Towards a New Understanding of the Russian Economy?

November 14, 2001
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by Michael S. Bernstam and Alvin Rabushka

President Vladimir Putin's visit to Washington, D.C., and to President Bush's ranch in Crawford, Texas, for three days in mid-November 2001 has led to considerable soul searching on Russia's economic prospects and if its recent high growth can be sustained.

On Monday, November 12, 2001, the lead editorial in The Wall Street Journal was entitled "A Russian Revival." We took issue with the central themes in that article, namely, that supply-side tax cuts and land reform were driving recent growth. We maintain, instead, that high energy prices coupled with the Central Bank's policy of mandatory repatriation of 75% (now reduced to 50%) of export earnings and their conversion to rubles were the grease that lubricated the payment jam between enterprises, thus fueling growth. (See our article posted to this site, "A Russian Revival?") Since the Central Bank's policy was imposed three years ago, mandated repatriation of export revenues inadvertently reduced subsidies and perverse, redistributive incentives. It transformed rising export revenues into the general economic recovery of 1999-2001. But we noted that the trend might be reversed by falling world oil prices and the reduction of forced repatriation of revenues.

On Tuesday, November 13, 2001, George Melloan's "Global View" column in The Wall Street Journal commented on Russia's economy. In marked contrast with the Journal's lead editorial the previous day, Melloan makes three important points:

(1) The improvements in Russia's foreign exchange reserves and its economic growth in recent past few years are due largely to higher oil and gas prices. These two commodities earn half of Russia's export revenues, with other raw materials bringing in most of the rest. Russia produces few manufactured goods that it can sell abroad, which means that Russia will depend on energy exports for growth for the near term. Falling oil prices this year has slowed growth (compared with 2000) and further price declines will result in still slower growth. (Compare our articles posted to this site, "The Secret of Russian Economic Growth: Testing an Old Hypothesis with New Data," "The IMF, Oil, and Russian Economic Policy," and "Bush and Putin at the Ranch.")

(2) Russia's banking system ranges between primitive and nonexistent. One approach to setting up a modern banking system is to bring in some foreign banks. (See page 96 in Fixing Russia's Banks: A Proposal For Growth and peruse the book for a detailed analysis of Russian finance.)

(3) The fastest way to develop Russia would be to follow the Chinese approach and bring in outsiders. (For a comparison of policies and growth in China and Russia during the past few decades, see Chapter 2 and the second half of Chapter 4 in From Predation to Prosperity.)

Melloan's main points make an important contribution to the emerging new understanding about Russian economic path, especially given the often leading role of The Wall Street Journal in policy debates. What we find most encouraging is his willingness to depart from an ideological orthodoxy that has too long resisted consideration of the facts and the need to match argument with evidence.