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Analysis & Opinion
19.12.08 Russia Profile Weekly Experts Panel: Russia's Handling Of The Crisis
Introduced by Vladimir Frolov

Contributors: Stephen Blank, Ethan Burger, Vlad Ivanenko, Andrei Tsygankov

It is now official – the Russian economy is in recession. Have Vladimir Putin and Dmitry Medvedev mishandled the crisis? Have they responded inadequately to the challenges facing the country? What could the Russian government have done differently? What impact will the deteriorating economic situation have on Russian politics? How will the crisis affect Russia’s foreign policy and its relations with major powers and neighbors? Will the West be able and willing to help Russia, or will Russia seek help from OPEC and China?

Prime Minister Vladimir Putin admitted last week that the Russian economy will grow by just six percent in 2008, which technically means that the growth will be negative during the last quarter (compared to a 7.3 percent growth in the first three).

The Russian government’s projection for economic growth in 2009 at 5.9 percent, with the median price of Urals oil at $57.4 a barrel looks unrealistic. Most economists now project stagnant or even negative growth rates of minus one to two percent, and some even see a 15 percent drop in 2009.

In many sectors, like metals, construction materials, machine building and transportation services, production volumes have fallen by ten to 20 percent. Unemployment is likely to double from four million to eight to nine million in 2009. The next year is shaping up to be the hardest Russia has experienced since 2000.

The Russian Central Bank has been burning its hard-currency reserves at an astounding rate of $50 billion per month (the reserves shrank from a high of $585 billion in August to $435 billion at the end of November) trying to maintain the increasingly untenable ruble to dollar valuations, with the oil prices only a third of what they were in the summer.

It now appears that the Russian leadership has been slow to understand the true impact of the international financial crisis on the Russian economy. All the way through November it had tried to portray the crisis as a U.S.-manufactured phenomenon that had nothing to do with Russia, and that the country would remain “an island of stability.”

With the crisis already in full force, the government has sought to dampen its effects by throwing money at it. Corporate borrowers have been compensated for the rising costs of credit, oil exporters – for falling oil prices, developers – for disappearing housing demand, the stock market, having shrunk to a fourth of its valuations in May of 2008, has been bolstered by buyers trading with government money. But all of this has not worked to prevent the economy from sliding into a recession.

The government is now at a crossroads – having privatized the political dividends from the rising oil prices in 2000-2008, it is now forced to admit that the rising living standards of the past eight years have more to do with high oil prices than with the able management of Russia’s economy, which remained commodities-driven.

There appears little the government can do now to fight the recession other than to devalue the ruble sharply, perhaps, by as much as 30 percent, in one drastic move to promote import substitution and prevent the depletion of currency reserves. This move, however, poses serious risks of social and political instability, and will obviously undercut Vladimir Putin and Dmitry Medvedev’s popularity. The Kremlin, aware of brewing unrest, has instituted a sweeping system of social monitoring and rapid reaction that involves all levels of political power and even the United Russia party.

Have Putin and Medvedev blown it? Have they mishandled the crisis? Have they responded inadequately to the challenges facing the country? What could the Russian government have done differently? What should be done now to help Russia weather the storm? What impact will the deteriorating economic situation have on Russian politics? How will the crisis affect Russia’s foreign policy and its relations with major powers and neighbors? Will the West be able and willing to help Russia, were it to face a severe economic contraction and a new financial meltdown? Or will Russia seek help from OPEC and China?

Vlad Ivanenko, Ph.D., Economist, Ottawa:

The short answer to the question of Russia’s current economic crisis is that it was imported from the West, but that Russia allowed the crisis to leak in. Now, the Kremlin faces two stark choices.

Firstly, it can associate Russia with the West, that is, to accept its share in the total costs of the crisis. This may not be entirely fair – as Russia did not benefit from the bonanza of postindustrial prosperity – but an accommodating stance might turn out to be its best option if the G7 reciprocates. Secondly, the Kremlin can decide to defend its interests independently.

Of these two options, I consider the accommodation stance to be more realistic. Until recently, Russia enjoyed a healthy growth at home and a positive foreign trade balance because of a favorable external environment. The prudent financial policies of 2004-8 provided Moscow with a significant “war chest” to weather the market storm. Along with social stability at home, the Kremlin was happy to put the problem of its long-term economic strategy on the back burner.

The crisis is still in its early stage, but Russia has been spared of its excesses so far. The alarming headlines about the Russian economy do not correspond with the available indicators. The price of crude oil has fallen within the range of prices dominant in 2004-6, the years during which the Russian economy expanded. Moscow’s stock market has sharply contracted since June, but congruently with the price of crude oil and, together with the fall in stock turnover, this simply indicates the departure of foreign portfolio investors. The CBR foreign reserves shrank from $585 billion in August to $435 billion in December, which is a comfortable amount comparable with that of 2007 (it would be interesting to see where the reserves have gone, but such data is still publicly unavailable). The Russian export revenue has fallen during the last three months; however, its import has decreased as well, leaving the balance positively strong. The same relates to data on unemployment, which has grown marginally since July.

However, the crisis highlights the fact that the Chinese-style export-driven development strategy has its natural limits. When importers – the EU, in Russia’s case – move into recession, their foreign contractors feel the pinch first. This is the lesson that the Kremlin is learning these days. Judging from the political signals that it emanates, I think that it is now thinking about its own “New Deal.”

Firstly, Russia is likely to use the crisis to expand its sphere of influence in the near abroad. The Kremlin has avoided the temptation to support Iceland with a structural loan, but was quick to provide a $2 billion loan to Kyrgyzstan. Support is expected to be granted to Belarus and Ukraine, if they fail to ensure continuing IMF support. Using the ruble as the price unit in state-sponsored trade credit lines will increase its role as regional reserve currency. Moreover, the crisis can push previously reluctant neighbors to form a regional trade union with Russia at the helm.

Secondly, a better delineation of state and private sector responsibilities will emerge. Unlike commentators who see the bailout of private Russian companies as a case of creeping nationalization, I treat this development as a correction of excesses associated with the wild privatization of the 1990s. Using public funds, the state reaffirms its role in defining strategic national objectives, but leaves the day-to-day operations in the hands of private managers. This arrangement does not fit well the Anglo-Saxon model of a free market, but it has a chance to become an effective and viable institution in Russia.

Finally, potential development of a brand-new economic system – prompted by the crisis – in this country cannot be excluded. Given the uncertainty that grapples not only the financial markets, but the economic policymaking in the West – it suffices to note the serious differences in crisis management between France and Germany – the Kremlin may start seriously thinking of its own development strategy.

Ethan S. Burger, Adjunct Professor, Georgetown University Law Center & Scholar-in-Residence, School of International Service, American University, Washington, D.C.:

The scope of the current economic crisis is so immense that it would frankly be too difficult to realistically expect anyone, no matter how capable and experienced, to handle it properly. Russia's economic emphasis on the export of commodities, and its neglect of the domestic industries and infrastructure (investing abroad, and not domestically) has made Prime Minister Vladimir Putin’s and President Dmitry Medvedev's challenges all the more difficult.

Russia's foreign policy, similarly, has not been helpful in establishing good will and trust with many of the other G20 leaders. Immediately after the G20 meeting, where a consensus was apparently reached that no country would increase its import tariffs, some Russian government officials said that Russia would increase its import tariffs, and president Medvedev quickly announced that Russia would make good on its commitment.

Everyday, a new aspect of the underlying causes of the crisis is revealed. In trying to identify the past and current mistakes of the Putin/Medvedev leadership, as well as creating a map for Russia's future, I have developed a list by which it might be possible to gauge their (and other political leaderships’) performance. Of course, each country's situation is different -- one size never fits all.

The first point is to think before announcing a policy. Bailouts of financial institutions and industries should be done in a well-thought out and systematic manner, according to well-defined standards and goals, and not in a rush. Merit must win out over cronyism. Egalitarian outcomes are important to maintain social stability. I think that the initial U.S. financial rescue plan, involving hundreds of billions of dollars, was announced too quickly and benefited too few (or so it seemed). The same seems to be the case in Russia. I think young married couples buying their first homes spend more time and thought weighing the pluses and minuses of making an offer on apartments than has been done by many governments.

There is a strong psychological element to the financial crisis. It is important that the political leadership inspires confidence among the business leaders both at home and abroad -- but that can only be accomplished through a careful analysis of the causes of the present crisis, and in coordination with the major financial players.

Attempts to control the flow of information to the citizenry only make it more anxious. At some point, a government's lack of credibility will come back to haunt it. There is more to fear than fear itself. In the absence of information, people are clueless as to what they should do as workers, savers, investors and consumers.

A credible “braintrust” of persons with opposing views should be assembled. Very often, the best policies are the result of dialectical debate. No one individual or small group of specialists can possibly have all the answers to complex problems. The “braintrust” must consist of persons with different backgrounds -- finance, industrial management, unions, etc.--and represent different interests. It should also reflect the country's geographic and ethnic diversity.

People fear losing their jobs, homes, and healthcare more than almost anything else, and are particularly aware of the impact this will have on their families and parents. There are always infrastructure projects that the government can undertake to employ workers (in an effort to lessen unemployment) and create demand for private companies when their traditional markets decline and they are afraid of excess employees or production capacity.

As emphasized by Berkeley University's Robert Reich, human capital should be invested in. Most economic crises are of a limited duration. Continued funding of educational institutions at high levels, particularly in fields such as engineering, computers, industrial management, and the sciences, is essential. Technological innovation, including a more efficient use of energy and commodities, may allow us to make revolutionary changes to the manner in which industry and finances operate -- representing the key to a better future.

Defense spending is the least productive use of capital by governments. Efforts to lessen political crises and increase cooperation will yield major long-term dividends.

Economic crime should be dealt with in the same way violent crime is. Massive economic crime causes more harm to society than traditional crime. Credible efforts to combat corruption and effective regulatory and law enforcement are needed to restore the businesses' and the citizens' faith in government. The criminal justice system and judiciary must inspire confidence in the population. Cynicism is corrosive.

Against these benchmarks, Putin and Medvedev have not earned high marks (the same could be said of the U.S. President George Bush). Both could learn a lot from President-elect Barack Obama, at least at present.

Andrei P. Tsygankov, Professor, International Relations/Political Science, San Francisco State University, San Francisco, CA:

Russia’s government has been slow to acknowledge the magnitude of the problem and to propose adequate solutions. The economic model developed under Vladimir Putin is now challenged in some of its core principles. This model assumed stability of high oil prices, which allowed the state and private energy corporations to be more assertive abroad, including by borrowing from foreign banks. Rather than becoming an opportunity to diversify the economy, expansion of energy production and contracts slowed down such diversification. Although at the time it made sense to exploit energy as a comparative advantage, the sharp decline of oil prices requires a principally different course. Given the continued uncertainty in the global markets, the Russian government faces difficult choices ahead.

It is however, wrong to attribute all the problems experienced by the Russian economy to the government’s recent decisions or to the overall policies pursued under Vladimir Putin. Some key elements of the Russian model, such as a growing role of the state in initiating economic projects and continued integration with European markets, remain vital under the crisis conditions and should not be abandoned. Professional critics of the government have rushed to insist that “Putinism” has failed the nation, and that now is the time to reverse the course by embracing the Western market-based economic model. The problem with this reasoning is that the good old market model no longer exists, and is currently in the process of a fundamental transformation.

The United States, the main advocate of the free-market model, has been shaken by major scandals on Wall Street and in the corporate world. Some of these scandals, like the recent accusation against the investment fund run by Bernard Madoff, may have cost the country some $50 billion, and in their design are reminiscent of Sergei Mavrodi’s financial schemes in Russia during the 1990s. President Bill Clinton’s decisions concerning deregulation on Wall Street, as well as America’s overall habit to live by borrowing from abroad, have been catching up with the country and must be rethought.

The Russian economic model needs to by scrutinized, but the solutions to the crisis will not appear without addressing all of its aspects. The underlying causes of the current economic crisis in Russia are complex and include the habitual mistrust in the state, exacerbated during the 1990s, the more recent model of economic expansion by way of accumulating large debts by energy corporations, and the U.S.-chosen type of global capitalism, much of which was shaped by financial speculators rather than by the real sector. Russia is not an island in the sea of the global economy – and certainly not an island of stability – and it will continue to be affected by market fluctuations in large economies, such as the United States and China. Although the United States is currently in recession, China continues to grow, and that remains an encouraging development that may preserve some degree of stability in the oil markets.

It is important to keep things in perspective. Russia’s fundamentals are not ideal, but they are not bad either, and can still serve as a basis for economic recovery. If the oil prices do not fall below $30 a barrel and the United States begins to recover within the next year, Russia is likely to feel the difference and will get back on its feet within a few years following the United States. Russia’s recession is very serious, but in relative terms, it is still possible not to make it much worse than that experienced by Western economies.

Professor Stephen Blank, the U.S. Army War College, Carlyle Barracks, PA:

These are big questions, and in some cases we cannot know the answer. For example, would the West be ready, willing, and able to help Russia? This would depend on the nature of the aid requested, the condition of the Russian economy at that moment in history, and the overall state of Russia's relations with its interlocutors.

The same holds true for Chinese aid, which Russia is unlikely to ask for beyond limited interventions (such as the projected loans for Rosneft and Transneft to build the pipeline to China) for this would entail a degree of obligation to China that Russia is not ready to accept. OPEC is also a dead end, because all it can do is raise prices and cut production, thus stimulating the search for alternatives, but it cannot cut production because its members cannot afford cutbacks in revenue. Iran and Venezuela, among others, are already in serious trouble, and cutbacks in production deal them serious blows.

Indeed, there is no question in that the leadership mishandled Russia's recovery. It used the revenues for political projects, conspicuous consumption, corruption and massive efforts to punch above Russia's weight in world politics.
As a result, Russia may not be able to produce enough energy for itself. It remains an international high-cost platform for production with noncompetitive industrial and postindustrial goods, and an increasingly inhospitable place for private investment.

The state is taking over more and more of the "commanding heights" of the economy, as well as other sectors, and has no idea how to escape the inevitable cycle of neo-Soviet and neo-Muscovite economics, where private property rights are tenuous and conditional and thus contracts are not binding, the rule of law is at constant risk, and rent-seeking is pervasive.

This crisis illustrates the essential bankruptcy of the program of sovereign democracy. Russia cannot participate in the world economy and then expect to escape retribution for its misdeeds when things go badly in that environment.

To a large degree, this crisis validates many of the Western (and domestic) criticisms of Putin's economic and political policies that were built on a castle of oil, which is no more substantial than sand. Reforms and a much lower profile in world politics while Russia recovered and developed meaningful economic capabilities, not unlike China, was and remains the way to go. But that means decisively breaking with the neo-Muscovite and patrimonial model and moving toward a genuine market economy and pluralism, if not democracy in politics.

The response to date has been the wrong one, pointing toward more state control and monitoring from above, as Frolov points out. Not only does this bring the country closer to fascism, without losing its neo-Tsarist and neo-Soviet attributes, but it also ensures that the country will pursue a great power status that is unattainable, and will crash at some future date in a major international crisis that will be of its making to a considerable degree.
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