The ICAS Lectures

No. 99-226-TEG

  The Russian Economy: 
 Where To, and Security Implications  

  Thomas E. Graham, Jr.

ICAS Winter Symposium
Asia's Challenges Ahead
University of Pennsylvania
February 26, 1999

Institute for Corean-American Studies, Inc.

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Biographic Sketch: Thomas E. Graham





Thomas E. Graham, Jr.

The Russian Economy: Where To, and Security Implications? Thomas E. Graham, Jr. Senior Associate Carnegie Endowment for International Peace Since the middle of last August, the West, to the extent it has thought of Russia at all, has found its attention drawn to two matters: the financial and economic turmoil that has ravaged the country and the threat to the safety and security of weapons of mass destruction the economic decay has raised. This is understandable. For several years until the August financial crisis, the centerpiece of the West's policy toward Russia was market reform, managed primarily by the IMF with strong backing from the Clinton Administration. Moreover, Russia's problems have been seen as part of a broader global financial turmoil, which has grown to dimensions that now threaten the West's own economic well-being. Likewise, Russia's possession of nuclear weapons has always been a major reason for the West's concern about internal Russian conditions. Against the background of Pakistan's and India's nuclear tests last spring, the West, and the United States in particular, has grown increasingly concerned by the proliferation risks of socio-economic decay in Russia. In addition, sharp decreases in the Russian military budget, the deterioration of its early-warning system, and doubts about the quality of the maintenance of its strategic arsenal have raised concerns about environmental catastrophes and accidental launches.

The economic turmoil and the heightened nuclear risks are symptoms of a much deeper Russian crisis, one that has received little sustained attention or analysis in the West. It is a systemic crisis, a crisis of political power and authority, about which Russian analysts have been writing for well over a year. A good Marxist might describe it as "the general crisis of the Russian regime." Appreciation of this crisis in the West is manifested usually in sentiments that Russia simply does not matter, economically, politically, and increasingly militarily.

This is unfortunate, because only by looking at this broader crisis can we put the current economic problems in their proper context. Three dimensions of this context merit close attention: secular decline, fragmentation of power, and succession politics. Together, these dimensions help explain way Russia finds itself in its current predicament and set the parameters for Russia's evolution over the next decade.

The General Crisis of the Russian Regime

For past twenty-five years, Russia has been in secular decline. That is, contrary to prevailing opinion in Russia today, the decline began not with Soviet leader Gorbachev or Russian President Yeltsin, but in the mid-seventies, ironically at the time the Soviet Union had reached nuclear parity with the United States and millions of petrodollars had started to flow into the Soviet Union as a result of the global energy crisis. Rather than invest that wealth in modernizing industry, Soviet leaders squandered it on a vast military buildup and costly foreign adventures that ended in tragedy in Afghanistan.

During this period of surface stability, the Soviet leadership grew increasingly corrupt and cynical. Cronyism was common at all levels of government. Indeed, crime, corruption, and cronyism were at least as widespread as they are in today's Russia. The key difference is that they were hidden from public view by vigilant censors; public discussion of them was taboo, and punishment was swift and severe for those that broke the taboo. The population reciprocated their leaders' cynicism with its own. People grew apathetic. They focused on their own private concerns to the detriment of the country's good.

Gorbachev set out to purge the Soviet system of this pervasive rot, when he assumed power in 1985. Without change, he argued, the Soviet Union could not enter the next century as a Great Power. Whether for lack of vision, energy, or will, the changes he unleashed overwhelmed him, and instead of reviving the Soviet Union, they led to its collapse. For his part, Yeltsin radicalized and stepped up the attack on the Soviet system, advocating rapid movement toward a market economy and widespread democratization. However necessary Gorbachev's and Yeltsin's policies might have been for the long-term health of Russia, so far they have tended to accelerate the decline.

At some level, we all appreciate the extent of changes in Russia's status. But some facts bear repetition so as to underscore how profound this decline has been and how devastating it has been to Russians' psyches.

  • Moscow lost its empire in Central East Europe in the space of several months in 1989; with the breakup of the Soviet Union in 1991, it lost half the population and a quarter of the territory it once controlled overnight.

  • Today, Russian GNP is about one-quarter of Soviet GNP at its peak, and continuing to decline.

  • The economy controlled by Moscow has already fallen in absolute GNP from third in the world in 1987 to fifteenth in 1996 (behind India, South Korea, and the Netherlands and just ahead of Mexico and Argentina).

  • In GNP per capita, Russia is a lower-middle-level-income country, like Croatia, Peru, and Jordan.

  • Public health is in a shambles: Over the past decade, the life expectancy of Russian males has declined from the mid-sixties to 58. Contagious diseases, such as tuberculosis, are making a comeback.

  • The Red Army, once the pride of the country, proved woefully incapable of putting down an insurrection in the small republic of Chechnya.

  • The country has lost its sense of identity and purpose. Russia is no longer the bearer of a grand idea or engaged in a grand project, such as building socialism.

Over the past decade, this general decline has been exacerbated by the fragmentation, degeneration, and erosion of state power, which has undermined Moscow's ability to govern effectively. This process began with Gorbachev's perestroyka, accelerated under Yeltsin, and has only gained momentum with the current crisis. In part, it is the conscious result of both Gorbachev's and Yeltsin's decision to modernize the Soviet Union and Russia by dismantling the hypercentralized Soviet state and devolving power to regional authorities and new economic entities. In part, it is the consequence of global trends, particularly in telecommunications and information technology, that have tended to diffuse power around the globe. In part, it has been the unintended by-product of bitter political struggles in Moscow that have allowed the more ambitious regional leaders to seize greater power, compelled the more timid to assume greater responsibility for local affairs as a matter of simple survival, and allowed numerous entreprenuers to acquire vast economic assets at both the national and regional level, often for a pittance.

As a result, Moscow no longer controls the political and economic situation. It no longer reliably wields power and authority, as it has traditionally, through the control of the institutions of coercion, the regulation of economic activity, and the ability to command the loyalty of or instill fear in the people.

The institutions of coercion are in abysmal conditions. A combination of slashed budgets, neglect, corruption, political infighting, and failed reform has put the military on the verge of ruin, according to a leading Duma expert on the military.1 The Ministry of Internal Affairs (MVD), Russia's police force, is universally considered to be deeply corrupt and ineffective. Even the Federal Security Service (FSB), the successor to the once feared KGB, has faced serious budget constraints and experienced a sharp decline in its ability to monitor and control society.

Moreover, Moscow does not enjoy the monopoly over the legitimate institutions of coercion it once did, nor does it necessarily reliably control those nominally subordinate to it. Military commanders are known to cut deals with regional and local governments to ensure themselves uninterrupted supplies of energy and provisions. Some military garrisons are supported with money from local entrepreneurs. Military officers and MVD and FSB officials routinely moonlight to earn extra income - or to cover for unpaid wages. As a result, the loyalty of the institutions of coercion to the central government - even of the elite units around Moscow - is dubious. This does not mean that they would carry out the will of local leaders - there is little evidence that they would - but rather that they would not necessarily defend the central government in a crisis. As is the case with the institutions of coercion, the national financial system is in a shambles. It has collapsed for several reasons, including Moscow's inability to collect taxes from both firms and individuals and its effort to cover the budget deficit through foreign borrowing and the issuance of various domestic debt instruments that amounted to little more than a massive pyramid scheme. Moscow has not been able to meet its budget obligations for the last several years; in particular, wage arrears to budget workers, including soldiers, doctors, teachers, and other professionals, is a persistent problem. The sharply devalued ruble remains the national currency, but the overwhelming majority of commercial transactions, up to 75 percent by some estimates, takes place outside the monetized sector, in the form of barter or currency surrogates.

Finally, for the first extended period in modern Russian history, the state is neither feared nor respected. The lack of fear is evident in the pervasive tax and draft evasion, as well as in such mundane matters as the widespread non-observance of traffic regulations. The lack of respect is evident in the general disregard for national holidays and monuments and the widespread public distrust of high-ranking government officials and central government institutions, repeatedly recorded in public opinion polls. For a year and a half, until the August meltdown, the internecine struggles for control of the central government among competing Moscow-based political/economic coalitions, most notably the vicious conflict between groups led by privatization mastermind Chubays and media magnate Berezovskiy, fueled public cynicism about Moscow. At the same time, Yeltsin's deteriorating health, both physical and mental, deepened doubts about the Moscow's strength and will.

More recently, it has been exactly Yeltsin's health that acts as a formidable block to building the policy consensus needed to move the country forward politically and economically. Despite the fragmentation, the Presidency remains key to the country's politics because of the vast constitutional powers invested in it. For at least the past year, the intense struggle to succeed the ailing Yeltsin has dominated Russian politics. The intensity of the struggle has been heightened by the provisions of the Constitution, which stipulate that, should Yeltsin die or step down for any reason, the Prime Minister serves as acting President and new presidential elections have to be held in three months. Consequently, would-be successors, concerned by Yeltsin's deteriorating health, have to be prepared to run a presidential campaign at a moment's notice any time from now until early next year, when the campaign to succeed Yeltsin will begin if he serves out his term (due to end in mid-2000).

In Moscow today, the maneuvering for position in the succession struggle has reached a feverish pitch. Calls for Yeltsin to resign are mounting, not only among his long-standing opponents, such as the Communists, but even among those who backed him strongly in 1996. The influential Foreign Policy and Defense Council, which brings together Russia's mainstream elites, recently published "for discussion" a document calling on him to resign.

Yeltsin has steadfastly resisted such calls, insisting that he will serve out his term. He remains jealous of his prerogatives, prepared to move against anyone he believes is trying to undermine his power and authority. And he will take decisions to underscore his prerogatives, even if it means destabilizing the political situation as a whole. Last March, for example, he fired Prime Minister Chernomyrdin, at least in part because he felt Chernomyrdin was assuming too many powers and acting too presidential. That decision thrust Russia into a government crisis at the very moment it needed strong leadership to deal with mounting threats to its financial system.

In short, the political situation is uncertain. Not surprisingly, as is often the case, the victim of succession politics is public policy. Russian elites are unwilling to take the tough, unpopular measures they must to address the country's deepening ills. This situation will change at the earliest only with Yeltsin's departure.

To sum up this overview of the Russian context, secular decline leaves Moscow with fewer resources to bring to bear on the problems facing it. Fragmentation reduces its capacity to use those decreasing resources effectively. And the succession struggle saps its will to deploy them vigorously. For these reasons, Moscow ultimately succumbed to the aftershocks of the Asian financial crisis and the precipitous drop in world commodity prices, although both these events would have challenged the talents of even much better ordered polities. Similarly, the current political context precludes an early or easy exit from the economic predicament Russian now faces.

Economic Prognosis: Muddle Down or Worse?

In the gloom and disappointment now surrounding discussions of Russia, it is difficult to remember that a little over a year ago, there were great expectations for Russia, albeit mixed with some uneasiness over the potential dangers of the Asian crisis. In fact, in September of 1997, Russia appeared to be turning the corner. Then, two "radical reformers" and darlings of the West, First Deputy Prime Ministers Chubays and Nemtsov, were spearheading the reform effort under the stolid leadership of Prime Minister Chernomyrdin. Annual inflation was quickly approaching single digits; the ruble was stable. The Russian stock market was the best performing market anywhere in the world. Living standards were slowly rising. The economy was experiencing its first glimmer of growth since the collapse of the Soviet Union - GDP rose by nearly 1 percent and industrial output by almost 2 in 1997 - and the government was predicting more rapid growth in 1998. In a major address on Russia at Stanford University on September 19, Deputy Secretary of State Strobe Talbott declared that Russia was at "the end of the beginning" of its journey toward becoming a "normal, modern state." "It may be," he said, "on the brink of a breakthrough." As August demonstrated, it was, but not of the type Talbott had in mind.

If the doomsayers of last fall had been correct, Russia would already be stuck in a vicious hyperinflationary cycle, the economy would be in a freefall, and the dispossessed middle class would be protesting in the streets of Moscow and other major urban centers. This has not happened, in large part because Prime Minister Primakov, Central Bank Chairman Gerashchenko, and First Deputy Prime Minister Maslyukov (who oversees marcoeconomic policy) have proven more adept at managing the politics and economics of a period of turmoil than most observers thought possible. As Primakov and Maslyukov have stressed in recent statements, industrial production in the last quarter of 1998 rose nearly 10 percent as compared to the third. This is an impressive result, even if it hardly marks the beginning of a sustained recovery and simply underscores how far Russia had fallen during the depths of the crisis last summer. Despite the fourth-quarter upswing, the overall socio-economic situation deteriorated substantially in 1998: GDP fell by 4.5 percent, industrial production by 5.8 percent, real after tax income by 16.3 percent. Annual inflation reached 97.1 percent.

Since he was appointed Prime Minister, critics have charged that Primakov has done little to deal with the enormous economic problems facing Russia and only postponed the hard decisions. His budget - just this week signed into law by President Yeltsin - has been ridiculed as "unrealistic," and the IMF has publicly stated its displeasure, warning that Russia is still far from accepting the conditions to receive the debt relief it seeks. On the surface, the critics are correct. The budget is unrealistic. It assumes annual inflation of 30 percent, while in the first two months of this year inflation has already exceeded 12 percent. It assumes a ruble/dollar exchange rate of 21.5 to 1, while the rate already stand at 22.8 to 1. And it assumes that Russia will receive disbursements of up to $7.5 billion in international credit and that it will pay only $7.2 billion in debt service, out of the $17.5 billion due, although little progress has been made in negotiations with the IMF.

It is important to remember, however, that all recent Russian budgets have been unrealistic. None have been fulfilled. As such, they are poor guides to how government revenue is ultimately allocated. The Primakov government retains the option of meeting the key numbers on the budget deficit - the ones that matter most to the IMF - the way previous governments have, by sequestering funds. And, judging by its recent policies, it is more likely to do that than print masses of rubles to cover its obligations.

Similarly, it is much too early to rule out an deal with the IMF. In fact, the most likely outcome of the negotiations is an agreement some time in late spring or early summer, because everyone realizes Russia cannot repay its debt and everyone is deeply concerned about the consequences of its defaulting. The outlines of a likely agreement have already been suggested publicly by Primakov and Maslyukov. The IMF program will call on Russia to meet certain conditions before any money is disbursed (in contrast to past practice when money was released on the promise that certain conditions would be fulfilled). This agreement will allow Primakov to reschedule debt witht the London and Paris Clubs. Later in the year, the IMF will announce that Russia has sufficiently satisfied the conditions for a loan that will cover the repayment of $4.5 billion it owes the IMF this year. As Primakov has noted, all the IMF will have to do is transfer the money from one account to another. Of course, none of this will solve Russia's underlying problems, but it will buy Moscow time to seek a solution.

While negotiating with the IMF, Primakov has focused his attention on getting the politics right for movement on economic policy. He is consolidating power, seeking to build an elite consensus, and maintaining a modicum of social stability. He has insinuated his allies into key government positions. (That most of them are former or current security officers is a cause for concern, but hardly surprising for a person who spent most of his career since the 1950's either in or in close contact with the security services.) He is reasserting government control over state-owned media and is currently engaged in a bitter struggle with media mogul Berezovskiy for control of Russian Public Television, which is 51 percent state owned. He is working closely with regional leaders, while warning about the growing danger of centrifugal forces to the country's integrity. He is cutting deals with key business leaders and has already won political support from two of Russia's most powerful financial-industrial groups - Gazprom, the giant gas monopoly, and Lukoil, Russia's leading oil company. He is slowly consolidating his position among Moscow political elites, while cautiously demonstrating his independence from an increasingly enfeebled President Yeltsin. He has in fact managed to do something no other Prime Minister under Yeltsin has done: Build himself into an autonomous center of power without provoking Yeltsin to fire him And he remains popular with the public - recent polls indicate that he would win presidential elections hands down.

In addition, Primakov has taken steps to improve the environment for foreign and Russian investors. Using his good standing with communists and nationalists in the Duma, he has pushed through the much-needed production-sharing legislation, which has the potential to attract billions of dollars in investment over the next few years. He has also secured passage of the "Law on Foreign Investment" to bolster the rights for private foreign investors. Finally, he has been making the right noises on corruption, although it remains to be seen whether he will have any greater success than his predecessors in rooting it out. Corruption is rife and deeply rooted, as the recent revelations about the Central Bank underscore: It maintained for several years an off-shore facility "to hide" some of its reserves from Western creditors. The Russian media speculates that Central Bank officials and their friends reaped handsome sums from using that state money for private gain. But there is reason to hope that Primakov will succeed, if only because he does not appear to be as deeply enmeshed as his predecessors in the domestic business world, where corruption thrives.

All this makes for a good start for Primakov, but none of it is going to lead to a rapid turnaround in the economy. Massive problems remain. The banking sector is far from recovering from the meltdown of last August. Wage arrears have been alleviated somewhat, but the private sector and the government still owe over $3.5 billion in back wages. Thousands of inefficient enterprises have to be pushed into bankruptcy, even at the risk of a surge in unemployment, which currently stands at 12 percent, and widespread labor unrest. And much remains to be done to restore investor confidence, a task made doubly hard by the general trend away from emerging markets.

The best forecast for 1999 is a 5-percent drop in GDP, with inflation around 60 percent. That would probably be sufficient to maintain political stability as Russia moves into an intense electoral cycle, with Duma elections scheduled for December 1999 and presidential elections due no later than June 2000. But the situation could turn out much worse for reasons beyond Moscow's control (e.g., a further decline in world commodity prices, a major industrial accident) or because of bad policy (will the government continue to be able to resist pressure for greater monetary emissions as the country gets closer to the elections and populist excesses could prove the key to gaining votes?). Even then the decline is unlikely to approach the doomsday scenarios of last fall.

Absolute or Relative Decline?

So the short-term does not look bright, although it is far from desparate. What about the longer term? Broadly speaking, Russia will move along one of two paths for the next decade: (1) continued decline, which a confrontational foreign policy would only accelerate, and (2) recovery through the deliberate building of the institutions of a pluralistic society and market economy, facilitated by the avoidance of major conflicts abroad. Under current conditions, attempts to revive Russia by returning to more intrusive government interference in the economy or rebuilding a rigid centralized authoritarian political system, as a strategic goal rather than a short-term tactic, are likely to meet fierce resistance, especially from regional leaders, and only accelerate Russia's decline.

If Russia takes the first path, the only questions would be the pace and the gravity of the consequences for the global balance of power. This path has two variants: abrupt, uncontrolled collapse and slow decay (or muddling down).

An abrupt, uncontrolled collapse would be a proliferation nightmare, given the vast amounts of nuclear material and modern weaponry spread across Russia; it would sharply raise the risk of a nuclear catastrophe, a la Chernobyl; and it would create a haven for organized crime. Instability in Russia would tend to spill beyond its borders, jeopardizing the fragile stability of most of its neighboring states. The West would quickly be confronted with the question of whether to intervene to contain the instability and to deal with the proliferation threat. In particular, the West would have to consider moving deep into Russia's interior to secure nuclear stockpiles or power stations, with or without local support. At the same time, China and other neighboring states would tempted to move in, either to defend their own borders or to exploit Russian chaos for their own advantage.

Although this scenario is highly improbable, it is far from impossible. The potential triggers are many, and all involve dramatically laying bare Moscow's inability to govern. For example, a renewal of armed conflict in Chechnya that engulfed the entire Caucasus, including the ethnic Russian regions of Krasnodar and Stavropol krays, would confront Moscow with an unpalatable choice: either to ignore the violence and, thereby discredit itself, or to risk a repeat of the humiliating defeat of the Chechen War but on a broader scale. The refusal of the regular army or internal troops to obey government orders to put down a large-scale riot in a major urban center, such as Moscow, St. Petersburg, or Yekaterinburg, could also cause the federal government to implode. A coup attempt that led to prolonged violent conflict in Moscow could spark a civil war across Russia or leave regions to fend for themselves.

Although muddling down would not have the catastrophic consequences of an abrupt collapse, it would still present formidable challenges. It would slowly undermine the integrity of the Russian state, as certain regions looked to the outside world first for economic well-being and then for security. Certain Russian regions could seek independence and international recognition, although few, if any, would have promising prospects for long-term survival as independent states. The potential breakup of Russia would produce a vast power vacuum in Central Asia and the Caucasus, at a minimum. This scenario need not lead to the proliferation nightmare of the abrupt collapse, because Moscow would have time to consolidate nuclear stockpiles and other key material, much as it did in the waning days of the Soviet Union. Nevertheless, this scenario would inevitably complicate the task of safeguarding nuclear weapons, technology, and material as the number of - weak - entities in Russia that would play on this issue would multiply. In a sense, this scenario is already unfolding, as the continuation of the secular decline and fragmentation discussed above. As these brief descriptions indicate, there are significant differences between the two decline scenarios in the consequences for international security. But they share one key feature: Russia emerges as a major problem for the international community, an object of grave concern, while becoming increasingly irrelevant as an actor.

Even if Russia follows the second path to domestic revival, however, it is not self-evident that it will eventually reemerge as a major power. As Russian watchers debate the current state of affairs inside Russia, they tend to ignore the outside world. Even a glance would reveal that the world is rapidly changing in ways unfavorable to Russia's future standing in the global hierarchy. Indeed, for the first time in the modern era, Russia (or more precisely, the former Soviet Union) is encircled by more dynamic states and regions.

  • In the east, China is quickly rising as a Great Power with vast economic and military potential, demographic vitality, and unsatisfied regional ambitions. South Korea remains a robust society of tremendous economic and significant military potential, despite the economic turmoil of the past year or two. Japan is already an economic heavyweight and, current difficulties notwithstanding, is likely to remain so long into the future.

  • To the south, the Islamic world is in a state of ferment. Militant fundamentalism is a growing political force and threat to Central Asia and the Caucasus, as well as Muslim regions within Russia. After years of stagnation, India has entered a period of rapid growth.

  • In the west, European integration in all its dimensions is proceeding (largely without Russia).

  • Even in the former Soviet Union, despite the tremendous difficulties and enduring fragility of political and economic structures, Ukraine and Uzbekistan are slowly consolidating as nation-states and turning away from Russia. The Commonwealth of Independent States appears to be more an instrument for effecting an amicable divorce than an institution for reintegrating the territory of the former Soviet Union.

To be sure, there is nothing predetermined about the evolution of international relations, and numerous events could occur that would upset predictions about the future standing of certain countries and regions. At a minimum, however, current trends raise the possibility that even with an economy growing at a healthy five percent per annum - and that is still at least a few years off under even the most optimistic projections - Russia will find itself lagging behind its neighbors in economic growth and in national elan for several decades, while eventually falling behind in military strength. That would mark an historic shift in the global balance of power.

Geopolitical Implications of Recovery

In this weakened state, Russia will be compelled to seek allies to maintain its sovereignty over its current territory. In particular, the far-flung, resource-rich, population-poor Russian Far East, bordering on the dynamic economies of East Asia, will be difficult for Moscow to defend over the long run. Moscow can look in two directions - to the West or to China - or it can try to enlarge its room for maneuver by embedding itself in a web of relations with leading world powers.

The costs and benefits of each variant have been the subject of intense discussions for some time now. Prime Minister Primakov, from the time he became Foreign Minister three years ago, has taken the lead in redressing what many members of the Russian elite saw as the unduly pro-Western stance of the first years of Russian independence. He has entrenched "multipolarity" as an essential element of Russian foreign policy, both as a description of the foundations of the emerging Cold-War international system and as a prescription for Russian action. How a recovering Russia ultimately decided to run its foreign policy would have some influence, although far from decisive, on the hierarchy of the major power centers of the first half of the next century - the United States, Europe, China, and Japan - but Russia itself would likely not be among them.

In short, even if Russia's current travails are short-lived and it begins to implement the policies, both political and economic, necessary to restore growth, it has probably fallen from the ranks of the Great Powers for an historical period. If it is not already there, Russia is on its way toward becoming a middle power, with one critical difference: Its vast natural resources, its possession of weapons of mass destruction and the technology and material to build them, and its strategic location mean it will continue to draw the attention of the world's leading powers. Hence, Russia matters, and will continue to do so well into the next century, but, in a radical departure from the past three hundred years, increasingly more for the nature of the territory it occupies than for Moscow's ability to mobilize the country's resources to project power abroad.

1. Alexei G. Arbatov, "Military Reform in Russia: Dilemmas, Obstacles, and Prospects," International Security 22/4 (Spring 1998), pp. 83-85.

This page last updated 5/27/99 jdb


ICAS Fellow