RISE OF CORPORATIST STATE

IN RUSSIA
(The 2006 Long Telegram)

A. Illarionov

Cato Institute, March 7, 2006

Institute of Economic Analysis
www.iea.ru
 If you are not behind bars yet
it is not your merit,
it means the system does not work properly.

Russian peoples wisdom.

Our system must work better.

Russian governments documents.

2
 Historical analogies are usually subjective,
never perfect,
but provide valuable historical perspective
to look upon todays situation
and possible future developments.

3
 The 2006 Long Telegram:

1. Periods in recent Russian history.

2. Russian authorities Economic policy.
3. Russian authorities Domestic policy.
4. Russian authorities Foreign Policy.
5. What made Russian economic boom?
6. Russias Corporatist State.
7. Russia is a member of G8. Which G8?

4
 Periods in recent (2000-2006) history
of the Russian authorities policies:

1. Jan 2000 June 2003: Sturm und Drang Period.

2. July 2003 Nov 2004: Period of Questions.
3. Dec 2004 Nov 2005: Period of Answers.
4. Since Dec 2005: No Debate Period.

5
 The most popular question among business
people in the 1990s up to mid-2003:

What will be the exchange rate of Ruble

tomorrow?
Day after tomorrow?
In a week?
In a month?
By the end of the year?

6
 The most popular question among business
people since mid-2003 and especially in the
last two years:

Is it not too late to leave the country?

Should I leave Russia by the end of the year?
In a month?
In a week?
Day after tomorrow?
Tomorrow?
Right now?

7
 Overall diagnosis for Russian
authorities current policies is

Darvensazimus disease.

8
 Darvensazimus disease
is a very rare, complex and dangerous illness.
It consists of at least 5 diseases:

- Dutch Disease.
- Argentinean Disease.
- Venezuelan Disease.
- Saudi Disease.
- Zimbabwean Disease.

9
 Combination of 3 diseases

Dutch Disease,
Argentinean Disease,
and Venezuelan Disease

can be used for description

of the current economic policy.

10
 Dutch Disease

sustaining high rate of inflation and

national currencys real appreciation
leading to undesirable structural changes
and budget profligacy.

11
 Higher oil prices led to a sharp increase
in the inflow of financial resources into Russia...
Value of Russias oil and oil products export

12
 to sustaining high money supply growth rate...
Annual increase in M2, %

13
 to sustaining high inflation rate,..
Annual increase in CPI, %

14
 to fast real appreciation of Ruble exchange rate,..
Russian Ruble real effective exchange rate (July 1998 = 100%)

15
 to sharp increase of the energy sector role
in the Russian economy,..
Value of energy exports as % of GDP

16
 to a relative decline of non-oil sectors share
in industrial output.
Non-oil output as % of industrial output

17
 Argentinean Disease

use of industrial policy

to correct undesirable structural changes
by redistributing value added from energy sector
into other sectors, primarily machine building

18
 Beginning of industrial policy in Russia, 2002-2004:

Increase in taxation of oil companies

Increase in government expenditure, including
government investments
Setting up different government-regulated transport
and energy tariffs for different sectors, industries
and companies
Further differentiation of import duties
Introduction of import quotas

19
 The fastest growing item was governments
expenditure on military and police
National defense and police expenditure as a share of GDP

20
 as well as on administration.
National expenditure on administration as a share of GDP

21
 As a result, the number of bureaucrats
and their share in total employment
have dramatically expanded.
Public administration as a share of total employment

22
 The rise in government expenditures has also led
to increase in non-market employment
Employment in non-market sector as % of total

23
 therefore reducing employment in market sector.
Employment in market sector as % of total

24
 While economic activities in processing industries
sharply slowed down, expenditure on government
administration, national defense and social security
skyrocketed.
Growth rates in value added by sectors, %

25
Implementation of industrial policy led to fall in growth
both in oil industry as well as in machine building,
and to a notable slowdown in overall industrial growth.
Annual growth rates in 19992004, 2005 and in January 2006

26
 Industrial policy led to decline in growth rates
in other sectors.

27
Dreams of adherents of industrial policy have
been finally implemented.

Arrival of industrial policy in Russia

has led to fall
in industrial output growth rate by 50%!
 New stage of industrial policy
development policy (MERT), 2005-2006:
Differentiation of taxation for different companies.
Destruction of Oil Stabilization Fund.
Expanding of old and creation of new state financial
developmental institutes Russian Bank of Development,
creation of the Government Investment Fund, creation of
Government Venture Funds.
Creation of Special Economic Zones.
Granting taxation privileges to different municipalities.
Adoption of programs of Development for different industrial
sectors.
Introduction of limitation to foreign ownership in 39 strategic
companies and sectors.
Adoption of Innovation and Technology Development programs.
Preparation of the Program for Government Support of Design.
Actually, we have many more ideas...

29
 Venezuelan Disease

nationalization and quasi-nationalization of private

assets in oil, gas, transportation, construction,
automobile industry, aviation.

30
 Accumulation of huge financial resources
by oil companies made them very attractive
for government intervention.
Oil companies revenues

31
 Quasi-nationalization began from the most successful
oil companies.
YUKOS oil output has almost doubled within 5 years, 19992004.

32
 Having launched their assault on Yukos,
the authorities by the end of 2004
have essentially destroyed the most effective,
most transparent and fastest growing company.
Its most valuable and effective part
Yuganskneftegaz has been handed over
to the state-owned company Rosneft.

33
 As a result of the forced transfer to Rosneft,
Yuganskneftegaz, the pearl of Russias oil industry,
saw its output collapsed after 4 years
of unprecedented growth within Yukos.
Yuganskneftegaz oil output growth as % to previous year

34
 Financial results of Yuganskneftegaz activity
under state management became
triumph of ineffectiveness and incompetence.
Yuganskneftegaz financial results
in Jan-Sep 2005 as % in Jan-Sep 2004.

35
 The transfer of Yuganskneftegaz from Yukos
to Rosneft neither increased, nor even sustained
the combined output of these two companies.
It reduced their combined output.
Total Oil Output of Yukos and Rosneft combined,
3 MMA, January 1999 November 2005

36
 In a response to the governments assault,
private investments in the oil sector in 2004 fell by 20%,
and growth in Russias oil output fell
from 12% in June 2003 to 0,9% in August 2005.
Oil Production Annual Growth Rates, January 1996 January 2006

37
 Political process became concentrated over
distribution and re-distribution of monopoly
rents and creation of their new sources,
not over formation of favorable conditions
for creation of value added.
Vibrant politics is devolving
into rent-seeking politics.

38
 Not only political elites,
but the whole Russian society is evolving
into a rent-seeking society,
where weak and ineffective people are demanding
subsidies and protectionism (and receive it),
and the most talented, educated and entrepreneurial
people are looking for possibilities to distribute and
redistribute rents.
National labor ethics en masse is evolving
in a rent-seeking ethics.
Grand populism
(in a form of the so-called national projects)
has arrived.

39
 Rent-seeking behavior becomes incredibly attractive
not only for todays political and economic elites,
but also for future generations.
Changes in preferences of future jobs by Russian youth
(FOM polls, 19972005)

40
 Only in this land which had never known
indeed any tolerant equilibrium of separate
powers, either internal or international, could a
doctrine thrive which viewed economic
conflicts of society as insoluble by peaceful
means They sacrificed every single ethical
value in their methods and tactics. Today they
cannot dispense with it...

G. Kennan, The Long Telegram, February 1946.

41
 The Russian authorities attitude towards
domestic politics and civil society can best be
described as

Zimbabwean Disease

establishing total control of executive power

over public and social life that
leading to destruction of virtually all non-state
political and economic institutions
of modern civilized society
legislative and judicial powers, political parties,
regions power, businesses, mass media, NGO,
religious organizations.

42
 Deterioration in Electoral Process Index in Russia.

43
 Deterioration in Judicial Framework & Independence
Index in Russia.

44
 Deterioration in Civil Society Index in Russia.

45
 Deterioration in Independent Media Index in Russia.

46
 Deterioration in Governance Index in Russia.

47
 Public demand for independent analysis,
non-government mass-media, opposition politics
is falling fast and sharply.
Their financial support by the private business
is quickly drying up
as authorities stifle the civil society.

48
 [They] work toward destruction of all forms of
personal independence, economic, political or
moral. Their system can handle only individuals
who have been brought into complete dependence
on higher power. Thus, persons who are financially
independent such as individual businessmen,
estate owners, successful farmers, artisans and all
those who exercise local leadership or have local
prestige, such as popular local clergymen or
political figures, are anathema.

G. Kennan, The Long Telegram, February 1946.

49
 Government propaganda saw return
of the Cold War syndromes.

Today enemies of people include liberals,

business people (oligarchs), westerners,
potential orange forces.

In preparation to the next round

of parliamentary and presidential elections
the authorities are de-facto encouraging activity
of nationalistic groups and simultaneously
creating officious anti-fascist movement
with Mr. Zhirinovskys party and the like
as its active participants.

Using antifascist demagogy as a pretext

they attack dissenting voices in the society.
50
 To frighten political and intellectual opponents
the state of fear is being created.

For those who are not feared, number of different

instruments are used:
- provocations, harassments, beating, hostage-taking,
- for Russian citizens expulsion,
- for foreigners non-granting visas, expulsion, too.

The latest decision is Anti-Terrorist Act taking basic

personal liberties away from Russian citizens.

51
 Efforts will be made to disrupt national self
confidence, to hamstring measures of national
defense, to increase social and industrial unrest, to
stimulate all forms of disunity. All persons with
grievances, whether economic or racial, will be
urged to spelt redress not in mediation and
compromise, but in defiant violent struggle for
destruction of other elements of society. Here poor
will be set against rich,.. young against old,
newcomers against established residents, etc.

G. Kennan, The Long Telegram, February 1946.

52
 Zimbabwe disease:
Political Freedom in Zimbabwe and Russia, 19912005

53
 By dynamics of Political Freedom Index in 19912005
Russia has demonstrated one of the worst performances
in the former USSR

54
 By changes in Political Freedom Index in 2005
Russia and Ukraine occupy polar positions.

55
 Foreign policy of the current Russian authorities
can best be described as

Saudi Disease

use of energy weaponry

in international relations.

56
 Backed by unstoppable influx
of financial resources into the country
regardless of quality of government policy
(in reality rewarding irresponsibility and
interventionism)
Russian authorities foreign policy becomes
more and more arrogant and aggressive.

57
 Energy warfare has been recently used against
democracy-oriented Ukraine, Moldova, Georgia.

At the same time Russian authorities

are positioning themselves
as an actual ally of political regimes
in Belarus, Uzbekistan, Iran, Syria, Venezuela,
and of such political forces like
Palestinian HAMAS.

At the same time government-controlled media

launched anti-European, anti-American,
and in general anti-Western hysteria.

58
 The Russian state is being transformed into
Corporatist State.

It means:
- ownership of the Russian state by the Corporation,
- use of the Russian state bodies (security service, tax
service, courts, others) in the interests of the
Corporation,
- destruction of rule of law, absence of identical rules,
- main award of the Corporation is paratrooping its
member (Russian or foreigner does not matter) into the
state-owned company,
- privatization of profits, nationalization of costs,
- PPP (public-private partnership) coercion of private
business to fulfill orders from the Corporation and bear
the costs,
- selectiveness taken as absolute principle,
- ideology of nascism (our ownism).
59
 The so called enlarged government,
i.e. federal government plus regional governors
must work like one corporation.

President of Russia.

The accumulation of powers, legislative,

executive, and judiciary in the same hands,
may justly be pronounced the very definition of
tyranny.

James Madison. Federalist papers, # 47.

60
 What is to expect?

Some historical analogies/warnings.

61
 Dutch Disease:
GDP per capita in the Netherlands as % of the USA,
19751988

62
 Argentinean Disease:
GDP per capita in Argentina as % of the USA, 19582005

63
 Venezuelan Disease:
GDP per capita in Venezuela as % of the USA, 19572005

64
 Zimbabwean Disease:
GDP per capita in Zimbabwe as % of the USA, 19822005

65
 But Wait a minute!

What about economic growth?

Consumption growth?
Investment growth?
Stock market growth?
Foreign exchange reserves growth?

Is it fictitious?

No. It is real!

66
 Since 1998 GDP in dollar terms grew almost 5-fold.

67
 Money income of population grew 4,5 times.

68
 Volume of consumption market in dollar terms
grew 4-fold.
Retail turnover, US$ bn

69
 Foreign exchange reserves including Stabilization fund
grew 23-fold.

70
Since December 1999 Russian stock market grew 10-fold.
RTS Index, December 1999 February 2006

71
 But it happened almost exclusively
due to terms of trade change
rather due to contribution of policies
of the Russian authorities.

72
 GDP in dollar terms grew almost 5-fold,
but in real terms by only 58%.
Cumulative GDP increase (1998=100%)

73
 Private consumption in dollar terms grew 4,1 times,
but in real terms only by 63%.
Cumulative private consumption increase (1998=100%)

74
 While Russias economy grew in last 6 years by 48%,
physical volume of imports surged more than 4-fold.
Cumulative increase in GDP and imports (1999=100%)

75
 Even Russian stock market is driven primarily by world
energy prices, not by domestic economic policies.
Russian Oil Export Price and RTS Index,
January 1998 February 2006

76
 It means that domestic policies contribute
negatively into economic performance.
Mainstream economic policy of 2000-2003
has being transformed into rent-seeking policy.

77
 Quality of economic policy has sharply deteriorated.
Real GDP growth rate adjusted for windfall profit received

78
 FDI as a share of GDP fell sharply,
especially in non-fuel sectors.

79
 Capital flight increased more than five-fold.
Non-finance enterprises and households investments
in foreign assets, 1992-2005

80
 Actual economic growth fell compare to potential ones.
GDP growth rates: actual and potential

81
 From the first glance Russian economic growth looks
impressive (though not compare to China or India).
What is more important, it is by half lower than in other
oil-exporting countries during periods
of high oil prices (periods no less than 6 years).

82
 Darvensazimus.

It is a Russian Disease

(Hugo Chavez)

83
 Russia is a member of G-8.

Really?

84
 GDP per capita by PPP at 2002 price in G8 countries,
2005.

85
 Real GDP Growth Rates in G8 countries, 2000-2004.

86
 Real GDP growth rate in G8 countries adjusted
for windfall profit received, 2000-2004.

87
 CPI in G8 countries, 2001-2005.

88
 Political Rights Index in G8 countries, 2005.

89
 Civil Liberties Index in G8 countries, 2005.

90
 Political Freedom Index in G8 countries, 2005.

91
 Changes in Political Freedom Index in G8 countries
in 1991-2005.

92
 Another G-8?

Which one?

93
 Another G8 by negative GDP Growth in 2000-2004

* Adjusted to ToT
94
 Another G8 in CIS by speed of degradation
of political freedoms in 1991-2005.

95
 In 2005 Political Freedom Index in Russian
fell lower than even in the OPEC countries

96
 By changes in Political Freedom Index in 1991-2005
Russia occupies 190th place
among 193 countries of the World.

97
 Another G8 by speed of degradation of political
freedoms in the World in 1991-2005.

98
 No matter how you will dress up the wolf
he will not become a grandmother.

President of Russia

99
RISE OF CORPORATIST STATE
IN RUSSIA
(The 2006 Long Telegram)

A. Illarionov

Cato Institute, March 7, 2006

Institute of Economic Analysis
www.iea.ru