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Putin Is Shocked by Falling Economic Growth, but We Should Not Be

by | April 26th, 2013 | 12:52 pm
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Russia’s growth rate has fallen suddenly and sharply, and President Vladimir Putin has become publicly agitated in response. After a time of passivity in economic policy, significant changes are to be expected. The dominant concern relates to economic growth, which has almost ground to a halt. On April 22, Putin used these alarmist words at a meeting with his economic advisors:

GDP [gross domestic product] growth in the first quarter of 2012 amounted to 4.8 percent, while in the fourth quarter it was 2.1 percent. For the first quarter of 2013 it was only 1.1 percent. The Economic Development Ministry has revised its economic growth forecast for 2013 downwards to 2.4 percent, but this is with energy prices still high. Let me bring to your attention that a growth rate of 2.4 percent is lower than the global economy’s growth rate. It’s been a long time since we were last in this situation.

In fact, Russia had the largest output decline of all G-20 countries, at 7.8 percent, in 2009. Russia recovered after that, achieving a respectable growth of 4.3 percent in both 2010 and 2011. Last year, GDP grew moderately at 3.4 percent. But Putin needs a high economic growth of 5 to 6 percent in order to satisfy all his commitments to social and military spending as well as increased investment.

Though the problems have been clear for some time, Putin’s rising concerns are quite recent. At his press conference on December 20, 2012, Putin blamed the euro area and the bad harvest for the sputtering performance of the economy: “What were the causes of the slowdown this year? … the general slowdown in global economic growth and even a recession in the euro zone, one of the leading global centers. The second reason is our domestic problem, which is primarily concerned with crop failure…” He did not suggest the need for any new measures.

Now his tune has changed.

Putin faces a stark choice. The Russian economic debate is between two opposite approaches. One is liberal and one is statist. In effect, Putin has pursued a dualist economic policy since the Yukos affair in 2003, in which Russian authorities cracked down on one of the nation’s most successful energy companies, forced it into bankruptcy, and jailed its CEO. On the one hand, his fiscal policy has been very conservative. On the other, he has encouraged substantial renationalization and ignored the need for structural reforms such as deregulation and privatization, leaving the country with pervasive top-level corruption.

Russia has a lively public economic debate. Recently, the state corporation managers and crony capitalists with good connections to the presidential administration have gained strength. They favor increasing renationalization and red tape, while claiming that Russia’s shortcoming is that it ignores the Keynesianism that dominates in the Anglo-Saxon world. They argue vividly for looser monetary policy and a substantial Keynesian fiscal stimulus, especially advocating cheap state financing for infrastructure investment. Their strongest spokesman is Sergei Glaziev, a former foreign trade minister who is currently economic advisor to the president.

But liberal free market supporters dominate Russia’s public economic debate. They argue that the Russian economy is overheated with no free capacity, pointing to Russia’s high inflation of 7 percent and minimal unemployment of just over 5 percent. Hence, to these advocates, neither fiscal nor monetary stimulus makes sense. Russia’s problem, on the contrary, is seen by them as minimal productivity growth caused by red tape and substantial renationalization. The most prominent liberal advocate is former Finance Minister Alexei Kudrin. He calls for far-reaching deregulation and measures against Russia’s pervasive corruption. In similar polemics to those of Putin, Kudrin argues that “the system of half-measures and half-reforms does not work any longer.”

Few believe that the liberals have any chance to convince Putin to take up a serious battle against corruption, even in the face of a slumping economy. Kirill Rogov, a liberal political scientist at the Gaidar Institute in Moscow, predicts much noise about corruption but no real change:

The government will fight corruption but at the same time cultivate it. It is necessary to fight corruption in order to seize the initiative from the opposition on this very popular theme and to check the apparat and the elite. But it also has to cultivate corruption to maintain the loyalty of the elite and the power apparatus while its legitimacy declines.

While Putin has primarily blamed lacking demand from the European Union, the free market liberals contend that the economic decline derives from domestic causes. Negative external effects are yet to come, caused by declining prices of commodities, mainly oil, gas, and steel. During the first quarter of 2013, oil prices held up well, but now they have started to fall. The US shale gas revolution is reducing European natural gas prices, and they are likely to fall further. Steel prices have already fallen somewhat. Oil, natural gas, and metals account for almost 90 percent of Russia’s exports, which means that the country’s growth prospects do not look promising.

What will Putin do? He will definitely do something. On April 22, he stated: “We need to do everything we can to ensure our economy’s stable development. We need a package of measures to stimulate economic growth.” While Putin acknowledged that “many people propose revving up economic growth through budget spending alone,” he seems to recognize the risks. Yet, he supports infrastructure investment in transportation and energy, although most of that spending is widely considered to be corrupt. He calls for using the National Welfare Fund, one of Russia’s two sovereign welfare funds, for long-term investment in infrastructure.

On April 23, Putin met with his two top economic aides, First Deputy Prime Minister Igor Shuvalov and Elvira Nabiullina, the new chair of the Russian Central Bank. He sounded less sure of himself, but he requested that they present a program of “concrete proposed measures” by May 15. During his big press call-in program on April 25, he stated that “changes are probably necessary, but…the foundations of our economic policy will remain the same.”

Almost a year has passed since Putin was inaugurated for his third presidential term on May 7, 2012. Since then, no structural market reform of significance has been adopted, and none is expected. Last November, an anti-corruption campaign was launched. Its most prominent victim was Defense Minister Anatoly Serdyukov, but he has not even been arrested, only sacked. Hardly anybody believes the campaign will reach the main culprits in the Kremlin. But if nothing is done about top-level corruption, little can be done about red tape, since these two scourges are so closely connected. Privatization is out of the question because of the political strength of the state corporations. Thus, productivity-enhancing reforms seem very unlikely.

President Putin’s choice appears preordained, and it is not likely to promote Russia’s economic growth. To judge from Putin’s statements, some fiscal stimulus and easing of the monetary policy appear likely, but this is no cure for an economy operating at full capacity but with limited efficiency. Any measure decided in May can only take effect next year.