The state of the state to the north

Long used to being seen and also to seeing itself as a rowboat between two men-of-war or as a minnow between two large fish (or sharks, depending on your attitude), Mongolia is now basking in prospects of the future. But how are its two neighbours doing? China is obviously going great guns, but things may not be that bright with Russia.  By force of habit that has not worn off,  the ordinary person here  almost unthinkingly seems to take it for granted that the northern neighbour is a world force, as it was when it was brother, and not just in the Orwellian sense.

In point of fact, of the four countries brought together with acronymal skill into BRIC, Russia could be the one that wobbles most. While its peers in the group are coping with an inflow of capital, $21 billion fled out of Russia in the first ten months of 2010, the latest figures I could lay my hands on. Russia’s private firms are too nervous to invest in their own economy, and in a complete reversal of  popular attitudes and priorities, “the spirit of money” -- the ideology that has ruled Russia ever since communism collapsed – is fast ebbing. Bureaucrat-entrepreneurs are a breed apart, and maybe it is their success and predation that is respnsible for a recent survey revealing that the young would rather have a job in the government or a state firm than in a private business or go into business. Over the past ten years the number of bureaucrats has gone up by 66%, from 527,000 to 878,000, and the cost of maintaining such a state machine has risen from 15% to 20% of GDP. At the same time, Russia’s standing in indices of corruption, property rights and business freedom has deteriorated. When its leaders talk up the state as the solution to all problems, the government’s failure to satisfy people’s basic needs, such as security and policing, becomes all the more striking.

Its main macroeconomic problem of the past three years—inflation—is far from vanquished, but a far ger problem is maintaining growth in an economy that during the boom years borrowed recklessly and used the money for higher living standards rather than diversification. The global financial crisis hit the Russian economy harder than that of any other large industrial country, exposing its structural weakness. The improvement in living standards was achieved at the cost of massive under-investment in the country’s industry and infrastructure. In the late Soviet era capital investment in Russia was 31% of GDP. In the past ten years Russia’s capital investment has been, on average, about 21.3% of GDP. (For comparison, the figure over the same period in China was 41%.)

Despite rising oil prices and a construction boom, in the post-Soviet period Russia has built only one cement factory and not a single oil refinery. The Soviet Union used to build 700 km of railways a year. In 2009, it built 60 km. Once again the main source of wealth is oil and gas, which is being exchanged for imported goods. The state today is no better than Gosplan was in the Soviet Union.

The latest World Bank report has warned Russia about the risks of inflation and an over-dependence on energy exports.  The global body has also urged the government not to engage in “complacency” and -- with oil prices still high --  to follow through on deep-rooted structural reforms it has been promoting for much of the past decade. “With strengthened growth in its largest trading partner, Western Europe, and oil prices on the rise, Russia is expected to grow by 4.4 percent in 2011, followed by 4.0 percent growth in 2012,” the World Bank report said. (Deputy Prime Minister Igor Sechin in January issued a 2012 forecast of at least six percent growth, which the Bank obviously thinks is too ambitious.) At the same time, it made clear and cautioned that the figures depended on steady gains in consumer consumption and an easing of the long-term credit market, adding that the “downside risks associated with highly volatile oil prices and global demand will remain”.

The report makes particular mention of inflationary pressures and the Russian government’s excessive monetary response to the 2009 downturn when the economy contracted 7.9 per cent. “The rapid monetisation of the economy during the first eight months of 2010 has proved to be excessive and has led to a buildup of inflationary pressures,” it said. “Managing these pressures and the resulting inflationary expectations will not be easy, given the escalation in world food prices, which add to price increases and negatively affect inflationary expectations.” It noted an 8.8-per cent jump in year-on-year prices in Russia in December 2010, largely because of last summer’s severe drought. Low-income households were most affected by the surge in prices, which caused a 5 per cent drop in consumption. This is why it is wrong to treat inflation as only a macroeconomic problem. It is a social one as well, because it results in serious pressure on real incomes for the middle and lower class.

The report stressed that Russia’s main challenge now was “to sustain reforms under the conditions of a new oil windfall” - advice it has included in most of its 24 post-Soviet reports on the country. It saw real fear that Russia will overshoot its central bank’s avowed inflation target this year as the government ramps up spending before the next nationwide parliamentary vote due in December, followed by presidential elections early next year, and preparations for the Sochi Olympics in 2014. Finance Minister Alexei Kudrin said in late February he is under “strong” pressure to increase spending to help win voters before national elections. Prime Minister Vladimir Putin said late last year that the government had no intention to trim social spending.

The number of Russians living in poverty fell by about 700,000 last year to 12.7 percent of the population, according to the report. That proportion may decline to 11.2 percent in 2011 and 10 percent the following year, the Bank said. It feels the poverty level is falling because of higher minimum wages and pension increases, as well as unemployment benefits. An impoverished person, according to the government figure, is anyone earning less than $208 per month.

Finance Minister Kudrin has said that part of the additional revenue coming from the oil and gas taxes and duties would be used to lower the budget deficit and increase the reserve fund, which now stands at just 2 per cent of GDP. The reserve fund decreased almost 50 per cent over the last year, having reached $26 billion by March 1, compared with $59 billion in March 2010, according to his Ministry’s web site.

According to the World Bank, poor infrastructure is a key factor constraining economic competitiveness. Improving the country’s investment climate is one of the crucial tasks for the government for the coming years. “It’s not a problem of one sector. It requires the government’s highest attention and the attention of state agencies in charge of developing small and medium business, as well as the issues of investment climate in general.”

Is it all not familiar reading for those of us in Mongolia?