Where is Russia Heading?

Dr. Yegor Gaidar spoke before an audience at the Carnegie Endowment for International Peace in Washington, D.C. on Thursday, June 13, 2002. Carnegie Senior Associate Anders Åslund moderated the discussion.

"Where has Russia been and where is Russia going?" Yegor Gaidar, former Prime Minister of Russia, Deputy of the State Duma, co-chairman of the Union of Right Forces, and Director of the Institute for the Economy in Transition in Moscow, is uniquely qualified to answer this daunting question.

Over the past year, the pace of economic reform in Russia has exceeded even Dr. Gaidar's high expectations. The implementation of the flat tax has been an unqualified success and income tax revenues have grown an astonishing 2.1 times in nominal terms (1.7 times in real terms), largely due to a decrease in tax evasion. The flat tax is now secure. Yet, Dr. Gaidar chose not to dwell on the many achievements of the past year but to focus on the risks awaiting Russia.

First, the pace of reform in Russia has become unsustainable. As the next Russian election cycle gets underway, the energy and enthusiasm for reform is waning. Reforms in the banking sector, natural monopolies, municipal finance, the military and a host of other fields will not be carried out in this political cycle. However, preparations are underway to capitalize on the next window for reform that is expected in the spring of 2004.

Russia's longstanding dependence on the price of oil continues to be a risk. While the danger of low oil prices is commonly appreciated, Dr. Gaidar pointed out that there is an equal, if not greater, danger in high oil prices (above $25/barrel). Such high oil prices would cause excessive appreciation of the ruble, damaging all non-oil sectors of the Russian economy. Low oil prices still pose a challenge, but the Russian government is adequately prepared to deal with them.

While the recent economic recovery has been a very welcome development, it has increased the risk of an excessive influx of short-term capital into Russia. In international financial circles the enthusiasm about Russia is exceptionally high and the danger of another investment bubble looms large. Yet, the risks are nowhere near as great as in 1998. The government is no longer so reliant on financial instruments, limiting the damage of any sudden financial collapse to the stock market. Even so, many Russians could be hurt. Therefore, Dr. Gaidar argued, the government should develop instruments to control the flow of short-term capital into the Russian market.

The roots of an impending crisis in Russia's banking sector are already clear. Perhaps the best news from the past year was the removal of the chairman of the Central Bank. For the first time, reform of Russia's banking system is a serious possibility. While the importance of such reform has long been obvious, its implementation has been stalled. Any attempt to raise capital requirements or otherwise challenge Russia's micro-banks will reveal their criminal ties, exposing them as money laundering operations. There is no way to fix the system without creating an inordinate number of very unsavory enemies. None the less, reform is both necessary and likely.

Turning to Russia's non-economic challenges, Dr. Gaidar pointed to President Putin's unpopular foreign policy. While this policy was born out of pragmatic
considerations and is on the whole viable, it has only proven sustainable through the sheer power of Putin's general popularity. Russia shares much in common with the West, including the threat of Islamic fundamentalism and a stake in stabile world oil prices. Yet, Putin's foreign policy remains deeply unpopular with Russia's ruling elite. Putin still needs concessions (repeal of Jackson-Vanick and support for WTO membership) from the US to show that Russia is being respected. The elite may be conservative, but a new generation is rising. The next few years may bring a shift in the composition of the security and military elites, thereby cementing Russia's shift to the West.

Undoubtedly Russia's greatest challenge in the coming years will be to define its own conception of democracy. Russia's embrace of the market economy is now irreversible, but its commitment to democracy remains tenuous. Recently, Russia has been drifting towards a form of managed democracy. A managed Russian democracy would still secure the basic rights and freedoms of its citizens while ensuring stability. Its major deficiency is that the political elite would tightly control the outcome of the electoral process. The problem with such a system is that it breeds corruption. Corruption is already Russia's greatest problem and it can only be effectively countered through an open and liberal democratic system. The key to this process will be the creation of a free press. Russia has not had a free press since the early 1990s. For the past decade, the media has been beholden to government funding in one form or another, be it through the oligarchs or the President himself. Now, with the recent explosion of Russia's advertising market, the conditions exist for the creation of financially viable media outlets. There is still hope for a free Russian press. In the end, the fate of Russian democracy will be for Russia to decide internally and there is little the US can do to influence the outcome. Russia has overcome great obstacles in the past and Dr. Gaidar is sure that Russia will commit itself to democracy in the future.

This concluded the formal portion of Dr. Gaidar's remarks and the floor was opened to questions. The first member of the audience to speak asked that Dr. Gaidar draw his attention to a recent report by the World Bank on the developing HIV/AIDS epidemic in Russia. Russia has the fastest growing rate of infection in the world with over a million HIV/AIDS positive cases already. At present, the Russian government has only allocated some $5.4 million of its budget to treatment and prevention. This is a woefully inadequate sum as even if Russia were to secure the same reduced drug prices that have been granted to areas of sub-Saharan Africa, it would need to spend at least a few billion dollars to treat its infected population. Dr. Gaidar assured the audience that he was aware of the problem and was doing his best to bolster government action in support of treatment and prevention.

Turning to the topic of Russia's small businesses, Dr. Gaidar was asked to clarify the measures the Russian government was taking in support of these enterprises. First, Dr. Gaidar pointed out that official statistics do not adequately reflect the actual number of Russia's small businesses. Many such operations remain in the informal economy to avoid official recognition, resulting in a substantially lower level of reported activity than is actually the case. Yet, even taking this into account, Russia's small business sector remains stunted. Principal blame for this must be placed on the bloated state machinery that continues to stifle entrepreneurs. The government is simply too big and too unproductive. Finding a way to eliminate this bureaucratic racket is of the utmost importance.

As concerns Russia's agricultural sector, Dr. Gaidar evinced unbridled optimism. The latest statistics show tremendous growth in this sector, indicating that Russia's farmers have finally adjusted to the market economy. The major driver behind this successful adaptation has been the food processing industry. Russia' food processors were huge beneficiaries of the 1998 crisis. As these companies grew, they found that it was much more profitable to invest in Russian agriculture rather than seek to import foodstuffs from abroad. The result has been a reorganization of Russian agriculture with a shift towards large-scale production. In Dr. Gaidar's view, the new land code will be adopted after the necessary compromises on foreign ownership (which will be postponed) and the size of possible holdings are made.

Finally, Dr. Gaidar addressed what he considers to be the biggest problem in US-Russian relation to date, namely Russian-Iranian nuclear cooperation. Dr. Gaidar stressed that US pressure alone will not be sufficient to end this dangerous endeavor. The key to stopping Russian sales to Iran lies in the ability of the US to design a packaged deal for Russia that addresses both joint security problems while remaining responsive to internal pressure within Russia. Fostering cooperation between the nuclear industries of the US, Europe and Russia along the lines of US/Russian space cooperation is vital.
With that, Dr. Gaidar thanked the audience and concluded his presentation.

Summary by Karlis Kirsis, Junior Fellow, Russian & Eurasian Program.