The Russian Economy and US-Russia Relations

May 4, 2011 3:30 PM

On April 15, the Peterson Institute for International Economics held a full-day conference on the Russian Economy and US-Russia Relations, which I helped to organize. It was co-sponsored by the Center for Strategic and International Studies and the New Economic School in Moscow as part of our joint Russia Balance Sheet project. The purpose was twofold: to review the Russian economy and Russia's accession to the World Trade Organization (WTO), and the need to terminate the Jackson-Vanik Amendment to clear the way for granting permanent normal trade relations with Russia. The speakers were key Russian and American officials, prominent economists and leading businessmen. The conference attracted about 250 participants in the course of the day, of whom over 30 were journalists.

The overall assessment was that Russia's economy has overcome the financial crisis but, in order to modernize its economy and reach a higher growth rate, it needs to join the WTO. The participants in the discussions agreed that the United States must terminate the Jackson-Vanik Amendment to benefit from Russia's reforms.

Russian Deputy Prime Minister and Finance Minister Alexei Kudrin, the longest serving finance minister in the G20, opened the conference with a judicious keynote speech on the role of Russia in the global economy. Coming from a BRICS (Brazil, Russia, India, China, South Africa) meeting in China and heading for a G20 meeting in Washington, Kudrin was preoccupied with these groups. Foremost in his mind was speculative capital inflows. Russia accepted Brazil's regulation of capital inflows but preferred to maintain free capital movements for Russia, which requires Russia to hold large reserves. Russia supported the BRICS ideas of reform and reinforcement of the International Monetary Fund (IMF). He emphasized that Russia was interested in the stability of the economies of the United States and the European Union (EU) and that its own macroeconomic policies were responsible, though expenditures had been growing faster than revenues.

Kudrin made a major plea for Russia's accession to the WTO as the next serious step in the liberalization of the Russian economy. Russia's foreign trade had been growing by 21 percent a year from 2000 until 2007, and Russia needed more imports of machinery and equipment and more foreign direct investment to boost its economic growth to 6-7 percent a year. The US share of Russia's trade had halved, which made no sense, he said. With WTO accession, he maintained, Russia's average import tariff would fall from 13 percent in 2006 and 10 percent in 2010 to 8 percent in 2016. He referred to the World Bank assessment that WTO accession would add 11 percent to Russia's GDP through more imports and foreign direct investment (FDI). The share of GDP coming from oil and gas would decline from 19 percent to 13 percent in 2020, which meant that all growth would have to come from other sectors of the economy.

First Deputy Chairman of the Central Bank of Russia Alexei Ulyukaev delivered two major messages. First, he said Russia had to cool down its economy and would bring inflation from the current level of 9.5 percent to 7 percent at the end of 2011. Second, Russia had moved to a floating exchange rate and inflation targeting. The Central Bank would allow the currency to appreciate with oil prices and had no intention of increasing its currency reserves of $500 billion. Higher oil prices would result in larger imports. The balance sheets of Russia's commercial banks were in good shape but the dominance of state banks was a big problem. Fortunately, large chunks of the state-dominated banks VTB and Sberbank were to be privatized, he said.

Prominent Moscow Professors Alexander Dynkin and Sergei Guriev offered severe criticisms of the state of the Russian economy. They complained about oil curse, state capitalism, a rent-seeking economic model, corruption and dominance of big, inefficient enterprises. As Dynkin put it: “Small is not yet beautiful in Russia.” Guriev worried about even more statism and anti-business sentiments and concluded: “All understand that the current system is not sustainable.” The sources of the recent growth were exhausted and no more free capacity was at hand. Both worried about emigration of skilled professionals and capital outflows. They emphasized that two policies were needed: improvement of the investment climate and privatization with protection of property rights. Guriev underlined that to establish good investment conditions and sound import competition, Russia needed to join not only the WTO but also the Organization for Economic Cooperation and Development (OECD).

Gary Hufbauer and I presented the Institute draft policy analysis Why It's in the US Interest to Establish Normal Trade Relations with Russia. Hufbauer displayed the expected gains for the United States: US exports to Russia were likely to rise from the current level of $9 billion to $19 billion. In my presentation, I showed how Russia differed from China. Russia is much richer than China with a GDP per capita that is almost three times higher than China's. Given that 90 percent of its exports consist of commodities and that it is a high-cost producer, Russia is not likely to be competitive in manufactures for the foreseeable future. Russia's interest in WTO accession is to increase imports for the sake of its modernization rather than to expand exports. Edward Verona, President of the US-Russia Business Council, explained how different US industries would benefit from Russia's WTO accession and the granting of permanent normal trade relations.

Russian Deputy Minister for Economic Development Stanislav Voskresensky elaborated on recent government measures to improve the investment climate in Russia. He underlined the appointment of First Deputy Prime Minister Igor Shuvalov as ombudsman for foreign investment, that the IKEA problems had been resolved, and that the government was establishing an investment venture fund. He cited the zero-profit tax for private firms in health care and education and said that highly-qualified foreigners could get work permits more easily since December, and that the Skolkovo high-tech project offered complete deregulation. Voskresensky dismissed complaints about Russia's reinforcement of intellectual property rights.

Michael McFaul, Senior Director of the National Security Council and Special Assistant to the President, gave a keynote speech at lunch on President Obama's “reset” of US relations with Russia and its results. He described the reset strategy as a matter of engagement and a search for win-win outcomes. The US-Russia agenda had to be expanded beyond arms control and engage with all aspects of society, he said. US-Russia summits had become frequent and the US-Russia Presidential Commission had no fewer  than 18 working groups. The administration pursued dual-track engagement both at the level of government and society. Finally, the administration did not accept any downgrading of relations with other countries to the benefit of reset with Russia, McFaul said.

McFaul mentioned positive results in no fewer than eleven areas: the Northern Distribution Network to Afghanistan, the new START treaty, Iran, ratification of the civilian nuclear agreement, Kyrgyzstan, the Russia-NATO reset, cooperation over missile defense, Russia's reset with several European countries such as Poland, Latvia and Norway, Libya, various regional conflicts such as North Korea, Ivory Coast and Sudan, and finally improved US-Russian popular attitudes. The main outstanding problem without significant progress was Georgia, he said.

The next big task was Russia's accession to the WTO and the termination of the Jackson-Vanik Amendment. McFaul emphasized that the Jackson-Vanik Amendment does nothing to improve the human rights situation in Russia and that opposition leader Boris Nemtsov favors its termination. He refused to guess when Russia could actually join the WTO but he said that it had never been closer than today. He did not suggest which should come first – Russia's accession to the WTO or the termination of the Jackson-Vanik Amendment – but he said they should come as close to one another as possible. The administration could not sell Russia's WTO accession to Congress until the final deal had been concluded. The biggest issues still outstanding are the bilateral protocol between Russia and Georgia and some technical issues, such as enforcement of intellectual property rights.

A US-Russia Business Roundtable followed. Sam Allen, CEO and Chairman of Deere & Co, told the conference how satisfied they were with their new factory in Domodedovo in the Moscow region. After agreement had been reached, they had been able to build and start production amazingly fast thanks to full alignment of local authorities. For Deere, it would be impossible to sell in Russia on a large scale without local production for logistical reasons, so Deere's establishment there increased US exports to Russia because of a large sale of high value-added parts, such as engines. Vladimir Dmitriev, CEO of state-owned Vnesheconombank, focused on the newly established state venture fund that initially will have $2 billion and then expand to $10 billion. He invited US companies to co-invest with them. Clay Lowery, Vice President of CISCO, laid out the case for their planned investment of $1 billion in the Skolkovo innovation project. Denis Morozov, former CEO of Norilsk Nickel and Uralkali, adopted a more pessimistic tone about the difficult business climate in Russia.

In his concluding remarks, Under Secretary of State Robert Hormats reinforced the US desire to see Russia accede to the WTO and the need to terminate the Jackson-Vanik Amendment. He also laid out the future US policy agenda related to Russian economic affairs. As soon as Russia joins the WTO, he said, it should also enter the OECD.  Specifically, the OECD has an anti-corruption convention, which could be very helpful for Russia. The administration was now close to adopting a new model treaty for bilateral investment treaties, and then the United States and Russia could also finally conclude and ratify a bilateral investment treaty, Hormats said.

Conclusion: The economic assessment may be summarized in four points: First, macroeconomic stability is reassuring though it could be better. Second, growth can be raised from the current 3-4 percent a year to 6-7 percent a year through liberalization and privatization. Third, substantial reforms have to be carried out rather soon because the current system is no longer sustainable. Fourth, reforms are likely to occur when oil price goes down. WTO accession is seen both by Russians and Americans as the most important game-changer at hand, and US companies will only achieve full benefits from Russia's WTO accession if the Jackson-Vanik Amendment is terminated.

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Anders Åslund Former Research Staff

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