Whither Russia? Politics and Economics at a Time of Change

It’s amazing that the nation that has bestowed to the civilization such giants as Tchaikovsky and Shostakovich, Tolstoy and Bulgakov has not been able to provide great economists and policy makers. If only the Russian economy were as splendid and robust as its culture, this country would be doing just great! Unfortunately,  this is not the case. The resource course is affecting the economy in a negative way and even more seriously than certain counterproductive habits and mental inertia from the old times as a statist, centrally planned economy.

I’m afraid there is not much time left for Russia. If it wants to catch up with the advanced world—and become a true member of the G8 group of developed countries—it must use the windfall revenues from the exploitation of its vast natural resources wisely for investment in restructuring and  diversifying its economy. Otherwise, the process of deindustrialization without the current offset from the services sector will continue, and this great country—with huge potential for fast, durable and sustainable development—will miss the chance to become one of the leaders of the world economy. This decade will decide the fate of Russia for the whole 21st century. And  time is running out.

Inflation remains too high, at over 9%, while the official rate of unemployment is above 7%. The true unemployment rate seems to be higher, somewhere between 10 and 12%, bringing the so-called misery index, i.e., the sum of inflation and unemployment, to around 20%. Even with extraordinary energy means, the budget is in the red and there is a deficit of 2.7% of GDP, yet this balance should be in surplus.

Two decades ago, at the dusk of the Soviet Union, Russia’s GDP was three times that of China. Today it’s one-third…In 2010-12, as China is able to grow by 10% y/y, Russia’s GDP  will only expand by 4.0-4.5%. Hence, the Russian contribution to the world GDP is stagnant, since world output increases at a similar rate. In China, after three years the output is higher in real terms by 33, while in Russia only by 12.5%. Over a decade with such a pace of growth it implies 260 and 48%, respectively…and that does make a difference, a very considerable difference, because Russia has so many natural resources, while China, which has to import most of them, has been forced to restructure and diversify its economy. If China had such enormous raw materials and the same energy means as Russia, I doubt it would be so successful. If Russia had fewer resources, it could be more prosperous.

Russia is accumulating  foreign reserves, already close to a half trillion dollars, which happens to be the most inefficient way of managing financial resources. A bulk of these reserves should be spent for investment in hard infrastructure, technological progress, and human capital. Of course, just investing is not enough to break the current drift. There is an urgent call for far-reaching structural reforms and institution-building for the sake of lifting the competitiveness of Russian firms and the quality of management; there is a need to fight corruption and decentralize the administration. Further liberalization of economic regulation is a must, without attempting to create a neoliberal utopia as was erroneously done in the 1990s.

This is the time to use the profound surplus (the positive trade balance for the last 12 months exceeds US$155 billion) for investment in high-tech industry. It must be done through encouragement for joint ventures with foreign partners, private-public partnerships and boosts for small and medium businesses, all of which have been lacking in the presence of the long shadow of the Soviet model of heavy industrialization.

What’s worse, the inequality in Russia is continuously increasing, not only beyond the point of social acceptance, but to the point where it turns against efficiency and growth. Hence, it must be an alert not only for social activists, but for the business people as well. Income disparity is as large as it was during the czar  era, before the Bolshevik revolution almost a century ago. This is the time to get rid of the ill-advised flat income tax and introduce a healthy progressive tax that is friendly for private entrepreneurship and at the same time contributes to social cohesion. There is not a single nation in the West that came to  affluence with a flat tax, and there won’t be  such in the East.

Additional fiscal revenue must be channeled to the public services sector, especially education and health care, for the purpose of sustaining social capital. It’s not only value per se; it’s an indispensable ingredient for private business to flourish. From the revenue  of exported  oil and gas one can buy Scotch whiskey or even a Lamborghini car or a villa in a pushy London district, but this is not necessarily true for the qualified workforce, without which there won’t be a positive future for entrepreneurship and sensible economic expansion.

Only under such circumstances—supported by progress in political democratization and the enhancement of civic society—will there be a chance to counteract the growing wave of professionals’ emigration and to reverse the devastating trend of population decline. Otherwise, Russia may altogether lose momentum for the foreseeable future.