Thursday, Jan. 11, 2007

By CHARLES WOLF

SANTA MONICA, California -- Fifteen years after the Soviet Union collapsed and split apart, Russia still fits British Prime Minister Winston Churchill's characterization of Josef Stalin's Soviet Union nearly seven decades ago: "a riddle wrapped in a mystery inside an enigma."

Throughout the presidencies of Boris Yeltsin in the 1990s and that of Vladimir Putin, Russia has opened its doors to international trade, investment, tourism, the media and the Internet. In sharp contrast to the Soviet Union, Russia now publishes voluminous (if not always reliable) economic, social and demographic information.

Among the many economies labeled "transitional," Russia's is the second largest, with a GDP about one fifth that of China, but double in per capita terms. But it is unclear where Russia lies on the spectrum of "transition." Is it headed toward market-driven, decentralized decision-making and resource allocation or state-controlled, centralized decision-making and resource allocation? Or is it oscillating between the two?

Yegor Gaidar, a distinguished economist in Yeltsin's administration and postcommunist Russia's first prime minister, argues that Russia's full transition to a market-based economy is likely to take 75 years because of the long "duration of the Socialist period and the distortions connected with it."

On the other hand, the United States and the European Union have formally accepted Russia as a "market economy," a status that makes it less likely that other market economies will impose "antidumping" tariffs or other protectionist measures on Russia's exports. But the fact that Russia has not yet qualified for membership in the World Trade Organization suggests that this status may have been accorded as much for political as economic reasons.

In fact, a heated debate is currently under way within Russia concerning the direction of its economic transition, which reflects the sharply different emphasis that the opposing sides place on "good news" pointing toward market-oriented change or "bad news" pointing in the opposite direction. The debate also highlights disagreement about the reliability of official data.

Since 1991, Russia's real GDP growth rate has been more than twice the unweighted average of the other Group of Eight members (Japan, Germany, France, Canada, Italy, Britain and the U.S.). During Putin's tenure since 2000, Russia's annual GDP growth has been 6 percent, compared to 2 percent for the Group of Seven, its foreign debt has been reduced from 50 percent of GDP to less than 30 percent, and its $ 3.3 billion debt to the IMF was repaid ahead of schedule in 2005. Of the $ 40 billion owed to its creditors in the Paris Club, Russia has paid $ 15 billion ahead of schedule, and its foreign exchange reserves have more than tripled, to more than $ 250 billion.

Optimists also cite evidence that the number of privately owned enterprises more than doubled in the past decade, to nearly 80 percent of all enterprises, while the share of state owned enterprises shrank from 14 percent to less than 4 percent. Likewise, employment in private enterprises grew by 41 percent while declining by 15 percent in state enterprises. Indeed, optimists contend that official data on private sector growth may actually understate the pace and magnitude of Russia's move toward private ownership, given efforts by private businesses to avoid tax liabilities by not registering or by under-reporting transactions.

A final "good news" indicator, reflecting both external influences (oil and gas prices) and internal developments, is the major ratings agencies' recent boost of Russia's sovereign debt rating from "junk" to investment grade. That decision lowers Russia's costs of access to foreign capital, and indicates that markets have at least modest confidence in the economy's prospects.

But, while there is ample good economic news, there is plenty of bad news as well. Inflation continues to hover around 10 percent, and capital flight -- an indicator of weakened confidence in the Russian economy -- was more than $ 9 billion in 2004, and increased further in 2005.

Furthermore, the pessimists dispute the picture of private sector growth represented by official data. The level of state ownership, production and employment in the Russian economy is at least as high now as it was in 2003, when Mikhail Khodorkovsky, the chief executive of the oil company Yukos, was arrested and the state seized Yukos's assets, along with those of several other privately owned companies.

Moreover, a key question about the "good news" is how much of it should properly be attributed to the windfall of higher oil and natural gas prices (hence, to factors not under Russia's control), rather than to improved economic policies and reform.

Recent empirical work at the RAND Corporation, a nonprofit research organization, highlights Russia's heavy dependence on fossil fuels. Increased oil and natural gas prices explain between one-third and two-fifths of the economy's growth over the period from 1993 to 2005. Oil and gas production accounted for between 16 percent and 20 percent of Russia's GDP and between 44 percent and 55 percent of its total export revenues since 2004. The buildup of Russian foreign exchange reserves is a further illustration of this dependence.

Where is the Russian economy heading? Toward decentralized resource allocation by competitive markets, or backward toward decision-making by the state and its bureaucracies? The answer remains highly uncertain. No less uncertain is what these economic puzzles imply with respect to Russia's role and behavior in the international arena.

Charles Wolf Jr. is senior economic adviser and corporate fellow in international economics at the RAND Corporation, and a senior research fellow at the Hoover Institution. He is coauthor (with Thomas Lang) of "Russia's Economy: Signs of Progress and Retreat on the Transitional Road." Copyright Project Syndicate 2007 (www.project-syndicate.org)

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