In the last five years, Russia has come along way from a colonial-type economy. The economic explosion of 2003 was brought about by companies of the new economy working in the ruble zone. These companies don’t need state capitalism. They need a democratic cluster policy with clear aims.

Tatiana Gurova and Alexander Ivanter

The autumn war between the authorities and the oligarchs cast a shadow over the positive trends in the Russian economy last year. We would like to point out three crucial developments.
First, 2003 saw the reversal of a negative trend in Russian economic development. While GDP growth decreased with each year beginning in 1999 and fell from 10 percent in 2001to 4.3 percent in 2002, the results for 2003 revealed a growth rate of 6.8 percent. This is no coincidence and not merely the consequence of high oil prices. This is the result of cumulative positive changes in the Russian economy.
The second statistical event remained little known, but growth at Russia’s largest companies, predominantly natural resource giants, remained notably lower for the second year in a row than the average growth rates in manufacturing. This testifies to a very important development. The economic growth we are witnessing is not due to a small number of large corporations, but primarily due to hundreds of mid-sized companies with turnover ranging from $200 to $300 million. Finally, the third event: Starting in 2002, economic growth has been directly tied to investment in the economy. This indicates qualitative growth connected to the active accumulation by Russia of new, technologically state-of-the-art fixed assets. In all the previous years of reforms, nothing like this has ever happened.
What do these facts tell us? All three events taken together are signs that the Russian economy has made a strong structural shift in the direction of the new economy. This is the economy that was created after reforms, that is capable of surviving on the market in general and on a market open to the outside world in particular. This new economy is growing rapidly, primarily due to the Russian domestic market, is quite diversified and is based on up-to-date capital.

Say Goodbye to Prejudice

The people who took it upon themselves to reform the Soviet economy were dealing with a moribund entity. GDP growth rates in the U.S.S.R. in the mid-1980s were equal to zero. To resuscitate the patient and slowly and patiently, transition to capitalism via the Asian version of state capitalism required political will. There is no point in even talking about Brezhnev and Chernenko here. Andropov died before he had a chance to do anything. For this reason, when we bemoan the fact that Russia did not take the Chinese approach, perhaps we are fooling ourselves. There was no one to push through a goal-oriented economic policy. At the same time, the still energetic minds among the intellectual elite became infatuated with economic liberalism. And no wonder. Against the backdrop of the objective death of the CPSU, liberalism won the heart first of Gorbachev and then of Yeltsin.
What did Russia lose as a result of the triumph of liberalism? From an economic standpoint, we lost exactly as much as we had to. The greater part of the Soviet economy Russia inherited was unviable. This is easy to explain. The Soviet Union missed practically 20 years of development. In the 1960s and early 1970s, we were on the same level as the rest of the world in practically all areas of economic life, from space exploration to design. However, while in the 1980s the Western world, having gone through the energy crisis of the 1970s, began to develop according to the new concept of the information and global economy, the U.S.S.R. merely pumped its oil and artlessly spent money on large national projects that had no relationship to trends in world economic development. 
How much deadwood accumulated in the Russian economy over 20 years of standstill? The history of the Great Depression (when the United States also went through a profound structural crisis in its transition from an industrial to a post-industrial economy) demonstrates that Russia should have lost at least 30 percent of its GDP. We lost 40 percent. More, but not much more. And one can say that the extra 10 percent went toward something very important.
The radicalism of the economic freedom of the early 1990s brought thousands of highly qualified people to the capital and labor market. Nothing of the kind has ever happened anywhere in the world. Americans are often accused of having achieved their economic success due to educated and hard-working immigrants. The Russian market from its very inception was created by people with an excellent education in physics, math and the natural sciences. Former defense workers applied their academic knowledge and organizational skills learned at some of the better defense industry organizations to the new capitalist environment. This immediately laid the groundwork for the future vitality and competitiveness of their companies.
This process occurred everywhere in the first half of the 1990s, and by around 1996, the groundwork for the Russian new economy had already been laid, an admittedly varied and diversified economy. This explains how the Russian economy, which Russians themselves considered third-world at the time, was able to take such efficient advantage of the blessings of the 1998 devaluation.

Away From the Colonial Economy

After the default on state debt and the devaluation of the ruble in August 1998, Russia not only broke its fall, but rapidly entered an economic upturn that has continued practically uninterrupted for the last five years.
To understand what happened and how profound these positive shifts in the Russian economy actually are, we need to compare two periods: 1997 to early 1998, and 2001 to 2003. In both periods, oil prices were high (though they are currently higher, of course). In both periods, the ruble was strong in real terms. However, back then imports were growing rapidly, and the balance of trade was at zero as a consequence. Now, imports are growing slowly, and the balance of trade is the best it has ever been. What’s the big difference? In our opinion, the answer lies in the particularities of the economy's structure and money circulation in the country, respectively, in the first and second period.
From 1995 to 1998, despite the appearance of new capitalist owners, the Russian economy was turning into a colonial-type economy. The reason for this was first and foremost the “currency corridor,” the policy that artificially propped up the ruble. Structurally the economy at that time was divided into two practically unrelated segments. At the top of the pyramid of economic agents was a small number of large natural resource companies making a quick buck. This money flowed into Russia and created solvent demand. However, practically all this demand swiftly turned into demand for imports, and as a result the money passed over almost all economic agents and flowed back out of the country. The pyramid also had its base. It was made up of thousands of economic agents including both Soviet companies and representatives of the new economy. The latter tried to get a hold of some of this money. They had a hard time doing this, however. Cheap imports got in their way and contributed to the high ruble exchange rate. In this very unbalanced economic system, some prospered while others starved.
In these years — 1996 to 1998 — Russia was obviously in danger of turning into a colony. The fact that state property had already been handed out to Russian oligarchs more likely than not saved us from this fate. Because the government, groaning under the weight of its foreign debt, could have decided to pay off its creditors with some nice assets. Fortunately, it no longer had them. In this way, when Chubais exclaims, “Who here is a Russian patriot? Me, I’m a Russian patriot!” he is right. In the power vacuum of that time, private property saved the country.

Toward a Ruble-Zone Economy

There was only one way out of this deadlock: Cut imports. No one had this goal in mind when they announced the default and freed the ruble. However, the new economy entrepreneurs understood that they had been rescued in the very first months after the devaluation. Many commented that the 1998 crisis was like a breath of fresh air. This fresh air was the oil dollars that finally started coming to them. Without its natural resource companies, Russia, in order to escape colonial dependency and develop a somewhat independent new economy, would have been forced to clamp down and, like North Korea, pump money into the economy, risking low investment efficiency and inflation. Fortunately, Russia had oil, and this gave us the chance to grow a new economy under free, competitive market conditions.
In 1999, after a brief but unpleasant stay at $12 per barrel, oil prices rose. Due to the devalued ruble, the oil dollars could not all go toward imports. They began to settle in Russia and feed the entire economy. Primarily the new companies began to work with this money. They had two advantages under the circumstances: They had the money they needed to expand operations and educated demand that forced them to strive for better quality. This came about because new, previously import-oriented customers were used to high-quality consumer goods. This process took off in 1999 and led to a whole range of developments: the rapid expansion of domestic manufacturing, a shift in the profile of domestic production toward better quality goods, the struggle to reduce costs in order to increase profits, and the development of trade infrastructure across Russia. At export companies, this period was also the period of increased efficiency. After coping with the unpleasant drop in prices, they began to seriously try to reduce costs. When they saw prices were rising, they began to invest in expanding their business.
As a result, the structure of the Russian economy changed. The extreme gulf between the top and the bottom of the pyramid disappeared. The dwarves of the new economy grew and turned into confident mid-market companies, laying the foundation for the ruble-zone economy. This process was complete by 2001, the end of the post-devaluation boom.

The Next Wave

The wide-spread conviction that oil dollars are still the main factor determining economic growth meant almost no one in Russia predicted high growth rates for 2003. It appeared that the benefits of devaluation had been used up and that what was needed was modernization of the economy. In other words, Russia needed investments, but there were no signs that investment was stepping up. All that was left were the same old oil dollars, which would make the economy grow by 3 to 3.5 percent. 
However, mid-sized companies, with a growing market and an increasingly mild monetary climate, had managed in the three years after devaluation to come into their own and start making medium-term economic plans and investments. The natural resource companies also started expanding investments. As a result, investments in fixed assets for last year grew 12 percent versus less than 3 percent the year before.
These processes were particularly visible on the corporate bond market, which saw not only growing trade volumes, but also growing diversity among market participants. In addition to the traditional natural resource giants, mid-level consumer product companies started entering the market, and investors bought their bonds. Market players talked about one very important quality shared by the new issuers: They could borrow at higher rates because the rates of return on their businesses were rarely lower than 20 percent.
What in the world happened? In our opinion, the next wave of economic upturn had begun. And it began in 2002. In 2003 it simply unfolded and became more obvious. It turned out this wave was actually connected to the new economic plans of many organizations in the economy. Their strategies were connected as a rule with more precise positioning of their companies, the elimination of production that could not compete and a concentration of forces on goods and services that clearly had big potential markets. As a consequence, they invested in new, more up-to-date production.
The leaders who pursued this strategy see no limits to their development today. The majority of them believe that their growth will continue next year at a level of around 25 to 30 percent.
Will these expectations prove true? More likely than not, they will. The growth mechanism that has evolved in Russia today is ideal. On one hand, hundreds of domestic companies and organizations have economic plans of current interest. On the other hand, the country is in great financial shape: relatively low foreign and private debt; a record-breaking, even excessive, amount of gold and currency reserves; and a greater-than-expected budget surplus. Thirdly, export companies are preparing to expand. Fourthly, global market conditions look good. Finally, the process of de-dollarization evolving as a result of the stronger ruble (the amount of cash kept in dollars by individuals alone shrank by $4 billion last year versus the stable increase by approximately $1 billion a year between 2000 and 2002) has not led to higher inflation, though the rate of ruble emissions has increased by 1 1/2 times. Under such conditions, it would be nearly impossible not to grow. For this very reason, the incessant attempts of certain politicians to dramatically change the way the economy is managed are extremely irritating.
A free-market system has in fact emerged in Russia, and for the moment it is working fairly well. Any reasonable politician would take a lesson and take his vision for the future from the economy. Instead, many want to “speed up the progress,” and what is most upsetting, they want to do so using old and alien methods.

The Illusion of Easy Solutions

Echoes of Keynes can be heard in the promises of one of the leaders of the Rodina political bloc, Sergei Glazyev, to stimulate consumer demand by massively increasing social spending and salaries paid by the federal budget after taking away natural resource revenues unjustly commandeered by the oligarchs. If we disregard the fact that his estimates of these revenues and of the scale of additional government spending are exponentially exaggerated, it is not completely clear that artificially pumping up demand would be that useful in speeding up growth. One suspects that if demand were to rise dramatically — it’s already growing by 10 to 15 percent a year — the successful mid-sized consumer product companies would simply not be able to satisfy it and maintain the quality of their goods and services. In the best case scenario, demand would be met by imports, and in the worse case scenario lead to a surge in inflation. It is upsetting to keep harping on the same subject, but for instance, the import of foodstuffs last year for the first time in four years fell by 2.3 percent, while domestic production grew by 5.3 percent. All this despite the strong ruble!
There are even more odious proposals, such as re-privatization of the major private natural resource companies, returning all the economic “high command” to the state. This idea can also be extensively justified by everything from making references to Roosevelt’s New Deal to pointing out contemporary examples in a variety of developing countries where all natural resource export is in the hands of one or a few state-owned companies. Unfortunately, none of the “new Russian statists” bother with a critical analysis of whether these approaches would work in Russia today. Are state-owned Rosneft or the Ministry of Energy responsible for current oil exports that have already exceeded the highest levels of the Soviet era by 1 1/2 times, wrenching the laurels of world leadership away from Saudi Arabia? No, they are the result of the efforts of private oil companies, at a time when government bureaucrats can’t even sort out their priorities for developing the export infrastructure.
We should also realize that if government raids on major private companies similar to the attack on Yukos become common practice instead of unfortunate incidents, the living economy will fight back. Thousands of companies, mid-sized as well as large, will be forced to export their capital. This would also be upsetting. Last year the net export of capital from the private sector of the Russian economy fell by $7 billion. All of this money was invested in Russia.

Seeing the Future

In protesting bombastic solutions to stimulate growth and diversify the economy, we nonetheless know full well that Russia does need some kind of economic plan today. The strategic interests of today’s Russian entrepreneurs in the most general sense can be reduced to two large-scale tasks: reclaiming Russia’s huge territory that has remained underdeveloped for centuries, and spreading Russia’s tolerant and lively culture to the rest of the world. These two challenges do not contradict each other. We need to respond to them in the proper order. First, we need to reclaim our country and develop our domestic market, and then in 10 to 15 years expand our culture.
What does this mean in terms of practical planning? By putting together the myth of predestination and today’s economic concepts, we can sketch out a Boston Matrix for Russia.
What does a focus on our own territory mean from the point of view of this matrix? One simple thing: Our “stars” today are the industries and clusters that provide for the domestic market. We have to live somewhere, and that means housing construction. We need to move around, and that means building roads. We need to provide the country with heat and electricity at minimal cost, and that means the energy industry and machine tools. We need to have something to wear, and that means developing our own light industry.
We have approximately seven to 10 years to develop the domestic market. This stage should lead to high growth rates, and as a consequence some of today’s mid-sized Russian companies will turn into large corporations capable of competing efficiently on foreign markets. Then the spread of Russia’s material culture will become a reality.
However, we have to get ready for this breakthrough now. This means that we need at least a rough outline of the economic clusters necessary for this expansion. In our opinion, there are three of them. The first is education, and Russia, by repackaging its intellectual strengths, could easily hope to become a leader on the 21^st-century market education. Then there is style or, more specifically, design. The original aspects of our worldview could materialize into things, and Russians could influence European design the way the Japanese have. Finally, there is the realm of scientific and technological innovation.
It is impossible to achieve this kind of diversification by fiat, but as the ball is already rolling in all areas, the government’s job is simply to support emerging trends. In this sense the so-called cluster policy approach is relevant. It would be worthwhile to methodically and patiently define all relevant clusters and begin to remove limitations on their development. The initiative could come from federal agencies, but could also come from the provinces and entrepreneurial organizations. The most important thing is the creation of the notion that we are acting objectively and collectively.

The Coming Reality

However, this is only a dream. What reality awaits us? What kind of risks are coming in the next year? What is the most likely turn of events?
The central risk, of course, lies in the extremely close ties between the government and Russia’s largest business owners. Right before New Year’s at a meeting of the Chamber of Commerce and Industry, Putin stated that there are still five to seven people in the country who should be worrying about their property. It is impossible to understand what the president actually wanted to achieve with this statement. Legitimate ways to redress the mistakes of privatization are being sought, and judging by the president’s tenacity, the search will continue. The oligarchs will somehow be made to pay for their cheap acquisition of state property.
This brings with it two obvious risks. The first, domestic risk will be connected to how tough the chosen method will be. If it seems too tough to the majority of entrepreneurs in Russia, and if it could be widely applied (far beyond the list of five to seven people), then capital will flee Russia again and investment will grind to a halt. Compensatory measures could immediately follow this: the government or quasi-government investment of resources from the stabilized state budget or the Central Bank’s gold reserves into industries deemed priorities by the authorities. This kind of investment, as has already been said, threatens to reduce the overall efficiency of the economy. However, the likelihood of this chain of events is at most 50 percent. The president’s caution and the fair number of liberal economists close to the president make this scenario less likely. More likely than not, a peaceful resolution to the conflict surrounding large assets will be sought over a long period of time. In our opinion, the solution lies in discussing strategies to develop large assets and connecting it directly to the country’s interests. If a compromise of this sort can be reached, retribution will cease to be an issue.
The second risk is connected to a potential overly abrupt opening of the market to foreign capital. If the government simultaneously sees its enemy in big national capital and even at close range can’t see a partner in mid-sized business (as it’s not classy enough), then it might conclude that the economy needs the support of foreign, primarily European, economic forces. 
The government has already defined its highest priority as the real estate market. This is a signal that will bring positive changes to the market over the course of the year and lead to the physical growth of this market. This, in turn, will stimulate the entire economy. To all appearances, this will be the main substantive move by the government, as in other clusters there is not the same degree of ready solutions.
However, the real estate market experiment will prove both to us and the authorities that cluster policy can work. For this reason, most likely the government will be willing to come into contact with many other Russian clusters, and the most active of them will reach their goals in the next two to three years.
Growth, of course, will continue in 2004. However it will only be possible to seriously measure its extent once the authorities decide how they will address the issue of the legitimacy of big Russian capital.

Andrei Naumkin and Yurk Chainikov contributed to this article.

More in Russian >> www.expert.ru