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RISE OF CORPORATIST STATE IN RUSSIA (The 2006 Long Telegram) A. Illarionov Cato Institute, March 7, 2006 © Institute of Economic Analysis www.iea.ru “If you are not behind bars yet it is not your merit, it means the system does not work properly.” Russian people’s wisdom. “Our system must work better.” Russian government’s documents. 2 © ИЭА Historical analogies are usually subjective, never perfect, but provide valuable historical perspective to look upon today’s situation and possible future developments. 3 © ИЭА The 2006 Long Telegram: 1. 2. 3. 4. 5. 6. 7. 4 Periods in recent Russian history. Russian authorities’ Economic policy. Russian authorities’ Domestic policy. Russian authorities’ Foreign Policy. What made Russian economic boom? Russia’s Corporatist State. Russia is a member of G8. Which G8? © ИЭА The most popular question among business people in the 1990s up to mid-2003: What will be the exchange rate of Ruble tomorrow? Day after tomorrow? In a week? In a month? By the end of the year? 5 © ИЭА The most popular question among business people since mid-2003 and especially in the last two years: Is it not too late to leave the country? Should I leave Russia by the end of the year? In a month? In a week? Day after tomorrow? Tomorrow? Right now? 6 © ИЭА Overall diagnosis for Russian authorities’ current policies is Darvensazimus disease. 7 DARVENSAZIMUS is the disease that Illarionov says Russia has contracted. The name comes from the mix of:Dutch Disease, Argentinean Disease, Venezuelan Disease , Saudi Disease and Zimbabwean Disease. According to Illarionov, such nasty mix of economic, political and social distortions preclude Russia from being a member of the G-8, which is, after all, the most exclusive club of industrialized democracies. © ИЭА Darvensazimus disease is a very rare, complex and dangerous illness. It consists of at least 5 diseases: - 8 “Dutch” Disease. “Argentinean” Disease. “Venezuelan” Disease. “Saudi” Disease. “Zimbabwean” Disease. © ИЭА Combination of 3 diseases – “Dutch Disease”, “Argentinean Disease”, and “Venezuelan Disease” can be used for description of the current economic policy. 9 © ИЭА “Dutch Disease” – sustaining high rate of inflation and national currency’s real appreciation leading to “undesirable” structural changes and budget profligacy. 10 © ИЭА Higher oil prices led to a sharp increase in the inflow of financial resources into Russia... Value of Russia’s oil and oil products export 11 © ИЭА … to sustaining high money supply growth rate... Annual increase in M2, % 12 © ИЭА … to sustaining high inflation rate,.. Annual increase in CPI, % 13 © ИЭА … to fast real appreciation of Ruble exchange rate,.. Russian Ruble real effective exchange rate (July 1998 = 100%) 14 © ИЭА … to sharp increase of the energy sector role in the Russian economy,.. Value of energy exports as % of GDP 15 © ИЭА … to a relative decline of non-oil sectors’ share in industrial output. Non-oil output as % of industrial output 16 © ИЭА “Argentinean Disease” – use of “industrial policy” to “correct” “undesirable” structural changes by redistributing value added from energy sector into other sectors, primarily machine building 17 © ИЭА Beginning of industrial policy in Russia, 2002-2004: 18 • Increase in taxation of oil companies • Increase in government expenditure, including government investments • Setting up different government-regulated transport and energy tariffs for different sectors, industries and companies • Further differentiation of import duties • Introduction of import quotas © ИЭА The fastest growing item was government’s expenditure on military and police… National defense and police expenditure as a share of GDP 19 © ИЭА … as well as on administration. National expenditure on administration as a share of GDP 20 © ИЭА As a result, the number of bureaucrats and their share in total employment have dramatically expanded. Public administration as a share of total employment 21 © ИЭА The rise in government expenditures has also led to increase in non-market employment… Employment in non-market sector as % of total 22 © ИЭА … therefore reducing employment in market sector. Employment in market sector as % of total 23 © ИЭА While economic activities in processing industries sharply slowed down, expenditure on government administration, national defense and social security skyrocketed. Growth rates in value added by sectors, % 24 © ИЭА Implementation of “industrial policy” led to fall in growth both in oil industry as well as in machine building, and to a notable slowdown in overall industrial growth. Annual growth rates in 1999–2004, 2005 and in January 2006 25 © ИЭА Industrial policy led to decline in growth rates in other sectors. 26 © ИЭА Dreams of adherents of industrial policy have been finally implemented. Arrival of “industrial policy” in Russia has led to fall in industrial output growth rate by 50%! New stage of industrial policy – “development policy” (MERT), 2005-2006: 28 • Differentiation of taxation for different companies. • Destruction of Oil Stabilization Fund. • Expanding of old and creation of new state financial developmental institutes – Russian Bank of Development, creation of the Government Investment Fund, creation of Government Venture Funds. • Creation of Special Economic Zones. • Granting taxation privileges to different municipalities. • Adoption of programs of Development for different industrial sectors. • Introduction of limitation to foreign ownership in 39 “strategic” companies and sectors. • Adoption of Innovation and Technology Development programs. • Preparation of the Program for Government Support of Design. • “Actually, we have many more ideas...” © ИЭА “Venezuelan Disease” – nationalization and quasi-nationalization of private assets in oil, gas, transportation, construction, automobile industry, aviation. 29 © ИЭА Accumulation of huge financial resources by oil companies made them very attractive for government intervention. Oil companies revenues 30 © ИЭА Quasi-nationalization began from the most successful oil companies. YUKOS’ oil output has almost doubled within 5 years, 1999–2004. 31 © ИЭА Having launched their assault on Yukos, the authorities by the end of 2004 have essentially destroyed the most effective, most transparent and fastest growing company. Its most valuable and effective part – Yuganskneftegaz – has been handed over to the state-owned company Rosneft. 32 © ИЭА As a result of the forced transfer to Rosneft, Yuganskneftegaz, the “pearl” of Russia’s oil industry, saw its output collapsed after 4 years of unprecedented growth within Yukos. Yuganskneftegaz oil output growth as % to previous year 33 © ИЭА Financial results of Yuganskneftegaz activity under state management became triumph of ineffectiveness and incompetence. Yuganskneftegaz’ financial results in Jan-Sep 2005 as % in Jan-Sep 2004. 34 © ИЭА The transfer of Yuganskneftegaz from Yukos to Rosneft neither increased, nor even sustained the combined output of these two companies. It reduced their combined output. Total Oil Output of Yukos and Rosneft combined, 3 MMA, January 1999 – November 2005 35 © ИЭА In a response to the government’s assault, private investments in the oil sector in 2004 fell by 20%, and growth in Russia’s oil output fell from 12% in June 2003 to 0,9% in August 2005. Oil Production Annual Growth Rates, January 1996 – January 2006 36 © ИЭА Political process became concentrated over distribution and re-distribution of monopoly rents and creation of their new sources, not over formation of favorable conditions for creation of value added. Vibrant politics is devolving into rent-seeking politics. 37 © ИЭА Not only political elites, but the whole Russian society is evolving into a rent-seeking society, where weak and ineffective people are demanding subsidies and protectionism (and receive it), and the most talented, educated and entrepreneurial people are looking for possibilities to distribute and redistribute rents. National labor ethics en masse is evolving in a rent-seeking ethics. Grand populism (in a form of the so-called “national projects”) has arrived. 38 © ИЭА Rent-seeking behavior becomes incredibly attractive not only for today’s political and economic elites, but also for future generations. Changes in preferences of future jobs by Russian youth (FOM polls, 1997–2005) 39 © ИЭА “Only in this land which had never known… indeed any tolerant equilibrium of separate powers, either internal or international, could a doctrine thrive which viewed economic conflicts of society as insoluble by peaceful means… They sacrificed every single ethical value in their methods and tactics. Today they cannot dispense with it...” G. Kennan, The Long Telegram, February 1946. 40 © ИЭА The Russian authorities’ attitude towards domestic politics and civil society can best be described as “Zimbabwean Disease” – establishing total control of executive power over public and social life that leading to destruction of virtually all non-state political and economic institutions of modern civilized society – legislative and judicial powers, political parties, regions power, businesses, mass media, NGO, religious organizations. 41 © ИЭА Deterioration in Electoral Process Index in Russia. 42 © ИЭА Deterioration in Judicial Framework & Independence Index in Russia. 43 © ИЭА Deterioration in Civil Society Index in Russia. 44 © ИЭА Deterioration in Independent Media Index in Russia. 45 © ИЭА Deterioration in Governance Index in Russia. 46 © ИЭА Public demand for independent analysis, non-government mass-media, opposition politics is falling fast and sharply. Their financial support by the private business is quickly drying up as authorities stifle the civil society. 47 © ИЭА “[They] work toward destruction of all forms of personal independence, economic, political or moral. Their system can handle only individuals who have been brought into complete dependence on higher power. Thus, persons who are financially independent – such as individual businessmen, estate owners, successful farmers, artisans and all those who exercise local leadership or have local prestige, such as popular local clergymen or political figures, are anathema.” G. Kennan, The Long Telegram, February 1946. 48 © ИЭА Government propaganda saw return of the Cold War syndromes. Today “enemies of people” include liberals, business people (“oligarchs”), westerners, potential “orange” forces. In preparation to the next round of parliamentary and presidential elections the authorities are de-facto encouraging activity of nationalistic groups and simultaneously creating officious “anti-fascist movement”. Using “antifascist” demagogy as a pretext they attack dissenting voices in the society. 49 © ИЭА To frighten political and intellectual opponents the state of fear is being created. For those who are not feared, number of different instruments are used: - provocations, harassments, beating, hostage-taking, - for Russian citizens – expulsion, - for foreigners – non-granting visas, expulsion, too. The latest decision is Anti-Terrorist Act taking basic personal liberties away from Russian citizens. 50 © ИЭА “Efforts will be made… to disrupt national self confidence, to hamstring measures of national defense, to increase social and industrial unrest, to stimulate all forms of disunity. All persons with grievances, whether economic or racial, will be urged to spelt redress not in mediation and compromise, but in defiant violent struggle for destruction of other elements of society. Here poor will be set against rich,.. young against old, newcomers against established residents, etc.” G. Kennan, The Long Telegram, February 1946. 51 © ИЭА Zimbabwe disease: Political Freedom in Zimbabwe and Russia, 1991−2005 52 © ИЭА By dynamics of Political Freedom Index in 1991−2005 Russia has demonstrated one of the worst performances in the former USSR 53 © ИЭА By changes in Political Freedom Index in 2005 Russia and Ukraine occupy polar positions. 54 © ИЭА Foreign policy of the current Russian authorities can best be described as Saudi Disease – use of energy weaponry in international relations. 55 © ИЭА Backed by unstoppable influx of financial resources into the country regardless of quality of government policy (in reality – rewarding irresponsibility and interventionism) Russian authorities’ foreign policy becomes more and more arrogant and aggressive. 56 © ИЭА Energy warfare has been recently used against democracy-oriented Ukraine, Moldova, Georgia. At the same time Russian authorities are positioning themselves as a strong ally of political regimes in Belarus, Uzbekistan, Iran, Syria, Venezuela, and of such political forces like Palestinian HAMAS. At the same time government-controlled media launched anti-European, anti-American, and in general anti-Western hysteria. 57 © ИЭА The Russian state is being transformed into Corporatist State. It means: - ownership of the Russian state by the Corporation, - use of the Russian state bodies (security service, tax service, courts, others) in the interests of the Corporation, - destruction of rule of law, absence of identical rules, - main award of the Corporation is paratrooping its member (Russian or foreigner – does not matter) into the state-owned company, - privatization of profits, nationalization of costs, - PPP (public-private partnership) – coercion of private business to fulfill orders from the Corporation and bear the costs, - selectiveness taken as absolute principle, - ideology of “nascism” (“our ownism”). 58 © ИЭА “The so called enlarged government, i.e. federal government plus regional governors must work like one corporation.” President of Russia. “The accumulation of powers, legislative, executive, and judiciary – in the same hands, may justly be pronounced the very definition of tyranny.” James Madison. Federalist papers, # 47. 59 © ИЭА Moscow Times, Monday, September 18, 2006. Issue 3499. Page 5. The report, titled "Governance Matters: A Decade of Measuring the Quality of Governance," ranked Russia 151st among 208 countries in terms of voice and accountability, political stability, effectiveness of the government, the quality of regulatory bodies, the rule of law and control over corruption. The indicators were crucial, the report said, in determining a country's level of economic development. Ahead of Russia were Zambia (148), Uganda (149) and Swaziland (150), while Niger (152), Kazakhstan (153) and East Timor (154) were just behind. Voice and accountability, the report said, deals with a country's freedom to choose its own government and the possibility to express individual opinion and other social liberties, including freedom of the media. In that category, Russia ranked among countries such as Qatar, Lebanon and many African nations, including Gambia, Congo and Algeria. Russia fell into a similar percentile as the Philippines, Kyrgyzstan and Israel in terms of political stability. The bank defined political stability as the perceived likelihood that a country's government will be destabilized or overthrown by unconstitutional or violent means, including domestic violence and terrorism. For effectiveness of government -- the quality of public services and credibility of the state's commitment to policy formation and implementation -- Russia was lumped together with Pakistan, San Marino and Tanzania. For quality of regulation, it was ranked on a similar level to Ukraine, Madagascar and Senegal. Rule of law in Russia was as effective as in Ecuador, Indonesia and Bangladesh. Rule of law was defined as the "extent to which agents have confidence in, and abide by, the rules of society and, in particular, the quality of contract enforcement, the police, and the courts," as well as the likelihood of crime and violence. 60 Nicaragua, East Timor and China showed a similar ability to control corruption as Russia. © ИЭА What is to expect? Some historical analogies/warnings. 61 © ИЭА Dutch Disease: GDP per capita in the Netherlands as % of the USA, 1975–1988 62 © ИЭА Argentinean Disease: GDP per capita in Argentina as % of the USA, 1958–2005 63 © ИЭА Venezuelan Disease: GDP per capita in Venezuela as % of the USA, 1957–2005 64 © ИЭА Zimbabwean Disease: GDP per capita in Zimbabwe as % of the USA, 1982–2005 65 © ИЭА But… Wait a minute! What about economic growth? Consumption growth? Investment growth? Stock market growth? Foreign exchange reserves growth? Is it fictitious? No. It is real! 66 © ИЭА Since 1998 GDP in dollar terms grew almost 5-fold. 67 © ИЭА Money income of population grew 4,5 times. 68 © ИЭА Volume of consumption market in dollar terms grew 4-fold. Retail turnover, US$ bn 69 © ИЭА Foreign exchange reserves including Stabilization fund grew 23-fold. 70 © ИЭА Since December 1999 Russian stock market grew 10-fold. RTS Index, December 1999 – February 2006 71 © ИЭА But it happened almost exclusively due to terms of trade change rather due to contribution of policies of the Russian authorities. 72 © ИЭА GDP in dollar terms grew almost 5-fold, but in real terms – by only 58%. Cumulative GDP increase (1998=100%) 73 © ИЭА Private consumption in dollar terms grew 4,1 times, but in real terms – only by 63%. Cumulative private consumption increase (1998=100%) 74 © ИЭА While Russia’s economy grew in last 6 years by 48%, physical volume of imports surged more than 4-fold. Cumulative increase in GDP and imports (1999=100%) 75 © ИЭА Even Russian stock market is driven primarily by world energy prices, not by domestic economic policies. Russian Oil Export Price and RTS Index, January 1998 – February 2006 76 © ИЭА It means that domestic policies contribute negatively into economic performance. Mainstream economic policy of 2000-2003 has being transformed into rent-seeking policy. 77 © ИЭА Quality of economic policy has sharply deteriorated. Real GDP growth rate adjusted for windfall profit received 78 © ИЭА FDI as a share of GDP fell sharply, especially in non-fuel sectors. 79 © ИЭА Capital flight increased more than five-fold. Non-finance enterprises and households’ investments in foreign assets, 1992-2005 80 © ИЭА Actual economic growth fell compare to potential ones. GDP growth rates: actual and potential 81 © ИЭА From the first glance Russian economic growth looks impressive (though not compare to China or India). What is more important, it is by half lower than in other oil-exporting countries during periods of high oil prices (periods no less than 6 years). 82 © ИЭА Darvensazimus. “It is a Russian Disease” (Hugo Chavez) 83 © ИЭА Russia is a member of G-8. Really? 84 © ИЭА GDP per capita by PPP at 2002 price in G8 countries, 2005. 85 © ИЭА Real GDP Growth Rates in G8 countries, 2000-2004. 86 © ИЭА Real GDP growth rate in G8 countries adjusted for windfall profit received, 2000-2004. 87 © ИЭА CPI in G8 countries, 2001-2005. 88 © ИЭА Political Rights Index in G8 countries, 2005. 89 © ИЭА Civil Liberties Index in G8 countries, 2005. 90 © ИЭА Political Freedom Index in G8 countries, 2005. 91 © ИЭА Changes in Political Freedom Index in G8 countries in 1991-2005. 92 © ИЭА Another G-8? Which one? 93 © ИЭА Another G8 by negative GDP Growth in 2000-2004 * Adjusted to ToT 94 © ИЭА Another G8 in CIS by speed of degradation of political freedoms in 1991-2005. 95 © ИЭА In 2005 Political Freedom Index in Russian fell lower than even in the OPEC countries 96 © ИЭА By changes in Political Freedom Index in 1991-2005 Russia occupies 190th place among 193 countries of the World. 97 © ИЭА Another G8 by speed of degradation of political freedoms in the World in 1991-2005. 98 © ИЭА RISE OF CORPORATIST STATE IN RUSSIA (The 2006 Long Telegram) A. Illarionov Cato Institute, March 7, 2006 © Institute of Economic Analysis www.iea.ru