Friday, July 14, 2006

Quo Vadis Russia?

As the G8 Summit gets underway in St Petersburg, the debate is on concerning the policies of Russia – and our policies towards the country.

The subject is important - and deserves some reflections somewhat longer than the usual.

We know more about where Russia is coming from than about where it is going.

Its recent history has been very dramatic.

It’s only 15 years ago since the political and economic collapse of the Soviet Union and its entire empire.

I remember our agenda then being dominated by issues like the need for emergency food shipment to reduce the risks for starvation in what was still Leningrad.

And there were well-founded concerns that we might be heading for military coups and military conflicts as the entire system come crashing down.

It has come a long way since then. And the worst of fears we had then have not come true.

During the Yeltsin period – chaotic as these years sometimes where – politics was driven by his firm belief that the establishment of a market economy must go hand in hand with the establishment of a Russian democracy.

And crisis by crisis, things actually moved in those directions.

The two Putin periods since 2000 have been different.

The first one was still in the shadows of the near death-experience of the Russian economy in August 1998. To restore stability – macroeconomic as well as political – was an obvious priority.

But it still went hand in hand with significant structural reforms in the economy. The introduction of the 13 % flat income tax is just one important example.

The second Putin period since 2004 has been different.

Economic reforms have slowed down, and are now approaching a standstill. And we have seen a very clear policy to transform the political system from an emerging democracy to an evolving semi-authoritarian system.

Economic growth is still impressive. Moscow is one of the true boom towns of Europe. Apart the vast wealth accumulated by some, personal disposable incomes have been rising fast for the majority of the Russians.

Looking ahead, I think three things are driving the policies being pursued by Putin and his team.

First and foremost, the concerns of the present Kremlin crowd to preserve power and protect – preferably also increase - their often very substantial private and semi-private assets beyond the 2008 presidential transition.

Second, the determination to fend off the “soft invasion” by the West of wider Russian space that the different colour revolutions, most notably in Ukraine and Georgia, were seen as, and to secure Russians dominating influence in these areas beyond its immediate boundaries.

Third, to restore respect for Russian power and policies in more general terms.

In early Soviet times, the aura of Communism was the instrument, in later Soviet times it was the shadow of military strength that fulfilled the function, and now it is its role as what they refer to as an energy superpower that is the instrument.

It is unlikely that there is an established and agreed succession scenario in place already, but practically all the political manoeuvring that we see inside the Garden Ring in Moscow is driven by this issue.

With the electronic media firmly under control, and a number of other steps taken, the Duma elections next year will be firmly controlled by the Kremlin and won by its United Russia party. The political process in Russia under Putin is substantially more controlled and less free than the political process in Serbia under Milosevic.

We can safely assume that Putin will promote one of his confidants as the next president, and that he personally will seek some position that will retain his influence.

In the immediate perspective this is highly likely to succeed, and we will get a smooth transition. In the somewhat longer perspective, I’m far less certain. The one way or the other, a new set of persons will start to set their own priorities and pursue their own private economic interests.

The true post-Putin succession will come some years after 2008 in the same way as the true post-Yeltsin succession come some years after 2000.

By that time the economic picture might look somewhat different from now.

The days of the boom in Russian oil production is clearly over. The spectacular increase we saw as the industry was privatized and opened to competition – production nearly doubled in a decade - has already ebbed out as roughly a third of oil production has been taken back in state hands with means that have been – at the very best – debatable.

And although Gazprom is a better managed company today than a decade ago, the priority given to securing its total monopoly on production, transportation, transit and distribution of gas in as wide an area as possible can only have a detrimental effect on supplies further down the road.

There is reason to be concern by the way Gazprom is not infrequently used by the Kremlin as a political weapon – or perhaps the other way around – but there is equal reason to be concerned with whether Gazprom will really be able to deliver on all its different commitments some years down the road.

As with Russia as a whole, the oil and gas industry is investing much too little.

There are vast investment needs wherever you look in the economy – energy, transportation, health, housing – but with only 18 % of GDP spent on investments, Russia is well below most other emerging and transition economies at around 25 % - not to speak of over-investing China with over 40 %. Also FDI in Russia is well below the level of other transition economies.

Critical is of course the development of the non-raw materials sector of the economy. And the conditions should be there – there is an industrial basis, and there is a desperate need to develop a service sector.

But while we see industrial production increasing with double digits in all other European transition economies, Russia remains in the single digit league. And while small and medium size businesses are booming in other economies – being the backbone also of employment generation - their share in Russia is still very limited.

Taking all these things together, and assuming that oil and gas prices don’t collapse, I believe that the post-Putin leadership some years down the road will be faced with a more difficult economic – and accordingly also social and political situation.

And it’s what happens then that will really answer the question of where Russia is heading.

Will it then see the need to return to a more liberal path of development, including more profound economic reforms, a true opening up to the West and a more democratic political system?

Or will the Kremlin of those days chose to handle the challenges by embarking on a road of more nationalism, more authoritarian rule and more of a petroleum-financed populism?

Up until then we are likely to witness a slow slide in the later direction – but all our policies must be geared towards encouraging a turn then in the first of these directions.