The Wild, Wild East


The Wild, Wild East

Dec 20th, 2000 2 min read

Director, CENRG and Senior Fellow, IAGS

Ariel served as the Director of the CENRG and Senior Fellow for IAGS
With its pervasive corruption, its lack of respect for property rights, and a $141 billion foreign debt, it's little surprise that outside investors consider Russia the "wild, wild East."

True, the former Soviet republic has been making some economic progress of late. Its gross domestic product is up 13 percent since 1997 and continues to grow. Russia now boasts a surplus of $23.9 billion, and has been repaying its old debts to the International Monetary Fund (IMF) and the World Bank. But this rosy situation isn't going to last long.

For one, it is driven by high oil and commodities prices worldwide. If these plunge, Russian prosperity will too. Second, the economic revival is a direct result of Russia's 1998 de facto default on foreign debt. The Russian Finance Ministry wants to borrow $1.2 billion from the IMF and $900 million from the World Bank, but the IMF left Moscow in late November without an agreement to renew lending, citing slow progress on economic reform.

Third, the 75 percent devaluation of the ruble the same year helped to protect the asset prices and ruble-denominated debts in Russia while simultaneously decreasing the cost of labor. Fourth, price controls on electricity, transportation and other domestic products are driving the current bounce. This is basically a subsidy paid to the Russian industry by the government.

But the roots of Russia's economic problems run deeper. According to the 2001 "Index of Economic Freedom," published by The Heritage Foundation and The Wall Street Journal, Russia ranks 127th among 155 rated countries. It trails its neighbors such as Poland, Hungary, the Czech Republic, Estonia and Lithuania in categories such as free trade, inflation and foreign investment.

Corruption also runs rampant, according to recent studies released by the World Bank Institute. One study found there is a 90 percent probability of losing a foreign direct investment in Russia within five years, versus 25 percent in Hungary. Another survey of companies found Russian courts corrupt, unfair, unreliable and incapable of enforcing decisions. Russia has a high level of "state capture," in which companies pay bribes for legislation and senior executive decisions.

Property rights in Russia are poorly protected. According to the World Bank, only 25 percent of Russian companies claimed in a survey that their property rights are protected, versus 75 percent of companies in Poland and Estonia. About 72 percent of Russia's land is still in state hands, and only 0.03 percent of land changes hands every year. There is no land market to speak of. And the privatization process is flawed, because property is allocated based largely on political connections, not criteria related to economic efficiency.

Demographics also argue against a Russian "economic miracle." The population is aging rapidly, and birth rates are among the lowest in Europe, while emigration of younger and educated population groups remains high.

Another type of aging-that of Russia's already obsolete industrial base-also threatens the Russian economy in the long run. In the power generation sector, some equipment dates back to the 1900s, a spokesman for the Russian electric company RAO UES said recently. RAO UES estimates it will need $70 billion in the next five to seven years to avoid severe power shortages. And without another $80 billion to replace Soviet-era equipment and pipelines in the cash-generating oil and gas sector, output will start declining.

Until Russia develops a credible legal system that recognizes and protects property rights, economic prosperity will remain contingent on the boom-and-bust cycles of oil prices. And without a transparent government with clear rules of the game, Western lending and rosy public relations aren't going to do the trick. Domestic capital flight will continue, and foreign investors will steer clear.

As Ed Lucas, a bureau chief with The Economist, has put it (paraphrasing Winston Churchill): "Russia is a wreck, wrapped in self-deception and surrounded by wishful thinking." Only bold implementation of a market-oriented economic reform package can enable Russia to corral essential foreign investors-and tame the "wild, wild East."

Ariel Cohen is the Research Fellow in Russian and Eurasian Studies at The Heritage Foundation, a Washington-based public policy institute.

Originally distributed by Scripps Howard News Wire