Note to readers – due to technical issues, I couldn’t post the image described in graf one but will do so later -Mora

The image above shows a corpulent former Russian President Boris Yeltsin bedecked in toga and driving the ???????young farm girl??????? and ???????young factory fellow??????? from a famous Soviet monument like horses before his chariot. The caption reads: ???????Corruption: An impediment to progress.??????? Will Russia fall as Rome did, it seems to ask? Yeltsin was justly criticized during his reign for personal and systemic corruption but in fairness we must ask: Was it any difference before or since in Russia? Is Russia making any economic progress now? As this article will show, the answer is a resounding ???????nyet!???????

On May 24, 2006, the Associated Press reported that the Russian Duma had voted 384-0 to ban the use of the term ???????dollar??????? in public statements by members of the executive branch. Ultranationalist lawmaker Vladimir Zhirinovksy, who spearheaded the measure, boldly declared: ???????All government officials must pronounce only the word: ruble!??????? While it may be comforting, in light of rising concerns about dictatorship in Russia, to imagine that the Russian legislature has such total control over executive power that it can even dictate its vocabulary, one can????????t help but think of the Emperor????????s New Clothes. After all, just because you don????????t mention the dollar doesn????????t mean the Emperor isn????????t in flagrante delicto.

But it is, to be sure, understandable that Russia would wish to sweep its economic dirt under the carpet for none to see. A review of recent economic developments in Russia makes clear that the country????????s economy is a house of cards, waiting for the first strong wind (a wind they call the business cycle) to topple it spectacularly. It is, in the words of Brookings Institution scholars Clifford Gaddy and Barry Ickes, a ???????virtual economy??????? based on smoke and mirrors. When Dorothy looks behind the (iron) curtain, she sees a host of calamities and disasters-in-waiting that would spook the most ardent Russian nationalist.

I. Wages, Inflation & Unemployment

Take as a starting point the most recent data on price inflation. In July, Russia posted 0.7% general price inflation, bringing it to a staggering 6.9% for just the first seven months of 2006 and placing it on track to put up jolting double figures at the end of the year. Even the baseline figure of 7-8.5% which the Kremlin had predicted at the beginning of the year would be the cause of talk of economic apocalypse if it were occurring in the U.S. or Europe, and this is not the worst of it by a long shot. Because when we isolate the actual basket of products that the average Russian, who earns about $300 per month, can afford to buy, we see the inflation rate skyrocket. In July, Russia posted 1.4% price inflation on the basic consumer basket, bringing the total inflation that ordinary Russians actually bear to a horrifying 14% in just the first half of this year alone.

And mind you, these are the Kremlin????????s own numbers. Given that the Kremlin is run by a clan of proud KGB spies who spent their careers learning the finer points of duplicity, it certainly wouldn????????t be surprising to learn that the data has been fudged in the Kremlin????????s favor, and that the real numbers are even more horrifying. Indeed, one of the most disturbing features of present-day Russia watching is the willingness of onlookers to take the Kremlin????????s data at face value. As Kommersant newspaper reported recently, Russia also uses the ???????consumer basket??????? to determine what level of income is necessary to qualify for ???????poverty??????? status, but the Kremlin has not adjusted the definition since 1999 in a deliberate attempt to reduce the number of people defined as ???????poor.??????? In Kommersant????????s words: ???????The delaying of the review of the consumer goods basket and the understatement the of subsistence level are bureaucratic means to combat poverty.??????? As Knight-Ridder reported in early June:

The government says the number of people living below the official poverty line has steadily declined in recent years, from 29 million in 2003 to 22 million last year. But some economists say the government’s poverty definition — those who make $90 to $150 monthly, depending on the regional cost of living — understates the number of people who should be considered poor. “These are absolute beggars,” Yelena Rumyantseva, president of the Center of Economic Policy and Business, said of the government numbers. “But there are more people who are poor, who don’t have medical treatment and the rest.” By Rumyantseva’s calculations, only 20% of Russia has achieved middle-class status or higher, which she defines, in Moscow, as a family of three who owns an apartment and has at least $1,000 in monthly income and, for cheaper provinces, at least $500 monthly. “All below are different categories of poor. They are not beggars, but they are poor,” Rumyantseva said. “State statistics are aimed at decorating the situation.”

Kommersant reported that the Kremlin claims real incomes rose by 11.1% in the first half of 2006, but it is hard to see how this could be so. The Kremlin????????s own data only show economic growth of 6.5% for this period, lower than the rate of inflation. Presumably, ???????real income??????? takes into account Russia????????s horrific inflation, meaning that the Kremlin might be claiming Russia????????s raw personal income levels rose at three or four times the rate at which the economy is growing. That defies credulity, to say the least, and if the figures are correct, that may be even worse, since it implies a vast amount of hocus-pocus on the Kremlin????????s part, not the least of which would be profligate printing of rubles and further stoking of inflation. On the other hand, 11.1% growth on a salary of $300 only works out to $33.30 extra per month.

In June, the Mercer Human Resource consulting firm ranked Moscow the world????????s most expensive city, beating out Seoul, Tokyo and Hong Kong. What most observers failed to notice about this shocking information was that Mercer compiled its list by simply recording the prices of a fixed cross-section of consumer products, and found them to be highest in Moscow. But Moscow????????s average wage scheme is radically different from that of its competitor cities in Asia, meaning that Moscow????????s prices are exponentially more burdensome for Muscovites than the prices of any other city. Rather than referring to Moscow as ???????most expensive??????? it would be more accurate to use the epithet ???????most oppressive.??????? And those familiar with Russian history can only find this fact profoundly unsettling. The Moscow of 2006 differs in no significant way from the Moscow of 1896, with princes in gilded carriages gliding through the streets, eating at inaccessible restaurants and living in guarded palaces while the rest of the population starves. This is the scenario that led to the Bolshevik revolution, but apparently Russia has learned nothing from the decades of totalitarianism and horror that followed. Indeed, it could easily be argued that this climate never left Russia, but that Communist overlords merely replaced the monarchists, and were better at hiding their elitism. The is confirmed by examining the ever-widening gap between rich and poor in Russia, which was confirmed by the State Statistic Committee????????s report published by Interfax in May. In the first quarter of this year, the wealthiest 10% of the population earned 29.7% of overall cash income, compared with 29.6% in the first quarter of 2005. The least well-off 10% of the population earned just 2% of overall revenue, down from 2.1% in the first quarter of 2005. The average annual income of the ???????top 10%??????? group is a puny $10,000 per person or $40,000 for a family of four. This constitutes ???????super rich??????? in Russia. 90% of the population subsists on an income of $12,000 for a family of four or less. The 10% at the bottom get by on less than $225 per month for a family of four.

The news on the employment front is just as grim. The total rate of the unemployed in Russia grew by 3.1 percent to 5.6 million people, or 7.5% of the economically active population, in June 2006 compared to June 2005, according to Russia’s Federal Statistics Service. Would the FSS tend to understate such data if it could? It????????s certainly possible, so these figures should definitely be viewed as conservative. U.S. unemployment is less than 5%, and it????????s not reaping on oil windfall. Oddly, with nosebleed inflation levels unemployment is supposed to be low, in a normal economy there????????s usually a tradeoff of one for the other. Russia has both problems simultaneously, because its economic fundamentals are, well, non-existent.

II. The Markets

Thus, despite Russia????????s much-ballyhooed oil windfall, economic catastrophes abounded, and the stock market has reflected them. In early August, two major bellwether enterprises of the non-oil economy, Sistema and Rostelecom, posted gigantic multi-million-dollar losses and took serious hits to their stock prices. This came on the heels of a general market collapse a in the early summer. In May, there was a general market crash, with the RTS Index (analogous to Dow Jones) losing more than 13% of its value in a single day, the worst trading day in its history. On June 13th, the RTS took a second massive hit, dropping more than 7% and dragging many emerging market bourses down with it. By the end of the month, the RTS has lost nearly one-third of its late-April value. Even as the Kremlin was banning the word dollar, it was also banning access to the country by its largest foreign investor, William Browder, operator of the Hermitage Capital Management hedge fund, because of critical statement he made about Kremlin policy towards shareholders. As a result, Hermitage has now pulled more than $500 million investment out of Russia.

And the oil sector has not been insulated from the bad news. In June, oil concern TAFNEFT proved unable to hold its listing on the New York Stock Exchange because it could not comply with NYSE????????s rigorous financial reporting requirements. In July, major oil conglomerate ROSNEFT attempted an international Initial Public Offering that was excoriated across the globe for being fundamentally corrupt and insanely risky. In the end, most of the buyers were Russians, and the shares are now trading below their initial offering price.

Russia????????s retail sector is also flaccid. In May, Kommersant reported that retail growth has been in steady decline for years. The paper stated: ???????The growth slid from 12.5 percent in 2004 to 12 percent in 2005 and to 10.2 percent in this first quarter. These trends in Russia????????s retail will soon trigger a qualitative leap, the analysts of A. T. Kearney forecasted, emphasizing the window of opportunity is closed at 90 percent now.??????? In other words, here comes Wal-mart. Then the dollar store. Then the beggar????????s bowl, Zaire with Permafrost.

III. The Fundamentals

So, the Russian economy is posting inflation, wage, unemployment and market levels which would incite fear of looming depression in any Western country, yet we continue to hear mostly about Russia as the ???????new energy superpower.??????? This is, to no small extent, the power of Neo-Soviet propaganda. Worse, if we look beyond the statistics and more important economic foundations, the picture becomes still gloomier.

Last month, the German think tank Transparency International published its most recent ranking of countries by level of official corruption. Of 159 nations surveyed, Russia tied with Niger, Albania and Sierra Leone for the proud title of 9th most corrupt regime on the face of the planet, just below Uganda and Libya in 10th place. Kazakhstan, Belarus and Ukraine all scored higher than Russia, as did Iran, and Russia????????s score in 2005 was worse than it had been the year before. How can a country that scores this way on questions of fundamental honesty be considered a G-8 partner? That is one for the ages. Meanwhile, ham-handed attempts to implement even the most basic of economic policies are instantly derailed by this fundamental, systemic, societal corruption. For months now, Russia has been mired in an utter fiasco as it attempted to impose new certification procedures on the sale of alcohol, the nation????????s lifeblood, and bottles of every description have disappeared from shelves. Crushing losses have been inflicted upon restaurants and liquor markets, and there is no end in sight. All this project involved was printing labels and affixing them to bottles; imagine if something more elaborate had been tried, especially an emergency measure in a time of economic crisis.

And corruption is not the only malignant force quietly eating away at Russia????????s future. The Russian education system has never been equipped to train economists, businessmen or market technicians. How could it become so, after wallowing so long in Communism and with such pandemic fear of foreigners as Russia is known to display? Calling Russia a nation of ???????C students and dilettantes,??????? Profil magazine editor Georgy Bovt states: ???????Company directors complain that there are no qualified bookkeepers, lawyers or personnel directors. Fairy tales about ???????computer geniuses???????? who could fill two cities of Bangalore are just that — fairy tales. These people may be talented, but they are self-taught and usually never had a systematic professional education. The country’s education system fell apart — in every sphere.??????? And indeed, this should come as no surprise. Russia suffers from three horrific flaws in its educational system, any one of which could be fatal on its own. First, societal corruption, leading to a ???????steal it rather than earn it??????? mentality (it????????s easily possible to simply buy a diploma, even from the most famous universities; even President Putin plagiarized his PhD thesis). Second, wretchedly low pay for teachers, below the national average, a further encouragement to sloth, ignorance and corruption. And third, a vast class of holdover aparachiks from the Soviet era who are not only devoid of modern knowledge and sensibility but, to all appearances, biding their time for the return of Communism.

Here is the fundamental paradox Russia faces (indeed, has always faced): There is no escape from this double whammy where economic fundamentals are concerned other than drastic reform, which cannot possibly occur because any such reform, by definition, would threaten the Kremlin????????s powerbase by creating viable centers of economic power throughout society and introducing new ways of thinking about old problems. To put it mildly, the Kremlin cannot have this. To put it bluntly, the Kremlin is more than prepared to grind Russia????????s economy right into the ground before it will surrender its authority; and indeed, impoverishing the population is one facile way to weaken it and make docile, hence easier to control.

IV. Myths and Misperceptions about Russian Economics

Despite all this horrifying data, some folks still imagine Russia is doing well economically right now. That????????s because three crucial myths plague our understanding of the Russian economy: that it is characterized by remarkable recent GNP growth, that it is reaping a magnificent oil windfall and that, because things are cheaper in Russia, Russia????????s standard of living is higher than it superficially appears. All these ideas are fundamentally bogus. The next time you wonder how Russians can be living in poverty and their stock market crashing when there is so much growth, oil and discounting, just remind yourself that, actually, there isn????????t.

A. The Mythology of Economic Growth

Over the past few years, as the price of oil has skyrocketed, Russia has posted economic growth of between 5 and 8 percent of GDP. This seems very impressive when you know that in the United States, growth of just 4% is considered wonderful.

But Russian economic growth is all illusion, for many reasons. First of all, most of it has nothing to do with increased productivity and diversity in the Russian economy, which is what the GDP figure was designed to measure, but is merely a reflection of the rising price of oil. Second, Russia is exceptionally bad at dispersing wealth among the population, which means that the vast majority of people continue to live in poverty no matter how much the economy grows (recall the Knight-Ridder report mentioned above). Third, data about Russian economic growth is dependent upon information that comes out of the Kremlin, which has an obvious motive to lie about its success and which is ruled over by trained liars, former members of the KGB. Again, the failure to review Kremlin data with more cynicism is one of the great failings of the Russia-watching community today.

But that????????s not the most important point about economic growth. In the second quarter of 2006, for instance, each American contributed on average $250 to economic growth (2.5% of America????????s $12 trillion economy divided by its 300 million people divided by four quarters). This growth rate caused the New York Times lead story on July 29th to proclaim American economic growth to be ???????modest??????? and related to a ???????big toll??????? on the economy. During the second quarter of 2006, each Russian contributed on average just $190 to Russian economic growth (7.1% of Russia????????s. $1.5 trillion economy divided by its 140 million people divided by four quarters). In other words, each American produced 43% more economic growth for his country than each Russian did for his. Despite this fact, this Russian growth rate caused an op-ed writer in the LA Times to call Russia????????s economic growth ???????surging??????? so that ???????urban Russians in particular are enjoying higher living standards ???????? and not just because of oil wealth.??????? That????????s just plain silly, and only a person who has never spent any time outside Moscow could write such a thing.

In other words, Russia????????s economic base is so tiny, and its population is so huge, that it has to post growth rates many times larger than the U.S. just to deliver the same amount of extra value. And, mind you, the $190 figure given above is wildly inflated, because it is based on the concept of ???????purchasing power parity,??????? a myth exploded in discussion below. Russia????????s raw figure for economic growth is much closer to $90 than to $190. Take oil, lies and purchasing power parity away and Russia????????s economic growth is pathetic and quite terrifying, a harbinger of doom.

B. The Mythology of ???????Purchasing Power Parity???????

Russia’s gross unadjusted GDP only slightly larger than that of tiny Netherlands. Its per capita unadjusted GDP places it 61st in the world, just behind Botswana and Malasia. By ???????unadjusted??????? is meant tabulating the value of all goods and services produced in rubles and then converting rubles to dollars. In other words, just the facts.

One way in which Russophiles and Russian nationalists habitually try to rationalize and deflect attention from Russian poverty and inherent weakness is by making reference to the concept of ???????purchasing power parity??????? (PPP), by which they try to inflate the value of Russia????????s economy using sleight of hand. Under the bogus PPP notion, since a Muscovite pays less for a subway ride or a loaf of bread than, say, a New Yorker, the Russian????????s salary need not be as high as the New Yorker????????s to produce the same standard of living. What this theory assumes, insanely, is that the quality of things purchased by Russians (say, a gallon of milk or a television set or a visit to a doctor????????s office) is the same as that purchased by Americans. But everyone knows it isn????????t remotely close to being the same. The quality of Russian consumer goods is shoddy, and Russian food products are often adulterated with contaminants which can even include radioactivity (thus, the Russian lifespan is much shorter than that in the West) or otherwise inferior to Western variants. Buy a random pound of green vegetables in Russia and compare them to the West (if you can even find fresh green vegetables, that is), you????????ll see that the quality is not comparable. If a person needed surgery and had to choose blind between a Russian and a German physician, would he be unable to do so? Hardly. When President Yeltsin needed surgery, he called in foreign experts. The PPP formula totally ignores all these basic facts.

What????????s more, even when we use PPP Russia????????s position relative to other countries doesn????????t even change. It still fails to rank in the top 60 countries in the world in terms of per capita GDP. The only thing PPP is slightly useful for is changing Russia????????s rank as a nation. Russia????????s unadjusted gross GDP places it 14th among nations, but Russia makes the top 10 when PPP is applied.

The clearest proof that PPP is bogus is that the Kremlin itself rejects it whenever it is convenient. As Andrei Illarionov brilliantly exposed in an interview reported by the Moscow News in May, when Russia assesses its defense spending and compares it to that of the West, it ignores PPP. Illarionov pointed out that if you convert Russia????????s raw defense budget PPP dollars, it turns out that impoverished Russia spends 20% more on national defense than France, and assessed per capita it is 50% greater. But President Putin, as Illarionov points out, recently declared that Russia spends less on defense than nations like France, relying on the raw figures rather than those modified by PPP.

C. The Mythology of Oil Riches

The casual observer might ask, then, how there can be so much horrifically bad news about the Russian economy when the price of oil is so high. The answer is simple: Oil isn????????t that significant to the Russian economy.

Seven countries have proven oil reserves larger than Russia????????s. Saudi Arabia????????s reserves are four times the size of Russia????????s. And unlike Saudia Arabia too, Russia has a giant population that instantly dilutes the significance of its oil revenues. At $72 per barrel, Russia????????s daily production of oil would be worth about $670 million if it were all sold on the international markets, which works out to less than $5 per day per Russian in terms of gross revenue. After you deduct for the cost of production, profits for the oil companies and oil that is sold below market to Russians and CIS states, the actual net value of Russia????????s oil to its citizenry pales into insignificance. It can????????t work one iota????????s worth of change in the lives of ordinary Russians.

And that????????s not the worst of it, because oil has a downside, the famous ???????Dutch disease.??????? The presence of ???????easy money??????? from oil obliterates any incentive the government might have to undertake fundamental economic reform. In Russia????????s case, it is well documented that the Kremlin is simply sucking the profits of the oil companies like a leech, denying them the ability to invest in infrastructure, and at the same it is hoarding the resources it receives rather than investing them in the economic welfare of the country, and meanwhile it is taking more and more direct control over the oil industry. It is, in other words, transforming itself in to a corporate regime, using control over natural resources in the same way the USSR used control over labor. The inflow of currency from oil sales combined with the lack of investment explains why both inflation and unemployment are rising simultaneously, a hallmark of an utterly failed economic policy.

Perhaps the best evidence of Russia????????s fundamental economic weakness, despite the rising price of oil, is the Kremlin????????s determined effort to secure status for Russia as the world????????s nuclear waste dump. Unable to populate Russia????????s vast territory, the Kremlin apparently hopes to secure it from Chinese invasion by making it radioactive, meanwhile securing billions in revenues with this original idea for enterprise. Such a strategy, it can hardly be gainsaid, does not bespeak a successful, confident, progressive regime in Moscow. The rising price of oil is good for the occupants of the Kremlin as it allow its occupants to gird their powerbases. For everyone else, it????????s practically meaningless.

V. Conclusion

The old adage ???????fool me once, shame on you, fool me twice, shame on me??????? applies most pointedly the sphere of Russia policy. The Soviet Union was able to dupe the West for years into believing it had a mighty economic engine under the hood of a beat-up old junker, but when the Iron Curtin collapsed of its own fetid weight, like the curtain parting to reveal the Wizard of Oz, we found out how high our flights of fancy had soared. It would not reflect well upon us if we were to allow Russia to lead us once again down this primrose path. Russia is an economic basket case, a third-world nation with oil resources, not a juggernaut. It is rapidly becoming, as Atlantic magazine predicted, ???????Zaire with permafrost.??????? It is in no position, and never will be, to dictate policy to the West, and it cannot shield itself from Western criticism except by sleight of hand. Trained in Judo, Russian President Vladimir Putin is adept at using his foes weight against themselves, but this tactic cannot succeed against a concerted effort in the West to deny the Soviet Union the chance to rise again. It is not in anyone????????s interest, least of all the people of the Russia, for it to do so.

If there Russian economy were really as strong as some Russophiles claim, then Russia????????s efforts to provide massive arms sales to extremist regimes around the globe, and its efforts to solicit the world????????s nuclear waste and turn Siberia into a vast radioactive garbage dump, would have to be seen in an extremely malevolent light. If, on the other hand, we understand that Russia is taking these actions mostly because it simply needs the money, then we must accept the fundamental weakness of the Neo-Soviet economy.

Kim Zigfeld is the publisher of the Russia blog La Russophobe. Contact her at larussophobeÉyahoo.com

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Note to readers – we had technical issues. This essay was written by Kim Zigfeld, and posted by A.M. Mora y Leon