Why Russia’s strongman economy can’t reform.
“There are two absolutely very well-known historical experiments in the world — East Germany and West Germany and North Korea and South Korea. Now these are cases that everyone can see!” So spoke Russian President Vladimir Putin in an address to the Duma in 2012. As a former KGB operative in communist East Germany, Putin knew of what he spoke. Communism was a “historic futility,” he later explained. “Communism and the power of the Soviets did not make Russia a prosperous country.” Its main legacy, he added, was “dooming our country to lagging steadily behind economically advanced countries. It was a blind alley, far away from the mainstream of world civilizations.”
Yet Russia today is lagging steadily behind economically advanced countries — and Russia’s president is doing nothing about it. Putin recently overtook Leonid Brezhnev as Russia’s longest-serving leader since Joseph Stalin. His economic record, coupling stability with stagnation, looks increasingly like Brezhnev’s too.
The past four years have proved that Russia’s economy can withstand brutal shocks, including the collapse in oil prices in 2014 and subsequent Western sanctions on Russian banks and energy firms. But the four years since have also demonstrated that a return to rapid growth is unlikely. In 2017, Russia’s economy grew by 1.4 percent, significantly slower than both the United States and the eurozone. It is expected to underperform in 2018, too, thanks to sanctions and low oil prices but also to a long-standing lack of investment. Russia is far poorer than its Western rivals, so it ought to be growing significantly faster than them. But last year Russia was one of the slowest-growing countries in Central and Eastern Europe, significantly lagging neighbors such as Poland and Romania. And don’t even ask about comparisons with Asia.
“Just wait until after the election,” some Russians promise, predicting that Putin will implement tough but necessary economic reforms after he is safely re-elected. That looks unlikely.
True, Russian economists, politicians, and business leaders are putting forth grand plans to revitalize the country’s economy. There are two main schools of thought. Former Finance Minister Alexei Kudrin, who has worked with Putin since their days in St. Petersburg in the 1990s, has an array of proposals to liberalize Russia’s economy and to invest in Russia’s population. Kudrin argues that Russia’s business climate — in which private firms are expropriated by the government and entrepreneurs tied up in red tape — deters the investment Russia needs to boost growth. Instead of spending money on the military and security services, which have been showered with funds in recent years, Kudrin advocates targeting spending on health and education instead, helping Russians work longer and giving them the skills needed to earn higher wages.
Where Kudrin and his allies believe that Russia can attract investment only by making its economy more appealing to the private sector, an alternative camp thinks that Russia’s government should invest more itself. Russian politician Boris Titov, for example, has urged the government to sharply reduce interest rates, making it cheaper for firms to borrow. He also wants the government to subsidize loans to corporations and to invest directly in industry. Titov’s calls for state-backed investment are supported by many industrialists, who would stand to gain from government-funded infusions of credit.
If Titov’s proposals were adopted, Russian inflation would spike, and the ruble would sink. Kudrin’s ideas about improving the business climate and investing in health and education are far more sensible. But neither set of proposals will be adopted because each would contradict a core principle of Putinomics — the set of economic policies that have kept Putin in power for nearly two decades.
Putin has deployed a three-pronged economic strategy that has allowed him to retain power.
First, maintain macroeconomic stability at all costs, pursuing low budget deficits, low debt levels, and low inflation even at the expense of growth. Second, use the social safety net to buy support from politically powerful groups — above all, pensioners — rather than to invest in the future. Third, tolerate private business only in “nonstrategic” sectors, leaving the state in control of spheres, such as energy or media, where business and politics intersect.
The Kremlin understands that maintaining its current policies will keep Russia stable but stagnant, underinvesting in human capital and in private businesses while overspending on wasteful and corrupt state-owned firms. Economic growth will be capped around 2 percent a year. From Putin’s perspective, economic stagnation is tolerable. He has the tools he needs to stay in power. Big changes in economic policy, by contrast, might anger key support groups and loosen the Kremlin’s control over Russian politics.
Titov’s proposals to have the government or central bank invest directly in industry are unlikely to win the Kremlin’s favor. Putin has built his political reputation as a provider of stability — not only political stability but also macroeconomic stability. He has paid down Russia’s foreign debt, limited the government budget deficit, and kept inflation low. Titov’s plans to increase government spending on industry, either by taking on debt or by printing money, would undermine this hard-earned stability.
Maybe there is a chance that implementing Titov’s proposals would double Russia’s GDP growth rate, as he promises. There is also a chance that they would boost inflation or cause the currency to crash. If Putin’s post-election economic reform program led to such a result, Russians would have no one to blame but him. So why take the risk when the status quo is sustainable?
For the political managers in the Kremlin, Kudrin’s proposals to increase health and education spending, to cut the budgets of the security services, and to improve the business climate are no less problematic. In economic terms, of course, these are better ideas than Titov’s plans to print money. Typical Russians would likely appreciate more social spending, particularly after multiple years of austerity. And who could oppose a better business climate?
Well, Putin’s political coalition could. Consider the groups in Russian politics that most strongly back the president. Support from urban middle classes is tepid. But Putin retains strong support from the security services, the military-industrial complex, and state-owned firms, which now control around two-thirds of Russia’s economy.
Kudrin’s proposal to shift spending away from the military and the security services and toward health and education, therefore, would harm a central component of Putin’s political coalition. Keeping military spending high is not only important for funding the Russian military’s foreign wars. It also keeps industrial workers employed because many Russian military factories have no hope of survival unless the Kremlin continues purchasing new military kit at generous prices. Even if Russia decided to wind down its wars in Syria and Ukraine, cuts to military procurement budgets would risk layoffs — and social unrest — in cities that depend on defense spending. Political necessity means Russia is unlikely to cut significantly its security budget.
But even if the military budget can’t be cut, surely improving the business climate would be a costless step for the Kremlin? Hardly. Reducing monopoly power, for example, or prohibiting state-owned firms from expropriating private sector rivals threatens the business model of many of Russia’s largest firms, which are key bases of support for Russia’s ruling elite. Cutting corruption and improving efficiency might sound easy — but they would hit some of Putin’s most powerful backers.
When Putin unveils his election program in the coming days, therefore, don’t expect much substance. Putin is likely to promise some short-term sweeteners in advance of the election. After the vote, meanwhile, Russia is likely to get painful economic changes, but they will come in the form of tax hikes on individuals and businesses, not via reforms that would boost economic growth. Putin’s political backers will defend their turf, making impossible any changes to Russia’s corrupt state-owned firms or its coddled security apparatus. Russia’s economy will continue to underperform other emerging markets. And Putin’s Russia will increasingly look like the “very well-known historical experiments” that Putin described to the Duma in 2012 — evidence that an economy that tolerates inefficiency and embraces autarky is doomed, as Putin put it, to lag steadily behind.