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economics and security
163 ESCEW 08 E bis
Original: English
NATO Parliamentary Assembly
SUB-COMMITTEE ON EAST-WEST ECONOMIC COOPERATION AND CONVERGENCE
state and market in the
new russian economy
Report
Attila MESTERHAZY (Hungary)
Rapporteur
International Secretariat 15 November 2008
Assembly documents are available on its website, http://www.nato-pa.int
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TABLE OF CONTENTS
I. Introduction 1
II. The evolution of Russian Incomes 3
III. Financial Crisis, Reform and Growing Prosperity 4
IV. The Macro-economics of the energy boom 6
V. The economic dimension of the crisis in Georgia 8
VI. Micro-economic Developments and the renationalisation of the Russian Economy 9
VII. The Geopolitics of Gas and Oil Pipelines 14
VIII. Conclusions 18
Bibliography 21
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I. Introduction
1. Over the past decade this Committee has reported on developments in the Russian economy on several occasions. The reasons are obvious. Russia’s post-Communist economic development has been a vital element of the global landscape. It was hoped that the construction of a market economy would help consolidate Russia’s nascent democracy insofar as economic liberty represents a fundamental precondition of political liberty. Market reforms would also correct decades of Russian underinvestment which, in turn, had been the product of an utter misallocation of resources and the lack of scarcity pricing in the Soviet Union. Political and economic reform would reinforce the rule of law and provide the foundation for contractual capitalism, the basis of economic trust and the lynchpin of long-term investment and economic development.
2. This optimism has been disappointed as reactions to Russia’s occupation of Georgia clearly reveal. A resurgent Russian state is asserting itself over the market and civil society while focusing its international efforts on weakening the states along its perimeter. Russia has become an energy exporting behemoth and has ridden recently soaring energy prices to achieve these dubious ambitions. It is currently the world’s eighth largest economy calculated by the purchasing power parity index and, along with China and India, has become one of the fast-growing developing countries in the Asia-Pacific region and the third largest holder of foreign reserves there (http://unescap.org/survey2008/notes/russian.asp). Many analysts, however, believe that over the long run, Russia cannot sustain its growth trajectory while disempowering civil society and pursuing an aggressive revanchist foreign policy.
3. Russia’s transformation has been extraordinarily turbulent. A kind of rough and tumble democracy briefly emerged under Boris Yeltsin, and the introduction of market forces during his tenure was anything but tranquil and ordered. Indeed, privatisations were conducted in a climate approaching utter lawlessness. Students of transition economics have been of two minds about moving state-owned assets into private hands. On the one hand, there is an argument that privatisation should only occur once rules of the game have been carefully and democratically established, and institutional structures put into place to ensure that the process is fair, transparent, open, and competitive. This is how privatisation largely unfolded in Hungary.
4. Another school of thought places a premium on speed. What is important in this case is moving state-owned assets as quickly as possible into private hands so that a kind of rough market begins to operate from the outset. The advantage is that once state-owned firms have been privatised, political elites will be denied the means of using or misusing economic assets to reinforce their political dominion or personal wealth. “Shock therapy”, so it was thought, gave unto the business world that which pertained to business and left to the politicians that which was properly political in a market democracy. This is the course that Russia seemed to be following, yet, in the eyes of many transition and democratic theorists, it has not worked to plan.
5. The Yeltsin years were indeed chaotic. State-owned assets were swiftly moved into the private sector through processes that were neither open nor transparent. A class of business oligarchs emerged while the Russian economy went into an inevitable tailspin. As the oligarchs’ wealth skyrocketed, the people of Russia suffered job losses and declining living standards. Of course, some degree of collapse was hardly to be avoided, given the poor quality of Russia’s economic infrastructure inherited from the Soviet Union, the non-market criteria which had long governed trade, and the dearth of market rules and practices, both of which would have been needed to kick start the economy. Russia was a victim of 70 years of Soviet rule, and its memories of market freedom were remote or non-existent. Indeed, Russia’s earlier market experience had been short-lived and essentially state-driven. Czarist absolutism and persistent feudalism in the great Russian hinterland were very much a part of the Russian experience. In light of these historical experiences, expectations for a seamless market and democratic evolution were bound to be disappointed.
6. Still, disenchantment was the reigning emotion in Russia as Yeltsin’s unsteady leadership, pervasive corruption, and plummeting standards of living conspired to alienate a large share of the Russian population. The tragedy of this was that many came to link these difficulties with proWestern reformers and the West in general. These emotions, in turn, proved useful as the state, under the stewardship of Yeltsin’s successor, Vladimir Putin, further recentralized national power, curtailed the development of democratic institutions, radically increased state control of the media, and renationalised a range of commercial assets. Ironically those assets had begun to perform admirably after the financial crisis of 1998. President Putin’s political U-turn coincided with soaring energy prices, which had started to lift the standard of living for many Russians. The lesson, capably cultivated by the Kremlin, seemed to be that Western-style democracy and liberal market reforms in a Russian context had been a formula for economic catastrophe, while the Kremlin’s centralization of authority, renationalisation of commercial assets and the silencing of regime critics, and particularly those advocating political and economic liberalization, represented the path to prosperity and the return of Russia to a great power status.
7. Well before the current crisis over Georgia began, Russian relations with the West had become far more difficult, disappointing many of those who had hoped to build a fundamental partnership with Russia based on common economic and political interests. While the West has remained relatively silent about the renationalisation of Russian energy assets, it has, to varying degrees, voiced concerns about state control of the media, the vilification of certain political groups in Russia, and the use of Russian law or, perhaps more accurately, the highly selective use of administrative authority to leverage commercial concessions from western companies that have signed commercial contracts with their Russian counterparts. Russia’s occupation of Georgia has placed these concerns into an entirely new context and it suggests a link between a more authoritarian Russia at home and a more aggressive Russia abroad.
8. Growing European dependence on Russian gas and oil has fuelled European concerns about its own vulnerabilities and has likely also tempered western criticism of Russia’s autocratic direction and increasingly aggressive foreign and defence policies. Roughly 70% of Russian energy output is sold to Europe (Milov). When Russia cut off gas supplies to Ukraine in January2006, ostensibly because of a commercial dispute with that country over gas prices, Europe’s energy dependence on Russia suddenly took centre stage in Brussels. The cut-off to Ukraine had immediately exposed Europe’s own vulnerabilities. The Russian-Ukrainian dispute was not simply a commercial matter; it unfolded just as pro-Russian and pro-Western political forces were vying for power in Ukraine. Many in the West and in Ukraine saw the gas incident as a warning that Russia was both capable and willing to impose hardship on governments pursuing policies not to Moscow’s liking. In retrospect, the crisis in January 2006 was the first shot across the bow; Putin’s Russia was determined to use its energy leverage to affect political outcomes in neighbouring countries. The 2006 crisis in Georgia represented a sharp escalation in this policy and, in retrospect, might be seen as an important element of an escalation chain that has culminated in Russian military occupation of parts of Georgia – a seamless escalation chain that began with energy threats and culminated with military force. From this perspective, Russia’s energy weapon can be understood as one that can be used at a fairly low threshold. This is one of many reasons why European concerns about the Georgian crisis and Russia’s ambitions are so acute.
9. There are few guarantees militating against Russia employing similar pressures against any of its energy clients. Russia has used this leverage against neighbouring countries, including Poland, Lithuania, Ukraine, Georgia, and the Czech Republic, to name a few (Milov). For example, in the wake of the signing of a deal in which the Czech Republic agreed to host elements of an American missile shield, Russian deliveries from its Friendship pipeline fell 40%. In what has become a perfectly predictable pattern, "technical difficulties” were blamed for the event. Moscow also signaled that it will use its energy leverage to retaliate against any European reprimand for its refusal to implement a ceasefire agreement signed with Georgia (McElroy). Prime Minister Putin recently announced that efforts to build an energy pipeline to the far East will now be redoubled; the implication, of course, is that Russia will sell its gas and oil elsewhere if Europe refuses to hew to the Russian policy line.
10. For its part, Russia is not without its complaints. As suggested above, there have been accusations in some Russian and western circles that the West, along with its proxies in the IMF and in Russia itself, was partly responsible for the chaos of Russia’s early transition (Stiglitz). A similar dynamic was at work on the strategic front. Rather than fully bury the Cold War after the Soviet Union’s demise, according to some Russian officials, NATO enlarged to Russia’s borders and even admitted former Soviet Republics, a policy that Russian leaders characterize as aggressive. From this perspective, Russia’s move in Georgia is not about South Ossetia, it is about Georgia’s Euro-Atlantic aspirations and Russia’s own sense that the Caucasus rightly lie within its own sphere of influence. In the same way, Russia’s leaders see Western efforts to build pipelines from the Caucasus into Europe as violating Russia’s privileged and historical role in these societies, while undermining its capacity to dictate terms in certain energy markets, including those in Europe. The Russian government has also cited the US decision to deploy a limited antimissile system, designed to counter a missile attack from the Middle East, as somehow proving NATO’s aggressive intent vis-à-vis Russia itself. President Putin threatened to target Poland and the Czech Republic with its own nuclear arsenal if they agreed to deploy the US system. More tellingly, perhaps, Russian officials have suggested that the Orange and Rose Revolutions were the product of Western meddling in countries in which Russia feels that it holds a set of interests outweighing those of the West. Highly restrictive registration requirements on Western NGOs in Russia have been one result.
11. Initially, the goal of this report was not to catalogue these various disputes between Russia and the West, but rather to explore, from a Western perspective, the changing nature of Russia’s economy and the potential implications for its relations with the West. The very situation in Georgia, however, cannot be separated from many of the economic questions with which the original version of this report dealt. There is a strong sense within the Euro-Atlantic community that the Georgian crisis represents a watershed event that will have long-term implications for Western relations with Russia and will affect economic relations as well.
II. The evolution of Russian Incomes
12. Russia’s economy has grown rapidly over the last eight years driven largely, but not exclusively, by soaring gas and oil prices, which quadrupled over the course of the Putin presidency. But there have been other factors driving growth, including a private sector which finally began to find its footing after a decade of turmoil and regulatory chaos. Russian officials also introduced solid macroeconomic policy management after the crisis of 1998 and this created solid foundations for steady growth, although there are clear signs of trouble on this particular front today due to overheating and high borrowing.
13. Russia’s initial transition phase was one of confusion and chaos during which the traditionally centrally planned structure was suddenly compelled to operate in a market or quasi-market context. Between 1991 and 1996, Russia’s real GDP fell by 37%. Fiscal problems predominated and budget deficits (based on IMF criteria) averaged roughly 26% of GDP between 1991 and1994. Output collapsed as Russian firms were ill-suited to operate in modern and competitive markets. Hyperinflation set in, with prices in 1992 rising 2,500%. Inevitably, household incomes and living standards plummeted as unemployment soared.
14. The growth of income inequality was perhaps the most politically consequential economic development in this period. Had there been economic improvement at the base of Russian society, growing inequality might have been easier to bear, but with standards of living falling precipitously, the political consequences were serious. Liberal market reformers working in the government and outside of it were blamed for giving away state assets while failing to galvanize the economy to improve living standards or at least stem their decline. Since the crude democratic order had produced this leadership, it too was blamed for the economic catastrophe. Russia’s experiment with market and democratic reform thus came to be understood in popular culture as largely an asset seizure, which coincided with a weakening of Russia’s global power, chaos in certain regions of Russia, particularly in the Caucasus, and sudden deterioration of living standards. This was an inauspicious beginning to Russian transition, and the political dynamic that eventually set in goes far towards explaining the Russian public’s disillusionment with democracy.
15. Although rapid growth has provided a powerful palliative, Russia’s rich are indeed getting richer in relative and absolute terms. Indeed Russia’s Gini coefficient – a measure of income distribution – has been rising steadily. Because many wealthy Russians evade taxes, the actual gap in income distribution is very likely far wider that these numbers indicate. Inequality is not only a class issue; it is also a regional matter. The average income in Moscow is seven times higher than the average income in Ingushetia, the poorest Russian region. The Moscow region itself has the highest level of inequality of any region in the country (http://www.gateway2russia.com/st/art_231925.php). A considerable proportion of Russians live below the officially defined poverty line. Twenty-two per cent or approximately 30 million Russians are destitute. Many of Russia’s poor include large families with many children, single-parent households, and the unemployed. One distinguishing feature of Russian poverty, however, is that half of the country’s poor actually have a job (http://www.gateway2russia.com/st/art_231925.php).