BRICs Series – 4: Russia – Impact of its History on its Economy

Historical facts:

It’s centralized and militarized state has distinguished Russia for centuries. It’s deeply ingrained sense of territorial security created the need for a large and expensive state bureaucracy and military. After WWI, the Russian empire lagged economically and technologically to the European powers. Strikes and food shortages in Moscow and St. Petersburg led to chaos in 1917, and Lenin’s Bolsheviks successfully engineered a coup. The Soviet propaganda was its role to lead the world towards socialism and combat the evil designs of world capitalism (mainly the US). After WWII, Stalin had an obsessive view of international security, which fueled his cruel synthesis of Soviet domestic and foreign policies.

In 1945, the Soviet Union was in a stronger international position as ever, but Stalin still perceived weakness. As the US had an atom bomb, Stalin pushed the Soviet science community and economy very hard to develop nuclear weapons. He continued to focus and value heavy industry, and military power. As a result, the core features of the Soviet economy were – state ownership, extreme centralization and administrative control, minimizing the role of markets, shortages and poor quality. Russia’s human capital and its science and engineering knowledge were great. But it was all allocated to military, as was its money – allocated badly (not for the people but for its military). Hence, it was a military superpower, but an economic dwarf in comparison to the West.

After Gorbachev assumed power in 1985, the economic development had hit a dead-end (20% of national production allocated to defense – heavy burden on long-term economic growth). His first priority was economic restructuring (Perestroika), which did not proceed smoothly due to bureaucratic resistance. The economic reforms destroyed the inefficient system, and reduced the Soviet economy to chaos and bankruptcy.

In 1991-92, Russia now had a new identity as a nation-state (it had been an empire since the 16th century). Boris Yeltsin led Russia through a revolution that marked the most concentrated effort in its 1000 year history to break free from its traditional ways. After getting advice from the West, Russia liberalized its domestic and foreign trade. The Russian economy as in disarray, as it was very inefficient, and not used to a market economy. Markets require rules, regulations, infrastructure, private property, concrete legal system…and all this takes time to build up. Russia didn’t have all of those requirements in place. It tried to privatize in a controlled way, only in the natural resources sector (which created wealthy oligarchs). All the highly educated scientists and engineers were unemployed and as a result, there was a massive migration of human capital to Europe and Israel (2/3rd of the highly skilled workers left – tremendous loss). Hence, even today, Russia has resentment towards the west, and blames it for the “bad advice” of liberalizing its economy. In the late 90s Yeltsin became unreliable and had health issues. He appointed Vladimir Putin (a former KGB guy) as his successor.

In 1998, due to the fall of the oil prices, the Russian economy collapsed, so did the Rubel. The collapse of the Russian currency was a blessing in disguise; and as the oil prices got higher, the Russian economy took off. Putin played a tough hand against the rebel groups from Chechnya and immediately gained popularity. He won the Presidential elections in 2000. Putin wanted to rebuild the old Russian glory – powerful military and a centralized authority. He abolished the direct elections of regional governors and they now became Presidential nominees. The Russian government started to become more authoritarian, but Putin’s popularity grew because Russia was experiencing an economic boom and relative stability after a long time (unlike the chaos of Yeltsin years).

Economy:

World Bank estimates oil and gas accounts for 20-25% of GDP. Retail and wholesale trade accounts for 10%. Energy dominates the industrial sector – fuel, energy and metallurgy together account for more than 35% of the industrial output. Electricity and food account for 25%. Therefore it is clear the manufacturing of high-tech and consumer goods account for only a small portion of the Russian economy. The economy is dominated by large industrial enterprises. Small and medium-sized enterprises are woefully underdeveloped (they are important source of economic growth) – held back by stifling taxes and regulations.

In 2005, the government introduced a new welfare system to curb the extensive benefits Russia inherited from the Soviet system. The social subsidies were poorly targeted making the rich richer. Despite these recent improvements, much remains to be done in terms of fiscal reform. The income inequalities have been increasing in Russia – inflation and export-driven recovery since 1999 have been the major reasons.

Agricultural sector:- most of the agricultural land is not fertile. Farming still lacks commercial incentives, and farm support remains a drag on the state budget. Russia is a significant but an inefficient producer of timber. Fishing output has declined – but it still accounts for 25% of world’s production of fresh and frozen fish, and 1/3rd of global output of tinned fish.

The bottom line is that Russia’s economy is dependent on the volatile international commodities market. Hydrocarbons account for more than 60% of all exports.

Strengths:

– Natural resources – abundance of oil, gas, coal and timber. Oil prices expected to stay high for the next few years.

– Strong economic growth for the past decade. Expected to grow at an average 4% the next 5 years.

– Education – quality still relative high.

– Very strong and capable military.

– Large territorial size and population.

– Large scale enterprises.

– No current military threats. Good relations with most of its neighboring countries – especially the CIS countries.

– Retail sales are booming….so is tourism.

Weaknesses:

– Hybrid democracy – state controlled media but free elections. Strong Presidency, government drifting towards authoritarianism. Weak checks and balances, lack of accountability.

– Political instability, widespread corruption and bureaucratic interference.

– “Brain Drain” – Gigantic human capital migration during the economic collapse in the 80s and 90s. Lost 2/3rd of its scientists and engineers – a tremendous loss.

– High crime and theft rates.

– High inflation mainly due to high food prices. Growing inequality as a result of the high inflation.

– Bad demographics – aging and declining population.

– Economy heavily dependant on energy sector / natural resources (mainly oil and gas).

– Too much state interference in the economy. Need for privatization.

– Burdensome and complicated tax system.

– Climate and soil not conducive for agriculture.

– History of heavy industrialization – cause for environmental concern.

– Economy heavily dominated by large industrial enterprises. Poor development of small-scale industries, and lack of innovation / entrepreneurship.

– Quality of Education – outdated curriculum and lack of education materials.

– Banking sector, and insurance sector weak.

– Infrastructure weak due to heavy neglect for the past 2 decades. Showing signs of positive change but still needs heavy investment.

– Need to invest in technology, telecommunications, healthcare sectors.

– Russian companies are poorly managed.

– Legislature is weak with little opposition to the President.

– Judiciary is severely compromised under communism – its authority is comparatively weak.

– Growing nationalism and threat of conflict with the Islamic rebel groups from the northern regions.

– Recent improvement in manufacturing sector, but still remains relatively weak.

– Weak property rights.

Threats to Russia:

– Islamic fundamentalism threat due to support to the Islamic rebels in the northern region of Russia.

– Neighborhood threat – China rise in economic power and global influence.

– HIV/Aids pose a long-term demographic threat.

– Population is declining, and ageing which could be a big burden on the economy.

– Low foreign investment due to burdensome and complicated tax policies.

– Heavy dependence on EU as its trade partner (50% of Russia’s trade is with the EU).

– Economy heavily dependent on its natural resources – oil, gas, and timber.

Opportunities…and what Russia needs to do:

– liberalize its economy.

– reform its tax system and encourage foreign investment.

– recent thawing of its relations with the US is a good thing. It needs to further improve its relations with the international community (including the US and the EU), and work together on arms reduction. It needs to adjust to new global context (China’s growing influence, US relations etc).

– needs to look at other market opportunities outside of the EU.

– build good relations with the CIS countries – will help national security and trade. Kazakhstan remains Russia’s most reliable partner within the CIS.

– should join the WTO (negotiations going on for 17 years) – will help in getting better access to global markets.

Its been more than 30 years since the cold war ended. But Russia still sees US as its main adversary…and thats its biggest flaw. It actually have more in common with the US now in terms of threats – China’s rise, terrorism, nuclear threats etc. And the reality is that Russia today needs the US, more than the US needs Russia. But its difficult to change Russia’s mentality. Its lack of trust towards the US is causing it to sacrifice economically, to maintain its military power and security. But in the process, its paying a high price.

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About pritamkabe

Originally from Bombay, India. Relocated to the United States in 1997 for attending graduate school at The University of Texas. Completed my Masters in Electrical Engineering in 1999 and then worked in the Hi-Tech industry for the next 11 years in Austin, Texas. I have a passion for travelling, meeting new people, and experiencing new cultures...and i've been very fortunate to have gotten the opportunity to travel quite a bit. Sports and food are my other big passions in life. Some life-changing experiences in my life a years ago changed my perspective of life, after which, just have an engineering job was not meaningful to me anymore. Hence i quit my engineering career, and I'm now motivated to give back to society and make a positive impact in some way. To get started on that journey, i went back in graduate school, and recently graduated as a "Mid-Career Fellow in Foreign Service", from the Edmund A. Walsh School of Foreign Service, at Georgetown University, Washington DC. Currently in New Delhi, India, on a research fellowship, to learn about the educational issues in India, and brainstorm my ideas about technological interventions for resolving those issues.
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