Saturday, November 1, 2014
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Moving Beyond Putinomics

MOSCOW – Dmitry Medvedev’s election as Russia’s new president was virtually guaranteed. Whether or not he can improve Russia’s economy after he takes office in May is far less certain.

To be sure, Vladimir Putin’s administration appears to have left Russia’s economy in a rosy state. Economic growth averaged 7.2% between 1999 and 2008. Foreign reserves stand at 30% of GDP and are the third highest in the world in absolute terms. The stock market has increased twenty-fold. The middle class is buying foreign cars, vacationing abroad, and dining at sushi restaurants, and surveys show that life satisfaction has increased across the board.

Russia’s economic success is partly attributable to high oil and commodities prices. But oil is not the whole story. The tax reform of 2001 improved incentives to work and decreased tax evasion by introducing a flat 13% income tax – one of the world’s lowest. Liberalizing the procedures for corporate registration and licensing, and limiting inspections, improved the climate for small businesses and entrepreneurs. Conservative macroeconomic policy and financial-sector reform lowered interest rates and fueled an investment and consumption boom. Real wages tripled, and poverty and unemployment fell by half.

Yet Medvedev’s most notable pre-election speech – unusually liberal even by Western standards – recognized several economic challenges. Medvedev seems to understand that sustaining growth will not be easy: oil prices cannot rise forever, and the “low hanging fruit” of basic economic reform and prudent macroeconomic policies have already been picked. According to Medvedev, the only solution is to empower private initiative and innovation.

Inequality and corruption are the main obstacles. Despite Russia’s recent economic achievements, both remain at alarmingly high levels. According to Forbes magazine, there were 87 Russian billionaires, with combined wealth of $471 billion, a figure second only to the United States. Yet their net worth accounts for roughly 30% of Russia’s GDP, whereas America’s 469 billionaires are worth only about 10% of US GDP.

More importantly, inequality of opportunity is very high as well. According to a recent survey, a majority of Russians believes that acquiring wealth requires criminal activity and political connections. Only 20% believe that talent matters. These beliefs are self-fulfilling prophecies.

Aside from the relatively small middle class and the even smaller business and intellectual elite, most Russians neither take risks to become entrepreneurs nor favor economic and political liberalization. According to a recent large survey by the European Bank of Reconstruction and Development, only 36% of Russians support democracy and a mere 28% support market reform, by far the lowest among all transition countries on both counts.

The other major barrier to growth is corruption. In another World Bank-EBRD survey, 40% of firms in Russia reported making frequent unofficial payments, and roughly the same percentage indicated that corruption is a serious problem in doing business. Unlike in other emerging markets, corruption has not declined with economic growth; it remains as high as in countries with one-quarter the per capita income of Russia.

One reason for sustained corruption is that Russia’s powerful bureaucracy stands to lose too much from economic liberalization. Perhaps more importantly, it is hard to fight corruption without political reform, media freedom, and a vibrant civil society.

Remarkably, Medvedev is not wary of speaking about political liberalization. Indeed, he quotes Catherine the Great: “Freedom is the soul of everything. I want obedience to the law but not to the law of slaves.” He knows that the rule of law is a pre-requisite for sustainable economic growth and promises to build an independent and effective court system. In other words, his program is similar to Putin’s in 2000. Unfortunately, as Putin himself recently acknowledged, much of that agenda never materialized.

Implementing Medvedev’s program would benefit both Russia and the West. This latter point should not be forgotten, because the West’s interests in Russia have grown since Putin was elected: foreign investment is booming, the middle class is hungry for all things Western, and even Russian companies are investing abroad.

Russia is already a large market, and if growth continues, it will be eligible to discuss OECD accession in a few years. One lever that the West has is to condition membership on political and economic liberalization. Medvedev appears to understand that such a new burst of liberalization is in Russia’s interest as well.

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