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The Russian Conundrum

Growing Economy, Failing Society

Federico Varese

which lies two hundred kilometers to the north of Moscow in the direction of St. Petersburg, was the capital of a powerful medieval state. In 1246, Alexander Nevsky entrusted it to his brother Y aroslav Y aroslavich, and very soon this dynasty transformed an inhospitable and uncultivated land into one of Russia wealthiest and most s populous states. The ensuing two-hundredyear battle for supremacy between Tver and Moscow is a much-visited historical subject. The Volga runs through the city of Tver and continues southward to Y aroslav, N izhniy N ovgorod, Sarat ov, Volgograd (former Stalingrad), and Astrachan, where it enters the Caspian Sea. One small town in the region, Kostinovo, has found its way into the papers because it now has just one inhabitant, Antonina Makarova, age seventy-eight. Her nearest neighbor, Maria Belkova, lives in the next town, which has a population of two. As reported in the St. Petersburg Times of October 2006 by Kim Murphy, the number of inhabitants in the region has decreased by about 250,000 since 1989, and deaths exceed births by two to one. Kostinovo is one of the 1,400 towns in the Tver region that have been officially declared depopulated (nezhiloe). Russia is one of the few countries in the world where life expectancy is declining; young people between the ages of fifteen and twentyeight have the highest mortality rate in Europe. In the 1980s, citizens of the Soviet Union had the same life expectancy as citizens of the United States. Today, the Russian male lives on average to an age of fifty-nine, sixteen years less than his U.S. counterpart. About ten million Russians are sterile as a result of bad health or abortions that went wrong. Accord-


ing to the Academy of Medical Sciences, 45 percent of newborns have a disease or a congenital birth defect. One typical story: when I first met him in the nineties, Oleg, age forty-two, was a respected assistant professor in the faculty of physics at the University of Perm in the Urals region and author of several articles in British and American academic journals. He went to the opera every week, and his three children took private violin lessons. For more than two months, he was my guide through the labyrinthine new market economy, and he introduced me to several entrepreneurs whom he knew personally. However, Oleg never managed to benefit from the new, post-Soviet wealth, and after offering his services to a few companies based in Perm, he was obliged to go back to doing translations and giving private lessons in mathematics. Today, he is recovering in the city hospital from the consequences of a heart attack. His wife tells me that they live on less than 150 dollars a month, and she cannot afford to pay the bribe that doctors and nurses demand to keep her husband in hospital. A reader of the Economist or the Financial Times would have good reason to be surprised and not a little skeptical about such news. How could the situation be so dismal? Over the last seven years, the Russian economy has grown on average by more than 6 percent per year, inflation does not exceed 10 percent, and the ruble appreciated by 10 percent in 2005 and by 8 percent in the first nine months of 2006. The financial system is considered stable and reliable. Western fund managers and various holders of reserve capital, including many central banks, have recently decided to hold rubles and to invest massively in Russia. The Stabilization Fund, set up by the government in 2004 to manage the proceeds from the sale of raw materials, has been growing at a vertiginous rate and currently holds seventy-seven billion
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dollars. Last but not least, the second Millionaire Fair, where you could have bought a cell phone for more than a million dollars, was held in Moscow early in the new year. Indeed, the majority of the ideologues from the Y eltsin era, such as the consultant Anders slund, considered the fall in the birth rate to be a contingent phenomenon due to the adjustments that followed the transition to a market economy and democracy. The graph for the birth rate does in fact show a fall in 1991 and a further fall in 1998, the year of the financial crisis. Y the economy has grown uninterruptet edly and at a staggering rate over the last seven years, while the population continues to die. What could be the cause? The Russian conundrum consists, first, of a growing economy with a gross domestic product that has increased by 50 percent since 1998, a solid and reliable financial system, companies listed on the London and New Y ork stock exchanges, thirty-three billionaires on the Forbes List in 2006, and a responsible monetary and fiscal policy that has produced a fiscal surplus since 2000. Then there are the dramatic social indicators: the suicide rate has increased by about 50 percent since the nineties; alcohol and drug consumption have soared; the AIDS epidemic is the worst in Europe; there are 120,000 new cases of tuberculosis every year; and access to hospitals under the corrupt and inadequate health system depends on bribing doctors and nurses. The political indicators are no less dismaying. The system is increasingly authoritarian: all the television channels are under direct or indirect government control; the nonaligned daily and weekly newspapers can be counted on the fingers of one hand and, in any case, have an extremely limited circulation; the president has abolished the elections for regional governors; a few politicians close to Putin have recently suggested the abolition of mayoral elections as well; and pro-government parties, which win with majorities of 70 percent, control sixtythree of the eighty-eight regional parliaments. Trade union activity is almost nonexistent because, as the American journalist David Satter has made clear, trade unionists are intimidated, beaten up, and even eliminated. The climate of fear extends to the ethnic minorities that

live in the country: the most recent victims have been the Georgians, who are guilty of having been born in a country that does not accept Russian political interference. During his recent anti-Georgian campaign, President Putin added a new expression to his vocabulary: korennoi narod (the rooted population), obviously a reference to the Russians. He insists that the interests of this latter group must be protected against ill-defined dangers. In the meantime, the police arrest and beat up the local blacks (non-Russians from the South).

H E GRAP H TH AT provides the best explanation of the Russian conundrum consists of three lines: the world oil price, the degree of democracy in Russia (political and civil rights) as measured by Freedom House, and the rate of corruption as measured by Transparency International. Once this graph has been drawn, the reader immediately sees illuminating correlations: every time the oil price goes up, the level of democracy in Russia goes down and the level of corruption goes up. For decades, political scientists have studied the so-called wealth paradox (most recently, Michael Ross, Steve Fish, and Peter Rutland); namely, the fact that countries that are rich in natural resources do not appear to be able to prosper economically over the long term. The classic example is that of Spanish colonization in the New World, which brought fabulous riches to the crown treasury but in the end produced economic decline. In the Spanish case, the American gold only produced powerful inflationary pressures. There is very good reason to believe that political institutions also suffer a decline. The causal mechanism is as follows: large and unexpected profits from the export of raw materials erode the institutional barriers that separate government and the producers of primary resources. The executive has strong incentives to appropriate the profits and weaken the institutional structure that regulates the use of public funds. Various examples from the twentieth century demonstrate how the revenues are spent on ineffectual projects or simply pocketed by the political elite. A further effect of the wealth paradox is that the state can afford to reduce taxes, as has in fact occurred in

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Russia in recent years. The proceeds from gas and oil production are so high that tax extraction becomes a less important source of revenue. The reduction of tax pressure weakens the incentive among the population to participate in political affairs and so, paradoxically, it reduces the level of participation in the debate on how taxes should be spent. This is not to say that these mechanisms are ineluctable. Norway, for instance, has managed to avoid the curse of natural resources. The political class can award the exploitation of natural resources to efficient companies, create indestructible institutional barriers, and introduce accounting innovations to manage the wealth generated by petrodollars. Russia, which has an authoritarian tradition and an absence of institutions independent from the executive, has taken a different route. In 2003, it launched an attack on Y ukos, a petroleum company that was showing signs of good governance and efficiency. When the chairman of Y ukos, Mikhail Khodorkovsky, revealed his political ambitions and started to finance opposition groups, he was immediately arrested for tax fraud and sentenced to eight years in prison. He still languishes in a cell in Prison Number 13 in the city of Krasnokamensk, in the region of Chita, close to the Chinese border. the formation of independent centers of power and has brought about a situation in which all the most important companiesparticularly those engaged in the production of raw materialshave become his political fiefdoms. It should come as no surprise that the system of appointments to statecontrolled companies is not that dissimilar to the one used in Italy when the coalition government of Christian-Democrats and Socialists was at the height of its power in the 1980s. A dense network of relations of Putins closest collaborators controls the most important companies and banks in the country. A few examples illustrate the current situation. Andrei Patrushev, the twenty-five-year-old son of the current chief of the secret services (FSB), has been appointed adviser to the chair of the board of directors of Rosneft, the state petroleum company that incorporated Y ukos after


Khodorkovsky arrest (the Number Two in the s presidential administration is in charge of Rosneft). Andrei older brother is in charge of s loans from the state bank Vneshtorgbank. The vice president of Vneshtorgbank, Sergei Matvienko, is the son of the governor of the St. Petersburg Region and a staunch ally of Putin. Before that, he was the owner of a private bank in which the state had a holding. Matvienko has just bought an island in Estonia and is preparing to turn it into a club for the super rich. Another fair-haired boy, the son of the minister of defense, was appointed vice president of Gazprombank in 2005, at the age of twenty-four. This bank bought out NTV the , last independent television company in the country. The son of the reformist minister Viktor Khristenko can also boast of membership in the exclusive circles of big business before his twenty-fifth birthday, having gained the post of director general of an enormous conglomerate that produces metals and industrial tubes. The list could go on, with cousins, nephews, and matrimonial alliances between the families of Putin allies, mostly drawn from s the bureaucracy or the KGB (the information presented in this paragraph comes from recent art icles pu blish ed in N ovaya G azeta, Kommersant, and eXile). The Russian conundrum can therefore be explained with the tools of political economy: a country can be both rich and have one of the worst health services in the world, a declining population, and an authoritarian and corrupt political system that faces almost no opposition. As Alexis de Tocqueville has taught us, revolutions occur when there is a redistribution of wealth to sectors excluded from political representation. This is not yet the case in Russia. Antonina Makarova, the last inhabitant of Kostinovo, should consider herself lucky to have reached the venerable age of seventyeight. After all, she is the product of an egalitarian revolution that today has been consigned to the history books, just like the medieval dynasty that governed Tver.
FE D E RI C O AR E SE is Professor of Criminology at Oxford University and the author of The Russian Mafia (Oxford University Press, 2005).

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