Economic Growth in Russia after the Collapse of the Soviet Union - Essay Example

? Economic Growth in Russia after the Collapse of the Soviet Union Introduction For economic and political reasons, the Union of Soviet Socialist Republic collapsed in 1991 and broke down into 15 independent states, which came to be called newly-independent states or NIS. During its break-down the economy of the independent states struggled to become market economies. The states formed economic integrations, depending on geographic proximity, history and cultural characteristics. Russia made it alone, starting political reforms from a communist state to an independent democracy with the president elected through popular election. Boris Yeltsin was the first elected head of state. (Shleifer and Treisman 151) Russia’s economic performance “after the fall” has been negatively described by many including members of the United States Congress. But in 2003, President Bush praised Russian President Putin over his democratic ideals in ruling present-day Russia. (Shleifer and Treisman 151) Let us examine first how Russia encountered those challenges in the early years after the fall of the Soviet Union. Russia first experienced currency devaluation due to large deficit. The newly-independent states (NIS) experienced a dramatic drop in the Gross Domestic Product by more than 40% for the period 1990 to 1995 (qtd. in Mondal 140). This situation led to numerous reforms in the economy, particularly the reconfiguration of the public finances. The international community helped to provide economic reform and infuse foreign aid. This led to an improved GDP. (Mondal 140) At the start, Russia had to depend on foreign capital to sustain economic growth because of internal factors like slow revenue collection and excessive state expenditures. The government was also encountering low savings rates and Russian banks refused to provide finance for domestic investment. Research on the Russian economy found that the legal system was “an obstacle to foreign investment” (qtd. in Kirkow 80) and there was no proper legal regulatory framework to provide efficient foreign trade arrangements. Other factors considered obstacle were spot-market and hierarchical transactions which are common in low-performance economies. The strategy of liberalization and internationalization changed the configuration of demand, price signals and transaction costs because of Russia’s “large territorial distances and fragmented economic space” (qtd. in Kirkow 80) even if Russia has rich natural resources and human capital. Liberalization and new foreign trade arrangements were faced with bureaucratic encroachment by means of export and import tariffs and quotas as these were opposed by resource-based industries (in metallurgy, oil, etc.) and “crony legal entities.” There were also external factors like export restrictions imposed by EU regulations and international cartels (Kirkow 81). These factors impeded the flow of foreign capital, technology and technological knowledge, and prevented the creation of new jobs and industries. Two industrial sectors supposed to attract FDI in Russia in 1993-1994 were not considered labor-intensive, and manpower was not a major FDI magnet. Moreover, there was a linking of the traditional and new approaches since the Russian government had “active state participation” over matters relating to Russian exports. This policy applied to what the government called “strategic resources,” such as military hardware, natural gas and precious metals. There were also export restrictions conducted by the government, like issuance of export licenses and quotas, taxes, the limitation of export producers, the monopoly of FTOs in acquiring export products on the domestic market and the policy to remit a portion of the hard currency revenues to the government (Kirkow 82). State-owned banks set up during the Soviet era and still operating abroad continued to provide state control and coordination of foreign trade. These banks were set up to provide credits for Russian firms at lower than domestic interest rates and to run their hard currency accounts (qtd. in Kirkow 82). The “perverse policy syndrome” introduced by Olson (qtd. in Kirkow 82) which states that small groups in unstable societies can provide influence and high level of protection could be applied on the Russian situation. An example is that during those times of the Russian transition, “authorities continued to have their leading brokerage role in foreign trade arrangements and monopoly power in third-party contract enforcement, while at the same time foreign markets were restricted and favouring large and often state-controlled companies with subsidies and tariff protection.” (Kirkow 82) This results into imperfect markets based on political considerations, which led to insecure property rights and distorted incentive systems. Russia resorted into barter deals in domestic and foreign trade which amounted to 7.5% of the officially registered total foreign trade turnover in 1995. Barter deals were the result of excessive taxation and the failure of the financial sector to invest or provide working capital particularly between Russian and other CIS enterprises. Michalopoulos and Tarr (qtd. in Kirkow 83) indicated that barter deals are a “special technique for capital flight through underinvoicing of exports and overinvoicing of imports.” Barter exchange was so common that it reflected liquidity and fiscal problems and “specific features of transactions in general, such as asset specificity, uncertainty and frequency prompting vertical integration” (Williamson, qtd. in Kirkow 83). In such a situation, Russian banks were not performing their primary role in a market economy. Banks should have operated as go-between between investors and clients as this has an impact on credit issues and payment settlements in foreign trade arrangements. Foreign Trade Relations Trade liberalization and internationalization impacted on monetary and fiscal policy. Russia had to adjust domestic prices to world market prices and to use predominantly interest rates and the exchange rate corridor to defend and stabilize the rubble. Russian producers had to compete with Western brand names, while the sharp real exchange rate appreciation was advantageous to Western imports (OECD qtd. in Kirkow 83). The sharp decline in world oil prices in 1998 impacted on the growth of Russian oil companies. Oil prices dropped from highs of almost $25 a barrel in January 1997 to $15 for North Sea Brent in 1998, although Russia’s main export crude, the Urals blend, reportedly traded at $1.30 discount to Brent (Financial Times qtd. in Kirkow 83). Export revenues in products such as ferrous metals, mineral fertilizers and unprocessed logs in 1995 and1996 also suffered because of volatile world market prices. The 1998 Meltdown In 1998, Russia experienced a rapidly growing public debt, slow economic development, reforms in fiscal and structural fundamentals, and credit defaults. (Kharas et al. 6) Russia made one of the ultimate moves to save the economy, devalue the ruble. Along with the devaluation was the restructuring of its obligations that were due up to the end of 1999, and imposed a ninety-day moratorium on the repayment of external debts in order to give support to Russian commercial banks. After about three weeks, the Central Bank of Russia (CBR) made another economic emergency by floating the ruble. This made the exchange rate to 21 rubles to the dollar, more than three times its previous worth of 6.29 rubles to the dollar in the previous month of August. (Kharas et al. 1) The result was very costly for the Russian economy: market borrowing had very high interests, banks were not making any positive moves, and there was so-called spike in inflation which was 84 percent for the whole year from an original target of 8 percent. There were fears of hyperinflation. The government of Sergei Kirienko was put out of office. To save the economy, international financing institutions provided a $22.6 billion package purposely to level the exchange rate before reforms could be implemented. But the package did not obtain its objectives since the total foreign exchange resources and the borrowings totaled $30 billion and the foreign currency debt increased by $20.5 billion. Despite the negative expectations from foreign finance, the macroeconomic situation made a turn around by 1999. The domestic industry rebounded strongly, aided perhaps by the devaluation, and made an output increase of 5.4 percent in 1999. Inflation was down to 40 percent and remained there. (Kharas et al. 3-5) The Global Financial Crisis Most of the foreign economic activities occur in resource-rich, machine-building and gateway regions. Economic indicators for these areas include exports, inflow of hard currency, joint ventures operations and fixed capital investment. (Kirkow 89) The recent global financial crisis impacted on the Russian economy. Oil prices dropped from $145 in July 2008 to less than $50 per barrel in September 2008. Foreign investors retreated, bringing along with them investments closed to $80 billion and Moscow’s stock exchange lost about 65%. The Russian government rescued two banks with $210 billion as crisis package. The GDP downed to 10% from the preceding half-year and by the end of 2009, it reached 8%, year-on-year. For the first time in 8 years, Russian budget had had a deficit and the government decided to bridge from a special reserve and increased the external debt through a Eurobond issue. The measures may have halted the problem, albeit temporarily, as Russia’s GDP registered a year-on-year growth of nearly 4%. Russia’s economic crisis provided a clear scenario on the country’s dependence on oil and gas revenues, which is just about one third of the domestic GDP that sustains about one half of the state budget. The main beneficiaries of Russian energy resources are European Union states, which are also the country’s key foreign investors. The European Union member states are Russia’s major trade partner, whose trade accounts to more than half of Russia’s trade. Russia exports crude oil and natural gas and imports highly-processed products. Therefore, the value of Russia’s exports depends on the prices of and the demand for the raw materials. It can also be concluded that Russia’s energy sources depend on the EU energy market which accounts for 80 percent of Russia’s oil exports and 64% of gas exports. (Cwiek-Karpowicz 30) The oil pipeline network supplies oil and gas to some parts of Europe. This was built during the Soviet era, to supply oil and gas from the fields on the Volga and in West Siberia to major urban-industrial centers in the Soviet Union and other socialist states in Eastern Europe. After the break-up of the Soviet Union, control of the pipeline system was distributed among the post-Soviet states. Russia had to have some agreement with the new transit states, particularly Ukraine and Belarus. But disagreements occurred and so the Russian authorities had to set alternative transmission routes that would bypass the transit countries and provide direct access to Western European markets. These projects are very costly which add to the cost of Russian energy resources. But it will have the assurance of delivering oil to Russia’s trade partners in Europe and add leverage in Russia’s position in renegotiations with the transit states. Russia ranks first in terms of global proven reserves of natural gas and eighth in oil. (Cwiek-Karpowicz 31-32) Because of its large territory, some regions in Russia were hit more by the negative impact of the meltdown in the 1990s than other regions. The geo-physical features have an advantage over other regions. (Roberta and Czyzewski 92) The Impact of the “Outsider” Status and Succession in the WTO The Russian Federation’s outsider status was established on 16 June 1993 and on 22 August 2012 the Russian Federation was formally admitted as the 156th member of the WTO. (“World Trade Organization: Russian Federation” par. 1) The entry to the WTO paved the way for a more market-oriented economy. This could conform Russia’s domestic laws and regulations with those of other countries. It was also expected that the problems and barriers to export to industrialized countries. At the time of its accession, there were uncertainties brought about by a number of factors. First, there was pessimism over the positive effects of free trade, both globally and inside Russia. Second, domestic sentiments over Russia’s accession to the WTO commented of negative gains since Russia was already recognized by many WTO members as a “most favored nation” (MFN). Third, some commentators argued that the WTO had a policy of asymmetric treatment. Fourth, the liberalization condition on domestic energy prices did not do well with Russia as this might have negative effects. Fifth, there were those who ideologically opposed WTO entry, especially on the concept of “economic liberalism.” (Lissovolik and Lissovolik 5) Russia’s succession to the WTO could benefit its level of trade from its former “outsider” status to the present member status. Russia will improve its trade-related benefits since trade restrictions will be removed. But President Vladimir Putin has recently commented that quick benefits could not be attained yet from his country’s accession since the global economy has slowed down and that there is “low investment activity” in the world economy. (“WTO Entry Unlikely to Yield Quick Benefits for Russia – Putin” par. 1) The Current State of the Economy During the second quarter of 2013 Russia’s GDP increased by 0.26 percent over last year, with an average growth rate of 1.1 percent every year since 2003. It had an all time high of 3.4 percent in December 2007 and the lowest at -4.8 percent in March 2009. The oil and gas sector has a share of 20 to 25 percent to GDP, which is about 65 percent of total exports. The economy improved this past decade, reducing poverty and unemployment and with a growing middle class. The problems incurred since the break-up of the Soviet Union in the 1990s have continued up to this day, albeit with some modifications. There is government intervention in the market, insufficient property rights laws, and corruption is still rampant. (“Aberdeen Group: Russia GDP Growth Rate” par. 1) Conclusion With its declaration of independence in 1991, Russia started to shift to a market economy and integration into the world economy. The new independent federation encountered severe economy problems as its external trade was based on political and ideological considerations and not on market principles. Export and import activities were dealt with socialist countries and were subsidized by governments. This sudden shift in the economic policy met further barriers with the financial meltdown in the 1990s. The economic background of the Russian Federation since its independence tells that there was a trade implosion in 1991to 1992 but the economy rebounded in 1993-2003, although there was a slight slippage in 1997-1998. (Lissovolik and Lissovolk 3) Since the break-up of the Soviet Union, Russia’s geographical composition almost did not change but its exports were composed of different products compared to the other CIS countries, and its share of the export markets was only 23 percent in 1995 compared with the other CIS countries which stood at 31-65 percent. There was also a reduction in the sale of machinery to non-CIS states. The changes were due to the pressure from the market economy to reduce “low or negative value-added activities” (Lissovolik and Lissovolk 4). The devaluation of the ruble was caused by the negative response to Russia’s exports. The entry of foreign market was somehow constrained by internal and external policies. There was government interference and administrative actions which were against free trade. Some export products were not allowed to protect the supply of external products. Russia also restricted exports of energy products in 1999. At the same time, some industrialized countries restricted Russian products like metals and chemicals. Works Cited Aberdeen Group: Russia GDP Growth Rate 2013. Web. 29 Nov. 2013. . Benini, Roberta and A. Czyzewski. “Regional disparities and economic growth in Russia: new growth patterns and catching up.” Economic Change. 40.1. (2007): 91-135. Springer. Web. 28 Nov. 2013. Cwiek-Karpowicz, Jaroslaw. “Russian Energy Policy Towards the European Union in the Context of the Economic Crisis.” The Polish Quarterly of International Affairs. 1.1 (2011): 30-48. ABI/INFORM Complete. Web. 27 Nov. 2013. Kharas, Homi, Brian Pinto, Sergie Ulatov, Lawrence Summers and John Williamson. “An analysis of Russia’s 1998 Meltdown: Fundamentals and Market Signals.” Brookings Papers on Economic Activity. 1.1 (2001): 1-68. ABI/INFORM Complete. Web. 28 Nov. 2013. 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