The following discourse is an analysis of Rudiger Ahrend’s article concerning the economic status of 21st century Russia. Unless otherwise stated all the ideas are taken from Ahrend’s work. In the said article, Ahrend argued that Russian economic development is in peril unless it will adopt drastic measures to remedy the so-called “resource curse” that is brought upon by resource-based development. Moreover, Ahrend pointed out that despite the overdependence on oil exports Russia exhibited positive growth in the last five years and therefore the goal of the government is to steer clear from an economic trap called the “resource curse” in order to sustain rapid growth seen in recent years.
In view of this assumption, Ahrend made a recommendation, to convince the Russian government that there is a need for major changes in the macro-economic management of their country, particularly the development of correct policies as well as diversification of the Russian economy. But he also added that there is a need to increase oil exports in order to generate funds needed to reengineer the Russian economy.
Overview
Ahrend made an important observation; he said that even though Russia was still reeling from the aftermath of the 1998 financial crisis, the country was still able to post impressive economic growth. Russia’s real GDP grew at just a shade under 6.8 percent per annum in the period 1999-2004. The author added that this growth is beyond expectations and yet this is no time for celebration. There is still that nagging feeling that Russia will not be able to sustain the economic growth that it has experienced in the past five years since emerging from the crisis of 1998.
Ahrend made the assertion that there is a high probability that Russia will be afflicted by what economists call the Dutch Disease. This affliction is brought about by overdependence on natural resources and using them as a main cash cow for the economy. Ahrend was also able to see a pattern when it comes to struggling economies and the presence of abundant natural resources. This led to the theory that there is a so-called “resource curse” that instead of becoming a blessing for the country, the presence of rich mineral deposits can create an environment where the people and the government will simply focus all its energies on exporting the precious commodity without thinking of other strategies that will help build a more efficient and stable economy.
In order to sustain rapid economic growth, there is a need to first understand the intricacies of the “resource curse” as well as the need to formulate sound fiscal policy, to establish a non-corrupt efficient state apparatus, to build a strong civil society and most importantly there must be diversification in the economy. If Russia will succeed then it will join the elite company of resource-based economies able to transform weakness to strength.
Ahrend first discussed the meaning of “resource curse” because the statement seems paradoxical at first. It should have been expected that the presence of resources could also mean that there are raw materials that can be turned into fuel, building materials, or refined into expensive commodities such as gold, platinum, etc. The presence of rich natural resources can also mean an increase in income. This would lead to other positive developments such as a strong expansion in the non-tradable sector e.g. services and construction. Natural resources usually mean exports and growing resource exports also allow the country to increase its capability for imports.
The importation of essential products such as medicines is a good thing and can help modernize the country. Overall improvements in the economy will jumpstart a chain reaction of events that will point Russia to the path of sustainable economic growth. Thus, Ahrend had to clarify his statements that although the presence of rich mineral deposits can help make a country and its citizens rich, it can create an environment that in the long run will not be beneficial to the economy.
Ahrend said that there is hope for Russia because although numerous studies abound with regards to resource-based economies that did not perform well in the long run, there are also exceptions to this rule. The resource-based economy of Canada, Australia, and Scandinavian countries are examples of economies with rich natural resource endowments and yet able to sustain growth and become leaders in the world economy.
On the other hand, Ahrend made the counterargument that there are important potential risks in a resource-based economy and these are listed as follows:
- Vulnerability to external shocks
- Dutch disease
- Political economy problems inherent in resource-based development
The Dutch Disease, on the other hand, can be easily contracted in a resource-based economy that suddenly experiences significant improvements in the way they exploit and export their natural resources. Even when Russia was still under the control of the Communist Party, it was already an established fact that Russia was in the resource exporting business and that the government generated income from the sale of such commodities. But in the new open market, the presence of rich deposits coupled with free enterprise made it possible for the export industry – focused on extracting and selling oil and gas – to experience a great degree of success.
Businessmen operating in this sector can adjust prices based on world demand and unlike in the previous type of government, these businessmen can benefit from high prices.
According to Ahrend this in turn will lead to the creation of an industry that is so attractive to businessmen and other talented individuals. It does not require rocket science to determine that one will make more money in this industry as compared to non-resource-based industries. As a result, there is little incentive to develop the manufacturing sector. This is a common symptom of Dutch Disease. Therefore, talent and resources will begin moving into the oil and gas export sector. According to Ahrend other sectors of the economy will suffer especially those that are linked to the service industry.
The economic problem brought about by Dutch Disease is exacerbated by the fact that in the oil and gas industry there is a distinctively low demand for labor. One simply has to imagine miles of pipelines that move oil and gas from one region to the other. There are no employees or workers involved in many of the high-tech operations of the oil and gas industry. No one can see laborers moving oil manually. Every major component of oil and gas exploration is managed and monitored by machines and computers. Thus, the success of the oil and gas industry will reduce the number of workers in non-resource-based industries because there are only a few investors willing to invest in these types of industries.
Corruption
Ahrend also pointed out that aside from the basic symptoms of Dutch Disease there is another important characteristic of the “resource curs” and it is the link between resource based development and the emergence of a corrupt government that has a propensity for rent-seeking and other inefficient behavior. This is especially true in Russia where the bureaucracy is known to be corrupt or easily corruptible. There is therefore a need to develop a system that will reduce corruption and rent-seeking.
In order to create non-corrupt government agencies, there is a need to develop rules and systems that are easy to follow and transparent. The more complicated the regulations, the more difficult it is for the people to adhere to said rules and the more opportunity for unscrupulous individuals to exploit weaknesses in a slow moving bureaucracy. Transparency will ensure that everyone must follow these regulations and that no single individual or group can ever expect to receive special treatment. The simplicity of the rules will ensure that these government agencies can be easily monitored by others.
It is corruption and inefficient governance that made it extremely difficult for Russia to move forward. The mere fact that Canada, Australia and other resource based economies were able to succeed is the best argument that in a society where corruption can be significantly reduced the abundance of natural resources is a blessing rather than a curse. The eradication or at least the considerable reduction of corruption in Russia can be achieved by encouraging deregulation as well as the development of a strong civil society.
It could not be stressed hard enough as to the importance of a strong civil society. There must be freedom of expression. The Russian people must be encouraged to participate in nation building and must demand for their rights and even challenge government policies that are not for the common good. There must also be press freedom. The international, as well as local, media will act like sentinels and will report on government corruption and other abuses of authority so that corruption can be reduced considerably.
Fiscal Policies
Ahrend’s main argument is to increase the diversification in the Russian economy. But in order for diversification to occur there is a need to establish laws that will lead to sound fiscal policies. One of the most noteworthy parts of the discourse is when Ahrend began to demonstrate the importance of a stabilization fund, one of the important features of a sound fiscal policy. Russian lawmakers have the ultimate say when it comes to the creation of a stabilization fund as well as how it will be implemented. And
Under the current laws a certain percentage of windfall from selling high priced oil and gas must be set aside and placed into the stabilization fund. This money will be used to reduce the impact of external shocks that may come in the future. But the stabilization fund should not be treated as a mere “piggy bank” that will be accessed during hard times. There must be a more proactive use of the said fund. An example would be to use the surplus money to invest abroad.
Another good example of sound fiscal policy is the creation of tax laws that are supposed to guarantee sustainability. For instance, the high earning resource sector must be taxed heavily. On the other hand non-resource based sectors must not be taxed the same way. The significant amount that can be collected from the resource based sector can be used to help strengthen the weak parts of the Russian economy. This will act as some sort of a stimulus program that will encourage businessmen to go into non-resource based businesses such as in providing services to the people e.g. banking, restaurants etc.
Obviously, the Russian government must have discipline in terms of the way it behaves during times of economic prosperity. The memory of a Russian government struggling to stay afloat during times of deep economic recession must be always in the forefront when discussing economic policies. The Russian people could not afford to go back to those dark and hard times. But slipping back into economic depression is very easy to accomplish. The current crop of leaders will only have to be complacent and resting on their laurels, make erroneous calculations when it come to the national budget and become overly dependent from the proceeds of high-priced oil and gas.
It is best to make conservative estimates at this point. The stabilization fund is based on a particular price level for oil exports. For instance, if oil is pegged at $20 a barrel, then if Russian oil sells more than the ceiling price, the surplus money is automatically diverted to the fund. But Russian leaders, comfortable in the knowledge of huge oil deposits and steady global demand for their oil, can easily increase the price limit and instead of $20 will make it into $27 per barrel. This will mean that Russia should be able to sell oil beyond the $27 dollar per barrel price in hopes of making enough money to contribute to the stabilization fund. This also means that the price of Russian oil must be maintained at very high levels before the stabilization fund can increase substantially. This is bad news for future generation of Russians and this is bad news for sustainability.
On the other hand it is the discretion of the Russian government whether to increase the stabilization fund or not. In economics, it is not merely about playing safe but also about opportunity costs. According to Ahrend it would be impossible to force Russia to divert more money into the stabilization fund. If the government will put more money in the stabilization fund then it could mean that there are other projects that will not be funded. Leaders will constantly weigh their options and they will make a decision based on what they feel is right in the long-term and the short term. More consideration must be given to the long-term consequences and Russia must look closely into the examples of other countries that made plans for the rainy days and made conscious effort to create savings during times of economic boom.
After Ahrend elaborate the need for a sound fiscal policy, he minced no words in declaring that the Russian government is riddled with corruption. There are at least two major implications for this problem. First of all there will be lower numbers of investors willing to come in and do business with the Russian people. This is coupled with capital flight and money coming out of the Russian economy, which can negatively impact growth and will make it hard to sustain development. The second major implication of corruption is inefficiency. If part of the solution is the creation of SMEs, then corruption will easily frustrate future businessmen because it is extremely difficult to do business in Russia.
Diversification
Ahrend’s explanation regarding the potential risks made it easy to understand why there is a need to diversify. For instance data taken from Russian government agencies clearly showed the country’s overdependence on oil exports. But history teaches that oil prices are volatile and thus the economy can easily be affected by external shocks. As a result the government may create policies based on high prices. Thus, government expenses and the national budget are based on projected incomes using data from high prices of oil. But if prices will fall then the projected income will be useless. A sharp fall in prices means that the Russian government will have limited sources of income because the profit margins were wiped out. They are overly dependent on this one commodity and therefore they can easily feel the negative impact and as economists aptly label it – external shocks.
While there is overdependence on oil exports there is modest growth in the exportation of gas. Ahrend therefore highlighted the fact that there is a world demand for gas. It is therefore logical that Russia should consider improving their capabilities in extracting gas. But there is one problem according to Ahrend. The gas sector is under a monopoly and strictly regulated. Aside from that there is an emerging pattern wherein the government is moving towards strict regulation as opposed to deregulation. The Russian government it seems is moving towards an increase in state control over the management and business aspect of natural resources exploitation. This is not a good thing and would create more problems instead of solving current ones.
According to Ahrend the manufacturing sector is the most common victim of the Dutch Disease. In the long run the manufacturing sector will be negatively affected and many factories will be forced to shut down. The workers employed by the manufacturing sector will have to find work elsewhere. But they could not move into the more lucrative industry because there are no job openings even if it is supposed to be undergoing expansion. As mentioned earlier the oil heavily mechanized and therefore the concentration of this type of business will mean that there is little employment opportunity for the rest of the population.
Ahrend was correct when he said that it will be extremely difficult to diversity. It is this heavy dependence on oil, as if the Russian economy is in life support and oil exports are the source life giving power. A radical disengagement from it will not only be detrimental but is also unwise. There is no need to stop exporting oil but there must be necessary actions taken that will ensure sustainability.
Thus, Ahrend made it clear that aside from the necessary adjustments in macro-economic management policies, there must be a strong case made with regards to diversification. Ahrend even made it clear that it is only through diversification that the country can move forward and break the “resource curse” in order to help Russia sustain its economic success for years to come. But his solution calls for more oil exports, which is wholly contradictory. In fact he even encouraged more government spending so that oil exports can be increased many times over. Ahrend even specifically highlighted the need to think ahead and encourage the exploration and exploitation of new oil fields so that the business of selling oil can be sustained for many years to come.
It was paradoxical when Ahrend made the argument that the presence of rich natural resources is disadvantageous to society. But this time it can be said that it is the height of irony when he proposed the release of government money to improve an already very popular industry. Oil exports already comprise more than a quarter of the nation’s GDP and instead of diversifying Ahrend made his second major recommendation: pump more money into this industry and make it more successful! It is indeed confusing as to why Ahrend would say something that is totally against his previous pronouncements.
A closer inspection of the data will reveal that Ahrend had no choice but to make a compromise. He was correct in saying that even if it is imperative that Russia diversify its economy as soon as possible, meaning urgently; it is also true that Russia has no choice but to make money first through its exportation of oil. Ahrend was able to pinpoint the source of the problem – Russia has been dependent on the resource sector for a very long time and it is not wise to suddenly transform the economy for the sake of diversification.
The Russian economy is not strong enough to sustain a sudden shift in the way it is doing business domestically and internationally. It is an inescapable truth that in order for Russia to diversity it will need to strengthen its exports as part of a long term plan to wean the nation away from its dependence on oil. Just like a baby is used to its mother’s milk, there must be a period of adjustment. Forcing the still growing baby away from the nourishing milk of the mother can hamper its growth or may even create worse problems for the infant.
In order for the Russian economy to start the diversification process, a strengthening of the export industry in conjunction with the creation of laws that will ensure sound fiscal policies as well as the creation of non-corrupt and efficient government agencies are needed. Russia had no choice but to bite the bullet so to speak. Without a significant increase in exports and without creating the necessary steps that will insure the flow of money coming from the sale of oil and gas, then there is no way that they can restructure the economy.
According to Ahrend the money must keep flowing while the Russian government made slow improvements in other areas. It is a slow process and Ahrend made it very clear that the Russian people must commit to pursue this path for the long haul. There are no simple solutions for a very complicated problem. These problems will not disappear overnight. Russians must not expect their government to suddenly develop a foolproof plan that will significantly reduce the dependence of Russia to oil exports.
More Exports
Ahrend begins the discussion by stating the advantages and risks of a resource based economy. He asserted that in the case of Russia there is more problem associated with rich mineral resource because of three major issues: corruption; a weak civil society, need to diversity and the absence of prudent fiscal policies. It was easy for Ahrend to convince his audience that there is inherent danger in Russia’s overdependence on oil but on the other hand in order for the country to remedy social and economic ills it has to sustain rapid economic growth.
Rapid economic growth is the only way to assure that there will be enough money to establish a stabilization fund. When Russia is no longer gasping for air and able to achieve sustained economic growth then the government can focus on the more important issues such as fiscal policies. Moreover, more exports mean more money for the government to spend on diversification projects. If the government will suddenly change policies and abandon its most lucrative business operation – which is the sale of oil to international markets – there will be no funds that can be used to guide the economy to the right path.
Ironically increasing the efficiency and capacity of the oil exporting sector is the only way to guarantee diversity in the economy. This is seen in the minor shift from oil exportation to the exportation of natural gas. But the extraction of natural gas requires further investments from the government and Russian businessmen who have the skill and the capital to move into a relatively new undertaking. Ahrend argues that this would be impossible if additional income could not be generated from increasing the sale of more oil from Russian oil field.
Extension
As mentioned earlier the main goal is to identify the necessary steps that will induce diversification in the Russian economy. But instead of going to the heart of the matter and present his solutions, the appropriate policies that are required to diversify the economy, Ahrend began to make an about face. Ahrend said that a detour is required before going face-to-face with diversification. Thus, he went back to the aforementioned needs: a) sound fiscal policy; b) non-corrupt and efficient state apparatus; and c) a strong and civil society.
It seems that there is more that can be accomplished by changing the focus of the problem. Instead of blaming the so-called “resource curse” it is time to focus on fundamental problems such as the need for sound fiscal policy, the creation of non-corrupt agencies, the establishment of efficient government agencies that will encourage the proliferation of SMEs and the creation of strong civil society where there is freedom of expression as well as institutions that will help ensure checks and balances in Russia.
It is becoming clearer that as Ahrend continued to move ahead with the discussion, he was going back and revisiting the fundamentals. It is becoming obvious that the so-called “resource curse” brought upon by resource based development should only be partially blamed for the current problems faced by Russia. It must be pointed out that the main culprit is the same problem faced by poor and struggling economies irregardless if they have rich natural resource endowments or not. In other words countries are poor and their economy shaky because of poor fiscal policy, corruption and the absence of press freedom and other systems that will insure checks and balances.
It seems that spending too much time in understanding the intricacies of the “curse of resources” will diminish the creation of innovative and creative solution to the problems plaguing the Russian economy. Based on the preceding discussion, Dutch Disease is not the main problem, but corruption, rent-seeking, and the pathetic desire of the Russian government to increase control over oil and gas exploration and extraction in the country. This is made more evident when Ahrend continued to experience difficulty in proposing the necessary steps needed to diversify the economy.
It is also understandable why Ahrend was unable to expound on his idea with regards to diversification. It seems that he himself was not sure if it is even possible for Russia to achieve diversification in its economy. Current data shows that even in the coming years, the structure of the economy was built upon the idea that oil and gas are the main moneymakers. In order to break this mindset there is a great deal of resources that must be used wisely. There must be significant tax incentives given to businessmen who will venture as far away as resource based industries as possible.
But what would be the incentive? Except perhaps for patriotism, there is no logical reason why a bright young man or woman will go into something very risky when they can make more money prospecting for oil and gas or improve the marketability of the said commodity. One way of encouraging future businessmen is for the government to make drastic steps in promoting the service sector. A feasibility study must be made available to show that businessmen can make money if they go to banking or the food and entertainment business.
The discussion will naturally revert back to the need to strengthen the export industry. It is only through the continued success of the oil and gas industry that will lead to a creation of demand for services. This in turn will provide enough incentives for venture capitalists to try their luck in the Russian market. A wise management of the industry will initiate a process that will make it more profitable to diversify. This is the main argument of Ahrend but he experienced problems when he began to solve the dilemma of reducing Russia’s dependence on oil but at the same time the need to sell more oil in the international market so that it can finally be freed from its addiction to oil exports.
Based on Ahrend’s arguments one can make the assertion that the “curse of resources” can be easily broken if the Russian government will do whatever it takes to reverse the negative impacts of resource based development. There is even no need to point out the fact that other resource rich nations – like Australia, Canada, and Scandinavian countries – were able to solve the problems intrinsic to resource rich societies. This assertion can be made because upon closer examination of the facts it was made clear that high mineral deposits is not the main problem but the way it is exploited and sold to the international market.
Therefore, there is no need to make a long discourse with regards to imagined fears because even if Russia is not endowed with rich mineral resources it has to learn to develop sound fiscal policies, to diversify its economy and to create a non-corrupt bureaucracy while creating strong civil society. This means that by focusing on these three components the Russian government will be able to hit two birds with one stone. The first major achievement would be to reverse the effects of the so-called “curse of resources” and the second major achievement would be to create sustainable economic growth.
There is no need to emphasize the controversial presupposition that nations endowed with rich natural resources is doomed to remain corrupt and inefficient. The overemphasis on this conjecture will simply cloud the issue and will require unnecessary effort because there is a need to first understand the intricacies of this belief. There is a need to make unnecessary detours. Ahrend had to make a long discourse to first convince his audience that there is indeed such a thing as a “curse of resources” and then after completing this first phase of the discussion he had to explain how to solve the problems associated with this phenomenon.
Reference
Ahrend, Rudiger. 2005. Can Russia Break the “Resource Curse”? Eurasian Geography and Economics 46(8), 584-609.