October 2005

Russia: Today, Tomorrow--and in 2008

After years of undeniable--if uneven--progress in Russia, a rising chorus of critics is warning that President Vladimir Putin has taken the country in a dangerous and destabilizing new direction. From the pursuit of a heavy-handed foreign policy to the recentralization of power in the Kremlin and the assault on the YUKOS oil company, an authoritarian drift is sweeping Moscow.

What does the future hold for Russia’s political, economic, and foreign policies? Can Russia’s liberal opposition unite to challenge Putin in the country’s upcoming parliamentary and presidential elections? Is it time for the Bush administration to overhaul its Russia strategy? Is it too late for Russia to reclaim the promise of its 1991 revolution? These and other questions were discussed at an October 14 AEI conference.

Panel I: Politics and Democracy

Yuri Levada
Levada Center

Since the massacre in Beslan in September of 2004, Russia has been going through a period of uncertainty. Public opinion polls shortly after the event showed that the Russian public believed that the operation in Beslan was a total failure. Since then, the government has lied about the events repeatedly. Unfortunately for Putin’s government, words cannot cover up deeds. As yesterday’s events in Nalchik demonstrate, Russian forces are totally helpless. But Putin’s problems transcend just the military: his political and social reforms have stagnated as well. 

During Putin’s tenure, there has been a general worsening of relations between Russia and the West. Relations with Russia’s neighbors have also deteriorated. Putin has had difficulty molding Russia into something between Kuwait and China--a country with huge human and capital resources but without any interference from international organizations on its neglect of human rights and destruction of civil society.

The colored revolutions in the post-Soviet space have also sent shockwaves throughout the region. Though Putin has tried to keep the former-Soviet apparatchiks in place, he has been unable to maintain the status quo. Democratic movements, led from below, have sprung up in many areas and must be supported.

Russian public opinion polls tell us much about the current disarray in Russian politics and what to expect in 2008. In September, Putin received a 70 percent job approval rating, largely because many Russians see no alternative leaders on whom they can rely. Today, Putin has no real opposition, no real allies, no real friends, and few true supporters. The lack of strong institutions may make the elections in 2008 a “catastrophic problem.” Putin is doomed to try to be his own successor, if for no other reason than that there are no other viable candidates.

The breakup of Yukos and the Khodorkovsky case have been another major events of the past year. The government’s actions were totally arbitrary, had little to do with true justice, and were a clear example of personal vengeance. One week ago, Khodorkovsky published an ironic birthday greeting for Putin and was subsequently sent to a colony in northern Siberia as an act of personal revenge.

There is no serious political process in Russia today. Putin has no political podiums, no real discussions, and no real debates. Leading Russian politicians want to be seen as true pragmatists, as modern Western people without any problems. Unfortunately, that is impossible, and the illusion is not sustainable. The problem of 2008 is bound to cause great uncertainties. It is possible that Putin will try to come back under the guise of some fantastic crisis. The people would like a true election; unfortunately, there is no one to elect.

Lilia Shevtsova
Carnegie Center, Moscow

The political game being played in Russia today can go by no other name than “virtual politics.” Russia really lacks an understanding of how political affairs should operate. What is most striking about Russia’s virtual reality is the existence of only one political actor--the president.

Russia’s political landscape is desolate. The country is run by a bureaucratic authoritarian regime which relies on close relations with Russia’s big business. It is difficult to speak of a clear model of development in Russia, but the country does resemble a petro-state similar to Indonesia or Nigeria. Like other energy-rich countries, Russia displays a few general characteristics: dependency on its natural resources, a close relationship between government and big business, corruption, and Dutch Disease and monopolization.
     
As such, Russia’s ruling elite tries to maintain the status quo at any price. The focus of this policy is a redistribution of economic resources in the energy field. Foreigners, meanwhile, are allowed in as minority shareholders only if they play by the rules.

Russia displays several systemic, what some would call structural, factors of instability. It is over-centralized, has a dreadful lack of “local information,” and displays signs of tension between the centralized powers. Some could even say that today the system is undermining itself. It is only a matter of time before cleavages deepen and a crisis occurs.

There is a Russian saying, “we wanted the best, but it happened like always.” This, unfortunately, seems to be Russia’s predicament. The “law of unintended consequences” is also making reappearance in Russia: the banking reform brought about a banking crisis, a desire to crush the Orange Revolution led to its growth, and recent attempts to lower the deficit led to a $15 billion expenditure. As a result, all the other reforms are currently on the backburner.

Russia is following a multi-vector foreign policy similar to that of China: avoiding strategic alliances and stringent commitments. It has also been noncommittal about forming strategic partnerships. This policy is of questionable merit. Calls from the international community demanding change in Russia are few and far between. Though progress in Russia and Eurasia is not sustainable, no one is stepping up. In short, Russia is a petro-state with post-imperial ambitions and a desire to be a regional superpower. The external variable will be the West and its commitment to the region. 

Today Russia is in a difficult position. There are multiple explanations for this, but the most probable is the “law of failure” explanation: the argument that during some historic periods, there are simply no alternative paths to development. Sometimes, people have to follow the road all the way to get somewhere. In Russia’s case, that road may in fact be a dead end.

Nikolai Zlobin
World Security Institute

Amidst all the pessimism surrounding Russia right now, there is a positive, the reemergence of political jokes. Some of these jokes even target the government, but in all of them Putin is powerful while those around him are “vegetables.” These are not imprecise characterizations. That Russia has not become “freer” on Putin’s watch is undebatable. Prospects for 2008 are worrisome because history has shown that Russian leaders tend to destroy the state they inherit from the previous leader and remold it into something very different.

Although international observers characterize Putin as strong and domineering, in fact the leader is weaker than many perceive. He is an isolated politician in what some might call political solitude with few real friends. People are afraid of him, but not for the right reasons. He despises his own elite and many from his own party are hostile towards him. A split is inevitable within his own team: sooner or later, different factions will split in what may be a major confrontation.

While outsiders and Russians are worried about what looms in 2008, Putin is not. In fact, he is relaxed. He knows that the Russian state cannot really exist without him even though it is going backwards and stagnating under his leadership. Putin’s supporters are hoping that someone emerges within his camp who is at least half as popular as the president himself. Finding this person is becoming exceedingly difficult. In the lead-up to 2008, the Kremlin may prove to be its own biggest enemy.

Panel II: Panel II: Foreign Policy and U.S.-Russian Relations

Thomas Graham
National Security Council
Special Assistant to the President and Senior Director for Russian Affairs

The administration came into office four and a half years ago convinced that the United States had an opportunity to transform the international system in ways that could enhance American security and promote our prosperity well into the twenty-first century. The moment was propitious. The great ideological struggles of the twentieth century between democratic values and totalitarianism had ended with a decisive victory for freedom. For one of those rare moments in history, there were no great power conflicts looming on the horizon. Globalization and revolutionary technologies--particularly in information and communication--opened up new opportunities for economic development and the spread of democratic values.

As we know, the new international environment also brought new security challenges. In the place of great power confrontation, the United States found itself confronted by more diffuse elements of disorder, instability, and danger. September 11 provided a tragic illustration of the gravest challenge we and our friends and allies faced: the wedding of terrorism and weapons of mass destructions facilitated by tyrannies around the globe and fueled by extremist ideologies. The president's second inaugural address crystallized the thinking that had lain behind the administration's policy from the very beginning in meeting this threat and the other challenges of the twenty-first century, the advance of freedom in the world.

What does this view of the world and America's role mean for U.S.-Russian relations? Most obviously, Russia no longer lies at the center of U.S. foreign policy, as the Soviet Union did during the Cold War. The new Russia that emerged from the Soviet Union is neither a strategic adversary nor a strategic threat, as the Soviet Union once was. But it remains a key country, by reason of its geographic location astride Europe, the broader Middle East, and East Asia; its vast nuclear weapons arsenal; its rich resources, especially of oil and gas; and its talented people. Early on, the president called for “a qualitatively new relationship” with Russia, one appropriate to the challenges and opportunities of the twenty-first century, and one that recognized that we are better off when Russia is on our side than working against us.
 
What kind of Russia did we want to see emerge in the first decades of this century as we pursued this new relationship?

• first, a Russia integrated into, and linking, two key security-economic zones: the Euro-Atlantic region and Northeast Asia;
• second, a Russia that was a key partner with the countries of these two zones in counterterrorism and counter-proliferation, especially in regions to its south, that is, the broader Middle East, the Caucasus, and Central Asia;
• third, a Russia that contributed to international coalitions for regional stability and humanitarian assistance;
• fourth, a Russia that was a reliable supplier of energy on commercial terms to global markets;
• fifth, a Russia that could be a partner in carrying out the president's space exploration vision and advancing high-tech frontiers; and
• sixth, a Russia that was a consolidated free-market democracy.

Four years ago, in this effort to build new relations, President Bush found a partner in President Putin. It is more fitting that our Russian colleague, Andrey Kortunov, address the question of what motivated his president. Let me just note that U.S.-Russian relations began to improve with the president’s first meeting in Slovenia in 2001. The improvement accelerated rapidly after 9/11, when President Putin reached out to the United States with condolences and offers of support at a time of great uncertainty and a heightened sense of vulnerability within American society. And the relationship reached a high point with the Moscow/St. Petersburg Summit of May 2002. The joint declaration and other statements issued there laid out the framework for the pursuit of a broad-based partnership.

Since then, the relationship has had its ups and down, but, contrary to the prevailing view in Russian and American commentary, I would argue that the trend line has been positive. The successes come in many forms. Both sides successfully managed the relationship even in the face of events that many had predicted would lead to major friction, such as the U.S. withdrawal from the ABM Treaty, NATO enlargement, and the deployment of troops in Central Asia. Real progress was achieved as the United States and Russia signed the Moscow Treaty reducing deployed strategic nuclear forces, developed converging positions on Iran and North Korean nuclear-weapons aspirations, and worked together in the framework of the Proliferation Security Initiative. We have also enhanced and accelerated our cooperative work on improving nuclear weapons and materials security in Russia and fostered closer relations between our intelligence services and militaries in the war on terrorism. And we have made progress in the NATO/Russia Council, created three years ago: we are now looking at ways to enhance the interoperability of NATO and Russian forces for peacekeeping and counterterrorist operations.

That said, much more remains to be done to achieve the broad-based partnership to which we aspire. The potential of energy cooperation remains largely untapped, despite the launching of an energy dialogue three years ago. U.S. support for democratic development in countries along Russia’s periphery has been misconstrued by many in Russia as aimed against Russian interests, and this in turn has hampered the cooperation that would redound to the advantage of the United States and Russia and to the countries of the region themselves. And domestic developments in Russia, particularly the growing concentration of power in the Kremlin, the waning accountability of the government to its citizens, and reports of widespread and growing corruption, have raised doubts about Russia’s commitment to the democratic values that must lie at the base of an enduring partnership. Over the past year, Russia’s domestic policies and behavior in its neighboring regions have sullied its image in the United States, and Russia's own debate over relations with the United States has evinced growing suspicion--and I would add misunderstanding--of U.S. motives. As a consequence, the publics in both countries are now focused more on the problems in U.S.-Russian relations than on the opportunities.

Under these circumstances, how do we move forward toward a broad-based partnership? Three thoughts.

First, we need to remember that building such a partnership is a long-term commitment. Our vision and our policies are aimed not only at this but at future generations of Russian leaders and citizens. To move toward and generate public support for that vision, we need to demonstrate to skeptical publics in both countries that there is genuine substance to U.S.-Russian relations that brings tangible benefits now. That goal in part lay behind the initiatives the two presidents announced during the Bratislava summit earlier this year, initiatives covering cooperation in the areas of nuclear security, counterterrorism, energy, trade and investment, space, humanitarian assistance, HIV/AIDS, and exchange programs. Working with our Russian colleagues, we chose these initiatives because each was clearly in the national interest of both the United States and Russia, and each country had something of importance to bring to the table that could be used to advance a common good. We also thought that these issues were of high enough profile to capture the public’s attention and focus it on the benefits of U.S.-Russian partnership.

Since Bratislava, we have made considerable progress in carrying out these initiatives.

• On nuclear security cooperation, a key centerpiece of our mutual security, we have agreed on the set of Russian nuclear weapons sites that will receive accelerated security upgrades. While some issues still remain, we have advanced work on these upgrades, and the Russians themselves are devoting more resources to this effort.
• We have prioritized timelines to return fresh and spent highly enriched uranium fuel from U.S.- and Russian-designed research reactors in third countries--the return of such fuel from a Czech reactor to Russia just a couple of weeks ago is the most recent example.
• On counterterrorism, we have agreed to information exchanges on man-portable air defense systems (MANPADS), and we are exchanging views on how to counteract IEDs, improvised explosive devices, that pose such a threat to our forces in Iraq and Russian troops in Chechnya. We continue efforts to disrupt financial networks that support terrorists.
• We are making progress toward concluding our bilateral negotiations on Russia's accession to the World Trade Organization while insisting that Russia move aggressively to protect and enforce intellectual property rights.
• There is growing promise in energy cooperation, with several projects coming to fruition and new deals being announced. Gazprom is moving toward signing deals that would bring liquefied natural gas from the giant Shtokman field in the Barents Sea to U.S. markets by the end of the decade.
• U.S.-Russian private/public partnerships are working actively in heightening awareness of the HIV/AIDS issue in Russia and developing lessons for third countries.

Much remains to be done, of course, but over the past several months a positive momentum has developed on some key issues on the U.S.-Russian agenda. Positive interaction like this is essential to building the trust necessary to deal with more sensitive issues.

And this brings me to my second thought, on Russia’s neighbors. This issue has become the subject of much commentary here and in Russia, particularly since the Rose Revolution in Georgia nearly two years ago. Our position is clear. We support the independence and territorial integrity of the states along Russia’s periphery, just as we do the independence and territorial integrity of states elsewhere in the world. We believe that the advance of democracy and free-market principles is the best long-term guarantee for their security and prosperity, and, as elsewhere, the best defense against extremist ideologies and terrorist forces. We are confident that democratic, prosperous states along its borders are good for Russia and will reinforce Russia’s integration into global security and economic structures. So we will continue to work with the states of East Europe, the Caucasus, and Central Asia, to advance these interests, bilaterally and multilaterally.

But we also need to be clear that our efforts are not intended to harm Russia’s relations with these states. For a host of historical, cultural, political, economic, and other reasons, these states will occupy a special place in Russia’s thinking and priorities. Russia needs to have good relations with them, and all these states will be better off if they have good relations with Russia. Indeed, it is hard to imagine durable security and economic structures along Russia’s borders without Russia’s active involvement. The challenge, as we move forward, is to manage and combine the interests of the countries of these regions, Russia, and other interested states into durable security and economic structures, taking into account the specific characteristics of and emerging trends in East Europe, the Caucasus, and Central Asia. Zero-sum thinking is not adequate to this challenge; something more creative is needed. And, to this end, as we build relations with these countries in their own right, we are prepared to sit down with our Russian colleagues--and with colleagues from these regions--to think through how we might do this, and the Russians have indicated they welcome such a discussion.

One final point on this issue: some in Russia seem to see the advance of democracy along their country's borders as an American plot to weaken Russia and eventually drive it out of neighboring states. That is a great misreading of the situation. What we are witnessing in Georgia, Ukraine, Kyrgyzstan, and elsewhere is the slow emergence of the first truly post-Soviet generation. This generation is connected to the outside world, it has traveled abroad, it has seen firsthand the success of free-market democracies, and it wants to replicate that success at home. This is not an American export, but the natural evolution of these post-Soviet states. And it is something to be welcomed, not resisted.

And this brings me to my final thought, on democracy. The president has made it clear that the spread of freedom and democracy is critical to America's security and that shared values of democracy and freedom are the essential foundation of an enduring U.S.-Russian partnership. The issues of democracy and freedom will inevitably attract greater attention as President Putin prepares to host the G-8 summit in St. Petersburg next summer and as Russia approaches the 2007-2008 electoral cycle. For these reasons, we have raised concerns about recent domestic developments in Russia. The concentration of power in the Kremlin, diminished public space for political debate, decreased governmental accountability before the public have all deprived the Kremlin of the reliable information, flexibility, and creativity it needs to deal with the challenges of the twenty-first century and to be a reliable, strong, self-confident partner for the United States. These developments also erode the trust and public support we need to realize the full potential of our relations.

The big question for us is how to encourage the consolidation of democracy in Russia.

Let me begin by saying that what we are looking for is steady progress, not instant perfection, and we realize that perfecting democracy is a constant task, one that is never fully accomplished. Russia has in fact made significant progress since the breakup of the Soviet Union. We are concerned about recent developments, not because we see a reversion to the Soviet system, but because we do not want to see a further delay in the development of democracy, toward which Russia was moving in the early twentieth century before the Bolshevik coup cut off this promising path.

As the president has stressed, the United States also appreciates that, while the principles of democracy are universal, the forms in which they manifest themselves vary greatly from country to country based on history, culture, tradition, and other factors. But, in the end, all of us have to strive to meet the same fundamental international standards.

As we promote democracy, we need to remember that, because of our close association with the developments in Russia in the 1990s, a period that most Russians view as one of decline and crisis, we have a credibility problem with many Russians when we speak about democracy in Russia or criticize their domestic policies, particularly at a time of robust economic growth.

If we are to regain credibility with the Russian public, we need to demonstrate that we appreciate the complexity of the challenges Russia faces. We need to be clear that our support for the rule of law and the sanctity of private property--issues raised by the Yukos affair--does not mean we support the socioeconomic injustices that grew out of the flawed and often corrupt privatization processes of the 1990s or condone the often corrupting role of vast accumulations of wealth in the Russian political system. Freedom of the press concerns editorial independence and pluralism of opinion, not support for one set of oligarchs over others. In regard to Chechnya, we must be clear that our legitimate concerns about serious human rights abuses by federal and pro-Moscow Chechen forces do not in any way diminish our commitment to work with Russia against terrorism and the appalling abuses that terrorists have inflicted on the Russian people, including yesterday in Nalchik.

Russia will need to deal with all aspects of the problems it faces if it is to consolidate a genuinely democratic society. That is an enormous undertaking, and we will not necessarily agree with the policy choices that are made, nor can we impose our views on Russia. But we can challenge our Russian counterparts to articulate their own strategy for consolidation of democracy, listen carefully to their plans and benchmarks, see if they make sense, and then watch to see if that strategy does indeed unfold. As we discuss these issues, we need to continue to pursue policies that help integrate Russia into rules-based institutions, such as the World Trade Organization; support civil society in Russia; and expand contacts between our two societies, particularly among young people, because that is perhaps the most effective way to promote democratic and free-market values over time. This, I would submit, is a constructive way of dealing with our concerns about democracy in Russia.

We have accomplished much over the past four years, yet much remains to be done in the next four to help realize the full potential of U.S.-Russian partnership. Each side needs to approach this relationship without illusions, and with a real appreciation of the hard work that will be needed on both sides to overcome the still lingering suspicions and distrust that are inevitable after decades of an adversarial relationship, the disappointments of the 1990s, and the uncertainties of the past four years. For our part, we will offer cooperation to Russia where our interests overlap and seek to minimize differences where they do not; we will continue to work with like-minded Russians in and out of government to advance democratic development in Russia because that is essential to enduring partnership; and we will make it clear that, under all circumstances, we are prepared to defend our interests, values, and friends. That is the approach we have taken in the past four years, and that is the approach, I would argue, that offers the best chance of realizing the still great promise of U.S.-Russian partnership.

Andrei Kortunov
Eurasia Foundation

Russian foreign policy is currently in a state of what may be best described as “schizophrenia.”  In fact, there appear to be two Russias, each with separate agendas. On one hand, the tremendous social changes that have occurred indicate that the country is rapidly integrating into the world community. Russian citizens now freely (and frequently) travel abroad, while Russian companies are now investing in enterprises in Europe and the United States. On the other hand, politically and socially, there has been a growing sense of encirclement and an inferiority complex.  These fears are reinforced by the fact that after Russia’s every historical attempt at integration, inevitable setbacks have followed.

Thus, Russia has yet not defined its place in the world community of the twenty-first century. Economically, Russia is over-reliant on energy exports, while the technological gap between Russia and the West has continued to widen. The problem, however, is more fundamental than being simply an issue of adjustment. There has been no institutional integration, relationships with the West have remained superfluous.

Foreign policy has not emerged as a priority for the current Russian administration because they gain no substantial benefits domestically from radically changing Russia’s foreign policy approach. Thus, there has been no pursuit of long-term strategic goals--Russian foreign policy has remained reactive rather than pro-active. Because of a diminished role of local administrative structures and a weakened civil society under Putin’s regime, there remain few balancing forces in Russia to influence policy otherwise.

Therefore, the future of the Russian foreign policy seems more opportunistic rather than strategic. The integrationist agenda, however, can be resurrected. Russia is not self-sufficient and will need Western assistance, including technology, experience, and human capital. In addition, a generational change will also predicate that an isolationist agenda in Russia will not and cannot succeed.

Angela Stent
National Intelligence Council and Georgetown University

Today, the United States and Russia have developed a partnership which is both pragmatic and compartmentalized. It can certainly continue until 2008 (and possibly long thereafter) because, ultimately, it is in both states’ interests to cooperate on energy security, counterterrorism, reducing nuclear proliferation and other issues.

Historical perspective helps to frame the current U.S.-Russian relations. For the past several dozen years, the United States has used a policy of containment and limited realpolitik and an occasional interventionism attempting to change domestic Russian policies. Since the mid-1970s, it has been understood that domestic Russian affairs play an important role in foreign policy-making. Ignoring these trends could prove dangerous. Russia, meanwhile, abolished any attempts to affect internal American domestic politics after Khrushchev. Contacts and networks which have developed over many years between Russian and U.S. decision-makers still play a crucial role today.

Some have correctly argued that the United States needs a strategic alliance with Russian reform. The challenge for American policymakers will be to push through these reforms even if, at times, they turn sour. The United States must recognize that its goals must be modest if they are to be at all successful. At first, the Bush administration had very concrete projects (especially after 9/11), such as terrorism and non-proliferation, but today we lack precise definitions or structured goals for the future. Working bilaterally and multilaterally with the G-8 is certainly a must if we are to expand relations and develop and exploit mutual interests. Some of these areas include counterterrorism and nuclear issues. Other issues, such as the Eurasian space, are more controversial, as Russia fears that their area is being infringed upon. Most importantly, the United States and Russia both want to maintain stability. Negotiating a settlement to some of the conflicts in the region would certainly be a positive development.

Panel III: Economic Prospects, Economic Policy, and the Free Market

Daniel Yergin
Cambridge Energy Research Associates

Oil wealth has endowed Russia with both positive and negative consequences. On the positive side, oil and gas can be viewed as Russia’s ticket back to being a great power--and indeed, Putin has placed energy security at the top of his agenda for the next G-8 meeting in St. Petersburg. In an era of energy security concerns, Russia has an important and major role to play with its tremendous resources. However, oil also brings significant negative implications for Russia--economic distortions, the postponement of crucial economic reforms, and the appearance that Russia is in essence riding for a fall.

The Russian state appears to be recapturing the oil sector, although the dominant firms, Gazprom and Rosneft, are state-controlled with significant foreign ownership through equity markets in them. Indeed, foreign companies are playing a massive role for the Russian economy, and Western companies say that Russia’s tremendous resources make it the one place companies need to be. Yet even with the increase in investment in Russia, with an unprecedented 20 percent increase in oil production over the past decade, evidence points to a flattening out of production growth. In the first half of 2004, oil output grew by 10 percent, while in the first half of 2005, oil output only grew by 3 percent, and seems to be slowing even more.

Why is such a slowdown occurring in Russia? Reasons include the effects of the YUKOS scandal on the investment climate and decision-making, to the decreased willingness to take risks and apply new technology, and to political uncertainty all affecting the continued growth of the oil sector. Additionally, the fiscal system plays an explanatory role, with the inadequate investment of oil revenues back into the industry. Characteristic of petro-states, reforms are not getting accomplished.

Clifford Gaddy
Brookings Institution

There are three assertions about the role of oil in Russia’s economy. First, oil has been and will continue to be good for Russia. Second, the idea of a resource curse is a myth, which, if taken seriously, leads to bad policy choices. If it is indeed true that oil is bad, it is quite natural to advocate diversification away from oil or other resources. But for Russia, Gaddy argues, promoting diversification has almost always been a cover for the industrial policies so disastrous to Russia’s economy in the past. Moving from a political economy that focuses on dividing up resource revenues to one that focuses on expanding the sector is thus at the core of Russia’s economic problems.

GDP growth prospects continue to look good for Russia, as long as oil prices continue to climb. While production and export stagnation have been ringing alarm bells for many inside Russia, as long as high revenues continue to be generated in this sector, the political struggle will be over redistribution, a fight currently consuming the country. Rents from oil production are divided into formal and informal taxes, the latter of which are tremendous, entailing bribes and payments by companies for social services; excess costs of extraction, price subsidies, and finally the net profits of the company. By making property rights unpredictable, having one of the most punitive formal tax systems in the world, to say nothing of the informal, and doing little to encourage long-term investment in the sector, Putin may well be presiding over what will pose a severe long-term disservice to Russia.

Poul Thomsen
International Monetary Fund
 
This will be a more optimistic assessment of the Russian economy. Since 1998, Russia’s external vulnerability has declined dramatically, going from a net debt position of $150 million in August of 1998 to a net asset position of $30 million. Russia’s foreign reserves now total $160 million. While the huge current account surpluses from oil have played a significant role in Russia’s economic recovery, the significant decline in imports--Russia’s terms of trade gain--is one of the major reasons for the strong increase in GDP Russia has been experiencing in recent years. Oil, indeed, may even have a broader impact on Russia’s economy by creating a more sustainable situation--even in an environment of lower oil prices. From 2000, GDP growth in Russia has been driven by domestic demand, largely by consumption due to terms of trade gain and the distribution of rents. Real wages and labor productivity have also rebounded from the compression of 1998-1999. Due to the indigenous, self-sustained complement to demand growth, there are reasons to be more optimistic about what will happen to Russia’s economy should oil prices fall.
     
Despite extraordinary terms of trade improvement, Russia has not witnessed a real appreciation of its exchange rate of a level that would choke its economic recovery. From a macroeconomic standpoint, Russia is a well-managed oil story--due primarily to its stabilization fund, which taxes and saves 90 percent of Russia’s oil revenues above $27 a barrel (due to move to a $31/barrel benchmark in 2006). Yet at present, Russia cannot continue to witness such high GDP growth without accelerating inflation--and indeed, the IMF argues Russia should have a more flexible monetary policy given the entrenchment of core inflation due to capacity constraints in the economy.
     
Several areas of concern are most prominent. Growth has slowed in the past year due to the YUKOS scandal, to supply constraints in the oil sector as new fields are not being developed, and that changes in the tax structure that have affected growth. Yet the predominant cause for the decline is Russia’s poor investment climate, due to bureaucratic problems and a lack of clearly defined property rights. Additionally, pressures are mounting for a fiscal relaxation, with Putin promising a significant increase in public sector wages--an increase of 50 percent over the next three years--and a cut in the value-added tax (VAT) from 18 to 13 percent. The IMF worries that relaxation may add to higher inflationary pressures, and, should oil prices fall, reveal a fiscal deficit that brings about a pro-cyclical tightening at the same time. Over the medium term, the chance for fiscal relaxation is significant but dependent upon oil prices. What is most important at present are structural reforms, which, taking a conservative estimate, would provide scope for some small deficit given high oil prices and high growth. Taking on such reforms will be very difficult due to the entrenched vested interests that surround them--high oil prices limit willingness to take them on, and the Kremlin seems unwilling to do so in the run-up to the elections.

AEI interns Ilya Bourtman and Diana Iskelov and research assistant Igor Khrestin prepared this summary.