• How Powerful is the Russian Bear?

  • By Ilona Svihlikova | 17 Feb 14 | Posted under: Russia
  • A lot of discussion has been going on regarding the Russian foreign policy and its military potential. The aim of this article is not to analyze the state and potential of the Russian military technique, but to look into the economic strengths and weaknesses of this huge country.

    The economic state is definitely one of (not the only one) determinants of the range of foreign policy, including starting a conflict. To evaluate real possibilities of Russian economy is also important, because Russian representatives used the essence of Realpolitik, when they said that foreign policy was more determined by potentials than by resolutions.

    Citing Vladimír Putin: “As Bismarck said long time ago, what really counts are potentials, more than good intentions or proclamations.” The President of the Russian Federation referred with this remark rather to NATO than to Russia. Moreover, his famous Munich speech reminds of the promise of that time NATO general secretary of not placing NATO armies outside the German territory as a firm guarantee for the Soviet Union... 

    The economic situation is influenced by a whole range of factors, including geographical, demographic and the influence of international economic environment, in the case of Russia e.g. the development of world oil prices.

    From the geographical point of view, Russia is by far the largest country in the world with 17 billion square kilometers and nine times zones (previously eleven). Only this bare fact demonstrates that ruling such a huge country is not easy. Furthermore, take into account that due the breakup of the Soviet Union, Russia lost many important access points to the sea, which it solves e.g. through the leasing of Crimea from Ukraine, and also access to important markets. On the other hand, we may view it as well that Russia is an important transit country for the countries of the former USSR in middle Asia, then to bypass such a large country, e.g. regarding pipelines, is quite impossible.

    Russia lacks any natural borders, which was viewed by critiques as an argument for continuous expansion (Russia does not know where it ends). The climate does not help the economic development either. Cruel climate conditions in the East complicate mining, in the South it is too hot for agriculture, big Russian rivers freeze over, or lead to the Caspian Sea and their economic impact is thus limited. The starting conditions are thus extremely difficult and show that Russian must give a lot of energy just to cope with natural conditions and vast distances and create just basics of infrastructure. Let us compare this with compact, by two oceans bordered area of the US with much better climate conditions including conditions for trade. 

    The demographic development does not look optimistic either. Comparing in the BRIC group (without South Africa) is Russia a dwarf with only about 140 million inhabitants. Regarding the vast area, it means a very low population density, which leads to areas that are uninhabited, especially in the Asian part of the country. This blocks the development of this part of the country and at the same time leads to an increase of Chinese in these areas. This can of course have serious geopolitical impacts.

    Fertility does not reach the coefficient of 2.11 children per woman, although the steep drop in fertility from the 90’s has been halted lately. There is the same tendency as in China – the fertility of non-Russian ethnics is higher than by ethnic Russians, who make about 80% of the population. In this regard, Russia and China find understanding in the Shanghai organization of cooperation, as well as by the fight against separatism (in Russia the painful issue of northern Caucasus, in China Tibet).

    A worrying demographic feature is the great gap between the life expectancy of men and women. By men the life expectancy hovers about 60 years of age, especially because of alcoholism.

    By the breakup of Soviet Union, many Russians found themselves in a foreign country and in some cases countries hostile to Russians (e.g. Baltic countries). Their return back to Russia (e.g. form Kazakhstan) may improve the Russian population balance, but of course this is not a permanent solution to the population problem.

    Russia belongs to so-called emerging countries (the BRIC group), although many analysts believe that the Russian economic growth in previous years was connected with the increase in world commodity prices (mostly oil). However, Russia is seventh largest world economy, GDP per capita almost 18 000 dollars.

    The economic structure of Russia (A-I-S), at first sight, is not bad and definitely does not make the impression of a country living from its natural resources or suffering from the Dutch disease. However, by closer look, we discover problems.

    Russia is not food-sufficient, which is a frequent point of criticism of presidential or prime minister’s speeches. Unlike typical oil countries, Russia has a vast industrial base – it would be a surprise, if a country that big would not have it – but the competitiveness of most industrial products on foreign markets is poor.

    Russia is successful in the sphere of military-industrial complex (like the US) and in many spheres outperforms them technologically. Another advanced sector is the space industry. However, in the sphere of civil industry the situation is much worse. That is undoubtedly reflected in international trade.

    Having a look at the Russian statistical office, for year 2012 export, we found out that: by large the biggest item are fuels and minerals – make more than 71% of the whole export on the second place there is an item, which again shows the strength of Russian natural resources – with 11% metals and precious stones, machinery (group 7 of SIT classification) makes only 5% of export in the long term (just comparing with the Czech Republic, where this group makes more than 50% of exports). To compare: the biggest import item is machinery (50% of imports), further chemical products (15%) and food and agricultural commodities (almost 13%).

    In international trade Russia gains mostly because it is the resource-richest country in the world. This dependency on fuel-energetic complex is also reflected in the domestic economy, in tax sphere and also in political (the influence of Gazprom).

    Russia is thus strongly dependent on world oil prices and also on the development in energetic sector worldwide. Shale gas in the US is considered to be the factor that will weaken Gazprom (and thus the whole Russia), both on the level of prices (Russians want world natural gas prices to be further connected to oil prices), and also the payment conditions (e.g. the clause “take or pay”). After the break out of the crisis, Russian had been playing with the idea of joining OPEC, which would thus have another major actor besides Saudi Arabia. Russia’s joining failed, as Russia later explained; joining of OPEC was not realistic due to tough Russian climate conditions that do not enable to change mining flexibly.

    The fuel-energetic complex is not only important for the international trade, but also for the state budget. The revenues from it (e.g. the import tariffs) make about 50% of the budget. The IMF warned Russia from excessive dependency on world price that Russia cannot influence. The so-called non oil budget deficit reaches 10% GDP, which is regarding the state of sovereign wealth funds worrying. The IMF recommends for countries, suffering from the Dutch disease a non-oil deficit of maximum 5% GDP.

    Flows to sovereign wealth funds for 2010-2014 have been halted and instead the revenue goes directly into the state budget. National sovereign funds thus reach only 88 billion dollars (4.4% GDP), which is very little in comparison with other funds and very little also in comparison with the historical development of these funds.

    The personalized dispute of Kudrin X Nabiullina concerned the sovereign wealth funds. The question has been whether to use the funds as a reserve for worse times (and thus use them as a cushion for the budget, if the oil price fell, or for slowing down the ruble devaluation), or to use these funds actively, even with the risk of higher inflation rate for the modernization of Russian economy (with the risk the fund disappears and will not be used for planned purposes).

    Russia is aware of the risk of over-dependency on natural resources, so it implements measures to decrease the dependency on oil and natural gas, including new mechanism for predictions of oil price for the state budget. Likewise, calls for diversification of Russian economy repeat themselves, however it would be more appropriate to talk about the increase in technological level of civil goods. 

    Let us return back to oil and natural gas. According to BP Statistical Review 2013, Russia disposes of (only) 5.2% world reserves (which may be underestimated because of not well mapped Eastern areas), with a rather bad R/P. This indicator tells us how long can a country drill at the same pace as currently. In Russia the R/P (reserves to production ratio) shows only 22 years by oil.

    However, Russia succeeded in increasing the production on new post-soviet record levels and even beat Saudi Arabia with overall oil output of 10.6 million barrels a day. It shall be reminded, however, that Saudi Arabia is not drilling at its maximum, whereas Russia is pumping all it can. Net export exceeds 7 million barrels a day. Most of Russian oil (about 80%) goes to Europe. Most important companies in the oil business are Transneft (distribution), and by extraction Rosneft, Lukoil and the consortium TNK-BP.

    The situation by natural gas looks better according to statistics. Russia disposes of 17% of world reserves and for a long time held the first position. It is interesting that only lately BP Statistical Review shifted Russia to second position and the first was given to Iran. Only a small reminder for the readers: the reserve estimates are not simply an expert matter (with probabilities), but a huge influence plays also politics.

    R/P exceeds 55 years, which look optimistically and leads also to thoughts of expansion of LNG than just distribution through pipelines. Gazprom of course dominates the trade with natural gas and both infrastructural projects appear in the centre of European energetic policy (one finished, but not completely used Nord Stream, and a planned South Stream). Fears of Gazprom influence on the European energetic network created the so-called Gazprom clause and unbundling projects that however, have not been realized in the European framework.

    The biggest threat to Russian natural gas is the shale gas boom in the US. It is highly probable that the boom will change into bubble, which would strengthen Russian position that is in any case making effort to build pipelines in Eastern direction, towards China (e.g. pipeline ESPO).

    Foreign direct investment. When mentioning foreign economic linkages, the development of foreign direct investment should also be referred to. UNCTAD in World Investment Report 2013 states for Russia that the inflow and outflow of investment is practically balanced. If the data were reliable, it would mean that Russia lost its position of a host country. However, there are countries like Cyprus, Luxemburg or British Virgin Islands in the statistics – e.g. banking and tax havens. Thus, we may assume that there is a process of round-tripping going on of the rich oligarchs (although the importance of Cyprus has lowered somewhat) and a purposeful tax evasion. 

    To sum up the main points, we may easily come to the conclusion that escalation of international tensions and conflicts are no good for Russia, as it has “enough of its own worries”, most of which are quite serious for the continuing existence of Russia as a great power (e.g. the demographic development).

    Furthermore, Russia is closely connected with its European partners (purchase of natural resources, source of export revenue, import of food!), although the diversification in Eastern direction is continuing. For the distribution of its natural wealth, Russia needs a functional infrastructure (building pipelines) and peace, not war. The current re-armament in progress already causes pressure in public finances. Unlike in the US that are not much preoccupied by their finance pressures, Russia does not have the main international currency, although it tries to strengthen the position of Ruble in bilateral relations.

    Regarding the fact that in conflicts Russia supports the weaker side, which is under the pressure of US, there is a risk that military aid would turn into an irretrievable loan. For Russia, it is more convenient to arm its potential allies so that they are not drawn into a military conflict and are able to pay back their loans.

    It is not probable that Russia would compensate its domestic economic and social problems by outer conflict than it does not have for now military capacities for that. However, it can be expected that Russia will more energetically protect and pursue its interests in near and far abroad.


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