15 min read

Crisis? What crisis?

Crisis? What crisis?

One of the stranger storylines to emerge from the COVID crisis has been Russia's position in the G-20 criticizing US, and by extension EU and Japanese, monetary policy and US stimulus spending efforts. Chief among the concerns voiced by finance minister Anton Siluanov has been the inflationary effect of higher spending. In the Russian account, US fiscal policy has exacerbated inflation for Russia and other emerging markets through its immoderation and, one surmises, rather odd assertions about the extent to which it's all just "printing money." Scroll through Russian financial outlets and you'll regularly see pieces delivering narratives built on sound money assumptions or citing the destabilizing effects of Federal Reserve announcements for financial markets. Siluanov went so far at the St. Petersburg International Economic Forum in June as to compare the current surge in social spending to a "childish disease" that must be overcome. He was articulating a position shared by former Economy Minister Maxim Oreshkin that higher levels of state spending are evidence of a leftist political turn. If we ask the question "who's an economy for?", then one wonders what's really intended by the odd hint towards a moral panic about leftism among the technocrats ostensibly responsible with delivering stability for the regime.

It's worth reconsidering that position given the worldview and contexts that have long shaped Moscow's response to inflation, global market gyrations, and the current crisis. Though economic policy since Crimea has been aimed at building up a sizeable moat to reduce the country's exposure to external shocks, then COVID has made a mockery of the presumed stability afforded by "Fortress Russia." As the United States is learning now, you have to spend money to spend money sometimes. What's perhaps most striking is a large degree of simultaneous fragility and resilience, both of which are intimately connected to the rapid escalation of political repression witnessed since Alexei Navalny's tragic return from Berlin in January. This mix of persistent economic policy and institutional continuity and frailty has deep roots that don't necessarily follow just from authoritarian instinct. The generational impact of the macroeconomic stabilization 1990s on the country's various elites translates into the regime's mobilization, legitimacy, and cadre politics as well as (self)imposed capacity constraints to govern effectively. If the path of Putinism is akin to the "Andropov option" – gradualist reform led by a competent cadre dependent on the security services that preserves the regime's monopoly on political power while maintaining a mixed economy of market and state management – then the anxieties of governance evident throughout the regime's response to COVID suggest a new phase for Russian politics and its political economy discordant both with the global lessons of COVID as well as much of the usual reservoir of historical examples from which countless arguments regarding Russia's position as an enduring or declining power are drawn. 2021 exposed just how much greater the economic capacities of most large economies truly are in a crisis so we have to make sense of what the comparative political constraints on action in Washington vs. Berlin vs. London vs. Moscow vs. Beijing look like since we're not seeing action on issues like climate or infrastructure proporationate to the capacity to act.

Russian policymakers' frustrations over loose monetary policy and fiscal policy measures as a source of the country's ills comes out of a long-established tradition of overly orthodox economic thinking. One can see it clearly react to the extreme pains of macreconomic stabilization in the 90s in the wake of extreme inflation in the late Soviet economy as interest groups and elites fought bitterly over resources and reform efforts. Vladimir Mau, currently the rector of the Presidential Academy of National Economy and Public Administration as well as a sitting member of Gazprom's board of directors, wrote a wonderfully candid and revealing article in 1999 titled "Economic Reforms as Perceived by Western Critics." He couches his analysis in accepting the constraints facing reformers and reform efforts with a weak state and fraying political context – he dismisses out of hand the idea that economic reforms could have been pursued prior to political reforms, that China is any way a logical comparison for the Russian case, and the notion that there was a 'better' way to conduct privatizations. The weakness of the state made privatization a necessity. There simply wasn't the capacity to properly administer so much state property that had relied on mechanisms of economic coordination, most of which had been smashed to bits. Most importantly, he offers a simple way of breaking down two distinct phases of macroeconomic stabilization that corresponds to what are possibly the most important operating assumptions of Russia's technocratic macroeconomic institutions. It took from 1992-1996 to create some semblance of currency stability as the ruble zone in other former Soviet republics was ended and a policy setting an exchange rate 'corridor' established in 1995 amid persistently high inflation. But the budget wouldn't be balanced until 1999 in the wake of the domestic default crisis in 1998 that doubled as a currency shock, triggering a devaluation. The ruble would be tightly managed till 2004-2005 when the last capital controls were finally lifted. The following is a graph he cites noting GDP budgets and surpluses of transition economies as a % of GDP and annualized inflation:

Poland's commitment to price liberalization and the repeal of various inefficient regulatory and market structures allowed it to evenutally get inflation under control. In the Russian case, shock therapy was abandoned shortly after it was started creating an institutional crisis. Mau makes the compelling point that the Russian economy did not dollarize as a result of monetary policy and a fixed rate of exchange, but because of the loss of trust and well-functioning financial and state institutions. Mau then builds on an argument from The Shock Therapist himself, Yegor Gaidar: post-communist economies experiencing budget crises benefit from the 'inflation tax' reducing the relative value of what is owed on domestic borrowing, creating a perverse linkage between ongoing budget deficits and high inflation. In other words, high inflation can create self-sustaining institutional dysfunction as the power of pricing mechanisms to guide economic decision-making is reduced, investment declines, and bureaucracies in a weak state scramble to find resources. Running up deficits is the easiest option in a vicious cycle. Anders Aslund, an exemplar of the liberal western tradition of those heavily invested in the success of shock therapy and privatization, expressly linked the rate of inflation in transition economies with the degree of rent-seeking on the assumption that most rent-seeking was financed by state budgets. Cut spending and privatize assets, per his thinking, you cut inflation. He links inflation levels and budget expenditures through the institutions that Gaidar and many in his orbit identified as victims of that inflation as much as drivers of it. It's still a fairly compelling framing, particularly if one takes the view put forth by Albert O. Hirschman that uncontrolled inflation is a function of political competition over resources rather than a function of the monetary base of the economy. Once we make this link, however, we get a different view of what happened after 1998, Aslund's related assertions that privatization would 'break' rent-seeking, and how both echo today in Russian policy. I doubt he himself fully understood what he was really proposing at the time.

The budget stabilization of 1999 cleared the way for a new normal, one in which budget surpluses must be maintained, deficits minimized, and inflation reined to prevent that chaos. Strengthening the state in a highly centralized, vertical manner was a logical economic antidote to the countless principal-agent problems between the center and regional governments throughout the 1990s on this basis. Macroeconomic stability had to be imposed from above on institutions that might otherwise undermine it in pursuit of their own interests and onto a bureaucracy accustomed to rent-seeking. At a high level, the regime that coalesced as truly "Putinist" by 2003-2004 pursued an economic policy approach that muddies the picture Aslund paints. The state's role in the economy began to steadily expand at the same time that spending was reined in and external debts paid down. Inflation has structurally decreased since 1999 despite the expanding role of the state:

Inflation steadily declines as Russia grows, with the sharpest drop coming in 1999-2000 from the post-crisis macro stabilization and steady progress made towards the dedollarization of most of the Russian economy by 2004-2005 when the Central Bank finally lifted the last capital controls. There is actually an inverse relationship over time compared to Aslund's original thesis from the time period – the expansion of the state's economic reach has coincided with the gradual reduction inflation. The basic cause can be linked to the state's ability to bring warring interest groups and industries to heel. The financial-industrial groups (FIGS в кармане) that captured the banking sector in the 90s could effectively print money for themselves with inflation being elevated and then parlay those resources into raids and legal acquisitions of assets without paying tax. Absent a strong fiscal authority that could collect taxes and discipline these processes, inflation rose. In a very basic sense, the construction of "Putinism" responds directly to this context seeking to mediate all significant resource conflicts through the state and the Kremlin's administrative functions particular. Yet in conditions of persistent stagnation, resource competition can rise again. Without growth and the unnecessarily harsh imposition of incredibly hard budget constraints on the state, conflicts are more zero-sum. Arguably the regime doesn't want to spend lots of money not so much because of any defined macroeconomic theory, but a political one – they fear that increased spending will spur greater political competition. Hence the focus on efficiency and cost control where possible. We can still see the roots of new rounds of political conflict amid rising inflation as the economy enters stagnation once more. Aslund's original thesis incorrectly equated state spending with rent-seeking – oligarchs and private asset owners can seek rents through regulatory capture, imperfect competition, and other means as well – but implied that Putin's decision to discipline the oligarchs and replace them was a net positive for macroeconomic stability.

The current inflation debate among Russian policymakers is clearly as much political as it is founded in theoretical assumptions or economic models. Inflation has been the most urgent economic challenge for the regime's governance amid the COVID crisis because it threatened to exacerbate the damage done from income losses and conservative levels of fiscal policy intervention in 2-3Q last year. For context on the latest size of the fiscal response including the one-off payments for Duma elections, we can see Russia's position relative to other EMs:

It's worth nothing, however, that going into the summer last year, estimates placed the fiscal response more in the range of 2.7-3% of GDP since it was going out in stages. In early May, Finance Minister Anton Siluanov announced that spending worth 2.8% of GDP had gone out the door while planned additional spending, including drawdowns from the National Welfare Fund would eventually add up to 6.5% of GDP. Those calculations get quite hazy because spending plans already included in the 2021-2022 budget cycle weren't canceled despite the oil and economic shock and included, most likely considered "accelerated" spending rather generously by the IMF based on existing budget rules.

The current round of stimulus checks worth 10-15,000 rubles being sent to pensioners and servicemen amounts to about 0.5% of GDP, what sounds like a large sum that becomes far less impressive in relation to total spending efforts when we realize that 1 trillion rubles in federally budgeted spending for 2020 went unspent. De facto 1% of GDP that could have contributed to anti-crisis measures wasn't mobilized for active spending, instead parked aside into the treasury account or shifted around to back pension liabilities as far as I've seen. Some of this can be explained by failures of administrative capacity to issue funds – a problem in the US in some cases in the last 18 months – but it's become commonplace since Crimea was annexed. Tightening control over where money goes is a more important driver, one that parallels glaring gaps in state capacity. One only has to look at Alexie Kudrin's consistent attempts to draw attention to the state's failings. Right when Dmitry Medevedev resigned and Mikhail Mishustin was named his replacement as Prime Minister, Kudrin was warning that hundreds of billions of rubles were effectively stolen from the state annually and decried hundreds of billions of unspent rubles by September 2020 amidst the worst of the economic contraction. Fiscal multipliers fall apart when self-dealing and the distortions caused by formal and informal institutions and systems reliably prevent the wide distribution of resources to SMEs, households, local, and regional governments to prevent the dispersion of political power through consumption, private credit creation, and more.

When Siluanov announced the packet of measures worth 2.8% of GDP by early May, economists from the Center for Macroeconomic Analyses and Short-term Forecasting urged an additional 3.3 trillion rubles (3.1% of GDP) be spent and budget rules parking aside funds based on oil price levels be suspended. The additional spending is roughly in line with those proposals, showing that despite its opacity, there is still something akin to a consensus guiding policymaking. As Maxim Oreshkin claimed in an interview just yesterday, the size of Russia's spending plans was optimal. It was a lazy way of then setting up an attack on the United States for massively increasing global inflation via its monetary policy, a claim that makes no sense given US fiscal policy has had more of an inflationary impact and the same style of accusation made by Igor Sechin in 2014 when US junk debt markets spurred by low rates financed the shale boom that led to massive oil price deflation. As I've written in the past, this all goes back to the operating assumption that COVID was a supply side shock from its beginnings.  The real story is that it was a massive demand side shock that then produced supply side bottlenecks because of the lopsided nature of recoveries globally, timing of the commodity cycle as prices rose cyclically, and decades of slack from underconsumption globally alongside the absence of state capacity to intervene in the US and most western markets. But it's more convenient to identify the US as an antagonist in a domestic policy story.

If early Putinism reined in competition, then late Putinism risks higher levels of inflation in the absence of growth due to renewed political competition over preferential policies, import bans, and more. Based on the state's own accounting identities for GDP by source of income, the state's tax take has actually fallen since 2010 while the share of gross profits and mixed incomes has risen. Companies, individuals, and sectors are sitting on a larger pile of rents now than they ever did in the 2000s when the economy was booming via wealth transfers from the natural resource sector to manufacturing and related industries via the state. Incomes are shown in billions of rubles in current prices:

Gross profits are as large a part of GDP now as they were during the oligarchs' peak in the late 90s and they rose back to that level right when Putin came back to power. The "taming" process ended by the time the state budget had been prioritized for military modernization and a nascent infrastructure push was never resourced properly. A prolonged period of stagnation coupled with high gross profits quashed inflation in the same manner it has in developed economies. The difference is that new class of state managers can now basically only increase their profits further by 1) cutting costs without risking other political priorities like employment 2) getting more money from the budget 3) distorting markets to their advantage 4) improving efficiency. Without income growth, they can't compete for an increasingly large domestic market and if it's exports, then it's usually strategic in nature and therefore linked closely to state support. 1 and 4 are similar, but operate under different premises. Firms may cut costs by trying to enlist policymakers to impose quasi-controls to fight inflation, precisely the types of responses coming out of Andrei Belousov's efforts. 4 entails higher levels of investment than are presently supported and make much less sense without a tight labor market and strong domestic demand. 2 and 3 both increase political contestation over resources and 1 and 4 can as well if laggards in any given sector or rivals to a leading figure get jealous or worried. The only means of managing higher inflation triggered by political competition is to tighten access to credit and kill demand unless there's a renaissance of fiscal thinking in Moscow. So it turns out that Aslund was, eventually, right but for the wrong reasons. The issue isn't private vs. state ownership and antiquated notions of rent-seeking, it's the function of markets, construction of supply/demand balances, and fiscal system that was built to stabilize and manage the competition he observed. Higher inflation is likelier to coincide with greater institutional dysfunction in these conditions, if for different reasons than in the 1990s. Whereas that was a fight to grab what anyone could in conditions of the rapid depreciation of assets and whatever was owed, today's context is about a similar constellation of actors doing all they can to avoid asset depreciation and price increases. It's not a rapid contraction followed by stabilization, but stagnation verging on gradual and constant contraction of domestic demand where this is taking place, a process that declining oil demand will only accelerate.

The concern Russian policymakers display over US monetary and fiscal policy speaks volumes not just about the perceived mechanisms and attendant risks of inflation in the Russian economy. The jibes about leftism and protest at the G-20 are really complaints about job security. The extant policy framework only affords them the tools to make the economy worse to fix price increases. One of the least appreciated institutional evolutions of late Putinism took place in 2017 when the Ministry of Finance took administrative responsibility and control of the state procurements system from MinEkonomiki. Billed as a means of improving transparency and fighting waste, the shift placed the ministry whose chief aim is to impose budget discipline and minimize spending due to the ever-present risk of waste in charge of the system rather than MinEkonomiki, whose priorities are more readily concerned with the real economy. Quickly forgotten, Maxim Oreshkin actually tried to create new mechanisms to allow regional governments to transfer money directly without the federal center's involvement in hopes of spurring on investment and improving budget planning. Anton Siluanov killed that dream quickly. In effect, Russia's remaining institutions originally designed to provide some semblance of federal planning capacities have been neutered by the dominance of the ministry most concerned with macroeconomic stability. It's a catch-22. All of the policy options available – greater income transfers and support, more state-led investment, the wholesale privatization of assets, the addition or repeal of regulatons – can only function with a fiscal partner in power. That does not exist at present. Fiscal authorities are chiefly tasked with saying no while using unfunded mandates or their hand in procurements as a disciplinary mechanism. The recent panic about leftism obliquely acknowledges that in institutional terms, the Russian economy and political system are being left behind by the West. High commodity prices are now an inflation risk, not a driver of rising capacity utilization, incomes, or investment. This cartoonish "leftism" is a threat to Russian dirigisme because the current constellation of policies in the United States have revealed the massive potential for untapped growth in Russia's chief geopolitical rival and the increasingly fragile economic balance the regime is dependent upon for its political survival. In short, these guys are at their wit's end trying to plug the holes in a system the excessive level of slack across the economy creates under stress amid higher commodity prices and a dyfunctional set of planning institutions.

Taken in this light, most of the strategic analysis of Russia as a competitor to the US or the "west" is mixing up the story. You commonly hear the refrain that despite its various weaknesses, the underappreciated strengths Russia has allow it to "punch above its weight." To claim this, one must resort to an exceedingly narrow understanding of power and a generally exaggerated understanding of its role as a spoiler. Quite the opposite is true. Russia is punching far below its weight because political decisions taken by the regime after 2000, even acknowledging the massive improvements made regarding public health indicators, living standards, and the modernization of many Russian cities. A population that is this well-educated possessing the technical legacy of the Soviet military-industrial complex should be not be living in an economy that is less complex today than it was in the 1980s while being this much more open and dependent on raw material exports. The lessons drawn from the Soviet system and Gorbachev's failures have basically been the wrong ones. Even gradualist reform won't succeed without some parallel focus on domestic consumption. But to focus on domestic consumption in order to make the leap out of middle-income status would be to reject the economic worldview that shaped Russia's torturous macroeconomic stabilization. Further, it would have to empower households and labor against the wishes of the oligarchs happy to bid up inflation and now against the state managers tasked with fighting it. The raison d'etre of the regime – an antithesis to the chaotic collapse of Soviet power and near destruction of the state in the 1990s – would be invalidated. Stability would be exposed as its opposite. Policymakers must assume the entire world economy operates like Russia to make these leaps. That they do is not just about politics being fixed or every system corrupt. It's about the actual mechanisms of action they believe in that cause economic phenomena in the first place. They preclude the success of the gradualist reform model Putin once exemplified as it stumbles into solipsism, decay, and profound economic contradictions.

Russia could be doing a hell of a lot more on the global stage. It chooses not to without knowing why, nor do the most ardent proponents of its power in stagnation have a relevant working theory yet. In a recent press conference, defense minister Sergei Shoigu was asked about Putin's response to his proposal to build 5 urban clusters of 300-500,000 people in Siberia in hopes of driving economic development and rebalancing population from European Russia. In Shoigu's words, someone told Putin there wasn't any money for the projects he's proposing to which Putin replied "there'll never be any if we don't start doing something." Maybe he's starting to realize the problem.

Like what you read? Pass it around to your friends! If anyone you know is a student or professor and is interested, hit me up at @ntrickett16 on Twitter or email me at nbtrickett@gmail.com and I’ll forward a link for an academic discount (edu accounts only!).

Subscribe now