Russia Profile
www.russiaprofile.org
September 24, 2007
For Want of Proper Governance
Russia's Economic Future Depends on Decisions Made Now
By Felix Goryunov
Felix Goryunov is a Russian journalist who has been observing the world economy for over 30 years. Now he runs an English language website www.rusbizconf.com covering Russia's economy and investment opportunities.
Among the many policy issues facing the new Russian government, two stand out as priorities fighting corruption and tightening the state's control over the economy. Both issues are of acute public concern, so addressing them will provide good publicity for the new cabinet in light of the upcoming parliamentary elections.
It would be a mistake to see fighting corruption as only a pre-election publicity stunt for the new government. It can, of course, be implied that the past government bears some blame for corrupt practices in general and graft in particular because it was not vigorous enough in curbing red tape, but the problem of corruption has assumed larger significance not only because of its endemic proportions, but also because it has become a national security risk, endangering political and economic stability.
Stability at risk
Occasional outbursts of political unrest in Moscow and other regions in recent years were caused primarily by anger at corrupt practices, ranging from extortions by police, embezzlement of money by construction companies or the illegal seizure of property by raiders backed by local authorities. The belief that the Russian people were grossly cheated during the privatization of state property in the early 1990s and are still being robbed by public servants of all ranks is deeply rooted in society. This certainty is constantly confirmed by reports of government-friendly tycoons buying foreign soccer teams and yachts and of senior bureaucrats going on lavish vacations at foreign resorts.
The economic impact of corruption is no less significant. Some economists claim that the amount of corruption in Russia is equal to the annual budget. Although this may be an exaggeration, corruption's detrimental impact is being felt in all spheres of economic and social life. Corruption boosts investment and operating costs, contributes to high inflation and largely decreases the domestic and global competitiveness of Russia's economy. The fact that the level of corruption in Russia is only a little higher than in other members of the BRIC group of emerging economies will not be a consolation once the country joins the WTO. Thus, fighting corruption in earnest instead of taking arbitrary counter-corruption measures is the first priority for the new cabinet.
There could hardly be a better man for the job of tackling corruption than new Prime Minister Viktor Zubkov. He is known for his high managerial record at the Taxes and Duties Ministry and at the Federal Service for Financial Monitoring, which he has headed since 2001. It was thanks to his efforts that Russia became a member of the global financial police agency. For the new prime minister, creating a counter-corruption federal task force may be a way to restrain these malignant practices.
For the Russian ruling elite, fighting corruption has become the order of the day for another vital reason. During President Vladimir Putin's two presidential terms, a post-Yeltsin wave of redistribution of industrial property between new political and business clans has been all but completed. The current sway of corruption endangers the achieved status quo and may end the ceasefire between constantly feuding factions in federal and regional establishments. With elections pending, a consolidation of executive power is especially important for the acting president, who does not hide the fact that he wants to stay in control. There is no doubt that after presidential elections in March 2008, Putin will use a legitimate way of keeping his finger on Russia's pulse without alienating public opinion at home and abroad.
In this respect also Zubkov is the best man for his job. It seems clear that he was chosen by Putin not only because they are old friends, but also because he does not belong to any of the ambitious factions in the presidential administration. It is also likely that Zubkov's past experience as a collective farm manager and bureaucrat in Leningrad Region was another point in his favor. This managerial know-how has been in short supply in the Russian government and is badly needed now that Russia's economic strategy has been defined.
Putin's road map
The strategy is a part of the five key national goals now widely publicized as Putin's Plan. They were laid out by the president last April in his annual Address to the Federal Assembly and have become an election banner for both pro-Kremlin parties, United Russia and Just Russia. Boris Gryzlov, Chairman of the United Russia party and speaker of the State Duma, described the core goal of Putin's economic strategy as "building up a competitive economy." This encompasses the development of innovative businesses by encouraging R&D, through increased investment in high-tech industries as major drivers of economic growth and by improving infrastructure and encouraging small enterprises.
This strategy has already been carried out by policies in such sectors as shipbuilding, manufacturing of civil and military aircraft and the development of nanotechnologies. Larger funding is considered for aerospace, defense industries and information technologies. State-owned companies are being established and lavishly funded in order to accelerate the development of high-tech products and services. State venture financing will also be provided to private businesses by state-run development banks and through easier credit facilities for SMEs.
Though somewhat reminiscent of Soviet five-year plans, these pro-active industrial policies are not aimed at creating a state-controlled economy. As Putin explains, the state is just offering support to industrial sectors that depend on government contracts or need its expertise and financial assistance. The major aim of these policies is to jump-start high-tech ventures and provide them with the long-term start-up capital that is not available in financial markets.
A similar approach can be seen in the development of Russian regions. The RBC Daily reported recently that a direct investment fund, "Development of Russia's South," is now in the making. Besides state-owned Development Bank and Vneshtorgbank, private banks MDM and Uralsib have become the fund's major contributors. At the project's initial stage, the banks will invest about $100 million into regional agriculture, construction and tourist industries as well as transport networks and utilities. There is no doubt that another huge program, "the Development of the Far East and the Lake Baikal Region," slated to be carried out in the next six years, will soon be funded in the same manner.
Liberal strategies on hold
Once the high-tech and regional programs are duly conditioned by domestic capital outlays, international funds in the form of foreign direct investment (FDI) and long-term credit facilities are expected to be invested into specific projects in order to capitalize on new business opportunities. Despite this proposed policy, some Western media have alleged that Russia is not encouraging foreign investment and point to the draft law on foreign investment in the so-called strategic industries, which is currently being discussed in the Duma. However, at recent press conference held by the Association of European Businesses in Russia, European lawyers express different concerns. It is not the considerable number of industries considered strategic and in which foreign capital would be restricted to minority shareholding that worries them, but rather the clear wording of the procedures and tactics of the law's enforcement by government agencies in order to prevent arbitrary application. They say that foreign investors want to be sure about the risks of committing money to sensitive Russian industries and projects prior to their decision to invest.
In view of restrictions on foreign (non-EU) investment in the European energy sector now considered by the European Commission, Russian legislation and practices seem liberal. Additionally, Bloomberg recently reported that German giant E.ON and Gazprom are going to spend a combined $8.58 billion to each to gain control of a Russian power generator. Earlier this year Italy's ENI acquired a sizable chunk of Russian power generating assets as state-owned monopoly UES exits the industry. The $120 billion of investment needed to upgrade and expand power generation and the power grid in Russia is supposed to be attracted from domestic and international capital markets.
No less illustrative of Russia's true investment policies is a recent report that Aricom Pl, formerly a division of Peter Hambro Mining, is becoming a partner of Oboronimpex, a daughter of Rosoboronexport, Russia's weapons exports monopoly, in the exploration and development of such strategic raw materials as tungsten, molybdenum and tantalum in the Russian Far East and abroad.
However, these deals between Russian state-owned enterprises and multinational companies have not yet dissipated fears that the government wants to increase its control over the economy, a policy that may put Russia's further integration into global economic structures at risk. It is well known that along with encouraging private enterprises that have proved their efficiency in ensuring the robust and sustained economic growth of past years, the Russian government is set to rely on state investment to bolster the creation of a knowledge-based economy. There is also a trend towards expanding state-ownership in the most lucrative industrial sectors such as oil, gas and rare metals. The government has also been nationalizing failing private firms such as Avtovaz and some civil aviation concerns.
Increasing the government's role in the economy will be a top priority for the new cabinet and this has both positive and negative aspects. It is surely a waste of time to read all the speculation of economic and political thinking in the Kremlin, but it is obvious that strengthening the state is one of the products of the power-sharing framework and vested interests among Russia's top elite. However, the current resurgence of statism has little to do with the supremacy of state interests over those of individuals, which was the ideological base of the communist regime. Contemporary Russian decision makers are motivated by bourgeois desires as well as by national interests that are, they believe, best realized in Realpolitik. Put simply, this means doing what is practically useful at the moment.
Old blueprints and new stumbling-blocks
Liberal economists have written volumes proving that private enterprises are more efficient than state-owned ones, but proof to the contrary abound.
The passenger trains of Swiss Federal Railways run with the accuracy of a Swatch, a situation that can only be envied by Amtrack, the American state-owned railway. Norway's Statnett is one of the most advanced stem power grids in Europe. Major Scandinavian telephone company Telia Sonora is 43.5 percent owned by the Swedish government and 13.2 percent owned by the Finnish state. In comparision, Russia's mobile telecoms market is an oligopoly of three major private operators. But the prize for most efficient state-owned enterprise goes to Sredmash, the Soviet Medium Machine-Building Ministry, a huge conglomeration of defense companies that developed and manufactured hundreds of high-tech products - from breeder reactors to missiles.
It is not the form of ownership per se that determines the success of a business. Its prerequisites include the availability of resources, good management and competition. In the case of Sredmash, all these factors were present. The Soviet government rarely spared on defense spending; the ministry's senior executives and company CEOs were scientists from academia with proven managerial talent; the conglomeration faced the fierce competition of the Cold War arms race. It was thanks to this combination that the Soviet Union achieved a strategic balance with the United States. Now that Russia is facing global competitive challenges and finds itself lagging behind in knowledge-based industries, it is only logical for Kremlin strategists to shake the dust from these old blueprints especially since the windfall of oil revenues can provide the resources for building an innovation economy.
After defining an economic strategy, setting competitive goals and securing funding, it may seem that the only thing remaining for the state to do is to set the wheels in motion through energetic management, but it happens that the governance of Russia's economic engine has become the main stumbling block to implementing the strategy. This is primarily due to the second-guessing among top decision makers on how national economic goals are to be achieved.
As an example, consider two giant Russian monopolies UES and Gazprom. Utility giant UES has already begun selling assets in preparation to dissolve its monopoly and create a competitive domestic utilities market. This is not the case with Gazprom, whose management behaves in the spirit of a well-known saying: what is good for the concern is good for the country. While Gazprom's state-enforced expansion into energy projects at home and abroad is now seen as no less than a menace to Europe, the efficiency of the monopoly's performance raises questions. During the first half of 2007, natural gas output in Russia rose by just 0.1 percent year on year whereas GDP growth this year is expected to increase by 7 percent.
In view of the increasing prices of natural gas, which contribute to persistent inflation, the creation of a competitive market in this sphere should be no less an important economic policy goal than the end of the UES monopoly. But the issue is not even discussed. Similarly, it is considered acceptable that quite a few state-owned concerns and banks are heavily borrowing in international financial markets in order to expand their business through leveraged buyouts of private companies. By some estimates, Russian corporations, mostly state-owned, have already borrowed abroad about $400 billion, straining the country's external payments position.
Such corporate behavior, contradictory to national interests, could hardly be possible without a go-ahead from the Kremlin. This conflict of governance practices is exemplary evidence of the exposure of Russia's elite to the pleasures and ills of capitalism. The majority of top managers and board members of major state-owned corporations are political appointees or cronies of highly placed government decision makers. Besides receiving lavish salaries, these managers own sizable packages of corporate assets and readily capitalize on share options schemes. So the value of corporate shares in the equity market and overall capitalization of a corporation, which depends on its size, are matters of personal concern. How wealthy Russia's top public servants have become thanks to the system of governance can only be guessed at, but the negative effect of this system on the realization of a national economic strategy is undoubted.
The silver lining in this cloud of vested interests constraining Russia's march towards a more advanced and civilized economy is that they are sure guarantees that there will be no return to a Soviet-style economy.