LetterOne LetterOne LetterOne

Russia’s economy looks increasingly like the old Soviet model it replaced, but it is actually more flexible, writes Petr Aven

At the beginning of the 1990s the Soviet economy was in crisis. Although GDP growth started slowing as far back as the mid-1960s, it was not until the late 1980s that it fell to zero before turning negative (-4.9 per cent) in 1990. By the autumn of 1991 the larger cities were facing a real threat of famine while the state was on the brink of bankruptcy.

It took such a desperate plight to force the country’s leadership into undertaking a genuine transformation of its economic model and, eventually, its political system. Under the guidance of Yegor Gaidar, architect of Russia’s market reforms,  the planned economy, with its centrally crafted production plans, regulated prices, non-convertible currency, foreign trade monopoly and almost total government ownership, was abandoned.

Today, the free market model’s radical difference from the one prevailing in the USSR for 70 years is no longer appreciated by a population which has forgotten the shortages and the penal laws that made buying and selling foreign currency a criminal, and even a capital, offence.

The institutions underpinning Russia’s market economy kept developing and strengthening up until the global economic crisis of 2008-2009. In the early 1990s the government carried out a ‘minor’, mostly voucher-based, privatization and by the end of that decade had completed a ‘major’ one which saw the main industrial assets pass into private hands. Government expenditure fell steadily as a share of GDP, declining to 31 per cent in 2006. A federal budget deficit turned to surplus. A tax reform was implemented. The exchange rate regime was fully liberalized in 2006. Business regulations grew progressively less onerous, which led to a moderate increase in the contribution of small and medium enterprises to GDP, from 12 per cent to 15-16 per cent. A private pension system was burgeoning.

Consistent strengthening of market institutions and the emergence of a sturdy entrepreneurial class were drivers of Russia’s economic success in the late 1990s and early 2000s. A crucial role was also played by rising oil and gas prices and the devaluation of the rouble in the aftermath of the 1998 debt crisis. The first years of the new millennium were among the best ever for the country’s economy.

From 1999 to 2007 real disposable income increased at a compound growth rate of more than 10 per cent. Car ownership increased more than five-fold, 10 million people started regularly spending their holidays abroad, and child mortality more than halved. It was this improvement in the quality-of-life metrics that handed a landslide victory to Vladimir Putin in the 2012 presidential elections.

The global crisis of 2008-2009 marked a shift away from strengthening market institutions towards heavier government intervention. The government deployed the country’s abundant international reserves to bail out troubled private companies that had lost access to western financial markets. While creating an illusion of the state’s omnipotence, the rescue of private business reinforced the rationale for re-nationalization, a concept that enjoyed greater social acceptance than the idea of merely bailing out the ‘oligarchs’ and letting them carry on.

As a consequence, the government regained control over some of the largest private companies, including the oil companies TNK-BP and Bashneft, bringing its ownership of the overall economy to more than 50 per cent (in oil production its share climbed from 11 per cent in 2000 to 55 per cent in 2014). Consolidated budget expenditure, which had been steadily decreasing through 2006, soared from 31 per cent of GDP to 41 per cent in 2009 and 38 per cent in 2014. The state-owned banks rapidly expanded their market share. However, the best illustration of the shift to heavier government involvement and greater paternalism is furnished by the rise in the number of public sector employees from 16.4 million in 2004 to 20 million in 2012 – 28 per cent of the workforce. Income growth in recent years has been largely driven by wage increases in the public sector.

It is in this employment structure and in the huge social security payments that Russia’s economy most closely resembles the later Soviet Union’s government subsidies and benefits, of which there are as many as 750 established by federal law alone, that make up 20 per cent of Russians’ incomes. Significantly, some of the social security payments, mainly pensions, rose at a record-breaking 30 per cent per year in real terms in the three post-crisis years. Indeed, the social sector already differs little from its Soviet counterpart and is being brought closer to it step by step. In 2013 and 2014 the government temporarily froze private pension savings, that is, it kept them for its own use. More recently, there have been increasingly insistent calls to abandon mandatory pension savings altogether. Healthcare remains virtually state-financed, with no insurance-based system operating in most of its parts.

Like its Soviet predecessor, Russia is lavishly financing inefficient investment projects, though it seems to have learnt from Soviet mistakes – it does not pay colossal agricultural subsidies, or pour billions of dollars into megalomaniac waterworks projects, or help ‘friendly’ regimes abroad. However, some of its projects cost way too much: the bill for the 2014 Winter Olympics has run to about $50 billion.

So is the Russian economy reverting to the Soviet model? On the face of it, it is. Both national traditions and society’s mentality are ‘pushing’ the budget closer to that of the Soviet Union. Its social security component remains essentially ‘Soviet’. Military expenditure has been growing (it accounted for 3.4 per cent of GDP in 2014, up from 2.0-2.5 per cent in the late 1990s). The public sector is drawing human and financial resources away from the private one. A huge capital outflow ($152 billion in 2014) and a lack of western investment, due in part to sanctions, have made economic growth critically dependent on government investment.

And yet, the reforms of the early 1990s have succeeded in establishing an economic model that is completely different from the Soviet one, even though it has inherited some of its elements and is converging with it in other areas such as pensions. Unregulated prices, a freely convertible currency, a still substantial private sector and the existence of privately owned banks ensure a degree of robustness that the Soviet system never enjoyed.

The flexibility of the current model virtually rules out the possibility of a Soviet-style economic collapse. This has been confirmed by the economy’s performance since the fall in the oil price and the introduction of sanctions: key indicators have come out much better than most experts predicted. Certainly, the economy is now in for a few years of decline and stagnation (experts forecast a 3-4 per cent drop in GDP in 2015), falling investment (already down 3 per cent in 2014) and contracting exports and imports. Inflation is bound to rise to 13-16 per cent, while incomes will fall (by 6-7 per cent in 2015).

Nevertheless, nothing like the economic collapse of 1991 is even remotely on the cards, nor is the threat of hunger and cold. That is, unless the government starts moving really fast down the road back to the USSR, by introducing price regulations, capital controls and foreign trade monopoly. This, fortunately, does not look at all likely as yet.

Petr Aven is a member of the Board of Directors of the L1 Group, he served as the Minister of Foreign Economic Relations for the Russia Federation between 1991 and 1992 and is co-author of ‘Gaidar’s Revolution’. This article appeared in The World Today, the magazine of Chatham House in June 2015 as part of Volume 71, Number 3.