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Sunday, July 13, 2008

The Sunday Sham

The Streetwise Professor demonstrates that the Russian emperor has no clothes:

It is evident that Russia’s current advances are powered by high energy prices and built on a foundation of quicksand, and hence are unlikely to persist long into the future. Russia suffers from several debilitating structural weaknesses, some of which I have touched on in SWP before, but which are worth remembering.

Three such weaknesses are readily apparent: institutions, demographics, and infrastructure.

Russia’s weak institutions are well known. Headline events, such as Yukos, or Sakhalin, or as of late, BP-TNK provide spectacular illustrations of the precarious state of property rights. It is widely acknowledged–by Russians and outsiders both–that corruption is worse today than even during the 90s–perhaps by an order of magnitude. Even President Medvedev acknowledges the “legal nihilism” of his country.

But this article describing a Levada Center poll shows how deep the institutional rot is in Russia, and how it affects not just foreigners or out-of-favor oligarchs, but every Russian. According to the poll, about half of the Russian middle class contemplates emigration, primarily because of their palpable sense of vulnerability to the predations of the state:

Only 13 percent of those polled by Levada Center agreed with the statement that Russia had entered a period of protracted stability, while 59 percent said the situation could change for the worse at any moment. Around 76 percent of those polled said that they could not protect themselves from the arbitrary actions of the authorities, in particular the police, and around 65 percent said they were not sure that they could protect their rights and interests in court.

“Despite the fact that Russians are not delighted by this situation, it appears that they have resigned themselves to it,” wrote Nezavisimaya gazeta. “Many of the respondents believe that they cannot influence the political processes in the country and are prepared to use dishonest and unlawful means for the resolution of conflicts and problems. The readiness to give bribes and to use personal contacts is very high within the Russian middle class.” Indeed, around half of the respondents in Levada Center polls have said that if they were falsely accused of not paying taxes, it would be better to use bribes to resolve the problem than to take it to court. The respondents indicated that they were prepared to act similarly in more “neutral” situations. For example,
59 percent said that they would pay for medical services, which in theory are provided at no cost. . . .

Asked why they were considering leaving Russia, 86 percent cited the desire to get a greater guarantee for a stable and safe future; 79 percent cited a desire to live under conditions in which the rule of law, rights and freedom prevailed;
69 percent cited the desire to avoid governmental lawlessness; and 83 percent cited the desire to enjoy better and more comfortable living conditions.
According to Nezavisimaya gazeta, the Levada Center’s researchers believe that the high level of desire to leave Russia is evidence of serious social malaise.

“The central feature of the consciousness of the middle class is a feeling of the in-betweenness [sic] of its own existence and a radical collision of the way of life with the way of thinking,” Dubin told Nezavisimaya gazeta. He added that without radical changes in society, the prospects for Russia’s middle class to grow and transform into a wide and stable social stratum seem doubtful (Nezavisimaya gazeta, June 27).

By design, the poll focused on those most likely to have thrived as a result of Russia’s economic rebound. Even among this restricted sample, the effects of institutional weakness are manifest. This is hardly conducive to the formation of trust and social capital that facilitates exchange and investment in human or physical capital. This bodes ill for Russian growth.

The fears expressed in the poll are anything but groundless. This article from the Guardian details the practice of corporate raiding a la Russe, which puts a whole new meaning on the phrase “hostile takeover.” Through a combination of force and fraud, often abetted by–or committed by–corrupt state organs, the raiders confiscate the assets of successful firms that attract their attention, often leaving the firm’s owner in jail. This is a tax on success and capital (accumulate no capital–no risk of expropriation!), and it is well known that capital taxes are extremely detrimental to growth. Now, this tax is not paid with certainty; not all successful entrepreneurs are subjected to the tender mercies of these latter-day Mongol hordes. Instead, it is, well, a Russian Roulette tax; you lose everything with some non-trivial probability. Again, hardly conducive to encouraging small business growth. (Another reason, perhaps, that small business formation in Russia is notoriously low.)

Need more evidence? Consider this Business Week piece describing the results of a poll conducted by my friend Sergei Guriev and Igor Fayukin, his colleague at the New Economic School:

The study’s participants believe “the lack of political competition and restrictions on political, economic and personal freedoms” are “a serious problem for the country.” The vast majority are concerned about Russia’s declining population, but also see corruption, the lack of an independent and effective judiciary and a disregard for citizens’ rights by the authorities as the leading challenges in the near future.”

Executives think the solution to corruption and state inefficiency can be found through “broader political change in the country.” One respondent said that the situationrequires the “liberalization of civil society, a reduction of barriers for business, and the modernization of government institutions in accordance with the aspirations and business and civil society.”

“In the eyes of many, the current problems are connected with the low level of competition in the country,” the study’s authors write. Another of their respondents thought what is needed is “more competition, a fight against the fusion of government and business and against monopolization.”

One might argue that other nations–notably China–have weak institutions as compared to the US and Europe, but have prospered in recent years. There appears to me to be a significant difference between China and Russia, however. China is ruled by what Mancur Olson called “stationary bandits.” Yeah, the Chinese bureaucrats and party elite steal, but they are sufficiently confident in the security of their positions that they take a relatively long view, and discipline their short run rapacity to increase their long run take; due to the security of their tenure, China’s new mandarins have an incentive to encourage growth. Russia in the 90s was beset by roving bandits, who knew that their long run prospects were dim, so they took everything they could, the future be damned. Things are a little better now (this is one of the wages of Putinesque “stability”), but as the raiding and confiscations and widespread sense of personal insecurity before the agents of the state demonstrate, roving banditry and short termism are still rife in Russia. (An example: it has been mooted that one source of conflict between BP and the Russian partners in TNK is that the latter want to maximize the short term revenues from the company’s properties, whereas the former wants to use techniques to conserve the oil reservoirs in order to maximize their long run potential.) Another potential difference is that Chinese businessmen have been more successful at organizing to advance their interests, whereas the atomization of Russian society has prevented the coalescence of any corporate resistance to the state’s predations.

With regards to demographics, although the government has crowed about increased birth rates, the overall picture is still grim. According to a recent report by the Russian State Statistical Service as reported in ITAR-TASS, Russia’s permanent population fell .07 percent in the first 4 months of 2008, corresponding to a .21 percent annual decrease. Although this figure is lower than the .5 percent decrease experienced throughout the 1990s and early-2000s, it is still hardly a sign of a healthy country. Indeed, immigration has cushioned the effect of continuing low birth rates and high death rates: “In the first four months of the year, the statistics service reported 547,100 births and 725,200 deaths, Prime Tass said.” Although the birth rate is up slightly, so is the death rate. And, as is widely understood, a good portion of the increased birthrate is a demographic fluke as the last large generation of Russian women is reaching childbearing age. Although the statistics do not say this explicitly, it should also be recognized that the educational and skill level of most of the immigrants and a disproportionate number of the childbearing families is below that of those dying–because immigrants and those having children are disproportionately from the more backward regions of the former-USSR and the more backward regions of Russia. Some baby boom. Some demographic rebound; more like a dead cat bounce.

Russia’s infrastructure woes are also widely acknowledged. I can’t find the cite (probably JRL), but I remember reading that the mileage (kilometerage?) of paved roads in Russia has actually declined in recent years. It is widely recognized that the railroad system is in desperate need of maintenance and expansion. In a country as large as Russia, infrastructure is crucial.

Of course, the government has announced grandiose plans to improve Russian infrastructure. The challenge is translating those airy promises into economically productive investment. The institutional deficit is one obstacle to achieving anything substantive; large infrastructure projects are especially vulnerable to corruption that inflates costs, not just in Russia, but in Russia the problem will be especially daunting. Moreover, the Edifice Complex and political considerations tend to divert too many resources to “prestige” projects and megadevelopments; the Sochi Olympics and the fantastical plans for a tunnel between Siberia and Alaska being conspicuous examples. Russian tendencies towards giganticism and the above-noted Russian desire to proclaim Russia’s resurgence in blingy ways will only exacerbate these problems. My prediction?: Infrastructure spending will indeed expand, but the social return on this investment will be very low. The private return–to those feeding at the trough–will be high indeed.

Other problems abound, but many fit comfortably in the categories just defined. Health care and public health are appalling in Russia, for instance, but this is really one of the sources of the demographic meltdown described above, and the intransigence of the problem reflects Russia’s institutional deficit.

So, to repeat old themes: Russia is never as strong as she looks, and her current strengths and successes are likely to be transitory as the institutional, demographic, and economic foundations for long run success are decrepit; the bleak long run prospects arguably contribute to the short term focus that characterizes Russian business and government; Russian aggressiveness is fueled by remarkable events in the commodities markets, the volatility of which make a very tenuous basis for long term success; and, in the end, no amount of chest thumping or prestige projects today will defer indefinitely a very painful future crash.

Russia would be much better served by a focus inwards on its pressing structural problems rather than by its current attempts to achieve some simulacrum of great power status. Not going to happen, unfortunately. And given that, Europe in particular should recognize Russia’s debilitating and deep seated weaknesses, and abandon its cringing and pusillanimous posture towards its eastern neighbor. This only feeds Russia’s presumptions and enables its dysfunctional political and economic culture.

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