A Long-Term Project for Russia

30 july 2005

Resume: 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.

 

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.

Last updated 30 july 2005, 16:05

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