Publication: Eurasia Daily Monitor Volume: 4 Issue: 69

Russian Defense Minister Sergei Ivanov

The Russian economic boom continues to gain momentum, leading the Ministry for Economic Development and Trade (MEDT) to raise its growth forecast for the Gross Domestic Product (GDP) in 2007 from 6.2% to 6.5% (RosBusinessConsulting, April 6). At the annual the Higher School of Economics conference held in Moscow last week, however, many voices warned against “irrational exuberance,” since the period of “easy growth” was coming to an end and further expansion would require massive investment. Finance Minister Alexei Kudrin argued that only private investments could generate new impulses for growth, as the returns on state-directed investments remained low (Rossiiskaya gazeta, April 4). Yet German Gref, the head of MEDT, insisted that only the state could invest sufficient money to modernize basic infrastructure, while admitting that six federal investment programs had to be closed due to low efficiency (Novye izvestiya, April 4;, April 6).

The quarrel between the two forever-disagreeing ministers might appear academic, but it happens against the background of the relentless and aggressive expansion of state control over key economic sectors. The latest chapter in this inglorious saga involves a series of carefully staged auctions that complete the destruction of the oil giant Yukos, while its owner, Mikhail Khodorkovsky, faces new charges that could double and triple his current eight-year sentence, of which 1,260 days have already been spent behind bars (New Times, March 5). The first auction went to state-owned Rosneft in late March; somewhat surprisingly, the Italian ENI won the second lot last week — but the deal involved the compulsory re-selling of gas assets to Gazprom (New York Times, March 26; Vedomosti, April 5). The next auction is scheduled for May 10, but there are few doubts that the winner would be pre-selected among state-controlled companies.

The predatory and ultimately destructive character of this bureaucratic capitalism was examined at the Moscow conference by Andrei Illarionov, Putin’s former economic adviser and now an independent expert associated with the Cato Institute in Washington DC. He argued against the popular theory of a “resource curse” and proposed that the inflow of revenues from hydrocarbon exports opened plentiful opportunities for accelerated modernization, but these opportunities were lost due to the deteriorating integrity of state institutions and rampant corruption (Gazeta, April 5; Kommersant, April 2). The low quality of the ruling elite thus constitutes the main driver of the “state curse” that condemns the Russian economy to declining growth, which currently camouflages the accumulation of deep structural flaws. According to Illarionov, up to 77% of top positions in the state service are currently occupied by “professionals” with a background in the special services, so their experiences and methods of operation determine many features of state policy (, April 3).

The dominance of this “cloak-and-dagger” elite does not bring any discipline to the bureaucracy and has yet to demonstrate any advantages of “horizontal networking.” It does, however, transform the competition between various state companies and political projects associated with them into clandestine “special operations.” Thus, First Deputy Prime Minister Sergei Ivanov, who has been charged with promoting industrial innovations, bluntly stated last week that the Russian auto industry is not competitive and has no plans for new passenger car models (RIA-Novosti, April 6). That sudden acknowledgement of the plain fact of technological backwardness had, however, little to do with stimulating innovations — but much to do with the fact that Russia’s largest car-producing company VAZ was taken over last year by state-owned Rosoboronexport, which is headed by Sergei Chemezov, who never was Ivanov’s ally and could become his rival for the Russian presidency (Expert, April 2; Ekho Moskvy, April 6). Ivanov’s pet project now is the Glonass space navigation system that is supposed to challenge the U.S.-controlled Global Positioning System (GPS); the funds necessary for launching eight Uragan-M satellites this year are considered the top-priority investment in Russia’s international prestige (International Herald Tribune, April 3).

The policy of pumping state money into high-profile “innovations” and the bottom-less barrel of the military-industrial complex, as well as expanding “national projects” in such socially sensitive sectors as education and health care is set to continue throughout this year of “limited-choice” parliamentary elections and next year, when Putin’s as-yet-unknown successor is due to take the reins of power. As a result, the total volume of the money in the economy (known to economists under the somewhat esoteric name “aggregate M2”) increased last year by a record 49% and is certain to keep growing fast (RosBusinessConsulting, April 4). Inflation for the first quarter was registered at a tolerable 3.4%, but an opinion poll showed a peculiar discrepancy between official estimates and consumer perceptions, as about a quarter of respondents gave the annual rate of inflation at above 25%, and another 40% put it in the range 15-20% (, April 3). Overall, just 8% of the population sees Russia’s economic performance as “good,” and that dissatisfaction correlates perfectly with the steadily growing gap between the rich and the poor, so that now in the official statistics the top 10% earn 15.3 times more than the bottom 10%.

The most worrisome macro-economic figures are the miniscule increases in oil and gas production and the steadily growing domestic demand for energy; even the gradually increasing world oil prices cannot deliver Russia into a “comfort zone.” It is in the energy sector that the inefficiency of state control, particularly through bloated Gazprom, is strikingly obvious. Yet foreign investors still flock to buy shares in and sign contracts with Kremlin-connected companies. They will definitely get what they deserve, but the question is what will it take for Russia to acknowledge the dead-end and break the omnipotent “state curse”?