The Difficulty of Ensuring Stability

07.25.2008

Under President Putin, Special Aide and Deputy Chief of Staff of the Administration Vladislav Surkov was viewed as the Kremlin’s top “ideologist.” Now First Deputy Chief of Staff under President Medvedev, Surkov recently visited the annual summer retreat of the youth group Nashi (Ours). This Kremlin-backed project was designed to counter revolutions engineered from abroad during the 2007-2008 elections.

It’s unclear whether the Kremlin believed its own propaganda; most analysts found the idea of a tent city on Red Square laughably impossible. Perhaps Surkov, too, knew this all along, or perhaps, feedback between Russia’s government and its citizens is so distorted that revolution was considered a genuine threat. The truth is immaterial; whether the paranoia was real or staged, the Kremlin mobilized all of its resources to ensure an uneventful presidential transition. Nashi played its part, so with the new president safely elected, Surkov went to congratulate the young activists on saving Russia’s sovereignty.

Yet it seems that this obsession with staving off an imagined revolution has diverted the Kremlin’s attention from an actual threat, both to economic stability, and to the public’s unflagging trust in new Prime Minister Putin and his program: accelerating inflation. In 2007, inflation was nearly 12%, passing the government’s 8% target; in 2008, inflation is running at about 15% annualized, despite a December 2007 prediction by Finance Minister Alexei Kudrin that inflation this year would remain within 8.5%. While the ongoing influx of petrodollars seems to be the main cause, Russia has also been hit hard by rising global food prices, with some products up 30-40 percent.

While the problem certainly didn’t creep up unnoticed, reading the Russian press, it now seems that almost overnight, the country is worried about prices. Predictably, the small middle class and Russia’s numerous poor are most acutely feeling the squeeze, as real wages fall, and it becomes harder to fill the refrigerator and the gas tank. According to June data from the Levada Center, Russia’s top independent polling bureau, over 80% of respondents now consider inflation the country’s most urgent problem. Such a result is up from 65% last year, and is the highest since 2000, well before oil prices began to rise in 2003, sparking Russia’s turnaround. In addition, inflation hurts not only consumers, but small and medium enterprises (SMEs), as well: in such an environment, banks will lend less, or raise their borrowing rates, making it harder for SMEs to make investments.

This creates serious problems for a government that styles itself the provider and guarantor of political and economic stability. While the stability that truly interests the Kremlin is continued stability, if not exactly harmony, among the elite clans, average citizens must reap some of the rewards of oil wealth, to maintain general social cohesion and support for the Putin/Medvedev system. Any serious economic distress threatens the government’s claims that its policies are a bulwark against the return of 1990s-style chaos. Russians are not so naïve as to think that the oil and gas bonanza benefits all equally, but if a population that has enjoyed recent rising living standards suddenly finds itself on the outside looking in as the superrich keep the party rolling, the tradeoff between prosperity and political inclusion in the name of stability will start to look hollow. The Kremlin surely realizes that all but the most repressive regimes require some degree of popular “buy-in” to retain their hold on power.

So far, though, the government’s response to inflation has been uninspiring and counterproductive. There have been clumsy attempts at export duties on grains; “voluntary” price controls “agreed to” by food manufacturers; increases in state salaries and pensions; and a proposal by the ruling party, United Russia, to hand out debit cards for food products. These last two measures, of course, are inflationary. The government itself is responsible for the problem to some degree, due to its decision to try to keep the ruble weak by sterilizing foreign currency inflows from the sale of oil and gas abroad. To this end, the Central Bank (which lacks independence) has been instructed to keep buying up foreign currency, which injects rubles into the system, thus fueling inflation. The irony is that a weak ruble was ostensibly meant to help Russian industry compete internationally, but as mentioned above, if rising prices make borrowing harder, the government is actually penalizing business (except for the big natural resource firms, which, flush with cash, can make investment decisions irrespective of interest rates).

The Internet and the Russian press abound with different realistic, and less realistic, explanations for, and policy solutions to, the inflation problem (too numerous to be considered here). But for various reasons, even the better proposals do not sit well with an oil-oriented Kremlin. Letting the ruble rise somewhat would be a start, but the Prime Minister continues to insist that the Central Bank target the exchange rate, not inflation. As far as explaining the problem is concerned, many analysts eventually come back to the idea that prices are high in Russia simply because aggregate demand outstrips supply. The solutions, on their face, are made to sound simple: wean the economy off natural resources, create good jobs, encourage diversification, lessen dependence on imported consumer goods, stimulate domestic investment and production. How can all of this be accomplished? Once again – analysts make it sound simple: support the SME sector; and in theory, President Medvedev claims to agree.

But when “the rubber meets the road,” we must ask whether Russia’s commitment to SME growth is serious. During the campaign, Medvedev came out with a vague plan of innovation, investment, institutions and infrastructure. But what concrete measures will be proposed? Can the former Gazprom chair shift his thinking from the energy sector to the “little guy”? Will the fall legislative season see proposals for tax reform to benefit smaller, flexible firms over massive enterprises? Will steps be taken to encourage banks to shift lending from consumer goods purchases to SME investment?

Most importantly, will there be a genuine effort to root out the corruption that that prevents new SMEs from opening and limits the growth of existing ones? This would be the best way to boost the SME sector. Medvedev entered office promising to tackle corruption; think tanks have set to work, holding meetings, publishing papers and giving interviews. But how serious is the president’s commitment? Can actual progress be made? Can a government in which corruption runs from the bottom to the very top fight its own corruption? Is there enough political will, or political capital, to resist the pushback by entrenched bureaucratic interests fighting to protect their power, influence and income?

Rather than waiting for the government to deal with corruption, Russia’s small and medium entrepreneurs will need to continue their bottom-up, grassroots approach to confronting the problem. Those who own and run SMEs confront the system’s endemic corruption on a daily basis; they know the price it exacts on Russia’s economy, and they are designing successful strategies to resist bribes, kickbacks and “raiding.” Efforts to continue and expand collective action by entrepreneurs, both across sectors of the economy and around the country, will include sharing information and encouraging wider participation in business associations. Besides supporting the SME sector, and thus growing the country’s economy in a sustainable, inclusive direction, such cooperation among entrepreneurs is a realistic way to build a more stable – and democratic – Russia.