Colloquium 1996 Panel IV : Scenarios for Economic Development and Social Cohesion

Two Scenarios for Russia: More of Same or Social Market Yuri V. Andreev Academic Secretary, Peace Research Institute Russian Academy of Sciences, Moscow Summary There are many schools of thought concerning the future economic development of Russia. It is fully understandable that these schools prepare, and deliver to society, different scenarios. All scenarios are based on well worked-out philosophical and socio-political principles and could be placed between two radical views: the one considers that everything in Russian economic life is predetermined and that the economy is forced to develop within a "corridor", that cannot be radically changed; the other expects dramatic changes, including the possibility to return our life to the "old times", with a centrally planned economy, or to an even-earlier pre-revolution period. My approach is rooted in the following presumptions. I believe firmly in objective economic laws, but subjective factors (human operators) could play a very active role and change significantly the configuration of the predetermined corridor. Objective laws prevail in the final analysis, but they could be broken for some time, as was quite typical in the past and is often the case now. Taking into account these socio-philosophical grounds we may consider practically two principal scenarios, which have, in my view, the best chances for implementation.

Scenario #1: The Same as Now The same development means, first of all, a slow tempo of economic growth or even no growth at all. Of course, Russia cannot allow its production to decrease indefinitely. The bottom line is about to be reached (many experts believe that it might happen in 1997) and economic growth could possibly begin, if stagnation doesn't last long, but investments are needed. Investments are the only real motor of economic progress. However, investments into the Russian economy have decreased and are falling, even more rapidly, than production. The Russian GDP fell by 50% from the level at the beginning of the nineties, but at the same time the investment ratio decreased from 32% of GDP in 1989 to 23% in 1995. In Russia the situation in this field looks rather strange in general - a relatively high investment ratio in recent years has been accompanied by a constant fall of GDP. This can be explained, to a large extent, by the fact that about 50% of these "investments" have gone into salaries! At the same time we know that a high tempo of economic growth in many countries, for example, in Asian states (ASEAN, Japan, China, South Korea) is principally based on a high investment ratio (30-40% of GDP). However, even such a ratio sometimes brings no success. If investments are not effective, or their effect comes later (it depends mainly on the structure of the capital flow), they will not lead to speedy economic development. But the main emphasis remains - without real investments the growth, as well as restructuring, of the economy cannot be effected. Why do we have serious problems with capital formation although savings as such do exist in considerable amounts in Russia, and they are even growing (we are not discussing here foreign investments - the modalities of their development are quite different and need special consideration)? The main stumbling block for transformation of domestic savings into private productive investments is the high level of inflation, which makes them absolutely unprofitable. Inflation of 1-2% monthly is considered as the aim of the present administration, but 1-2% is a norm only if it is on a yearly basis, as is the case in many developed economies. In February and March 1996, the inflation rate was 2,8%, but it may grow in the second half of the year as a result of some populist decisions. Inflation in Russia has the usual standard roots; in addition the total hegemony of oligopolies in some, very important, parts of the Russian economy, and the war in Chechnya make life more complicated, to put it mildly. What is even more alarming - Russia is now being transformed from an industrial to a raw material economy, where manufacturing is dramatically declining, agriculture is in a deep depression and only mining, and especially gas and oil extraction, and the corresponding infrastructure have a chance to prosper. But they are also not thriving due to lack of investments. And what about social cohesion, which must be the ultimate aim of all these scenarios? Here we have to underline three very important factors. Firstly, the crisis of nonpayments, which includes nonpayment of salaries. Nonpayment of salaries involves millions of employees paid from the budgets - federal, regional or local (doctors, teachers, workers of state factories etc.). The problem in this case is not in the low salaries or pensions, which really prevail in modern Russia, but in the unthinkable and unheard of fact before this - that these low salaries and pensions are delayed for one, two or even more months. Secondly, unemployment may increase considerably in the context of delayed economic growth: if it reaches (according to official statistics) a rate of about 13% now, any rise could be socially very dangerous. Thirdly, the living standard of a majority of people has deteriorated. Therefore, as public opinion polls show, 62% of the Russian population is not satisfied with market economy reforms, as they are being implemented now. We should not forget that incomes are not only the most important social phenomenon- they constitute the base of the domestic market. Taking into account all these facts, we can expect dramatic social confrontation instead of cohesion. Very counterproductive also is the rapid rise of internal and external debt of Russia. This doesn't create a positive environment for productive investments and economic growth. Also important is the fact that the correlation between centripetal and centrifugal forces in Russian economic and political life is changing: regions are getting more rights, freedoms and privileges, but the possibilities for regulation by the federal center are declining. After a period of intensive disintegration some countries of the CIS have started economic integration with the prospect of progress in other areas. This process will continue under this scenario. However, it must be understood that creation of a new superpower on the territory of the fSU depends fully on the relations between Russia and Ukraine. Without reunification of these two peoples no geopolitical and geoeconomic solutions are feasible. In short: scenario #1 means, in my view, wild, criminal, nomenklatura capitalism. Of course, this might - and most probably will - be transformed in the future into something more civilized, but nobody knows if social problems and confrontations will allow it to happen. Scenario #2: Social Market Economy In this case economic development could get a strong impulse to overcome depression. The principal key to the solution lies in productive investments, public and private. In order to increase public capital flow the budget should be used more effectively. On one side, some expenditures ought to be eliminated (the major example- Chechnya), on the other - revenues should be extensively increased. The tax system needs dramatic overhaul - taxes must promote production, at the same time stricter financial discipline should put an end to different privileges usually connected with criminal elements and considerably raise tax collection (for example, it reached only a 2/3 rate for the first quarter of 1996). An improved tax system and more regulation of activities by the state (especially concerning natural monopolies) could contribute decisively to a positive development of mining and manufacturing. In turn, this will limit inflation. The vicious circle: inflation - no productive investments- no economic growth- no rising living standard- could be broken. A better banking system will not only increase savings, but it might attract money from abroad, first of all Russian money invested in other countries. We have to stress, that both major growth models - export-led growth and import-substitution development - are protectionist and are of "dirigist" character. However, present day Russia cannot concentrate on one model, but should use all elements of both models. In any case, protection of existing manufacturing industries is of paramount importance. But the social character of this scenario is mostly underlined by special attention paid to the needs of human beings. Nonpayment of pensions and salaries should be eliminated at any cost - it is a shame that the regular payments depend on elections. The fact that they are being paid out now, shows that scenario #1 allows such crimes and only an election campaign and contingency measures could somehow eliminate these extremely strong social irritants. A more aggressive fight against unemployment should be fought - in our social circumstances this is a must. The principal aim in this scenario is to bring back - and improve - the living standard of the population, which is the only solid base for social cohesion, as well as for economic development in general. Reintegration on the territory of the fSU should be pursued more vigorously, with special attention paid to Ukraine. As I have already pointed out, the entire international situation will depend in many very important respects on relations between our two countries. Position of the Military Industrial Complex (MIC) and its Conversion in these Scenarios First of all, we have to evaluate the present situation and then extrapolate possible development trends. In order to do this correctly, we have to be reminded here again about what is considered as "conversion". The global interpretation of conversion includes transfer of all types of resources from the military to the civilian field. The re-employment of military personnel and the civilian use of military hardware are important parts of the global interpretation. But in the narrower interpretation, conversion is considered as a process whereby military production and R&D are stopped and civilian production and R&D begin instead. It is important to underline that conversion includes both these developments, not just one. In present day Russia some experts debate two types of conversion - so called "physical" and "economic". "Physical" conversion is actually the real conversion, connected with replacement of military production by civilian. Time is needed, as well as, extremely important, considerable investments. "Economic" conversion looks more like diversification. Military and civilian productions are developed at the same time, often with more emphasis on military production and with an increase of output in this field. Exports of military products are considered as a major source of investments in the military-industrial complex (MIC), including for its conversion. Needless to say, the logic of this type of development will lead to the perpetual existence of both sections of MIC and diversification as such. In short, "economic" conversion is, in the final analysis, not conversion at all. In the fSU, as well as in present day Russia, conversion was and is often considered as stopping of military production and R&D only. Based on such an interpretation, its supporters blamed and are blaming "conversion" for economic and social problems of many defense-oriented industries. In reality their problems are caused not by conversion, but by the lack of it. The initiation of civilian production could solve many, if not the majority of, problems. In my view, we have to do the following things: We have to define finally the conception of our national security, where not only military, but also all other aspects are taken into account. We have to define that part of our MIC which is absolutely needed for our national security. This part must be maintained and developed, first of all qualitatively. The rest of the MIC could be converted using investments from state and other sources. This part could - and maybe even should - be privatized without any dangers. Privatization would help to mobilize the private resources needed for conversion. To put it in brief, conversion leads in the final analysis to deep restructuring of the entire economy of Russia. Let us see where we are now. A conception of national security has still not been adopted, but privatization has already begun. Only 426 factories are left in full state ownership. Even more important results are shown by analysis of the major statistical indicators of conversion. The production of defense goods in the Russian MIC decreased dramatically, and in 1995 amounted to 17% of the level in 1991. However, production of civilian goods has not increased, as must be expected in case of real conversion, but instead it also decreased in the same period and totaled only 40% of the 1991 level. How could such a process be called conversion? Another indicator is the demand for investments for conversion projects. As of 1 November 1994, such demand amounted to $2 billion; however, in 1990-1991 it was evaluated at the level of $150 billion (or more) for 10-15 years. Even if we consider that evaluation as overstated, the development of the MIC has left fewer and fewer possibilities, and therefore less and less demand, for investments in conversion. The same goes for state financing of the conversion process. Resources set aside for this purpose are absolutely not adequate, but even these are stuck somewhere and do not reach the industry. And what is the situation on the labour market in the defense industry? We know that employment in the defence industries of Russia has decreased by 50% in 1995 as compared with 1991. However, there is considerable hidden unemployment in the defence industry- the factories and research institutions still keep a lot of workers and researchers (presumably about half) on their payroll, in the hope that they might get contracts one day. It has to be pointed out that the MIC has already lost a great part of the most dynamic, industrious and young people. Some Conclusions Concerning Russian MIC and its Conversion Taking into consideration all the above, I insist that there is no conversion as a macroeconomic process, but instead destruction of the MIC is going on in Russia. This statement does not exclude the existence of many examples - sometimes very good examples - of conversion on a micro or even regional level. But the military-industrial complex, as such, could be soon eliminated and replaced by a number of defence factories. The political, economic and social consequences of this situation have not been evaluated yet to a full extent. This is my first conclusion. The second conclusion: if things continue as they do now, soon there will be an "end to history" of Russian conversion, because there will be very little left to convert. The third conclusion: in such a case the new leadership of the country will have to think not so much about conversion, but about recreation, of a military-industrial complex of optimal size to secure our national interests and priorities.