International Politics

	Vol. 226 No. 7
JACQUES SAPIR, CONTRIBUTING EDITOR, FSU

Russia’s economy is sick. There is no doubt that the recent sentencing of former Yukos CEO Mikhail Khodorkovsky to nine years in jail, after a six-month trial, is attracting much discussion in the Western media. However, looking at the real Russia, not the one you can see in your newspapers or by talking with English-speaking “Westernized” Russians, the end of Khodorkovsky’s trial could well be a non-event.

A crisis is looming in Russia. But this is in no way connected to Khodorkovsky. The country is now suffering a deep attack of “Dutch Disease.” Government officials have been unable to address the situation and its consequences.

A glance at statistics is like plunging into a schizophrenic world. On one hand, official data show Russia’s GDP is growing, probably more slowly in 2005 than in 2004, when the growth rate exceeded 7%. However, the forecasted rate would still water the mouths of most Western leaders. Industrial production, too, is supposed to increase at a 4.5% rate this year.

Yet, Russian industries are stagnating or even entering a new depression. Layoffs will reach 4,000 people at the AvtoVaz automobile assembly company, and probably the same figure will occur at IzhAvto, another auto firm. The UAZ company had a loss of $2.5 million for first-quarter 2005 after registering good profits in previous years. The picture is bleak, and could extend to much of manufacturing and engineering.

Why is it happening now? Private consumption is still increasing. Since January 2000, household consumption has increased, in real value, more than 40%. The domestic market looks buoyant. But Russia’s economy is sick, and it is not related to institutions, ownership rights or Khodorkovsky’s trial. Oil and gas, and raw materials generally, have been the reason for Dutch Disease.

Maybe the phenomenon never has actually been Dutch, even if it was first discussed in the mid-1960s, when North Sea gas fields boosted Netherlands export revenues. However, the chain of events is well known, and has been discussed in many publications. Raw material export revenues, when they return to the country, propel the rate of change in ruble valuation even faster. Internal competitiveness declines fast, because labor productivity cannot emulate such a move.

At the same time, the exporting sector can offer much higher wages to workers. Naturally, wage-earners in the rest of the economy ask for increased incomes. This is detrimental to competitiveness and can lead to inflation. Then, manufacturing slows down and collapses progressively. Thus, the raw material sector – in this case oil and gas – will have destroyed the rest of the economy.

Fig. 1. Mikhail Khodorkovsky is the least of Russia’s problems.

While oil and gas prices were moderate, “Dutch Syndrome” was not an issue for Russia. Actually, Russian growth from early 1999 until 2002 was quite balanced. The energy sector was not dominant, and manufacturing industries pulled the country ahead. This situation changed after the summer of 2002. At first, most foreign observers focused on how energy export revenues boosted the Russian state’s budget. Few people raised concerns.

By 2003, actual over-valuation of the ruble began to be felt in Russian industries. The situation began degrading fast in 2004, but the previous growth impetus shielded this reality, at least until October. The 2004 – 2005 winter was a season of discontent. This spring has been no better. The end of 2005 could be really bad. One question arises – if this situation is so well known and analyzed, why are Russian officials not reacting? Actually, they did react, but unconvincingly.

The Ministry of Finance enacted a Stabilization Fund to prevent much of the exports’ inflationary effects. But this was a partial answer to a global problem. The main link was the rate of change in ruble valuation. Neither the Minister of Finance, nor the Minister of Economic Development, was ready to change the rules to prevent over-valuation of the ruble. What could have been smoothly implemented last winter will probably come harshly at the end of this year. 

This is only one part of the story. If Ministers Alexei Kudrin and German Gref failed to react adequately when needed, it is also true that strategic economic thinking has been confused in Russia’s power structure. Nobody doubts that President Vladimir Putin is seriously committed to economic modernization and development. However, setting ambitious goals is easy. Defining the tools to reach them is the real test.

Since last January, there has been a lot of talk about restructuring the energy sector. The Gazprom-Rosneft merger is just one example. This has been announced, then countermanded. No doubt, some restructuring is needed. Another reality is that Russia has strategic interests with China and India, as well as with Western Europe. But making long-term strategic plans, when your own economy is collapsing under your feet, is not good policy. This is not policy at all.

Dreaming about strategy is cheap. Amateurs talk about tactics. Professionals talk about logistics. Russia is no Saudi Arabia. The country’s real backbone is its industrial base. Allowing oil and gas to weaken or even destroy it will have dramatic consequences.

So, forget Mr. Khodorkovsky – no longer a player, just a remnant of past times. Russia will enter a serious storm by the end of 2005. This is not connected to so-called “Putin authoritarianism” or, as some Western media say, backtracking from reforms. The Russian form of Dutch Disease must be addressed quickly, or it could get out of control. 

Jacques Sapir is professor of economics at EHESS-Paris and at the Higher School of Economics in Moscow. He is a regular contributor to this column.