By any measure of economic performance
Russia is failing. The economy--not its
foreign adventures in Ukraine, Syria or elsewhere--will determine whether
Russia’s future is secure. Russia needs
to transform itself into another Russia.
Future economic growth is projected to be small
under a new Russian normal, due to deeply rooted structural problems in the
economy, a sharp fall in capital investment and the absence of foreign direct
investment. The IMF now projects a
decline in GDP of 3.8 percent in 2015 and a further decline of 0.6 percent in
2016, with growth afterwards of only 1.5 percent per annum into the foreseeable
future. The IMF’s 2015 Article IV report
on Russia sums up the economic challenge,
“…staff’s medium-term
projection is based on persistently low oil prices, suggesting a muted
recovery. Coupled with the lingering
effects of sanctions, negative population dynamics and slowing productivity due
to the lack of structural reforms, this is expected to result in weak potential
growth in the medium term (around 1.5 percent).”
However,
this may be optimistic. Growth was only
1.3 percent in 2013 and falling before the current economic difficulties, which
suggests even lower future growth without major reforms.
The World
Bank’s 2015 Russia Economic Report paints a more pessimistic short-term picture
than the IMF, with similar future prospects,
The World Bank also projects that Russia’s GDP will contract a
further 0.6 percent in 2016, with medium-term growth of around 1.5 percent if
internal and external economic conditions improve. Again, an optimistic scenario given the
Russian economy’s performance prior to the current economic difficulties.
The
Bank of Russia is even more pessimistic.
It projects a fall in GDP of up to 4.4 percent in 2015 and a fall of up
to 1.0 percent in 2016, before a return to growth (no figure given)—a substantial
deterioration from its earlier projections.
What is worrisome
about the IMF-World Bank-Bank of Russia projections is that their projections
have been revised steadily downwards and project increasingly dire prospects in
the short-term before a return to low growth that is now unlikely before at
least 2017.
Russia needs both internal reform and
improved economic relations with other countries to lift economic growth, no
matter what happens to oil prices.
The
picture is not entirely dire. Russia has
economic and financial institutions that have acted credibly. The Bank of Russia responded vigorously to
the near collapse of the ruble in 2014 and did the right thing by freeing the
exchange rate and raising interest rates.
In its recent pronouncements, the Russian budget office appears to
understand that extraordinary budgetary and economic policy measures are
required to restructure the economy and promote growth. In fact, the relative independence of the
Bank of Russia in financial policy should be a model for economic policy, as
well. The Kremlin cannot centralize
economic management in its own hands and achieve growth through dirigiste measures.
The IMF and World Bank reports include
numerous suggestions to improve economic performance. Most important though is a reform agenda that
is at the center of government and is acted on. Growth will continue to decline if
broad-based reform is not undertaken.
To improve its growth prospects, Russia
needs progress in four areas of economic reform.
First, Russia
needs to dramatically improve capital and labor productivity by reducing
corruption and instilling the rule of law in business and economic policy so
that capital and labor can be allocated efficiently according to market pricing. It cannot be overemphasized that the
provision of additional capital alone, without a change in the business and
economic environment, will not sustain Russian growth.
The IMF points to internal reforms in governance and in labor
and capital markets as key to lifting Russia’s long-term growth, including curtailing
government involvement in the economy and reviving the Russian privatization
program. The national and regional
budgets need to be restructured, as well, to direct resources toward productive
economic activities; in particular, military spending needs to be cut and
savings redirected toward social spending, especially health and education for
the young, upon which greater labor productivity will depend.
While Russia needs to own its own political
agenda, confidence in the rule of law will not happen until Russia halts internal
and international political provocations that are perceived as heightening
political risk. Among the necessary
measures is resolution of culpability for the downing of Malaysia Flight MH17. It is wishful thinking to believe that the
deaths of nearly 300 European and Asian citizens will be simply forgotten or
forgiven without an accounting for who is responsbile. It is also necessary to roll back much recent
legislation that restricts or distorts Russia’s capital and labor markets,
including not only economic restrictions but also restrictions on the media and
internet that inhibit the exchange of information about economic conditions
that are necessary to make informed business and economic policy decisions at
the level of the individual and the firm.
Freeing the economic potential of Russia
will probably also require empowering the Russian regions by giving every
region a voice in Moscow. Economic fiat
directed outward and downward from Moscow will not provide enough flexibility
to capture local economic opportunities.
Equally unhelpful is the capture of economic gains by Moscow through
taxation and administrative measures that starve regional economies of investment,
especially investment in small- and medium-sized business enterprises.
Second,
Russia needs to embrace Europe, not confront it. Europe was the largest source of foreign
capital for Russia, the most advanced source of technology needed to improve
Russian economic performance and Russia’s largest trading partner. Russia also needs Europe as an economic partner
to gain from trade between Europe and Asia, especially with China.
Given the state of relations, Russia needs
to take pragmatic first steps in economic cooperation through existing
institutions where Russia already has a presence but is not dominant enough to
dictate the terms of cooperation. The
Eurasian Union does not have the structure or the reach. Russia can build economic resilience through,
for instance, its membership in the WTO.
Russia became a member in 2012, but has not yet realized the potential
for increasing Russian trade (for instance, in agriculture), in part due to
Russia’s obsessive focus on primary resource exports. While the current government has focused on
import substitution to bolster domestic production, it will mean little for
growth if Russian domestic industry cannot increase exports of globally
competitive products.
Third, Russia needs to improve investment
and trade relations with the Central Asian economies and with China to capture
the economic potential in transportation and communication between Asia and
Europe. Right now Russia is losing out. Why?
Because China is investing considerably more than Russia in the infrastructure
for a new Silk Road linking Asian and European markets, and that Chinese
investment is not flowing into Russia. Rather,
Chinese investment is flowing into the Central Asian countries, which are
capturing an increasing share of the growth opportunities (http://on.ft.com/1NHBGOt).
Despite the heavily promoted pipeline
deals between Russia and China, actual investment by China is outpacing actual investment
by Russia by a wide margin. Russia needs to increase infrastructure
investment that supports inter-country trade through routes and services that
are anchored in the Russian economy, such as Russian port, rail and road
services.
Strengthening participation in global and
regional economic institutions will allow Russia to rebuild and extend its
economic influence without overt political friction, which over time will build
confidence in its intent to engage constructively with its neighbors and the
rest of the world. This will eventually
allow political bridges to be built.
While it is beyond the scope of this article to discuss political and
military associations with neighbors, viewing those associations in terms of
economic priorities will advance Russia’s economic prospects.
Fourth, improving Russian economic prospects
means solving Russia’s demographic problem. Russian’s population is expected to decrease
from about 144m today to as little as 116m by 2050 (http://www.wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2015/04/12/090224b082df919...). Although Putin views the multi-ethnic
character of Russia as a threat to state cohesion, Russia needs to attract
in-migration from the Russian periphery—especially the Russian diaspora but
other sources as well--on a greater scale to reverse its population decline. Otherwise, Russia’s labor force and domestic
market will continue to shrink. Without
a more attractive social environment, including better economic opportunities
and tolerance for minority rights, Russia faces a Russian world—spread out
across ten or so neighboring countries—that is increasingly skeptical of its
social and economic benefits; such as the people of Ukraine who constituted up
to 20% of the Soviet Union’s population but, in view of Russian conduct, are now
unlikely to chose to freely associate with or be a part of Russia’s economic
sphere. Russians in Estonia, Latvia and
Lithuania are not clamoring to reenter Russia because their economic welfare--and
personal security--is better than it would be in Russia.
Imagine
another Russia. One that has embraced
internal reform and repaired its economic relations with the outside world. A realistic, alternative Russia that is
possible because Russia is not ordained to follow its current path of
confrontation and decline. It is
possible for its leadership and people to choose alternative paths with better
outcomes.
A
Russia that looks--if you will--like a vast Sweden or Switzerland. Sweden--once considered a modern economic
hinterland itself--diversified its economy from basic processing (iron ore and
forestry) into a global leader in advanced manufacturing and services. Russia, like Sweden, has a peripheral position
to the European economy, not to mention a challenging climate; but, like Sweden,
Russia is situated in close proximity to major European markets on which to
build demand for more advanced Russian products and services. Switzerland is geographically isolated but centrally
located to take advantage of major European markets and undertook an economic
transformation similar to Sweden’s (even while it is not a member of the
European Union). Russia, in the manner
of Switzerland, is strategically located to take advantage of key Europe-Asia
transportation and communication land and air routes (also without being a
member of the EU). Even the Swiss free association
political model looks tempting, since only free association will hold Russia
together.
Imagine
again another Russia that looks--if you will--like a France or Britain, with
global soft power and powerful cultural exports, as well as a secure, diverse
economic base. A Russia that markets its
cultural riches rather than closes its doors behind them.
Rather
than chase the chimera of empire, Russia needs vision and inspiration to place
itself in a new economic context based on economic competitiveness--not unlike
what other countries have already done (Sweden once sought empire also).
With
the right vision, Russia transforms from a frustrated, insecure Eurasian core
state (that is, frankly, over concerned with security matters) to a nexus state
based on advanced processing and engineering of its primary resources and on transport
and communication between Asia and Europe, the world’s two largest economic poles.
At
the moment Russia lacks the necessary linkages.
The government is not committed to economic or social reform or adapting
to new circumstances, and reformers outside the government are
marginalized. Without enlightened
leadership and an active, independent civil society, Russia doesn’t have the
levers to change course and realize its economic potential.
