Friday, April 18, 2014
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From Moscow to Sochi

NEW YORK – The Winter Olympics in Sochi are the first to be hosted by Russia since the Cold War-era Moscow Summer Games in 1980. Obviously, much has changed politically in the interim. But today’s Games also create an opportune moment to look back at Russia’s recent economic history – and to peer forward as well.

Many people who remember the collapse of the Soviet Union in 1991 and its tumultuous aftermath believe that Russia’s economy today must be impoverished and unstable – and far behind booming China. Wrong. According to the International Monetary Fund, Russia’s per capita income in 2013, measured in terms of purchasing power parity, is roughly $18,600, nearly double China’s per capita income of around $10,000. And, according to World Bank data, extreme poverty is close to zero, compared to 11.8% in China in 2009 (the most recent year for which data are available).

Yes, Russia’s economy has been buoyed recently not only by sound macroeconomic policies, but also by high world oil and gas prices. In fact, the collapse of world oil prices after 1985 contributed to the severe economic crisis in the Soviet Union and Russia in the late 1980’s and early 1990’s. This is an important point, given that the economic reforms implemented by former Soviet President Mikhail Gorbachev and former Russian President Boris Yeltsin thus confronted powerful headwinds.

For two years (1992-1993), I was a macroeconomic adviser to Prime Minister Yegor Gaidar and Finance Minister Boris Fyodorov, trying to help Russia to end the high inflation and extreme shortages that characterized the last years of the Soviet era, and to begin Russia’s transition to a market economy. I recommended a macroeconomic stabilization strategy that had been highly successful in nearby Poland, and that called for timely financial assistance from the United States, Europe, and the IMF, just as Poland had received.

Unfortunately, the West did not provide the needed financial assistance, contrary to my (and many other people’s) recommendations, and the Russian economic and financial calamity was more severe as a result. At the time, I attributed Western inaction to incompetence on the part of the US government and the IMF. Looking back, it is clear that there was also a deliberate strategy by US neoconservatives, such as then-Defense Secretary Dick Cheney, to weaken the new Russian state. The US government was also complicit during the mid-1990’s in the plundering of Russian state-owned property, including oil assets that were unscrupulously privatized.

The good news is that Russia was able to bounce back from those terrible years, no thanks to the West or the US government. Russia’s market economy, albeit marred by corruption, took root. After several years of political infighting and unnecessary delay, macroeconomic stabilization was achieved, and Russia’s economic growth was restored, especially as world oil and gas prices began to rise. From 2001 to 2013, Russia’s GDP grew at a robust 4.4% average annual rate.

Russia achieved a good measure of financial stability as well. The IMF puts Russia’s inflation rate at 6.9% in 2013, with unemployment at 5.5%, while the budget deficit was just 0.3% of GDP. Moreover, Russia’s foreign-exchange reserves stand at a healthy $500 billion.

But Russia could achieve still greater success by basing its economy on two growth engines rather than one. Oil and gas will continue to provide a strong lift to Russia for years to come, especially as China becomes a major customer. Yet Russia also has vast and still under-developed potential in many global high-tech industries.

During the Soviet era, Russia produced a vast array of technology-based industrial products, from airplanes to computers to sophisticated machine goods. Unlike Chinese industry, Russia’s manufacturing branches were almost completely cut off from world markets, both by the Cold War and by Soviet planning. When post-Soviet Russia opened itself to trade, its industrial enterprises lagged far behind cutting-edge technologies, especially in the dynamic information and communications technology (ICT) sector.

Many industries collapsed, owing to neglect, lack of international partners, and financial chaos. Those that survived did so only barely, with greatly reduced output going mainly to the ex-Soviet market.

Russia has the know-how, skilled engineering, and natural-resource base to become a global competitor in a range of major high-tech industries, including nuclear energy, commercial aviation, commercial space technology (including satellites and GPS), ICT hardware and software, electric vehicles, high-speed rail, petrochemicals, and heavy equipment for the mining and hydrocarbon sectors. All of these industries will benefit from the potential for enormous demand growth in large markets, such as China, Africa, and India.

But achieving long-term growth led by high-tech industries requires a business environment that encourages private-sector investment, including openness to foreign players. Moreover, the social and political environment must be conducive to a high-tech labor force, providing an attractive quality of life, ensuring civil liberties, and supporting entrepreneurship and creativity. Finally, economic policies must promote technological advances and global technical cooperation in promising sectors.

It is notable that Russia recently completed an agreement to finance a nuclear power plant in Hungary, and looks likely to do the same in Turkey. The demand for nuclear energy will grow as part of the global effort to decarbonize the world energy system. Russia’s new reactors seem to be safe and competitive with those produced elsewhere. Similarly, we might see new Russian-built civilian aircraft entering the global market in partnership with international firms, especially those that can work with Russian companies on advanced ICT avionics.

Back in 1991, many thought that Russia could not end high inflation, adopt a market economy, or compete effectively in world markets. Two decades later, Russia has proved the skeptics wrong. Yes, Russia remains too dependent on oil and gas, and should move further on transparency, openness, and competition in business and governance. Yet the trend is positive: Russia has become a stable, high-income market economy, with strong prospects for decades of rapid GDP growth and high-tech progress if it pursues a sensible economic strategy in the coming years.

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  1. CommentedLeo Arouet

    I agree. La transición rusa fue aprovechada por el FMI y Estados Unidos, que buscaron sobre todo llevar a la banca rota a Rusia. Debido a estas situaciones, ahora se ve a Rusia con un alto resentimiento. La expoliación de Rusia también es denunciado por Joseph Stiglitz.

  2. CommentedEvgeniya Mogilevskaya

    Jeffrey, this is the top news from Russia now: banning the Internet. Use Google translator and enjoy: http://dolboeb.livejournal.com/2649463.html

    You can also check this one, just next door:
    https://www.project-syndicate.org/commentary/sergei-guriev-breaks-down-the-direct-and-indirect-costs-of-russia-s-intervention-in-ukraine

  3. CommentedEllie Kesselman

    Professor Sachs, I am puzzled by your vehemence in attributing Russia's imperfect economic transition to U.S. and IMF incompetence. I don't recall such strongly negative sentiment expressed by Russian emigrants to the USA or Europe. The opinion columns of RT, the online news presence of Russia Today, are not favorable to the U.S., yet they do not assign blame as directly as you.
    * You are certainly correct about the shameful plundering of Russian state-owned oil assets.

  4. Commentedtemesgen abate

    an affidavit of the ever present play of geopolitical maneuverings in finance.the fact impinges on the flaunted disinterestedness of Bretton woods institutions. the author paints a rosy picture of Russia but compare it with one by Jan Winiecki,``Russia`s last act`` .it does not expire easily both are reading the same referent. there seems an epistemological leap in economics viz.,it has entered in to a play of significations untethered from the REAL.

  5. Portrait of Michael Heller

    CommentedMichael Heller

    In the good old days of the neoliberal interlude, before the western welfare state juggernaut regained ascendancy with a fancy new range of stylish moral hazards which would eventually cause the global financial crisis, Jeffrey Sachs made a name for himself as an advocate of shock therapy for countries transitioning out of socialism and dirigisme. It’s interesting to read his retrospective piece on Russia at Project Syndicate. Sachs had already warned in the mid-90s that Russia faced even graver risks than, for example, Poland because of its levels of criminality and the peculiarities of its political system and economic profile. It was perhaps disingenuous of Sachs ever to have expected open-handed generosity towards Russia from it’s cold war enemies. What is more important, I think, is that the theory of rapid stabilisation and structural adjustment which Sachs proposed was the correct one. With good leadership Russia could do this alone. So it is heartening now to read Sachs indirectly validating the original position with this analysis of Russia’s progress towards market economy, and its positive results as compared with China. Clearly now is the time for Russia to rediscover neoliberalism and give new impetus to 2nd and 3rd phase structural economic (Doing Business) and institutional (Good Governance) reforms -- with dollops of Schumpeterian creative destruction.

    It is important for all of us to remember why Russia was *different* in the 1990s. Revisiting the debates of the period would be of benefit to countries in the European fringe and developing countries throughout the world which need to complete several sequences of capitalist transition. The comparison with Latin America was especially instructive. Privatisation in Latin America was often rushed, and the bulk of the relevant regulation naturally followed privatisation rather than preceded it. Milton Friedman, whose ideas helped shape the world’s earliest neoliberal reforms in Chile, commented in 2002 that “privatisation is meaningless if you don’t have the rule of law”. He was referring to privatisation in Russia which created huge private monopolies with enough power to re-centralise market planning in private hands. It’s clearly true that privatisation will not promote long-run growth without ‘rule of law’.

    Yet three counterarguments are relevant in the short run. First, there are good reasons why market expansion is itself the pressure mechanism for the evolution of modern institutions. Second, when a country has a post-crisis opportunity to privatise rapidly it would be unwise to delay until the legal-regulatory system can be established. This, in essence, was the advice some economists, including Jeffrey Sachs, offered to Eastern European countries in the 1990s. When discussing the Russian privatisation experience, Hay-Shleifer-Vishny (1996) wrote: The effective political pressure for legal reform appears only after privatization ... The politically feasible order of institutional reform is privatization first, legal rules second, and bureaucratic reform only in the very long run.”

    A third argument is relevant to the discussions of Latin American and East Asian market reforms. Countries in both these regions did not face very high risk of criminality that former socialist countries ran in the 1990s. Premodern norms in the Asian and Latin American state institutions were clearly not perfectly compatible with market reforms. Yet the existing basic framework of state legal-administrative structures was sufficiently evolved to sustain market reform. In sharp contrast, the institutions of socialist countries were already re-engineered to perform socialist functions. Fear, propaganda, secrecy, and totalitarianism had institutionalised doctrines, habits, and organisations that were opposed to market freedom. In that context, a loosening of socialist structures caused disintegration of political and economic order. In the resulting vacuum, new alliances permitted ‘robber capitalists’ to operate with impunity. The equivalent political transitions in Latin America and East Asia were different. Even during periods of authoritarian rule in the 1990s, economic reforms still had to be justified and legitimised politically. Although checks and balances were not sophisticated, there was quite intense legal, media, and legislative scrutiny of market-reform processes in Latin America. Existing institutions offered some protection against the severest abuses of economic privilege. This did not exist in Russia.

    On the other hand, there were clear similarities between Argentina and Russia. Looking at the mafias of politicians and robber capitalists who became dominant through market liberalisation in Russia or Argentina in the 1990s, it is difficult to accept the claim that market expansion will of itself produce desirable market ethics and laws in the short run. It is easier to give credence to this apparently controversial claim about historical sequencing if it is kept in mind that the Russian and Argentine mafias created narrow monopolistic markets by capturing state agencies responsible for deregulation, and by hijacking the bidding process for the privatisation of public enterprises. The model of policy sequences I proposed in my book ‘Capitalism, Institutions, and Economic Development’ requires policy technocrats to be more appropriately motivated or incentivised, and (most importantly) to have knowledge of the sequence, so that they are not blindly muddling through, and are not hostage to interest groups. Robber capitalists are really no different from the rest of us. They know ‘honesty is the best policy’. The problem in Russia and Argentina was that existing institutional incentives neutralised that principle. Market competition was absent. The unravelling of socialism in Russia and the unravelling of statist-corporatism in Argentina in the 1990s created institutional vacuums where fresh alliances for regulatory capture and rent-seeking could be forged, allowing robber capitalists to control new markets with impunity.

    An ideology that promotes the market ethic can be the instrument for prising open a closed economy. I notice that Vladimir Putin has a new Sochi skip in his step. Maybe Russia can be strong after all. Maybe Putin should hire Sachs and give Sachs a new skip in his step, a neoliberal skip, a revisiting of the youthful idealism! They could skip together through Sochi singing ‘we must not skip the neoliberal sequencing’. Now that it has been proved true ...

    1. CommentedEllie Kesselman

      Mr. Michael Heller, you believe that It was,
      "perhaps disingenuous of Sachs ever to have expected open-handed generosity towards Russia from it’s cold war enemies."

      You are an expert with a good reputation. I am merely a widow in the hinterlands, so I can be blunt. I think you are correct; it is not "perhaps", but rather, entirely disingenuous for Sachs to have expected such generosity from the USA towards Russia at that time.

  6. Commentedhari naidu

    Jeffery I share your optimistic outlook on developments in Russia. However Putin will have to demonstrate that he’s left-behind his ex-KJB affiliation and the raison d’etre ex-Soviet Union. Putin is a political prisoner of cold war period….



    I am reproducing below (extracts) from Moscow Expert Magazine interview with present Iranian Ambassador in Moscow (10 Feb 2014)



    *Iran, Russia have vast potential to boost economic ties: (Iranian) ambassador*



    Q: What areas of economic cooperation, in your opinion, are the most promising?

    Economic cooperation is conventionally divided into two parts -- trade and industrial production. In both areas we have joint projects.

    So, there is a mutual understanding on the construction of the second unit of the Bushehr nuclear power plant. There are some serious prospects in the automotive industry. We are interested in cooperating with the Russian automotive industry and are willing to make joint investments in various projects.

    There are prospects for extensive cooperation in the energy field. Russia can work in the Iranian oil and gas sector, buy hydrocarbons from us for some of its regions, or to invest in our industry. Russian companies have already worked on this market, but quickly folded up shop due to the sanctions imposed against us.

    In addition, we can cooperate on energy issues in the Caspian Sea region. Finally, we can buy a few hundred megawatts of electricity from Russia.

    Another area is the railways. We need hundreds of kilometers of railway tracks, and we currently are buying them from other countries, when we could buy them from you. We also want to electrify our railroads, and Russia has vast experience in this field.

    Finally, we need grain. Russia also could capture a significant part of this Iranian market, but unfortunately, it hasn't yet.



    Q: Russia is actively returning to the Middle East, and this return is welcomed by a number of countries. What does Iran see as our place and role in the region?

    A: After the collapse of the USSR many criticized Russia for its lack of a clear and consistent policy in the Middle East. But for the past last two years and even now Russia has had a position appropriate for its status in the region, particularly with Syria. Now Russia is entering a new phase in its Middle East policy, and does so with close consultation and cooperation with Iran. Our cooperation in the Middle East has produced very good results. We hope for similar cooperation in Central Asia and the Caucasus

    =====================================================================================



    If Putin’s Russia is capable of delivering bankable project technology transfers, as listed by Iran, it could become the way forward for Moscow’s global industrial cooperation with EM.

  7. CommentedMr Econotarian

    "Yet Russia also has vast and still under-developed potential in many global high-tech industries."

    Perhaps if Russia wasn't run by a anti-gay megalomaniac, if it didn't score 127th out of 177 countries in Transparency International's corruption index (worse than China and India), if it didn't score "Not Free" in Freedom House's Freedom in the World Index, if it didn't score "Mostly Unfree" on the Heritage Index of Economic Freedom, etc.

    Change some of these things for the better, and perhaps high-tech people would prefer to stay in or move to Russia instead of working hard to get the heck out ASAP.

  8. CommentedEvgeniya Mogilevskaya

    Jeffrey, even if Russian authorities decide (all of a sudden) to stick to your recommendation, the starting point will be effectively zero, if not worse even. To think the way you are presenting here, is one of those macro view mistakes. Check 6may.org, ask how many entrepreneurs and scientists are in jails and prisons (here is a link in English: http://www.bbc.co.uk/news/magazine-18706597), ask why drivers in Moscow spend 15-20% of their lives in traffic jams to learn more about the business environment in Russia nowadays.

  9. CommentedVal Samonis

    Jeffrey, current China-Russia per capita differences are almost fully due to Russia's natural resources (and absence of them in China) under the conditions of horribly declining Russian demographics (emigration, vodka, smoking, HIV, etc.). In terms of current and future development potential, there is no comparison between China and Russia.
    Greetings from Toronto,
    Val Samonis
    Formerly Stanford Economic Transition Group (to Mr. Nemtsov)

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