"Russia in Limbo"

[Carl Remick]

[From today's Guardian.]

Russia in limbo

By Larry Elliott

The speed of Russia's decade-long descent from superpower to basket case has 
been staggering. Living standards have fallen by more than a third; five 
times as many people are living in absolute poverty now compared with 10 
years ago; suicides and vodka binges have slashed years off the life 
expectancy of men.

But the numbers tell only half the story. What Russians have lived through 
over the past decade is a slump deeper and longer than the Great Depression 
of the early 30s. The 15% decline in German gross domestic product between 
1929 and 1932 helped bring Hitler to power. The 28% fall in US GDP brought 
Roosevelt to power. By contrast, the great free-market experiment in Russia 
saw the market value of the Russian economy contract by 44% between 1989 and 
1998.

In the circumstances, it is easy to forget that 40 years ago the west was 
seriously concerned about the economic threat posed by the Soviet Union. 
Even at the end of the 70s, when oil prices were shooting up for the second 
time and the US was deep in post-Watergate gloom, there was a sense that 
Moscow was a force that could not be ignored.

The days when Nikita Khruschev could say to the west with a reasonably 
straight face "we will bury you" are long gone. Well might Vladimir Putin 
say that strengthening the economy is the only way for Russia to avoid 
further blows to its self-esteem following the loss of the Kursk nuclear 
submarine and the fire in Moscow's Ostankino TV tower. These high-profile 
calamities have merely highlighted the fact that Russia is not making a 
rapid transition from centrally planned to market-driven economy.

Instead it is trapped in limbo between the two systems, suffering from the 
worst defects of each - an explosion of income inequality and poverty 
alongside obsolete plant and a basic economic structure that stifles (legal) 
enterprise. Or, as Evgeny Gavrilenkov of the Bureau of Economic Analysis in 
Moscow puts it, "the Russian economy is open at the exit points and remains 
fairly closed at the entry points."

Russia was not ready for the shock treatment administered a decade ago by 
free-market ideologues drunk on victory in the cold war. While it had become 
increasingly clear that isolationism behind the iron curtain helped explain 
the country's relative economic decline under Leonid Brezhnev, the building 
blocks of a market economy were simply not in place. The USSR had been a 
centrally planned economy for more than 70 years, and even under the tsars 
had only taken the first tentative steps towards a western-style industrial 
economy. There was no class of entrepreneurs ready and willing to fill the 
vacuum left by a contraction of the state, with the old Soviet middle class 
- doctors, university professors, scientists - among the worst affected by 
cuts. The bedrock of a market economy, a transport system that can get goods 
from producers to consumers, did not exist.

Yet the belief was strong that all a liberalised Russia needed were 
macro-economic policies to keep inflation low, control the money supply, 
roll back the state and keep the currency stable. There was a strong desire, 
too, to prevent any resurrection of communism by an intensive programme of 
privatisation.

The upshot was that the Soviet military-industrial complex collapsed but 
nothing took its place. State assets were sold off to gangsters and the 
proceeds spirited away overseas. Foreign direct investment to replace 
capital stock that has an average age of around 20 years has been deterred 
by corruption, the lack of an effective system of property rights, a poorly 
functioning banking system and the absence of anything resembling a 
competition policy to root out subsidies that unfairly benefit some 
enterprises at the expense of others. The fact that Moscow has a chain of 
McDonald's restaurants does not mean that Russia is now a fully-fledged 
market economy.

The good news for President Putin is that the macro-economic climate is now 
looking more favourable. The crisis of two years ago, when Russia gave up 
listening to the International Monetary Fund and decided to devalue the 
rouble and repudiate its foreign debts, has meant that manufactured imports 
are now dearer and exports cheaper. The result has been a recovery in 
industrial production, bolstered by an increase in overseas of Russia's 
biggest export earner - oil - driven by the trebling of the price of a 
barrel of crude since early 1999. Industrial production was up by just over 
8% last year, a rate of growth not seen since the early 70s.

However, Russian economists are not fooled. "In the future, it will not be 
possible to count on the devaluation effect", says Mr Gavrilenkov. "Growth 
should be tied to a reduction in costs, and an increase in production 
efficiency, which has not yet happened". Already, inflation has started to 
erode some of the benefits of the boost provided by a cheaper currency.

In one sense, President Putin's problem is simple. Russia needs capital - 
and plenty of it - if it is to transform itself into a modern capitalist 
economy. But that means either staunching the flight of domestic capital and 
recycling into investment or making Russia a safe and profitable home for 
foreign investors. By attacking the so-called oligarchs, those who cleaned 
up in the 90s, President Putin won himself some cheap plaudits at home but 
did little or nothing to hasten the repatriation of capital. Nor does it 
seem sensible to lapse back into cold war posturing when an enfeebled Russia 
is desperately in need of western aid.

A more effective long-term strategy would be for Mr Putin to show that the 
Russian state is capable of performing its basic functions - not least the 
maintenance of the rule of law and the rule of contract. That would help to 
underpin the supply-side reforms Russia needs if it is to make the 
transition to a market economy. But this requires two things Putin does not 
possess - time and money.

• Larry Elliott is the Guardian's economics editor
larry.elliott at guardian.co.uk

[end]

Carl

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