RISE OF CORPORATIST STATERISE OF CORPORATIST STATEIN RUSSIAIN RUSSIA

(The 2006 Long Telegram)(The 2006 Long Telegram)

A.A. Illarionov Illarionov

Cato Institute, March 7, 2006Cato Institute, March 7, 2006

© © InstituteInstitute of Economic Analysisof Economic Analysis

www.iea.ruwww.iea.ru

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“If you are not behind bars yet it is not your merit,

it means the system does not work properly.”

Russian people’s wisdom.

“Our system must work better.”

Russian government’s documents.

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Historical analogies are usually subjective, never perfect,

but provide valuable historical perspective to look upon today’s situation

and possible future developments.

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The 2006 Long Telegram:

1. Periods in recent Russian history.2. Russian authorities’ Economic policy.3. Russian authorities’ Domestic policy.4. Russian authorities’ Foreign Policy. 5. What made Russian economic boom?6. Russia’s Corporatist State. 7. Russia is a member of G8. Which G8?

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The most popular question among business people in the 1990s up to mid-2003:

What will be the exchange rate of Ruble tomorrow?Day after tomorrow?In a week?In a month?By the end of the year?

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The most popular question among business people since mid-2003 and especially in the last two years:

Is it not too late to leave the country? Should I leave Russia by the end of the year? In a month? In a week?Day after tomorrow?Tomorrow?Right now?

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Overall diagnosis for Russian authorities’ current policies is Darvensazimus disease.

DARVENSAZIMUS is the disease that Illarionov says DARVENSAZIMUS is the disease that Illarionov says Russia has contracted. The name comes from the mix Russia has contracted. The name comes from the mix of:Dutch Disease, Argentinean Disease, Venezuelan of:Dutch Disease, Argentinean Disease, Venezuelan Disease , Saudi Disease and Zimbabwean Disease. Disease , Saudi Disease and Zimbabwean Disease. According to Illarionov, such nasty mix of economic, According to Illarionov, such nasty mix of economic, political and social distortions preclude Russia from political and social distortions preclude Russia from being a member of the G-8, which is, after all, the most being a member of the G-8, which is, after all, the most exclusive club of industrialized democracies. exclusive club of industrialized democracies.

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Darvensazimus disease

is a very rare, complex and dangerous illness. It consists of at least 5 diseases:

- “Dutch” Disease.- “Argentinean” Disease.- “Venezuelan” Disease.- “Saudi” Disease.- “Zimbabwean” Disease.

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Combination of 3 diseases –

“Dutch Disease”,“Argentinean Disease”,

and “Venezuelan Disease”

can be used for description

of the current economic policy.

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“Dutch Disease” –

sustaining high rate of inflation andnational currency’s real appreciation

leading to “undesirable” structural changesand budget profligacy.

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Higher oil prices led to a sharp increase in the inflow of financial resources into Russia...

Value of Russia’s oil and oil products export

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… to sustaining high money supply growth rate... Annual increase in M2, %

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… to sustaining high inflation rate,.. Annual increase in CPI, %

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… to fast real appreciation of Ruble exchange rate,..Russian Ruble real effective exchange rate (July 1998 = 100%)

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… to sharp increase of the energy sector role in the Russian economy,..

Value of energy exports as % of GDP

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… to a relative decline of non-oil sectors’ share in industrial output.

Non-oil output as % of industrial output

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“Argentinean Disease” –

use of “industrial policy” to “correct” “undesirable” structural changes

by redistributing value added from energy sector into other sectors, primarily machine building

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Beginning of industrial policy in Russia, 2002-2004::

• Increase in taxation of oil companiesIncrease in taxation of oil companies• Increase in government expenditure, including Increase in government expenditure, including

government investmentsgovernment investments• Setting up different government-regulated transport and Setting up different government-regulated transport and

energy tariffs for different sectors, industries and energy tariffs for different sectors, industries and companiescompanies

• Further differentiation of import dutiesFurther differentiation of import duties• Introduction of import quotasIntroduction of import quotas

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The fastest growing item was government’s expenditure on military and police…

National defense and police expenditure as a share of GDP

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… as well as on administration.National expenditure on administration as a share of GDP

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As a result, the number of bureaucrats and their share in total employment

have dramatically expanded.Public administration as a share of total employment

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The rise in government expenditures has also led to increase in non-market employment…Employment in non-market sector as % of total

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… therefore reducing employment in market sector.Employment in market sector as % of total

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While economic activities in processing industries sharply slowed down, expenditure on government administration,

national defense and social security skyrocketed.Growth rates in value added by sectors, %

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Implementation of “industrial policy” led to fall in growth both in oil industry as well as in machine building,

and to a notable slowdown in overall industrial growth.Annual growth rates in 1999–2004, 2005 and in January 2006

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Industrial policy led to decline in growth rates in other sectors.

Dreams of adherents of industrial policy have been Dreams of adherents of industrial policy have been finally implemented.finally implemented.

Arrival of “industrial policy” in Russia Arrival of “industrial policy” in Russia has led to fall has led to fall

in industrial output growth rate by 50%in industrial output growth rate by 50%!!

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New stage of industrial policy – “development policy” (MERT), 2005-2006::

• Differentiation of taxation for different companies.Differentiation of taxation for different companies.• Destruction of Oil Stabilization Fund.Destruction of Oil Stabilization Fund.• Expanding of old and creation of new state financial developmental Expanding of old and creation of new state financial developmental

institutes institutes – – Russian Bank of Development, creation of the Russian Bank of Development, creation of the Government Investment Fund, creation of Government Venture Government Investment Fund, creation of Government Venture Funds.Funds.

• Creation of Special Economic Zones.Creation of Special Economic Zones. • Granting taxation privileges to different municipalities. Granting taxation privileges to different municipalities. • Adoption of programs of Development for different industrial sectors.Adoption of programs of Development for different industrial sectors.• Introduction of limitation to foreign ownership in 39 “strategic” Introduction of limitation to foreign ownership in 39 “strategic”

companies and sectors. companies and sectors. • Adoption of Innovation and Technology Development programs.Adoption of Innovation and Technology Development programs.• Preparation of the Program for Government Support of Design.Preparation of the Program for Government Support of Design.• ““Actually, we have many more ideasActually, we have many more ideas......””

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“Venezuelan Disease” –

nationalization and quasi-nationalization of private assets in oil, gas, transportation, construction, automobile

industry, aviation.

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Accumulation of huge financial resources by oil companies made them very attractive

for government intervention. Oil companies revenues

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Quasi-nationalization began from the most successful oil companies.

YUKOS’ oil output has almost doubled within 5 years, 1999–2004.

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Having launched their assault on Yukos, the authorities by the end of 2004

have essentially destroyed the most effective, most transparent and fastest growing company.

Its most valuable and effective part – Yuganskneftegaz – has been handed over

to the state-owned company Rosneft.

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As a result of the forced transfer to Rosneft, Yuganskneftegaz, the “pearl” of Russia’s oil industry, saw its

output collapsed after 4 years of unprecedented growth within Yukos.

Yuganskneftegaz oil output growth as % to previous year

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Financial results of Yuganskneftegaz activity under state management became

triumph of ineffectiveness and incompetence. Yuganskneftegaz’ financial results

in Jan-Sep 2005 as % in Jan-Sep 2004.

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The transfer of Yuganskneftegaz from Yukos to Rosneft neither increased, nor even sustained

the combined output of these two companies. It reduced their combined output.

Total Oil Output of Yukos and Rosneft combined, 3 MMA, January 1999 – November 2005

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In a response to the government’s assault, private investments in the oil sector in 2004 fell by 20%,

and growth in Russia’s oil output fell from 12% in June 2003 to 0,9% in August 2005.

Oil Production Annual Growth Rates, January 1996 – January 2006

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Political process became concentrated over distribution and re-distribution of monopoly rents

and creation of their new sources, not over formation of favorable conditions

for creation of value added. Vibrant politics is devolving

into rent-seeking politics.

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Not only political elites, but the whole Russian society is evolving

into a rent-seeking society, where weak and ineffective people are demanding subsidies

and protectionism (and receive it), and the most talented, educated and entrepreneurial people

are looking for possibilities to distribute and redistribute rents.

National labor ethics en masse is evolving in a rent-seeking ethics.

Grand populism (in a form of the so-called “national projects”)

has arrived.

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Rent-seeking behavior becomes incredibly attractivenot only for today’s political and economic elites,

but also for future generations.Changes in preferences of future jobs by Russian youth

(FOM polls, 1997–2005)

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“Only in this land which had never known… indeed any tolerant equilibrium of separate powers, either

internal or international, could a doctrine thrive which viewed economic conflicts of society as

insoluble by peaceful means… They sacrificed every single ethical value in their methods and tactics.

Today they cannot dispense with it...”

G. Kennan, The Long Telegram, February 1946.

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The Russian authorities’ attitude towards domestic politics and civil society can best be described as

“Zimbabwean Disease” –

establishing total control of executive power over public and social life that

leading to destruction of virtually all non-state political and economic institutions

of modern civilized society – legislative and judicial powers, political parties, regions power, businesses, mass media, NGO,

religious organizations.

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Deterioration in Electoral Process Index in Russia.

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Deterioration in Judicial Framework & Independence Index in Russia.

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Deterioration in Civil Society Index in Russia.

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Deterioration in Independent Media Index in Russia.

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Deterioration in Governance Index in Russia.

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Public demand for independent analysis, non-government mass-media, opposition politics

is falling fast and sharply. Their financial support by the private business

is quickly drying up as authorities stifle the civil society.

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“[They] work toward destruction of all forms of personal independence, economic, political or moral. Their

system can handle only individuals who have been brought into complete dependence on higher power.

Thus, persons who are financially independent – such as individual businessmen, estate owners, successful farmers, artisans and all those who exercise local

leadership or have local prestige, such as popular local clergymen or political figures, are anathema.”

G. Kennan, The Long Telegram, February 1946.

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Government propaganda saw return of the Cold War syndromes.

Today “enemies of people” include liberals, business people (“oligarchs”), westerners,

potential “orange” forces.

In preparation to the next round of parliamentary and presidential elections

the authorities are de-facto encouraging activity of nationalistic groups and simultaneously creating officious “anti-fascist movement”.

Using “antifascist” demagogy as a pretext they attack dissenting voices in the society.

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To frighten political and intellectual opponents the state of fear is being created.

For those who are not feared, number of different instruments are used: - provocations, harassments, beating, hostage-taking,- for Russian citizens – expulsion,- for foreigners – non-granting visas, expulsion, too.

The latest decision is Anti-Terrorist Act taking basic personal liberties away from Russian citizens.

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“Efforts will be made… to disrupt national self confidence, to hamstring measures of national defense, to increase social and industrial unrest, to stimulate all forms of disunity. All persons with grievances, whether economic or racial, will be urged to spelt redress not in

mediation and compromise, but in defiant violent struggle for destruction of other elements of society.

Here poor will be set against rich,.. young against old, newcomers against established residents, etc.”

G. Kennan, The Long Telegram, February 1946.

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Zimbabwe disease: Political Freedom in Zimbabwe and Russia, 1991−2005

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By dynamics of Political Freedom Index in 1991−2005 Russia has demonstrated one of the worst performances

in the former USSR

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By changes in Political Freedom Index in 2005 Russia and Ukraine occupy polar positions.

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Foreign policy of the current Russian authorities can best be described as

Saudi Disease –

use of energy weaponry in international relations.

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Backed by unstoppable influx of financial resources into the country

regardless of quality of government policy (in reality – rewarding irresponsibility and

interventionism)Russian authorities’ foreign policy becomes

more and more arrogant and aggressive.

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Energy warfare has been recently used against democracy-oriented Ukraine, Moldova, Georgia.

At the same time Russian authorities are positioning themselves

as a strong ally of political regimesin Belarus, Uzbekistan, Iran, Syria, Venezuela,

and of such political forces like Palestinian HAMAS.

At the same time government-controlled media launched anti-European, anti-American,

and in general anti-Western hysteria.

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The Russian state is being transformed into Corporatist State.

It means: - ownership of the Russian state by the Corporation,- use of the Russian state bodies (security service, tax service, courts, others) in the interests of the Corporation, - destruction of rule of law, absence of identical rules, - main award of the Corporation is paratrooping its member (Russian or foreigner – does not matter) into the state-owned company,- privatization of profits, nationalization of costs, - PPP (public-private partnership) – coercion of private business to fulfill orders from the Corporation and bear the costs,- selectiveness taken as absolute principle,- ideology of “nascism” (“our ownism”).

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“The so called enlarged government, i.e. federal government plus regional governors

must work like one corporation.”

President of Russia.

“The accumulation of powers, legislative, executive, and judiciary – in the same hands, may justly be

pronounced the very definition of tyranny.”

James Madison. Federalist papers, # 47.

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World Bank Puts Russia on Par With Swaziland :Moscow Times, Monday, September 18, 2006. Issue 3499. Page 5.

The report, titled "Governance Matters: A Decade of Measuring the Quality of Governance," ranked Russia 151st among 208 countries in terms of voice and accountability, political stability, effectiveness of the government, the quality of regulatory bodies, the rule of law and control over corruption.

The indicators were crucial, the report said, in determining a country's level of economic development. Ahead of Russia were Zambia (148), Uganda (149) and Swaziland (150), while Niger (152), Kazakhstan (153) and East Timor (154) were just behind.

Voice and accountability, the report said, deals with a country's freedom to choose its own government and the possibility to express individual opinion and other social liberties, including freedom of the media. In that category, Russia ranked among countries such as Qatar, Lebanon and many African nations, including Gambia, Congo and Algeria.

Russia fell into a similar percentile as the Philippines, Kyrgyzstan and Israel in terms of political stability. The bank defined political stability as the perceived likelihood that a country's government will be destabilized or overthrown by unconstitutional or violent means, including domestic violence and terrorism.

For effectiveness of government -- the quality of public services and credibility of the state's commitment to policy formation and implementation -- Russia was lumped together with Pakistan, San Marino and Tanzania. For quality of regulation, it was ranked on a similar level to Ukraine, Madagascar and Senegal.

Rule of law in Russia was as effective as in Ecuador, Indonesia and Bangladesh. Rule of law was defined as the "extent to which agents have confidence in, and abide by, the rules of society and, in particular, the quality of contract enforcement, the police, and the courts," as well as the likelihood of crime and violence.

Nicaragua, East Timor and China showed a similar ability to control corruption as Russia.

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What is to expect?

Some historical analogies/warnings.

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Dutch Disease:Dutch Disease:GDP per capita in the Netherlands as % of the USAGDP per capita in the Netherlands as % of the USA, 1975–, 1975–

19881988

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Argentinean DiseaseArgentinean Disease: : GDP per capita in Argentina as % of the USAGDP per capita in Argentina as % of the USA, 1958–2005, 1958–2005

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Venezuelan DiseaseVenezuelan Disease: : GDP per capita in Venezuela as % of the USAGDP per capita in Venezuela as % of the USA, 1957–2005, 1957–2005

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Zimbabwean DiseaseZimbabwean Disease: : GDP per capita in Zimbabwe as % of the USAGDP per capita in Zimbabwe as % of the USA, 1982–2005, 1982–2005

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But… Wait a minute!

What about economic growth?Consumption growth?Investment growth?

Stock market growth?Foreign exchange reserves growth?

Is it fictitious?

No. It is real!

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Since 1998 GDP in dollar terms grew almost 5-fold.

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Money income of population grew 4,5 times.

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Volume of consumption market in dollar terms grew 4-fold.

Retail turnover, US$ bn

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Foreign exchange reserves including Stabilization fund grew 23-fold.

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Since December 1999 Russian stock market grew 10-fold.RTS Index, December 1999 – February 2006

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But it happened almost exclusively due to terms of trade change

rather due to contribution of policiesof the Russian authorities.

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GDP in dollar terms grew almost 5-fold, but in real terms – by only 58%.

Cumulative GDP increase (1998=100%)

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Private consumption in dollar terms grew 4,1 times, but in real terms – only by 63%.

Cumulative private consumption increase (1998=100%)

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While Russia’s economy grew in last 6 years by 48%,physical volume of imports surged more than 4-fold.

Cumulative increase in GDP and imports (1999=100%)

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Even Russian stock market is driven primarily by world energy prices, not by domestic economic policies.

Russian Oil Export Price and RTS Index,January 1998 – February 2006

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It means that domestic policies contribute negatively into economic performance.

Mainstream economic policy of 2000-2003 has being transformed into rent-seeking policy.

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Quality of economic policy has sharply deteriorated. Real GDP growth rate adjusted for windfall profit received

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FDI as a share of GDP fell sharply, especially in non-fuel sectors.

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Capital flight increased more than five-fold. Non-finance enterprises and households’ investments

in foreign assets, 1992-2005

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Actual economic growth fell compare to potential ones. GDP growth rates: actual and potential

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From the first glance Russian economic growth looks impressive (though not compare to China or India). What is

more important, it is by half lower than in other oil-exporting countries during periods

of high oil prices (periods no less than 6 years).

© ИЭА83

Darvensazimus.

“It is a Russian Disease”

(Hugo Chavez)

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Russia is a member of G-8.

Really?

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GDP per capita by PPP at 2002 price in G8 countries, 2005.

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Real GDP Growth Rates in G8 countries, 2000-2004.

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Real GDP growth rate in G8 countries adjusted for windfall profit received, 2000-2004.

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CPI in G8 countries, 2001-2005.

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Political Rights Index in G8 countries, 2005.

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Civil Liberties Index in G8 countries, 2005.

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Political Freedom Index in G8 countries, 2005.

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Changes in Political Freedom Index in G8 countries in 1991-2005.

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Another G-8?

Which one?

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Another G8 by negative GDP Growth in 2000-2004

* Adjusted to ToT

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Another G8 in CIS by speed of degradation of political freedoms in 1991-2005.

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In 2005 Political Freedom Index in Russian fell lower than even in the OPEC countries

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By changes in Political Freedom Index in 1991-2005 Russia occupies 190th place

among 193 countries of the World.

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Another G8 by speed of degradation of political freedoms in the World in 1991-2005.

RISE OF CORPORATIST STATERISE OF CORPORATIST STATEIN RUSSIAIN RUSSIA

(The 2006 Long Telegram)(The 2006 Long Telegram)

A.A. Illarionov Illarionov

Cato Institute, March 7, 2006Cato Institute, March 7, 2006

© © InstituteInstitute of Economic Analysisof Economic Analysis

www.iea.ruwww.iea.ru