Russia forced out of the neoliberal camp

It is remarkable how much corruption oil, and the income it provides, brings in its wake.  It is damn difficult to name any country that has a lot of oil that isn't hopelessly corrupt.  Norway, perhaps.  It's pretty easy to see why.  Oil tends to create a class of people who become ridiculously wealthy without having to work very hard (if at all).  This certainly does not include all of the oil industry.  Most of the people responsible for actually finding, extracting, refining, and distributing oil products work extremely hard in often unpleasant and dangerous conditions.  Many are highly educated in subjects such as 3D underground mapping techniques, design and construction of production platforms that must be operated in extreme locations, or sophisticated chemical reactions such as molecular cracking.  But yes, the public persona of Halliburton is Dick Cheney and not the thousands who help provide the fuels to run a civilization.

And then there is the social corruption and economic distortion that follows in the wake of a significant oil find.  At one point this was named the Dutch Disease.  North Sea oil drove up the value of the Dutch currency.  Imported goods became cheaper.  Exporters faced shrinking markets as their prices rose.  The people in power were mostly Leisure Class whose lives had suddenly become more luxurious.  Why should they care about jobs?  And if taxes fell because folks in export industries were losing their jobs, why a small increase on the new petroleum income could keep the Dutch governments open.  The net effect on the Netherlands was that compared to the thrifty, hardworking, ingenious culture that had achieved remarkable levels of prosperity for centuries, the new oil economy was fat, lazy, and stupid.  (That's the essential theory—there are books on the subject.)

Russia under Putin had at least slowed the brazen corruption but had still contracted a serious case of Dutch disease.  When oil was over $100 / barrel, Russia didn't have to do much else besides export oil.  They could afford damn near anything they wanted.  And for a while, Putin seemed intent on becoming a good little neoliberal stooge.  He tried very hard to join the clubs that advanced the neoliberal agenda such as WTO and G8-7.  And yes, the rest of the economy became quite weak.

And then came the sanctions and the Russians were forced to be reminded about their incredible history of self-sufficiency.  It remains to be seen how much of their basic industry they can revive, but it looks like they are going to give it a serious try.  Vladimir I. Yakunin argues below that sanctions are saving the motherland.  He even cites the great German development economist, Friedrich List (there are moments when he even writes like Tony!)  And then we have Ambrose Evans-Pritchard noticing the same phenomenon only he sees it as a return to Russia's peasant past.  No matter, if Russia can combine a mostly self-sufficient economy with an oil-exporting one, they will have achieved the prosperity everyone imagines when seeing the vast resources of that nation.

Are Sanctions Saving Russia?

Vladimir I. Yakunin, OCT 13, 2015

MOSCOW – The economic sanctions imposed on Russia by the West in March 2014 have undoubtedly been painful. But they have so far failed to achieve the goal of weakening Russian President Vladimir Putin’s position. In fact, they may have the opposite effect, leaving Russia – and its president – even stronger than before.

European Union countries are estimated to have lost about $100 billion in trade with Russia, hitting the likes of Bavarian dairy farmers and eastern German industrial exporters. Russian GDP, which grew modestly in 2014, contracted by 4.6% in annual terms in the second quarter of this year. The ruble lost more than half of its US dollar value in the second half of last year, fueling inflation, which increased by 15.6% year on year in July.

But inflation now seems to have peaked, and the effects of the drop in oil and gas prices were mitigated by the US dollar’s appreciation, so that the value of Russia’s foreign reserves actually increased, reaching $362 billion in June (13% of which is in gold). And despite belt-tightening in Russia, Putin is more popular than ever.

The rationale behind economic sanctions is straightforward: free trade and free markets deliver growth (and thus political support for the government), whereas restrictions choke off growth (and thus erode support for the government). This emphasis on free trade and free markets was a central tenet of nineteenth-century British classical economics. It remains a core message of today’s dominant neoclassical school – embodied in the so-called “Washington Consensus,” adopted across the world under the International Monetary Fund’s advice – which claims that the key to economic development is to open up, deregulate, liberalize, and privatize.

But the theory is fundamentally flawed. No economic power has ever developed solely on the basis of laissez-faire policies. The economic rise of the United Kingdom, for example, was heavily dependent on strategic protection, industrial policy, tariffs, and non-tariff trade barriers.

The UK’s industrial prowess originated with the textile industry. The country’s leaders realized that the export of raw materials, mainly wool, would be inadequate to spur economic development. For that, England would have to move up the value-added ladder, by importing raw materials and exporting finished goods.

So England’s leaders devised an industrial policy, which entailed bringing in Flemish textile weavers to provide know-how to British firms. Moreover, they erected trade barriers: By banning the export of raw wool and the import of finished wool products, Indian textiles, which were often superior and cheaper, could not compete with domestic output. They adopted navigation laws that restricted foreign ships’ access to British ports and even enacted a demand-boosting law requiring the dead to be buried in woolens. Ultimately, the mechanization of the textile industry ushered in the Industrial Revolution, and mass production and exports underpinned the development of the world’s largest maritime fleet.

In the mid-nineteenth century, the German economist Friedrich List highlighted the role that such policies played in the UK’s development. In line with his advice, the United States, Germany, and Japan employed judicious trade protection and industrial policies, while working actively to support nascent sectors – a strategy that enabled them to develop rapidly and even overtake Britain.

Restrictions also proved effective to spur economic development: In 1812, when the UK declared war and imposed a trade embargo on the US, import substitution caused American manufacturing to flourish. When the embargo was lifted and trade tariffs were reduced, US manufacturing floundered – until 1828, when new British tariffs boosted US manufacturing again. Likewise, during World War I, a British trade embargo spurred the development of German high-tech industries due to the demand for substitutes.

Of course, embargoes can have a devastating effect when a country lacks the resources needed for import substitution. That is why economic sanctions were so damaging for Iran and, earlier, for Iraq’s population.

But, for a country like Russia, with its abundant natural resources, technological expertise, and skilled workforce, sanctions can have the opposite effect. The Soviet Union struggled to capitalize on these factors, owing to communism’s weak incentive structure. Today, by contrast, Russia has a capitalist system that offers considerable benefits to those who adapt best to the restrictions.

In short, Russia has all it needs to thrive, despite – or because of – the sanctions. But turning opportunity into reality requires Russia to pursue an economic transformation.

Neoclassical trade theory is based on the concept of comparative advantage: countries should capitalize on their relative strengths, from technological prowess to resource endowments. But, as English leaders knew and as the experience of many African and Latin American countries has shown, simply exporting raw materials is inadequate to propel development. Historically, the most effective development policy has centered on government intervention to establish higher-value-added domestic industries. In previous decades, Japan, Taiwan, South Korea, and China have all taken this path.

For Russia, moving up the value-added ladder should not be difficult; it has all it needs to manufacture the finished products that it previously imported. In fact, import substitution has already increased productivity in several key sectors: engineering, petrochemicals, light industry, pharmaceuticals, and agriculture. Annual exports of high-value-added goods rose by 6% in the first quarter of this year.

Furthermore, Russia’s leadership has accelerated cooperation with the other BRICS economies (Brazil, India, China, and South Africa), and Putin recently announced ambitious plans to boost domestic demand.

The West’s sanctions against Russia may not only fail to change the Ukraine situation; they may well spur the country’s long-awaited structural transformation. If Russia successfully replicates the credit-guidance regime used by East Asia’s economies, while increasing managerial efficiency, yet another economic miracle is possible. more

Russia abandons hope of oil price recovery and turns to the plough

The Kremlin has launched an incredible volte-face in economic policy and turned to traditional industries like farming in the face of tumbling oil prices

By Ambrose Evans-Pritchard, in Moscow

13 Oct 2015

Russia has abandoned hopes for a lasting recovery in oil prices, bracing for a new era of abundant crude as US shale production transforms the global energy market.

The Kremlin has launched a radical shift in strategy, rationing funds for the once-sacrosanct oil and gas industry and relying instead on a revival of manufacturing and farming, driven by a much more competitive rouble.

"We have to have prudent forecasts. Our budget is based very conservative assumptions of oil at around $50 a barrel," said Vladimir Putin, the Russian president.

"It is no secret that if the price goes down, investment peters out and disappears," he told a group of investors at VTB Capital's 'Russia Calling!' forum in Moscow.

The Russian finance minister, Anton Siluanov, said over-reliance on oil and gas over the last decade had been a fundamental error, leading to an overvalued currency and the slow death of other industries in a textbook case of the Dutch Disease.

"We should stop caring so much about the oil industry and leave more space for others. We have to take very tough decisions and redistribute our resources," he said.

The new $50 benchmark for oil is even lower than the Russian central bank's "extreme scenario" of $60 first prepared last year.

The new realism has forced the Kremlin to ditch a raft of budget commitments and to stop topping up the pension reserve fund. Oil and gas taxes make up half the state's revenue, and almost 70pc of Russia's exports.

Igor Sechin, chairman of Russia's oil giant Rosneft, accused the government of turning its back on the energy industry, lamenting that his company is being throttled by high taxes. He warned that the Russia oil sector will slowly shrivel unless there is a change of policy.

Mr Sechin said Russia's oil companies are already facing "negative free cash flow". They face an erosion in output of up to 6pc over the next three years as the Soviet-era fields in Western Siberia go into decline. "You have to maintain investment," he said

Rosneft, the world's biggest traded oil company, is facing taxes and export duties that amount to a marginal rate of 82pc on revenues. "This is enormous, it's unbelievable. The attractiveness of the oil industry is all about tax rates," he said.

He stated caustically that the government cannot seem to make up its mind how to tackle the economic crisis, openly attacking ministers sitting next to him at the VTB Capital forum. "We have lots of models but unfortunately we are failing to see any actual growth," he said.

Mr Sechin said Russia faces stiff competition from Saudi Arabia, which has begun ship oil at cut-throat prices into the Baltic through the Polish port of Gdansk, taking local market share from under the noses of the Russians.

But the 'game changer' is US shale that has displaced Saudi Arabia as the fundamental price-setter for the world. He said the immediate prospects of the global oil industry now depend on whether shale producers have enough hedging contracts to last beyond the end of the year.

Russia is currently the world's largest oil producer, extracting 10.7m barrels a day (b\d), but is living off legacy investments. Plans to develop the off-shore fields in the Arctic and the vast shale reserves of the Bazhenov Basin are not viable at current oil prices, and in any case rely on imported technology that is subject to western sanctions.

Mr Putin said the economic crisis has touched bottom and the decision to let the currency slide by 50pc rather than waste reserves defending the exchange rate is starting to bear fruit.

"We are seeing the first signs of stabilization, even though some sectors of the economy are still in recession. We are seeing more confidence in manufacturing industries. Things are looking up," he said.

Russian companies have survived being shut out of the global capital markets for most of the last eighteen months and have repaid much of their hard currency debt as it comes due, greatly reducing their vulnerability.

Capital is no longer fleeing the country. There were net inflows of $5.3bn in the third quarter, the first positive figures since 2010. "What it shows is that markets are responding very quickly to what is happening in our country", he said.

The International Monetary Fund is less sanguine. It has cut its forecast for Russia yet again, expecting the economy to contract by 3.8pc this year and a further 0.6pc next year. more