which fell to the pre-crisis level of
early 2007.
Second, world trade turnover fell as
the crisis hit the banking system. According to the Organization
for Economic Cooperation and Development (OCED), the aggregate
monthly trade turnover of OECD member-states and the eight OECD
candidates, including Russia, plummeted from $2.32 trillion in July
2008 to $1.47 trillion in February 2009. The balances of net
importers and net exporters decreased considerably, as the balance
coefficient of variation fell to an all-time low since 2003. The
latter fact indicates that the countries take measures to balance
their trade.
Third, active government
interference in the affairs of creditors and debtors, hitherto
regarded as private, indicated an actual change in the economic
paradigm in the United States, whose economic model underlies the
modern world economy. Massive injections of government money –
first in the banking system, and then in the car manufacturing
industry and energy infrastructure – meant de-facto renouncement by
the bureaucratic Washington of free market tradition and a transfer
to the “manual control” model, which Russia knows so well.
UNCERTAINTIES OF THE CRISIS
The tentative economic stabilization does not imply
that the world has become less ambiguous. On the contrary, the
governments of several countries are mulling difficult decisions
that they will have to make in the near future.
Washington is facing the biggest difficulties because
it has not yet decided how to get out of the budget trap. The U.S.
Treasury says the government debt grew from $9.646 trillion in late
August 2008 to $11.813 trillion in late August 2009, and that the
monthly growth rate never slowed until recently. The breakdown of
the holders of the U.S. government debt shows that private
investors, including foreigners, are making additional
acquisitions. Since this category of investors behaves
unpredictably, Washington may soon find itself in a situation where
loans on the market will only be available at high interest rates.
The government could decide to raise interest rates, but that is
fraught with the risk of arranging a financial pyramid of its bonds
or the government could be forced to print money, which could fuel
an inflationary spiral.
The second option looks less damaging for the U.S.
economy in the short-term. If the U.S. dollar’s exchange rate
falls, a considerable portion of losses will be carried by the
foreign holders of U.S. bonds in China, Japan, oil exporting Arab
countries and the offshore centers located in the Caribbean and
Great Britain. But the inflationary redistribution of welfare will
affect the United States as well: pension funds will depreciate and
it is anybody’s guess how the U.S. middle class, the backbone of
American democracy, will react to the loss of their lifelong
savings. In addition, the gap between the incomes of residents in
relatively well-to-do states and impoverished ones will increase,
thus testing the limits of intra-American solidarity.
Aside from the budget deficit problem, Washington
will have to come to grips with the economic development model,
whose earlier, free-market version was spontaneously swapped under
pressure from last year’s debts. Although the U.S. government
openly claims that the reprivatization of “temporarily”
nationalized assets is inevitable, above all in banking and auto
manufacturing, one gets the impression that private companies have
begun to tailor their investment plans to government programs in
earnest. Therefore, even if the government puts up its stakes in
companies for sale, national private players may be unwilling to
buy them without a considerable discount and the promise of
continued government support. Most likely, Washington will show the
foreign contenders the door, citing the “strategic importance” of
assets. But will this not preclude the return to lost economic
ideals?
The problem of the foreign trade imbalance and a
possible revision of the development model by Washington have
considerable repercussions for countries that have selected an
export strategy, such as the Eastern economies (China and Japan),
Germany, and Russia, to a certain extent. A distinguishing feature
of this group is the overt and covert specialization in servicing
the markets of larger and richer states. To excel within this
model, the supplier needs to have his exports grow permanently, but
according to the OECD’s data of November 2009, exports have not yet
restored to the global highs. The new uncertainty challenges the
expedience of the export model, which eventually may make Berlin,
Moscow, Beijing and Tokyo revise their development ideology.
At the same time, the rapid growth of U.S. government
spending is beginning to worry foreign creditors. China, which is
particularly concerned, began to withdraw from the federal bonds
market in June 2009, according to the U.S. Treasury. For now,
Washington has found a replacement for China in more loyal
investors from Japan, Hong Kong and Great Britain (including the
offshore zones), but this game cannot continue without solving the
problem of the U.S. budget deficit. If this is solved through an
increase in money supply, other countries will face a dilemma: they
will either follow Washington, which will result in world price
hikes, or develop innovative methods to defend their national
economies from the consequences of the dollar’s downfall.
For Russia to convert all the dangers and
opportunities that have emerged in the world over the past 12
months into practical use, it should determine in the first place
what objectives it sets for itself as a federal Eurasian state.
In identifying national priorities, a country may use
the method of democratic choice. In this case, political parties
offer reference points for development and the most popular of them
will get the benefit of voters’ trust in an election. On the whole,
this method suits Russia, whose citizens have the right to vote, if
not the right to set objectives before the government. The Russian
specifics are such that the program of the United Russia party –
the winner of the 2007 elections (Putin’s plan) – has not been
fully explained in detail. It leaves much room for various
interpretations. Still, the actions taken by the Russian
authorities after the elections and opinion polls suggest that the
elite and the “silent majority” opt for two main objectives:
-
the preservation of a single Russian cultural
space, which implies independent domestic and foreign
policies; -
the development of the economy and infrastructure,
sufficient for sustaining the state and a high standard of
living.
In practice, it means defining and fixing the borders
of this space with neighboring civilization blocs and a more rapid
growth of Russia’s welfare compared with other countries. Let us
consider how favorable the current situation is for the above
priorities and what measures might contribute to their
realization.
CULTURAL SPACE BOUNDARIES SET BY ECONOMIC REALITY
Although there are several ways to interpret the
commonness of culture, economically it can be defined as the
identical patterns of behavior by business people, government
employees, producers and consumers in neighboring territories in
creating goods and services with market value. Such similarities in
behavior make contacts easier, or “reduce transaction costs” to put
it in economic jargon. Therefore, a single civilization space, be
it Russian or someone else’s, differs from adjacent territories not
only by the commonness of formal laws, but also by an increased
volume of trade, a closer interweaving in terms of technological
and marketing chains and trends towards “special” relations between
its formally independent members.
In my article published in this journal two years ago
(No. 2/2007), I raised the issue of identifying the natural borders
of Russia’s space on the basis of data on mutual trade between
Eurasian countries. Using the gravitational model, I calculated the
temporal changes in the “distance” between Russia and its trading
partners as a ratio between the Gross Domestic Product and mutual
exports in 1997-2005. The shorter the distance, the higher the
gravity. Since the figures showed that Russia was in closest
proximity to Belarus, Kazakhstan and Ukraine, these four
conceivably form a common economic space.
New data have appeared which can be used to check the
result obtained for consistency. An analysis of the new data shows
that the distance between Russia and the above-mentioned countries
continued to rapidly decrease in 2006-2008, despite repeated
reports about their “trade wars.” Such a development of relations
may make it possible to identify a cultural bloc made up of
Belarus, Kazakhstan, Russia and Ukraine.
At the same time, Russia’s trade ties were rapidly
expanding with the North European (Finland) and Central European
(Germany, Italy, the Netherlands) civilization blocs. A more
detailed analysis of trading flows shows that a dramatic decrease
in the distance between Russia and these countries is taking place
thanks to Russian exports of fuel in the first place, in exchange
for a broad range of highly-processed goods. This setup of trade
flows shows Russia’s fledging integration in the economic space of
part of the EU through the Russian energy sector, which is becoming
increasingly transnational. The same applies to Kazakhstan, whose
oil industry is being gradually embedded into the European
market.
Another indicator of integration, this time
technological, is trade data for semi-finished products; a list can
be found on the UN Statistics Division’s website. These products
include goods with a small degree of processing (e.g. semi-products
of ferrous and non-ferrous metals), and highly tailored goods, such
as electronic components. The market for these goods is less
developed than the markets of raw materials or end-demand products,
since their producers depend on buyers to a greater extent.
Therefore, an increased share of intermediate goods in a country’s
exports is a sign of the integration of its national producers in
foreign technological and marketing chains.
The share of intermediary goods in Russia’s exports
amounted to 15 percent in 2008; i.e. the country’s integration in
world industrial conglomerates was insignificant (except for
metallurgy, which is mostly aimed at servicing consumers the world
over). On the other hand, semi-finished products in Russia’s
imports accounted for 30 percent in 2008, which might indicate that
foreign supplies potentially have been included in local
technological and marketing chains.
A more detailed study of supplies to Russia from CIS
countries shows that integration processes are not homogenous. For
example, Ukraine has a high share in supplies of intermediate
goods. However, iron and steel products make up the bulk of its
exports to other states, in even greater quantities compared with
Russia. Integration processes in Belarusian supplies are more
obvious, especially in car manufacturing and electrical equipment.
Like Russia, Kazakhstan is heavily oriented towards the production
of raw materials; the presence of its companies in Russian or
foreign technological and marketing chains is minor, except for
metallurgical companies. Therefore it follows that the production
setup of modern Russia conforms more within its national borders
than to the putative single cultural space.
Voting results at international organizations can be
viewed as indicators of the similarity in the views of national
elites on global political problems. The UN keeps track of voting
at the General Assembly; its statistics on the results of 249 polls
for the period from 2006-2008 shows that Russia’s position most
frequently matches that of Belarus and three Central Asian
countries (Kazakhstan, Kyrgyzstan and Uzbekistan), while often at
odds with Ukraine, which sides with EU countries. Thus, one might
assume that there is mutual understanding between the elites in
Russia and some of its neighboring states except for Ukraine.
Kyiv’s choice, however, can be explained more by certain
opportunistic factors than by any principled position, because it
is the EU’s opinion that mostly prevails during UN General Assembly
voting.
All these observations lead us to the conclusion that
Russian aspirations to the status of a regional center are only
partially supported by facts. Furthermore, in certain fields the
country traverses the boundaries of its hypothetical civilization
bloc, while in others it is smaller than its boundaries.
AN ECONOMIC MODEL TO BOOST RUSSIA’S WELFARE
The selection of a development strategy is roughly a
choice between the export model of development and a model of
economic growth that stimulates domestic demand.
As we noted above, the first model implies
specialization in the production of the most competitive products
within the country, where it steps up output, eliminating foreign
rivals. This can be achieved with natural factors; for example,
unique natural resources or climate, or cheap labor. As a result,
the producing country can sell its products at dumping prices; or,
due to innovations, the national product makes it the leader in
quality.
The second model is suitable for countries that are
unable for some reason to launch exports (due to high
transportation costs for example), or whose economy has outgrown
the markets of their erstwhile influential partners. In this event
economic agents focus on servicing the most important domestic
markets in the region, thus generating secondary demand for
additional products and services. Foreign trade relations acquire
secondary status because these countries need export revenue not so
much to pay for the procurements of consumer goods, as for the
import of raw materials and goods required for domestic investments
projects.
Both the export model and its alternative have pros
and cons. The export model is easier to launch, but it is effective
when the markets of potential importers are quite large and when
they can afford to pay for supplies. On the other hand, the
domestic demand model is trickier to handle; its success depends on
the presence of what is called “the spirit of
entrepreneurship.”
Entrepreneurship, or the capability to discover and
capture new markets, is probably one of the most elusive factors in
a nation’s bid to secure success. Advice on how to excel in this
undertaking normally boils down to a set of rules for governments,
aimed at creating “a favorable business climate.” This implies that
entrepreneurship would only flourish in artificial conditions
arranged by the state, not in the shaping of the institutional
environment favorable for conducting business. This assumption
contradicts historical observations which link the economic success
of the domestic demand model with the intensity of entrepreneurial
activity rather than government support of business. It should be
noted that small businesses indeed react to the environment created
by the state and society, because their small size forces them to
adjust to preset conditions.
The modern Russian development model can be
classified as a variant of export development. Chosen in the 1970s
on the basis of oil and gas exports, it launched and established a
stable exchange of Russian hydrocarbons for Europe’s consumer
goods. Admittedly, a country can rely on the export model in order
to increase its welfare. The results of the past decade show that
Russia, with its $16,000 per capita in 2008 (by purchasing power
parity) differs little from new members of the European Union. One
might hope that it will reach the welfare level of Portugal, the
poorest country of the “old” EU, with $23,000 per capita, within
the next decade if oil prices remain high.
Exports need to be diversified in order to optimize
the export model; i.e. expand the range of exports to Europe by
investing in the production of such intermediate products as, for
example, flat-roll iron, wood sawn, or fertilizers. In this case
Russian exports would be less dependent on world oil prices, a
positive factor for Russian personal incomes. On the other hand,
improving welfare through exports means that Russia actually has to
give up its other objective; i.e. sustaining a cultural space which
is different from the European Union. Trade growth leads to
interdependence between Greater Europe and Russia, and,
consequently, erodes the border of the Russian cultural space.
The internal development model is therefore better
suited to the task of raising living standards, while at the same
time preserving national identity. Admittedly, it would be more
difficult to realize. Data suggest that private entrepreneurship,
for which the groundwork was laid in Russia in 1992, has not become
an effective form of economic activity and not necessarily because
of the restrictions placed on business by outside forces. According
to the World Bank, which evaluates the quality of the business
environment, Russian businessmen are happier with the performance
of those government agencies, which are found to be more venal. It
follows that a Russian entrepreneur would be pleased with the
possibility to break rules rather than seek opportunities to play
by these rules. This is confirmed by World Economic Forum reports
on Russia’s dubious achievements in business ethics.
An additional factor that casts doubts on the
effectiveness of Russia’s private market is information about the
income inequality, which is the highest among G8 countries (except
for the United States). According to information from the Federal
State Statistics Service for 2008, the Gini coefficient, which
indicates the degree of inequality, was 42.3 for Russia compared to
43.9 for the United States (2007), and it is continuing to
increase. This kind of redistribution of GDP cannot be explained by
differences in “human capital,” since Russians have approximately
the same level of education on average. Most likely, the existing
conditions for engaging in private business in Russia are such as
to enable a few to gain profit at others’ expense.
The situation with inflation is not clear either. The
inflation rate remains high despite Moscow’s attempts to limit
price hikes by using classic monetary instruments. One gets the
impression that a Russian entrepreneur would rather acquire
monopolistic privileges than maximize profits by reducing costs and
improving quality.
RUSSIA’S OPPORTUNITIES IN THE CRISIS SITUATION
A comparison of possible scenarios for the economic
crisis and behavior options for Russia points to both emerging
opportunities and potential dangers.
As the Anglo-American global economic model loses its
appeal, the leading nations are starting to rethink their
development strategies. Countries which hitherto have stuck to the
export development model will probably be the worst hit. This
concerns Russia, too, as it is a major oil supplier. However, the
relative inflexibility in demand for oil means that although the
potential volatility in world prices will affect the stability of
Russia’s export revenues, the degree of the maximum drop in prices
will be lower than in other commodity groups. In this respect, a
change of the paradigm implies much more serious consequences for
another potential member of the common Russian space – Ukraine –
which could lose a considerable portion of the iron and steel
market, its main product. Therefore, the crisis is contributing to
the reorientation of Ukraine’s economic interests towards
integration with its eastern and northern neighbors.
The crisis has exposed the limits of the markets’
ability for self-regulation, which will entail a major overhaul of
the relations between private companies and the state in favor of
the latter. Many believe that government programs to stimulate the
market, launched in the autumn of 2008, will be around for a long
time. In these conditions, Russia will remain competitive if its
government takes full responsibility for national development. It
does not need to bet on state-run corporations as the locomotives
of growth. The government has to set the parameters and offer
financial guarantees in such large-scale investment programs as
housing construction, modernizing its infrastructure or conducting
technological retooling to start up the development of the domestic
market.
The growing influence of the state in crisis
conditions strengthens the quality requirements for state
governance, rated traditionally low for Russia (according to World
Economic Forum figures for 2006, Russia was ranked 110th out of 117
countries according to the “legibility” of government
instructions). The expected increase in the role of officials as
customers of new national development programs underlines the
necessity to limit, at the very least, the opportunities for the
venal squandering of allocated funds, but this is a topic for a
separate discussion.
The new threats caused by the crisis also include the
potential devaluation of the world’s major currency – the U.S.
dollar – which leads to the depreciation of the dollar-denominated
savings of net exporters. At present, the world community believes
it is not yet necessary to start looking for safer alternatives to
preserve the value of its export savings that continue to be
absorbed in the form of U.S. financial assets. It looks as if many
countries are trying to keep the parity of their currencies with
the dollar, while secretly hoping that the notorious spirit of U.S.
entrepreneurship will help the U.S. emerge from the recession.
It is a risky approach as it does not take into
account the fact that the American recession could drag on for
years if not decades. This scenario may lead to a sudden surge in
world commodity inflation and the ensuing painful redistribution
processes worldwide, similar to those a majority of Russians
experienced in 1991-1998. The side effects of price hikes will
likely be favorable for Russia as an exporter of
increasingly-expensive raw materials and it could save the country
from the upheavals related to the depreciation of
dollar-denominated savings.
The end of the active stage of the crisis does not
mean an automatic return to the old situation. We are likely to see
a fundamental overhaul of the global economic system during the
next few years. The role of the state as an initiator of
development programs may grow to a level beyond which the free
market idea may be invalid. Amid conditions of increasing
uncertainty, Russia, as any other country, had better stick to the
old sailor’s saying: “If you sail out into the sea, don’t bend to
the whims of nature; just stay the original course.”
