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Monday, June 11, 2007

Annals of Neo-Soviet "Success" -- Part II

Writing in the Moscow Times Margareta Drzeniek, senior economist at the World Economic Forum, lays out the reforms that would be necessary to transform the appearence of economic success in Russia into actual prosperity. Anyone vaguely familiar with Vladimir Putin's government knows full well not one of these measures will ever actually be taken, because the natural restult would be to invigorate moribund centers of power that could then challenge the Kremlin's supremacy. Rather than let that happen, the Kremlin would prefer to let the whole country go right down the toilet.

Russia's economic history over the past decade and a half has been characterized by erratic reform progress and some important setbacks, such as the 1998 crisis. Lacking a clear policy anchor, as European Union enlargement was for the East European countries, for example, efforts have been more dispersed. Despite the country's undeniable potential, economic development has not kept up with expectations, as gross domestic product even declined in the earlier phase of transition and has recovered only slowly. Despite the country's enormous wealth in natural resources, the standard of living has fallen for much of the population, leaving the country with worse human development indicators, such as primary education levels, average life expectancy and infant mortality rates, than witnessed toward the end of the Soviet era.

Over the past few years, with rising demand for energy resources, Russia has benefited from robust growth. And as in many other energy-exporting countries, policymakers are faced with the challenge of providing this growth with a sound footing to make it sustainable should energy prices fall in the future. This requires the establishment of solid foundations for the domestic economy that will allow businesses to prosper and attract investment in areas other than energy. Current conditions of high growth can help provide a cushion during reforms, but the state reforms aimed at creating and maintain broader competitiveness are still an important question.

A country's level of competitiveness, understood as the ability to put in place policies and institutions that contribute to economic growth, is an indicator of how prepared it is for the future. In the most recent Global Competitiveness Report from the World Economic Forum, Russia ranks 62nd out of 125 countries, nine spots lower than in the last report, for 2005. Although it finished ahead of Brazil and all of the other CIS countries, with the exception of Kazakhstan, it trails India, China, Turkey and the EU members in Central and Eastern Europe.

A closer look at the results reveals both strengths and weaknesses. Given high oil prices, it is not surprising that Russia ranks 33rd in terms of macroeconomic stability. Labor markets are also relatively efficient and flexible, and transport, energy and telecommunications infrastructure is improving gradually. The country also continues its tradition of scoring well on educational indicators, and in particular with regard to higher education. Russia still benefits from the capacity for innovation built up during the Soviet period and from cultural factors that support strong activity in this direction.

Despite these competitive advantages, however, the index points to other areas in which enormous potential for growth remains unrealized. The most important leap toward improving competitiveness involves a thorough reform of the institutional environment, and particularly in the public sector, which lacks transparency and is still ill adapted to the functioning of a market economy. The comprehensive public sector reform program adopted in October 2005 represents progress toward realizing where the institutional difficulties lie. But although the issues to be addressed are well known, implementation of these reforms is progressing too slowly and too erratically to result in real progress. Not surprisingly, the worsening institutional environment was one of the main reasons for the fall in Russia's competitiveness ratings over the past year.

At the same time, the past year shows that Russia's particular strength, the capacity for innovation, is being undermined by deteriorating higher education and human development indicators. Although the institutional environment is clearly the most important weakness, business leaders view the economy as overregulated and markets as highly concentrated. The country's financial markets, although developing slowly, clearly do not yet serve as efficient financial intermediaries, and the penetration of most advanced technologies, such as the use of computers and Internet, is not on par with other countries that are at the same level of development.

The question is why progress on reforms has slowed when high growth rates and increasing budget revenues from oil and gas exports should be providing an ideal setting for putting them in place. The problem is that periods of high growth tend to relieve the pressure to institute reforms, creating the danger that progress will stall. In Russia, as in many other energy-exporting countries, this has contributed to a slowing down in the implementation of painful reforms instead of facilitating a reorganization of the economy. Even though Russia has seen improvement in some indicators relative to its own history, other countries have made better use of current conditions to improve at a greater pace, thus moving ahead of Russia in the rankings.

The political will to continue and speed up current reforms, therefore, is going to be crucial for future development. In particular, efforts related to the institutional environment and the health and deregulation of markets will allow the country to develop the small enterprise sector -- something that has become an important engine of growth in most post-communist countries. Improvements in the overall business environment will also contribute to the attraction of foreign investment to sectors not related to energy, and thereby to the diversification of the economy. A continuation of the reform of the banking sector will be equally beneficial.

While upgrading these basics, Russia should also continue to develop its already strong system of higher education and enhance its competitive strengths in the field of innovation. Both areas are going to be increasingly important in both current development and as the country moves toward the next stage.

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