A Question of Diversity: Growth is High, But Narrow

The search is clearly on for ways to buttress and increase growth in Russia’s economy. If GDP is to grow in accordance with targets set by President Vladimir Putin, doubling the figure in the space of 10 years, then average growth will have to be about 7.2 percent per year. Government members, primarily Economic Development and Trade Minister German Gref, warn that achieving these targets will be difficult, if not impossible, without some fundamental changes in the country’s economy.

In the midst of a spat with Prime Minister Mikhail Fradkov at the end of August, Gref took the stance that the economy is clearly too dependent on oil revenues and that more has to be done to promote diversification if economic growth is to be maintained. Figures from Russian-based Alfa Bank show that excess income generated by high oil prices accounted for 3 percent of the 7.3 percent growth in GDP in 2003.

Reducing the country’s dependence on commodity exports, particularly Russia’s staples of oil, gas and metals, however, is easier said than done. Russia’s oil production and oil and gas exports are set to increase further over the next 10 years on the back of rising demand for gas in Europe and oil and gas in Asia – especially if the necessary pipelines and infrastructure are built to remove the existing constraints and bottlenecks to higher production and exports and to handle the increased output in the future.

So even if oil prices fall, the volume of oil produced and exported will almost certainly continue to rise due to increased demand in Asia as strong economic growth and industrialization continue. Much the same applies to gas – with Europe keen to switch to the cleaner fuel, demand there also looks set to increase.

One school of thought on the subject is that the high oil prices in recent years and the even higher prices in 2004 actually hinder growth – the so-called “Dutch disease” – pushing the value of the ruble higher, making exports more expensive and harming the country’s competitive position, as well as crowding out investment in other sectors.

Gref, however, has argued that a weak ruble would have preserved the old economic structure and hindered programs which are intended to improve living standards, while a stronger currency means that Russian exporters will just have to work all the harder to maintain their competitive edge by becoming much leaner.

Another argument favored by the Dutch disease school is that the high oil prices greatly ease the pressures on the state budget, reducing the imperative to reform and diversify the economy, a view the World Bank put forward in its annual report on Russia published in February.

But why low oil prices and consequent pressure on the budget should force the Russians into action is in any case unclear. In the Middle East, the Arab oil producers and Iran have singularly failed to diversify their economies over decades, although such comparisons are odious at best and Russia can boast a much more developed economy than they can.

In any event, the World Bank and others warning about Dutch disease seem out of touch with Russian political reality. As Gref himself has pointed out, one of the biggest obstacles to reform in Russia is the weakness of the state and its profound inability to push through change. Reform is always likely to be hindered, as in any polity, by vested interests and incompetence.

So the Russian economy continues to be dogged by major structural impediments despite the considerable progress made on correcting imbalances since President Vladimir Putin came to power. In a speech to a joint meeting of the Ministry of Economic Development and Trade and the Finance Ministry in March, Putin said that the excessive administrative interference in the economy had to be reduced.

But to diversify the economy, Russia needs to encourage the development of small and medium-sized businesses (SMEs), which form the backbone of the German economy and account for most jobs in the United States. But lacking the financial resources and high-level contacts enjoyed by the big oil, gas and metal companies, Russian SMEs in particular suffer from inadequate property rights, bureaucratic arbitrariness and a host of legal problems.

The Russian government is in the throes of a massive administrative reform aimed at making the government and administrative apparatus much leaner by cutting back the number of ministries, deputy ministers and bureaucrats, with the ultimate goal of making the state much more efficient and reducing the rampant corruption in the country. At the same time, the government is continuing with its privatization policy of divesting its stakes in a number of large companies to earn revenue, further reducing the role of the state in the economy and increasing competition in the private sector.

Meanwhile, you do not have to be an economist to see that the Russian economy is developing and diversifying. A stroll through Moscow reveals the boom in construction (much of which is of course related to the petrodollars), retailing and mobile telephony. Banks are falling over themselves to offer consumer credit and are more willing than ever before to make loans to business.

In his speech to the two ministries, Putin mentioned stimulating high-tech, so Russia could be set to develop offshore computer programming. Local computer specialists argue that Russian programmers are much superior to their Indian counterparts, since they receive a more thorough university training in mathematics and physics.

But for the moment, while domestic investment and capital expenditure have been rising, they still remain far too low, and far too much of domestic consumer demand, for instance, is met by foreign imports. If Russia wants to achieve higher – and better quality – growth, it must seriously develop its domestic industry and services and begin moving up the value chain, rather than relying on exports of crude oil and its other natural resources. Only time will tell whether the government’s reforms will bring about the desired results and give business the scope it needs to develop.

Special to Russia Profile, an online and monthly print magazine dedicated to Russia and published jointly by RIA-Novosti and Independent Media, Moscow.

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