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Alexei Kudrin: Debating controversial legacy of a veteran minister

Alexei KudrinAlexei Kudrin's deputy Anton Siluanov was appointed Acting Finance Minister on Tuesday. Since Siluanov is only known in expert circles, he will likely be an interim minister, unlike his former long-serving boss.

Analysts are divided over the ex-minister's legacy. There is both praise and sharp criticism for the projects he has pursued over the years. And there are reasonable economic arguments to be made on both sides of the debate.

Kudrin's failures and achievements

The list of Kudrin's achievements includes Russia's early repayment of its debts to the Paris Club, creating the Stabilization Fund, and the tax reform of 2000-2001, which included, inter alia, replacing the progressive taxation system with a flat tax rate, reducing the value-added tax from 20% to 12%, and repealing the 5% sales tax.

Foreign debt repayment and the accumulation of stabilization reserves are elements of the strict budget discipline which Kudrin always insisted on during his time as finance minister.

"[Kudrin] was keenly aware of the country's need to have a balanced budget," said Vyacheslav Senchagov, head of the Center for Financial and Banking Studies at the Russian Academy of Science's Economics Institute. "And so he applied his administrative weight to resist numerous attempts to lobby for increased spending."

However, many argue that Kudrin's fight for budget discipline and the sterilization of revenues in the Reserve Fund incapacitated the use of earnings from high world prices of raw materials to stimulate the real economy.

"He has a somewhat narrow understanding of what a balanced economy is," Senchagov said. "He thought that if he balanced the budget this would automatically balance the entire economy. In this, Kudrin differed from Witte [a Russian finance minister in the late 19th century. - Ed.], who knew that finance was only part of the economy and that balanced budgets must be accompanied by incentives for development."

Underinvesting in the economy resulted in the depreciation of infrastructure and fixed assets in key industries, such as the machine-tool industry, without which "any retooling, new industrialization and, in fact, even modernization are possible," the analyst said.

Save or spend?

The expediency of government investment in the economy is subject to debate, to say the least. "Kudrin has been accused of neglecting Russia's economic development," said Yevgeny Yasin, the Academic Supervisor of the Higher School of Economics. "Some argue that the economy needed more investment and that this should have been the objective of budgetary policy. I don't think this must be the objective of a budgetary policy, because there are special development institutions, for example Vnesheconombank, for this."

Yasin believes that economic development should come from private investment, and that government investment should be minor and made "only to fulfill government functions." A lavish budgetary policy can lead to an excess of money in the market without proportionate demand. The main result of this would be a surge in inflation.

Kudrin preferred using windfall profits from oil production to resolve the most painful problem of post-Soviet Russia - the huge foreign debt. In the early 1990s, its foreign debt exceeded 100% of the GDP but started to shrink rapidly in the early 2000s thanks to growing oil prices.

In 2006, the Russian authorities allocated over $21 billion for the early repayment of debts to the Paris Club. As a result, Russia's sovereign debt is now among the lowest in the world.

"Our current rating in the global economy is largely based on the fact that we have a very small sovereign debt," Yasin said.

The Stabilization Fund was another way to remove surplus money from the economy. The fund was split into the Reserve Fund and the National Wealth Fund in 2008.

"The idea was initially proposed by Andrei Illarionov, but it was realized at Kudrin's insistence," said Sergei Guriev, rector of the New Economic School. In his view, this helped Russia weather the economic crisis without sustaining catastrophic losses.

Size matters

Not surprisingly, some have criticized Kudrin for establishing the Stabilization Fund. "Kudrin invested all the oil and gas revenues, as well as revenues gained thanks to an incredibly favorable market situation, in other countries," said Oksana Dmitriyeva, a member of the State Duma Budget and Tax Committee. "This is probably why he is praised as the best finance minister abroad." The thing is that a considerable part of the Reserve Fund has been invested in U.S. and European securities.

This is not entirely true. Most economists agree that every country needs reserves, and that it is their size that matters. "In Russia, reserves often exceeded many macroeconomic indicators," Senchagov said.

The accumulation of huge reserves meant that this money could not be used for industrial retooling.

Furthermore, these huge reserves tempted the authorities to increase social and military spending, which Kudrin vigorously opposed, says Igor Nikolayev, chief strategist at private audit company FBK.

But is government investment really bad for the economy? It is worth recalling that government funds provided the basis for the rapid growth of Japan, South Korea, Taiwan and several other Asian economies. Their governments made up for the shortage of private capital, investing in key industries that subsequently became the drivers of their economic growth.

Analysts say that infrastructure development is almost always the government's responsibility. Government investment in roads, bridges and communications generates a good multiplier effect without spurring inflation.

And lastly, the Finance Ministry's rigid budgetary policy did not rule out lavish spending on bureaucrats and on support for ineffective enterprises, says Yevgeny Gavrilenkov, Managing Director of Troika Dialog. This made the budget more dependent on oil revenues and created an unfavorable macroeconomic environment that frightened off potential investors.

There is an argument against government investment in the economy rooted in specific features of today's Russia: the money accumulated in the Reserve Fund is not squandered and can even grow. "This money can be invested in Russia, but remember that it costs approximately $10-$15 million to build one kilometer of a road here, and that half of it, if not more, will be stolen," Yasin said. "In Europe, it costs $2.5 million."

But this is a question of the quality of the government. Unless we address this, both government and private investment will go down the drain and private investors (except for stock market speculators) will not invest in the Russian economy.


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