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
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