THE RUSSIAN ECONOMY, LOST IN THE DARK

By Elena Chinyaeva

At face value, the economic results of the last year in Russia are rather good: The economy grew by 4.2 percent, which is more than the 3.5-4 percent the government predicted at the beginning of the year. For the fourth consecutive year the state budget ran a surplus. The government continued to pay off its foreign debts on schedule while it worked on domestic structural reforms. International rating agencies raised the rating of Russia’s sovereign debts to just below investment grade level. All that helped Russia to reach its main foreign policy success of the year. It was finally granted full membership of the G-7 group of leading industrial countries at their June meeting in Kananaskis, Canada, with the right to participate in discussions and decision-making regarding global economic policy. Russia was also removed from the Financial Action Task Force black list of countries facilitating money laundering.

Observers inside the country see 2002 as a year of lost opportunities, however, because Russia failed to achieve a qualitative breakthrough in its economic development. Given that 2003 is an election year for Russia’s parliament and the last year before the presidential ballot, one would not expect any major changes to rock the status quo in the immediate future.

Nonetheless, a number of such changes are still needed. Government officials themselves acknowledge that last year’s economic growth was due to the high world prices on oil, gas and metals, gold included, which are still Russia’s primary exports. Inflation remains high at over 14 percent (compared to 18.6 percent in 2001 and 20.2 percent in 2000), and according to some analysts the internal factors stimulating growth have now been exhausted. The dubious quality of economic development is revealed by the lag of investment growth behind the rise in GDP in 2002. The rates of investment and GDP growth respectively were 1 and 5 percent in 1999, 17 percent and 9 percent in 2000, 7.5 percent and 5 percent in 2001, and 2.5 percent and 4.2 percent in 2002.

2000 was the last year that saw growth stimulated by the effects of the 1998 ruble devaluation. After that, world oil prices helped sustain growth, but the government has largely failed to create conditions for further qualitative growth. As the real income of the population started to grow imports increased, indicating that domestic industries remain mainly noncompetitive.

The current government headed by Mikhail Kasyanov was formed to fulfill the so-called presidential program of economic development after Vladimir Putin was elected in March of 2000. It envisaged a number of reforms, including cutting taxes and breaking up state monopolies, developing a legislative base for business and simplifying conditions for small and medium-sized firms.

The main reform achievement of the administration was tax reform, but this stopped half-way with the 13 percent flat rate on personal incomes its only real result. The tax on corporate profits was also officially lowered, from 35 to 24 percent, but because allowances for investments were abolished, the effective tax rate actually rose, from 17 to 24 percent. Meanwhile, a new unified payroll tax (for pensions and social benefits) made the life of employers more difficult. For small businesses, the tax changes made almost no difference. As a result, a large portion of Russian business remains in the shadow economy. Opinion polls confirm that most of the ordinary public have not seen positive benefits from the tax reforms.

The reforms of the monopolies–the gas giant Gazprom, the power system EES, the railways and the utilities (in effect, another state monopoly and perhaps the most inefficient one)–remained incomplete. The same goes for banking reform. No wonder, then, that the investment rate has dropped dramatically. Not only are there no stimuli to invest, the investment capacity of the Russian economy in its present state is restricted–it simply would not be able to absorb investment even if it comes. Low investment capacity is evident for instance from the fast growth in real estate prices, especially in Moscow, where money is concentrated. In the absence of investment instruments, a weak banking system and no stimuli to open new businesses, investors buy real estate, driving up prices regardless of the quality of what they are acquiring.

The main problem in the country’s economic life seems to be the absence of an official economic policy. If any, it consists of a single principle: non-interference with “natural market forces.” Rather than being a real reflection of the government’s genuine commitment to liberalism, it serves as an excuse to avoid responsibility, since an active policy that produces real change might have potentially threatening political repercussions.

While the government is unable, or unwilling, to come up with a coherent economic policy, the president’s economic adviser Andrei Illarionov does it with an inexhaustible degree of enthusiasm. Illarionov, a liberal-minded economist who had long argued for a controlled devaluation of the ruble before August 1998, was conscripted to articulate the president’s economic views once Putin took office. Since then Illarionov has become a source of both valuable economic ideas and scandalous criticism of almost everyone who has anything to do with the country’s economic policy.

Illarionov appears to have what the government is lacking–a clear set of views on how to achieve a sustainable economic growth by using the domestic resources: lowering taxes, decreasing inflation, weakening the ruble, cutting state spending from the current 35 percent of GDP to 12 percent, lowering foreign debts and taking no more loans, avoiding rises in state monopolies’ tariffs, unifying and lowering import and export duties, liberalizing the currency market, deregulating state interference in economic matters, and no restrictions on oil exports (with the revenue used to pay down Russia’s international debts).

Illarionov uses every opportunity to advance his views, participating in numerous economic conferences and international meetings of state officials. And as he could hardly be accused of being overly diplomatic, he has made enemies at all levels of economic life. His main target is Anatoly Chubais, whom he sharply criticized for what now are seen as the mistakes of the reformist period as well as for the intended reform of the EES, headed by Chubais. Unlike Chubais, who wants to break up the monopoly horizontally into generating entities and a state-controlled distribution system, Illarionov argues for vertical disintegration of the monopoly into a number of regional EES.

Arguing against a strong ruble, Illarionov has repeatedly clashed with Viktor Gerashchenko, the former head of the Central Bank. And, of course, Kasyanov, together with all members of the government’s economic bloc, as well as Duma deputies in charge of economic issues, have been the target of Illarionov’s constant criticism. On various occasions, they have been accused of mishandling foreign debt, high inflation, bad budgets, and even creating the threat of excessive foreign investment. The media have long followed Illarionov’s public appearances, not so much for his economic ideas, as in expectation of a public scandal.

Though his views appear a coherent liberal worldview, they are more than a set of “right” ideas than a program to be implemented. Not surprisingly, the government and the Central Bank’s officials continue to run their own affairs as they see fit. Liberal economists who form the current government do not object in principle either to lowering state spending or inflation, but with obligations to keep the public quiet, if not happy, they cannot afford to cut wages or subsidies to the underfunded social sphere.

Illarionov’s other ideas are equally controversial. In his interpretation, balancing the budget, clearing foreign debt and “sterilizing” the influx of dollars have become obsessions rather than instruments of economic policy. He argues that low oil prices would be good for the economy–too many dollars would harm the economy, investments should be no more than 17-20 percent of the GDP, otherwise the economy becomes “too lazy.” Meanwhile, he has been actively against any restrictions on Russian oil exports at a time when prices are high.

Supporting the reform of the state monopolies, he has been sharply against any increase in their tariffs as that drives up inflation. And–his favorite issue–a strong ruble is bad for the economy. And since his views on these two matters differed from that of international economic bodies, Illarionov does not hesitate to sharply criticize them as well. Thus, Martin Gilmore, the former head of the IMF office in Moscow, who believed that the strong ruble would help increase the average wage, also became a target.

There is, however, a man who seems to have succumbed to Illarionov’s passionate preaching. Putin not only has kept Illarionov on as his adviser for three years, but has also taken some of his ideas onboard in his official statements. Thus, in his 2001 budget appeal the president argued for a stabilization fund (money set aside to keep inflation down and external and state accounts in balance), and in his 2002 budget appeal he called for medium-term (three-years) budget planning–both ideas authored by Illarionov.

Yet, the adviser’s influence obviously has limits. Thus, the president, formerly a staunch supporter of tax reform, declared in mid-2002 that the time had come to halt reforms and tax cuts. The stabilization fund was created by the government in the form of a budget reserve fund, which appears to have already been used to help the regions. And the idea of lowering state spending to 12 percent of GDP in a pre-election year is not worth a mention. From time to time the oligarchs are able to intervene and pressure the government to act on a particular issue, such as raising tariffs on imported cars. But such interventions do not amount to a coherent program. Quite the contrary.

Thus, between the radical views of Illarionov and the no-action policy of the Russian government, the Russian economy continues to wander in the dark without clear guidance, grazing here and there on oil and metal exports and hoping that everything will somehow sort itself out. In a paradoxical symbiosis, the liberal beliefs in the self-organizing forces of the market easily converge with the notorious concept of Russian fatalism, producing a synergy of inaction.

Elena Chinyaeva, who holds a doctorate in modern history from Oxford University, is a writer with the leading Russian political weekly Kommersant-Vlast.