Analyzing the Russian Situation
The media reports that the ruble is in a free fall. In the open market it has reached 100 rubles per dollar. People are panicky, rushing to stores to buy products and get rid of the local currency.
It is expected that billions in foreign exchange will exit the Russian market; the capital is moving out of the country while investments from abroad are drying up.
In an effort to stop the outflow of money abroad, the Russian central bank raised interest rates to 17 percent which will seriously impact the economic growth of the country.
In other words, Russia is in a downward economic spiral.
The Obama administration is trying to take credit for this by claiming the crisis was brought about by the sanctions imposed on Russia, and the American strategy to unseat Putin is working.
I beg to disagree.
The sanctions have hardly made a dent in their economy. The impact on Russia for refusing visas to Putin cronies is laughable. Moreover sanctioning the transfer of technology in the energy area could have an effect on Russia but only in the long term; therefore it cannot be seen as playing a determining role in the present crisis. The only noticeable impact on the crisis today can be traced to the prohibition of financial transactions with Russia.
The major cause of Russia’s economic difficulties is the decreasing price of oil. It is going down and will continue to plummet. But it has little if anything to do with sanctions. It has instead a great deal to do with the cost of producing fractional oil, the new technology that is threatening the dominance of OPEC.
The major producers of oil want to make it prohibitive to extract oil from shale which threatens their monopoly. So they are allowing the price to go down and will let it fall all the way to 32 dollars a barrel, a price at which producing oil from fraction is prohibitive. There is simply not enough revenue to justify the investment in this new technology.
So, what is causing Russia’s economic crisis now?
As usual when we look for the enemy we find that it is us. The troubles confronting Russia at the end of 2014 are being caused by Russia itself.
Let me explain.
Russia did not diversify its economy fast enough away from oil and gas. The strategy of diversification is like the weather. Everyone talks about it but no one does much….True, Skolkovo was built to encourage high tech developments, but the effort failed. It needed Putin’s blessing which he refused to give.
Because it was perceived as Medvedev’s project. Without Putin’s backing, it had no chance. Among those who know the internal working of the government, it is an open secret that these two are not working together smoothly.
Russia’s problems today are not caused only by the low price of oil. True it is affecting government operations; after all the oil business is the Russian government’s major source of revenue. But Putin could still have reduced Russia’s expenses and accommodate to the new reality. Instead, not only did he not reduce expenses, but he increased them significantly in a show of pride called the winter Olympics in Sochi, which cost the Russian government over fifty billion dollars.
The assumption that such a show would attract investors was a naïve one. Investors need to feel secure if they are going to part with their money and Russia is not perceived as safe for investments. One dramatic example that made international headlines involved Khodorkovsky who was put in jail and his company Yukos Oil taken over by a corporation owned by the government.
We really do not know whether the charges against him were trumped up or justified. But if investors believe that they were politically driven then facts and the truth are irrelevant. Perception is as good as reality as a driver of behavior. In this case many people (along with the media) believed the asset was taken away from Khodorkovsky so as to benefit the government.
Now it is Yevtushenko’s turn. Yevtushenko, one of the major oligarchs of Russia, has been placed under house arrest, accused of fraudulently taking control of an oil company. Again the perception on the street is that the government wants to take over his oil company.
Then there is the case of British Petroleum. It lost its shirt in a partnership within Russia and pulled out.
The over-all climate then is one of suspicion and fear. The perception is that at any point the government might come and arbitrarily seize your company and throw you into prison.
The legal system is messy. Many overlapping laws. Moreover Russia has three different accounting systems. The result is that by and large every business man is guilty of something, and it is only a question of whether the government wants to nationalize his assets and send the entrepreneur to jail. It is not strange than that investors shy away from putting their money in Russia. Who can blame them when the Russians themselves, those who can afford it, are taking their money out of the country? Many oligarchs do not even have their families in Russia. Their wives and children are either in London, Switzerland, Barcelona or Cyprus.
Add to all of this the chronic, rampant corruption of the judiciary, the bureaucracy, and the law enforcement system. What you get is not a very encouraging environment for investments.
Russia does not have an economic problem. The economic issues rather are a manifestation of a systemic deficiency in how the country is run.
And it is a mistake to diagnose Putin as the cause of the problems: blame the leader and conduct a witch hunt.
Instead it is important to look at Russia’s culture. The national leadership is autocratic and has been like this forever. Putin cannot change his style, even if he wants to, and survive politically.
Furthermore, he is surrounded by a group of cronies who benefit from their proximity to him and who feed him the information he wants to hear. And as expected, their recommendations are self-serving to the detriment of the nation. But he needs their support to survive politically and they need him to prosper economically. How does one cut this Gordian knot?
Let me be clear: The sanctions imposed by the West are a political step not to be ignored. But they are not the cause of Russia’s crisis.
We need to look instead to the economic, legal, and cultural system. Russia has an environment of cronyism and corruption. The sanctions and the defensive strategy of the OPEC countries exacerbated the problems which are inherent in the system. They were the catalyst not the cause of Russia’s problems.
This present crisis should be perceived by the leadership of Russia as a cry for soul searching: A spotlight on the systemic changes the country needs to undertake. Some of these would include: establishing the rule of law; creating an environment of participation and self-criticism which should lead to continuous improvement; restructuring the economy so as to remove government ownership of major industries; and finally, putting an end to cronyism as part of national decision making. Such moves will inevitably decentralize authority and in the process heal the system for future success.
Ichak Kalderon Adizes