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Tackling corruption in the Russian economy

Russia's President Medvedev has warned that continued dependence on raw materials exports has a negative impact on industrial production and the development of his country. But there can be no modernisation in Russia without tackling corruption and this will be impossible without reforming political institutions, warns Sergei Guriev
Sergei Guriev
12 November 2009

The Dutch disease

There is currently much discussion of the fact that the effects of the global crisis are more serious in Russia than most other countries because of the Dutch disease. Indeed, the resource dependency of the Russian economy contributes to major instability: when oil prices are high, the economy grows faster than other comparable countries, and when they are low, the Russian economy falls faster. But the main problem is not short-term instability:  it’s the fact that there is no stimulus for long-term growth. If the country’s elite, primarily officials, live off the revenue from resources, then this elite has no incentive to build the institutions necessary for long-term development.

At first glance, everyone is interested in long-term economic growth. But only at first glance. Growth requires specific economic institutions: the protection of ownership rights and of competition, the fulfillment of contracts (i.e. an independent and effective court system).  What is important for the elite is not economic growth per se, but the profits that are to be harvested from it. Applied to Russia, this means that the key role is played by that part of resource revenue that the elite can take for itself. The subtlety is that the better the economic institutions, the greater the restrictions on appropriating the revenue. For this reason, the elite in a resource economy has no interest in creating conditions for long-term growth.

Does this sound abstract? Not at all. If one looks at the results of the last 10 years, it becomes apparent that Russia has made virtually no progress on the path of modernisation or economic institution building. In his article „Forward, Russia!” President Medvedev writes about corruption as one of the key problems of Russia. Over the last 10 years, at best it can be said that the level of corruption in Russia has not dropped at all (and according to some data, it has significantly increased). At the same time, all Eastern European countries have had enormous success in fighting corruption.

So it is hardly surprising that Russia has been unable to overcome another problem mentioned by Medvedev – the dependency on raw materials. What is needed to escape from the trap of the „resource curse” is an effective and non-corrupt state. All known methods of diversification only work when key decisions are taken by competent officials working in the interests of society. This includes industrial policy (targeted development of individual non-raw materials sectors), investment in infrastructure and education. In all these spheres state participation is essential.

However, there is also another method of diversification – the development of the financial system. Access to financial resources is much more important for the non-raw materials sectors than for those involving raw materials. To develop the financial system the state usually only has to create the rules of the game for the market mechanisms to swing into action. In Russia this is not the case. On the one hand, the regulation of the financial sector has dramatically improved (most significantly demonstrated by the system of insuring deposits, the office of credit histories, and new Central Bank instruments for providing liquidity). Both the banking system and the financial markets have come a long way over the last five years. If a package of measures is adopted for creating an international financial centre in Russia, we really will have a fundamentally new financial system. On the other hand, state banks continue to dominate in Russia. Furthermore, high inflation hinders the development of a truly effective financial sector. So there is no reason to think that post-crisis development will automatically be successful.

Alarmism

This is why we should agree with the authorities’ dramatic statements about how difficult the situation really is, which is what Medvedev was writing about. The speech by then-president Putin to the State Council on 8 February 2008 was even more frank. He said categorically that allowing the country to develop by inertia would create a threat to its very existence. The current situation is very reminiscent of the late Soviet Union.  It was unable to overcome the inertia and it no longer exists.

However, despite correct assessments and speeches by high-ranking officials, there have been few real actions so far. For example, it is clearly difficult to fight corruption without political competition, government accountability and increased transparency. Some technical measures could be taken – officials could be forced to publish statements of income, and cameras could be installed in traffic police cars and in courtrooms. But in the absence of a free media, any political opposition in parliament or accountability of executive authority to the legislature, corrupt officials need have no fear that information from declarations and footage from cameras will be of serious interest to anyone. At least, over the last five years, no technical methods of fighting corruption have had any results.  Political centralisation together with reduced government transparency and accountability have only resulted in an increase in corruption over this period

Politics and modernisation

For this reason there should be a move from political statements about modernisation to actions. What needs to be done is clear. There has been much discussion of plans for reform and for improving the institutions, including by the Putin government. The so-called Gref programme 2001-10, adopted with the direct participation of then-President Putin, should be implemented.   Or the Long-term Development Plan 2020, in whose development President Medvedev was directly involved. Everything in Dmitry Medvedev’s Krasnoyarsk speech of 15 February 2008 must be acted on.

There is much in both of these documents that is correct: the need to develop democratic institutions, the battle with corruption, increasing the competitiveness of the economy and reforming social institutions. Unfortunately, recent experience has shown that in a resource-based and corrupt economy, the state has no incentive to implement these wonderful plans.

Perhaps the crisis will create the incentives? At first glance, the main lessons of the crisis are that a) the government was right to hope for a stroke of luck and wait for the oil prices to recover and b) state banks are best at implementing anti-crisis policies, so they should not be privatised. But this is deceptive. In order to meet the next crisis fully armed, the financial system must be competitive and flexible. And this concerns oil prices – although they are staying at relatively high levels, it is unlikely they will continue to rise. So the economy will not grow as quickly as it did before the crisis; so our economy does not have enough money to raise pensions, as was promised. The planned increase of the social tax to 8% in 2011 will not happen – if this tax is increased, no one will pay it and salaries will once more move into the shadows. If the authorities really do force companies to pay it, then job creation will slow down to such an extent that money will be needed to support the unemployed.

The recognition of these problems is probably what compels President Medvedev to appeal to society to discuss reforms. But we must not forget the lessons of the last 10 years: there can be no diversification or modernisation if corruption is not defeated. And corruption cannot be defeated without changing political institutions.

Sergei Guriev is a Russian economist. He is currently a Morgan Stanley Professor of Economics and a Rector at the New Economic School (NES) in Moscow, Russia.

 (From a speech at a roundtable in Novaya Gazeta, 02.11.2009)

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