Panel Discussion at the Boston Meeting of Economists for Peace and Security (EPS), 4 January 2015

A couple of months ago, at Sochi on the Black Sea, I put the following question to Vladimir Putin:

Would you not accept that your biggest failure since you became President in 2000 has been your failure to diversify the Russian economy? Russia has dismantled the old Soviet industrial system without finding a hard currency replacement. Its economy is dependent on oil exports and is dangerously vulnerable to any fall in the oil price. What do you propose to do to make Russia an attractive place for Russians to invest in and not buy up real estate in London, sending house prices to insane levels?

Putin gave a long reply, in which he reeled off a lot of positive statistics but evaded the question. I faced no sinister visitations from men in black; my visa has not been suspended; in fact the exchange was reported on Russian TV.

Russia’s post-communist economic story is not entirely negative. Following the semi-criminal ‘shock therapy’ of the 1990s, the state recovered from the kind of economic and political crisis which might easily have brought about its disintegration. Personal consumption is above the 1989 level. The level of education is higher than that of most developed countries. Russia survived the 2008 global recession fairly easily. Nevertheless, the global economic crisis has made it abundantly clear that the Russian model of economic development has reached deadlock.
Russia is basically a petro-economy -Saudi Arabia with nuclear weapons as one wit called it. Its business model relies on unstable external rents derived from high energy prices. GDP and state revenues grow mainly in line with the prices of oil, gas, metals chemicals, timber and grain.
Two-third of Russian exports are oil and gas. Fifty per cent of government revenues come from taxes on oil and gas. Every $ drop in the oil price knocks $1.4bn off the state’s revenue.
The state is almost the only engine of investment. It pushes investment from above because of the lack of entrepreneurial push from below. The population is declining by 700,000 a year; there has been sharp shift in the interests of young people over the past decade from business to the civil service. The struggle for rents, the universal corruption, obstructs its economic development at all levels of government, including the regional one.

We can understand what has been happening to the Russian economy in terms of two well known macro models. The first is Walt Rostow’s ‘s stages of growth, based on capital accumulation. Russia is in danger of failing in its third attempt to ‘take off’ into self-sustaining economic growth, the first two being the silver age of 1880-1914 and the Stalinist ‘mobilization’ economy of the 1930s and 1940s. Since Putin came to power, the growth of private wealth has been far in excess of the growth of productive capital.

Secondly, the Keynesian model locates capitalist crisis in the excess of desired saving over desired investment. Over the decade of the 2000s private sector saving averaged 20% of GDP. Of this, one-third was exported abroad, and much of the remainder went into real estate and prestige construction projects. Investment in manufacturing and machine building has been meagre. Inward foreign investment has been deterred by the cost of doing business in Russia, as well as political risk, and has anyway gone mainly into oil, gas, and minerals.

In other words, over 10 years of high oil prices Russia has failed to find a way of putting its own savings to proper use, and has failed to attract foreign savings. As a result it has been ‘de-industrializing’ -something which started in the 1990s when its planned economy collapsed. Despite possessing some of the finest human and educational capital in the developed world it has failed to create anything like a ‘knowledge economy’ and it imports most of its high-tech.

The Russian economist Leonid Grigoriev makes a good point when he writes: ‘The debate over whether the oil rent is good or bad for development is fruitless. The rent in combination with good institutions is a development resource. The rent without adequate institutions is a risk of stagnation’ . This makes sense. The trouble is that oil rents undermine the incentive to create efficient institutions which encourage private investment, domestic and foreign. They enable a dysfunctional system to survive without reform. This is what analysts mean when they talk about the ‘oil curse’.
The Putin system of government is one that is integrally tied to the continuation of the petro-economy. The petro-economy has enabled it to pacify the property owning class by allowing it to keep most of the rents from rising energy and mineral prices. Very low income taxes have allowed the professional middle class to boost its personal consumption. And there has been enough left over for distribution to the power elite from the state budget. But the whole system depends on the price of energy and commodities, continuing to go up.
The pre-crash oil boom was Russia’s equivalent of America’s pre-crash real estate bubble, but much more toxic, since Russia is so heavily dependent on a single sector.

The following chart shows the price of a barrel of crude Brent in 2014 dollars since 1968:

You will see the jump from a $20 to a $40 barrel in 1973, with a peak of $117 a barrel in 1980. You will then see the first post-OPEC collapse from $117 down to $20 in 1986. This put paid to Gorbachev’s perestroika, which was based on accumulating foreign exchange reserves to finance domestic restructuring of the command economy. It also put paid to Gorbachev himself.
The low oil price persisted through the 1990s falling to $12.45 in December 1998. In August 1998 Russia devalued the rouble and defaulted on its foreign debt. Yeltsin resigned a year later -the second leader to go because of plunging oil prices.

The Putin boom years followed as the oil price rose from its 1998 low to $136 a barrel in June 2008. Then a collapse to $20 in 2009, followed by a quick bounce back. In June 2014 the price of a barrel of Brent crude was $115, it has now halved to $57, and speculators are betting on heavy further falls. The surplus on the stabilization fund which Russia accumulated in the good years limited the fall in output to one year, 2009; the recovery in the oil price enabled growth to resume; but Russia’s position is again dire.

The budget for 2014-15 is set to balance with a $100 oil price. Of course that’s an average over the year, which may still be achieved. But the bad oil news comes just as Russia’s oil industry joins its defence industry and banks in feeling the effect off US and EU sanctions. In retaliation Russia has imposed a ban on foreign food imports -which nevertheless continue through the porous borders of Belarus and Kazakhstan.
The central bank has given up trying to maintain the value of the rouble which has depreciated 30% against the dollar since end of November. Rouble depreciation hits at the biggest middle-class perk -access to foreign holidays. The Finance Ministry has been using money from the National Wealth Fund to buy shares in Gazprombank, VTB and Trust Bank. The Central Bank has been printing money to refinance the banks’ foreign debt, amounting to about $500bn. The economy is forecast to shrink by about 5% next year.

Putin has warned of ‘hard times’ for at least 2 years: but his policy errors of omission and commission have caused them.

He has failed to modernize the economy: the Putin system depends on not modernizing it, leaving it dependent on the oil price.

Putin’s rash Ukrainian policy has increased this vulnerability.

Let me end with a word about south-east Ukraine. I owe the following analysis to Christopher Granville of Trusted Sources, one of the acutest of Russian observers.
The Russian goal was never to detach, let alone annex this territory, as the Western media has supposed.Instead the idea all along has been simply to ensure that the rebellion remains undefeated by the Ukraine state. Russia has provided the separatists with sufficient military muscle to ensure this. When accused by Barroso in August of ‘invading’ the Ukraine, Putin said that if Russia had really invaded the country ‘we would have been in Kiev in a fortnight’.

The strategic aim behind the tactical support for the rebels has been to ensure that Ukraine remains ineligible to join NATO, since Ukraine does not control its own frontiers. In the collective mind of the Russian leadership, the strategic nightmare (whether objectively justified or not is beside the point) is the possible projection of US military power from Ukrainian territory.
This was the immediate imperative for the Russian move into the Crimea last March: the Ukrainian state had been captured by ferociously anti-Russian nationalists. The US had immediately recognised that revolutionary government. So not only might Russia’s rights in its naval base of Sevastopol be removed, but the whole of the Crimean peninsula (let alone the rest of the Ukraine) might quickly become available for US military deployments.

Since Moscow and Kiev agree that Donbass is legally part of Ukraine, it should be possible to negotiate a settlement of devolution for Donbass, provided the NATO expansion problem can be overcome.
That it’s not going to be easy can be seen from the following conversation between Merkel and Putin reported by a high German official:

Merkel: Can you guarantee that you will not attempt to make further changes of borders?

Putin: Can you guarantee that NATO will not expand further?

Merkel and Putin: There could be some discussion of a security cordon that separates permanently-based Russian and NATO forces by some hundreds of kilometres.
Merkel: The question of Crimea must be settled.