What are the current constraints on Russia's economic modernisation?

What are the current constraints on Russia's economic modernisation

Introduction

Despite the Yegor Gaidar’s “shock therapy” reforms right after the collapse of the SovietUnion or Dmitriy Medvedev’s determination to modernise Russia’s economic system duringhispresidency, the country still hasn’t managed to overcome the challenges associated withthe economic modernisation process. There are internal and external factors which preventRussia to modernise its economy and fully integrate it into the global financial system.

Widespread corruption, autocratic rule, rentier model, lack of skilled workforce, unfavorablebusiness climate, corruption in the judicial system as well as, the unwillingness of the Russianpolitical elite in implementation of reforms are the primary internal constraints in this path. Since 2014, Russia’s annexation of Crimea, and the war in Eastern Ukraine has forced the westparticularly the USA and the EU to impose economic sanctions on Russia, which made thingsmuch more complicated for the Kremlin. In this policy brief, I am going to examine the currentinternal and external constraints on Russian economic modernisation process and will come upwith recommendations on how these issues can be tackled.

Russian Economy

Russia holds world’s 30% of energy resources, export of commodities such as oil and gasenable Russia to fill its budget, unsuccessful diversification attempts of the economy makesRussia reliant on revenues from hydrocarbon resources. Therefore, the slowdown in majoreconomies, the decline of demand for oil and gas directly impacts on Russian economicindicators. During the Vladimir Putin’s first and the second term GDP growth was 7% per year,from 2008 world financial crisis to 2014, GDP growth was around 2% per year, however since2014 after the drop of oil prices in the world energy market, as well as imposition of westernsanctions on Russia,GDP growth is around 1% per year . Russian Central Bank switched tofree-floating currency in 2014, as the result ruble has lost its value over 50%, capital outflowsfrom Russia are increasing due to economic instability in the country. However, despite thesechallenges, the inflation rate is about 4%, and the unemployment rate is in the region of 5%.Currently, Russian international reserves are 487 USD billions8 . Self-sufficiency and crisisprevention programs of the economic authorities of Russia has allowed the country to respondto the challenges and minimise the effects of the crisis. With that being said, governmentspending programs have been decreased, the role of the state in the economy increased since2014. Continuation of thewestern sanctions against Russia and instability in the energy marketallows us to say that the crisis will be far from over in upcomingmonths or years. Russianeconomy badly requires structural reforms. Otherwise, the deep economic crisis will beinevitable.

Current Constraints for Russian Economic Modernisation

It is vital to divide current constraints which prevent Russia from concluding the economicmodernisation process into internal and external constraints:

a) Internal Constraints

1. Privatization and state enterprises

After the dissolution of the Soviet Union, Russian economists werearguing over whicheconomic model will suit the country better, there were debates between gradual economymodel and shock therapymodel, in the end, Russian authorities have decided to go forwardwith Yegor Gaydar’s shock therapy model, one of the critical components of this modelincluded large-scale privatization. With that being said,the privatisation process wasn’t wellorganised and lackedtransparency, and it enabled those who had closer ties to thegovernmentcircles to buy large properties and companies for aminimal amount of money. Later on, itled to monopoly in differentfields of Russian economy and laid the foundation of oligarchs.Twenty-seven years since the implementation of these reforms theRussian economy is stilldominated by state-owned enterprises and big corporations, which are possessed byoligarchs. Another problematic issue connected to the privatisation process was that not allstate enterprises were privatised and there are still thousands ofstate enterprises remain to beprivatised, and these companies receive subsidies from the government. Subsidising suchcompanies are economically not profitable for the government because not all of thosecompanies can bring profits to the state budget, however, if thestate subsidies are withdrawn,most likely some of those companies will go bankrupt, and the employers of those companieswill be left without jobs.

2. Overreliance on energy revenues

Russia mainly exports raw materials and semi-finished products toother countries, the primarysource of income for the Russian state budget is energy resources, particularly commoditiessuch as oil and gas. In 2013 oil and gas exports consisted of 66% of all Russian exports.Since 2014 Russian economy has faced a set of challenges in consequence of the low oil pricesin the international energy market, the sharp decline of demand for oil in major economies ledto falling of oil prices. As a result, the Russian national currency ruble hassignificantly lostits value against the dollar. Stable prices in the energymarket are crucial for the Russianeconomy, once prices fallgovernment needs to squeeze its belt and to decrease government
spending.

3. Lack of investment

Government spending is a necessary element for the Russianeconomy in the creation of newemployment opportunities, asinvestors aren’t willing to invest in the Russian economy. Russiahas so far failed to attract substantial foreign investors in the last fewyears, the primary reasonfor that is the lack of favorable business climate. Moreover, capital outflows from Russiaafter the 2014 oil crisis has also increased, which indicates local investors are looking foropportunities outside of Russia.

4. Lack of political will

Vladimir Putin is also not keen on implementing necessary reforms toaccelerate the economicmodernisation process, for Putin political and economic stability is critically important, and herealises theintroduction of economic reforms may have a negative effect in theshort term forthe Russian economy as well. In that end, it is worth to mention that, oligarchs close to Putinwho have economic interests are also lobbying to block the implementation of such reformsas theyunderstand such improvements mean they won’t be able tomonopolise the differentsectors of economy anymore.

5. Judicial system

Russian judicial system is one of the most corrupted areas in thecountry. Decisions are beingtaken in favor of those who have close ties to local or central authorities. Intellectual propertyrights and patent rights aren’t well respected. The situation is even worse when it comes toproperty rights. Often, the properties of small and medium enterprises are being absorbed bylarge enterprises which haveconnections to government circles, lack of enforced propertyrights mechanism scares both local and foreign investors.

6. Public Support

Reforms connected to economic modernisation process isn’t widelysupported by Russianpublic too, the Russian population stillremembers reforms of Chubais and Gaydar and believesthesereforms paved the way for the economic stagnation in the 1990s. InRussia, people alwaysremember the dark days of the early 1990s when the country faced food shortages, and thecrime rate was quite high. Russian authorities had convinced the population that anyinstability might bring the 1990s back.

b) External Constraints

1. Western sanctions

The primary external constraint for Russian economic modernisationprocess so far has beenthe international sanctions imposed on Russia, shortly after the Russian aggression againstUkraine after the Euro-Maidan revolution, the European Union and the USA have sanctionedseveral Russian companies and oligarchs who have closer ties to Kremlin. Although theimpact of western sanctions on theRussian economy is a debatable topic, it’s the fact that sinceRussian actions towards Ukraine, its GDP growth slowed down.

Policy Implications and Recommendations

Current circumstances articulate that the Russian government isn’twilling to make reforms toaccelerate the economic modernisationprocess in the short term. With that being said, in thelong run without economic modernisation, Russian economy may face a deep crisis which mayforce the country to knock on the door of the InternationalMonetary Fund for bail-out program.Government’s Concept-2020strategic programme 27 which includes a set of tasks and projectsfor execution of deep economic reforms are a promising sign,nevertheless in this direction sofar, no action has been taken.Russian economy requires both political and economic changesto be able to be compatible with the world’s major economies. In myopinion, the followingsteps must be done to modernise the economy:

a) Diversification of Economy: the shale revolution in the USA turned the US into the biggestoil producer in the world, lifting of ban on US crude oil exports and ambitious US strategy todominate the LNGmarket further complicates Russia’s ambitious energy strategy.Particularly,protests from Washington towards Russia’s Nordstream-2 gas pipeline and EU’s strategy todiversify its energy importsdemonstrate that in the long run, Russia’s monopolistic position inthe EU energy market will be under question. Russia needs to diversify itseconomy to decreaseits reliance on the export of raw materials.

b) Judicial reforms: to attract both local and foreign investors, Russianeeds to improve thebusiness climate, to achieve it first thing which needs to be done is judicial reforms.

c) Research and Innovation: Russian education system needsinvestment in research andinnovation. Brain drain among Russianscientific circle is quite high, as they leave the countryfor better opportunities.

d) Privatisation: state-owned enterprises dominate the Russianeconomy, most of them makeless profit but receive subsidies from thestate budget, to improve the situation country needsto introduce a new wave of privatisation.

Conclusion

Russia has failed to complete the economic transition process which it started following thecollapse of the Soviet Union. For this reason, the country currently faces profound economic challenges. The Russian economy is heavily dependent on revenues coming from oil and gasexports, the share of export of oil and gas in total exports of Russia isincreasing year-by-year.Overreliance on raw materials puts the country in a vulnerable position during the globalrecession period, or when the prices of such materials decline. The annexation of Crimea byRussia in 2014, made things even worse for the country, as the US and the EU decided toimpose sanctions on Russia. Russia needs structural reforms to boost its economy, especiallyin the area of judiciary, tax system, education and country needs another wave of theprivatisation process. However, the Russian political elite aims to maintain political andeconomic stability and regards to such reforms skeptically. Currently, the Russian economy isrelatively stable and is in a position to react to any short-term shocks, notwithstanding in the
long term without deep and structural reforms, and with lower oil and gas prices Russianeconomy may face the crisis and stagnation.

Bibliography

B. Secondary Sources

b.1.Books;

Anders Aslund. How Capitalism Was Built: The Transformation of Central and EasternEurope, Russia, and Central Asia. (Cambridge University Press, 2007)

Anders Aslund. How Russia Became a Market Economy. Washington DC: The BrookingsInstitution, 1995.

b.2.Articles;

Connolly Richard, “The Empire Strikes Back: Economic Statecraft andthe Securitisation ofPolitical Economy in Russia”, Europe-Asia Studies, 67:4,2016.

Connolly Richard, “Troubled Times: Stagnation, Sanctions and theProspects for EconomicReform in Russia”, Chatham House Research Paper, February 2015

Eteri Kvintradze, “Russia’s Output Collapse and Recovery: Evidencefrom the Post-SovietTransition”, IMF Working Paper, WP/10/89, International Monetary Fund, April 2010.

Mark A Smith, “Russian Series :Medvedev and the ModernisationDilemma”, The DefenceAcademy of the United Kingdom, 10/15, November 2010

Silvana Malle, “Economic modernization and diversification in Russia:Constraints andchallenges, Journal of Eurasian Studies, 4 (2013).

Tatiana Romanova, “Sanctions and the Future of EU–RussianEconomicRelations”, Europe-Asia Studies, 68:4, 2016.

Vladimir Mau, “Russia’s economic policy in 2015–2016: the imperativeof structural reform”,Post-Soviet Affairs, 33:1.

Vladimir Popov, “Shock Therapy versus Gradualism Reconsidered:Lessons from TransitionEconomies after 15 Years of Reforms”, Comparative Economic Studies (2007)

Vladislav Inozemtsev, “Russia’s Economic Modernization: The Causes of a Failure, Notes de l’Ifri:The Institut français des relations internationales, September 2016