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ISSN 1075 7007, Studies on Russian Economic Development, 2010, Vol. 21, No. 1, pp. 1–4. © Pleiades Publishing, Ltd., 2010. Original Russian Text © N. Ya. Petrakov, 2010.

ECONOMIC POLICY

The Possibilities of Dealing with the Impact of the Economic Crisis in Russia

N. Ya. Petrakov

Abstract—The possible ways of dealing with the impact of the current economic crisis in Russia are consid ered and it is emphasized that to date there has been no strategy for addressing the internal causes of the crisis (no structural policy or modernization of production, orientation on single product exports). Furthermore, a set of measures within the anticrisis program is proposed, preventing the recurrence of new crisis situations and including primarily the lines of the organization of the investment process and long term crediting of production, antitrust regulation, promotion of new job creation, and tax policy. DOI: 10.1134/S1075700710010016

Recently, it has been widely discussed whether the Russian economy has already passed the trough after the shock of 2008. A significant number of the members of the economic block of the Russian Government are fairly optimistic. The sharp decline in output has stopped, stock markets in Russia and worldwide have stabilized and even somewhat recovered, there is an apparent ruble appreciation, and almost complete absence of social dis turbances due to high unemployment and wage arrears—all these are presented as the basis for the start of an economic recovery. If this is the case, then the “fire fighters” coping with the crisis (and to a large extent guilty of its aggravation in our country) can regard their task as complete. Without making any structural changes in the economy, not lifting a finger in high technology based modernization, and without developing produc tion infrastructure, one can speak of the economic recov ery remaining on the “oil needle.” World oil prices at $70 a barrel with costs of production at $1015 a barrel create an optimistic cushion for the current captains of the eco nomic block of the country. I consider that this position is very vulnerable. It is another hole closing process. There is no strategy to address the internal causes, which gave rise to the crisis. No significant attempts have been undertaken to estab lish real mechanisms that will allow us to effectively pre pare the conditions for the diversification and modern ization of the economy. Without such facilities, the best intentions become wishful thinking. The anticrisis program should be strategic and should shape the country’s long term economic policy. In prin ciple, an anticrisis program is based on a set of measures preventing the recurrence of new crisis situations. We should cure the causes rather than the consequences of the economic failure. Otherwise, the Russian economy will be chronically prone to recurrent and destructive cri ses.

Recall the government debt default in August 1998 ensued by ruble devaluation and the crash of the banking

system. Before the beginning of the collapse, the author ities for years had been maintaining an exchange rate of 6 rubles per U.S. dollar, allowing residents (and later, nonresidents) to participate in the financial pyramid of Government Short Term Obligations (GKO), thereby generating bubbles of excess revenues for commercial banks. All these burst within a period of a few days.

In 2008, the artificial capitalization of private and public corporations through speculative inflation of glo bal energy prices vanished in a week. Russia managed to avoid complete default by using the Stabilization Fund withdrawn from the real economy to keep the “system generating” banks afloat. However, the country’s inter national reserves were obviously insufficient to stabilize the ruble.

All this happened because the economic policy pur sued after the 1998 crisis, except for a short period when the Government of Yevgeny Primakov was in office in late 1998 and early 1999, was almost the same as before 1998. That is, first of all, the orientation on the single product export sector (oil and gas), an increasing share of import in the consumer sector, “appreciation” of the ruble exchange rate (from 30 to 23 rubles per US dollar), while inflation in the Russian market was 3–4 times higher than in developed western countries.

Before turning to the specific proposals, I would like to dwell on the similarities of the crises in 1998 and 2008. Their common feature is the development of financial bubbles. In the former case, in order to maintain the GKO pyramid, a continuous increase in the return on investment was needed to attract additional capital. As a result, the GKO yields and payments grew until the gov ernment simply became bankrupt, declaring default on its public debt. At the same time, the starting point for building of the GKO system was the idea to move away from the Central Bank’s financing of the federal budget deficit, as it was considered that it was just such financing, which lead to the weakening of the ruble and inflation.

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This time the situation was different. For several years, the country had creamed off the profit from the rise in global energy prices, because in fact nothing had been happening in the real economy; the companies simply raised enormous funds against large expected yields. However, the actual growth in production of the Gaz prom, for example, over the past few years was on average 1.3% per annum, which is incomparable with the rapid growth rates of the company’s capitalization and debt. It can be argued that although the devaluation occurred in both crises, in the latter case, it was not accompanied by default and the crash of the banking sys tem. With the accumulation of the Stabilization Fund over the course of several years, the injection of its money in the systemic banks kept them afloat; if one recalls 1998, many of the largest banks at that time failed. However, the problem is that the Stabilization Fund was established in a rather strange way, because in fact the budget’s items are the balance sheet items, i.e., no coun try of the world had ever seen such a large budget surplus as in Russia over the past three or four years. It reached 3.8 trillion rubles. These excess revenues were transferred to western financial entities and remained there. In this way, the export of Russian capital abroad by the government was officially authorized. The cost of money in the domestic credit market increased and the investment in the diversification of the economy declined. This strategy was based on an unprovable axiom that the Russian economy cannot absorb the received revenues and so the best choice is to save them for a rainy day. And this day had come. It turned out that Russia had a rather large number of investment projects and corporations and banks were forced to borrow from western banks. By the beginning of 2009, the indebtedness of the corporate and banking sec tors was $497.7 billion. Meanwhile the debt service in 2009 will include $114.1 billion as the principal repay ment and $22 billion as interest payment. The total will be $136.1 billion. However, many companies raised funds from western creditors, against the security of shares of enterprises with state participation. It is some thing like “shares for loans auctions,” which once resulted in the loss of a significant part of national prop erty by the state. Now, the second wave of shares for loans auctions can erode the material base of the national security of Russia. After making the above analytical notes, let us turn to the specific proposals regarding the creation of the mech anisms of the anticrisis policy mechanisms. The organization of the investment process. The estab lishment of the “long” money system. Certainly, the key to the creation of a mobile market economy is the organiza tion of the investment and innovation process. In effect, Russia has kept itself out of direct budget financing of specific projects. Projects in fundamental science and some secret defense projects have been left on the list. Perhaps, this is the right solution. Then, the banking sys

tem remains the source of financing for the rest of the items. However, this system is not free from a certain drawback. The government and households give money to commercial banks that can be invested in the real economy, or can be used to purchase foreign currency and transfer it to western financial entities, or public money can be used to privatize, for example, Norilsk Nickel and other national properties through shares for loans auctions. Moreover, this is the natural state of things. It is well known that commercial banks need “margin”, i.e., profit from money, not from goods. So, by their economic nature, they are indifferent to investment in the real economy. However, in every civilized country, there exist banks that are engaged in long term investment develop ment. Their credit policy is different from other commer cial banks. The main feature of this policy is directed lending. Such loans are used for infrastructure, the con struction of power plants, implementation of space projects, addressing problems in heredity and in the related areas of healthcare, etc. Directed credits must not be used on currency exchanges and in stock speculations. They are provided and—crucially important—disbursed for specific projects. The borrower does not possess cold hard cash. He procures certain works and materials from the con tractors and submits their invoices to the long term development bank. If the bank considers these works fit the investment project, it pays them. Unfortunately, in Russia the system of directed long term lending is in the incipient stage. However, the problem of the recovery of the invest ment process is not limited to the establishment of the system of long term lending. There is a deeper invest ment policy problem, closely related to the methods of fighting inflation. I mean the general approach of the Central Bank in conducting interest rate policy and man aging the refinance rate. This issue also has significant theoretical and methodological importance. The conceptual view of domestic monetarist reform ers has always been the idea of restricting money to the greatest possible, which is considered the main tool of fighting inflation. From Gaidar to Illarionov and Yassin all harp on the same string: the less money the consumer has the lower the producer prices. Yet, money is also a commodity. Reduction in the money supply leads to the shortage and appreciation of money. The interest rate for credit resources rises, particularly when private capital and the state aggressively withdraw their revenues from the country. Enterprises have to borrow not only for investment but for working capital (whose value declined in the first months of reforms) at a high interest rate. However, it is clear that this interest is included in the prices of the goods and services and the consumers have to pay for it. When the consumers are out of money, prices by no means decline. Enterprises either reduce their output or fail. This is what became obvious in the crazy nineties when the output fell by 30–40% and some manufacturing industries almost disappeared. Inflation

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varied from 839% in 1993 to 21.8% in 1996. Over the same years, the Central Bank’s rates (CBR) varied from 185 to 104%. Now, with some stabilization, during the crisis the CBR rate initially increased to 13% and then declined to 10%. Commercial banks provide credit to the real sector for 15–20% and inflation remains within 13– 12%. Expensive money brings about high prices. This has been illustrated by the experience of coun tries throughout the world, in particular the United States. For many years, the discount rate of the Federal Reserve System of the United States did not exceed 3– 5%. Inflation over these years varied from 1.6 to 5%. Dur ing the crisis, the Federal Reserve reduced the rate to 0.25%. A period of deflation began, which meant the rise of consumers’ purchasing power. It was done abruptly and had an immediate effect. Western Europe acted in a similar way. However, sometimes, the West is not an authority for Russian prowestern reformers. Reduction in the interest rate by the Central Bank of Russia occurred with a delay and was intended for the long term. That said, inflation will decline and then we will reduce the refinancing rate. In fact, everything is vice versa! Cheap credit resources boost the recovery of production, promote innovations, and the development of small and medium sized busi ness, make their products more affordable for the con sumer. Therefore, the Central Bank of Russia should promptly reduce the rate for credit resources to 4–5%. Unfortunately, pseudo reformer bureaucrats have stalled the implementation even of the direct instructions of the Head of the Russian Government. Antitrust regulation. Let us turn to another issue of no less importance. The excessive profitability of some goods and activities has been a delayed action mine, which prepared the economic crisis. One can track this both on the global and Russian levels. In the year of the inauguration of Bush Jr. as the President of the United

States (2001), the price of oil in the world market was $22

a barrel. What could have happened in a normal oil

export oriented economy if by July 2008 this price increased by six and a half times? The answer is that the economy degraded to extreme speculation. Oil prices caused a chain effect. And now, the per square meter price of housing in Moscow exceeds its costs three–four times. These are the consequences of a speculative econ omy. Of course, sooner or later, this entire system will blow up.

I believe that the only way to counter such bubbles is

the adoption of strict antitrust regulation. When speaking

of advantages of the market economy, it is often forgotten

that as soon as some market area becomes a monopoly, it ceases to be a market. In my opinion, when speaking of government intervention, the government should, grit ting its teeth, keep defending the competitive market. Yet, in our country in a vast number of sectors there exists only one seller. Indeed, this is not a market but a monop

oly. And it is not very important whether this monopoly is artificial or natural.

STUDIES ON RUSSIAN ECONOMIC DEVELOPMENT

Thus, fighting the growing crisis phenomena requires a radical change in the work style of the antitrust author ities. At present, they are mainly occupied with finding the facts of price collusion between individual enterprises and companies. However, the experience of development not only of natural but, primarily of artificial monopolies, shows that overpricing can by no means result from agreements between sellers. Squeezing competitors from regions and industries often takes the form of a “friendly acquisition” and other soft and rough raiding practices.

A key indicator of a monopoly is the generation of excess profit. The concept of the normal rate on return, which includes not so much bonuses to top managers, as the expenses for innovations, quality improvement, and reduction in production costs of goods and services, should be legally codified. All the remaining excess profit should go to the consumers’ pocket through the compul sory reduction in prices under the threat of confiscatory penalties imposed by the state. This is what fighting monopolism and the rise of crisis phenomena in the economy are about.

Job creation. Another fundamental block of the stra tegic anticrisis program should be the government’s pro motion of new job creation. It was the state that destroyed the system of training labor reserves and vocational train ing schools. So far, private business cannot (or does not want to) finance this system. Therefore, a significant part of working age men are employed as private security guards and cheap semiskilled labor is attracted from countries of the former Soviet Union.

Of course, the task of organizing the training of highly skilled labor should be the responsibility of the govern ment. It should also provide the conditions for interre gional labor migration. However, government officials are obsessed with mortgages, the encumbrance of each (including young) family with housing property, instead of establishing an extensive lease system in the housing market. Such a policy ties the population to specific regions and boosts unemployment in crisis situations.

I would also like to note that the issue of new job cre ation is inherently linked with addressing the problems discussed above of monopolism. At present, we have no jobs. And we will not have any jobs. After all, what did the metal producers do? They massively exported bars and slabs to western countries but did not manufacture mill products. And now they are unable to start such a pro duction—in this area we are not competitive even in the domestic market.

Finally, to deal with the impact of the economic crisis in Russia, the professionalism of management should be increased drastically. Domestic middle and high level managers have no skills in strategic management in a competitive environment. They are oriented on the achievement of current targets. Analytical services of cor porations and banks are unable to perform serious ana lytical work. The ratings of western rating agencies are often made a fetish, which entails severe errors and losses.

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In order to overcome the crisis situation, banks and corporations should drastically change the operating style and methods of their management. Tax policy. The above described fundamental anticri sis measures should be supplemented with shift to a more flexible tax policy. Taxes should play not only a fiscal but also a stimulatory role. For example, as one of the gov ernment’s objectives should be efforts towards new job creation, it would be necessary to promote the develop ment of processing stages through the increase in taxes on natural resources. The reduction or abolishment of taxes on the share of profit, used for investment is also possible.

All countries use this practice as well as schemes provid ing an increase in taxes on commodities and a decrease in taxes on high technology production.

This stimulating policy is very important. Examples are plentiful: in all countries there exist restrictive taxes on tobacco and alcoholic beverages intended to limit their consumption.

In the context of coping with the crisis, it is necessary to provide a tax holiday for small and medium sized businesses and knowledge intensive enterprises.

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