Russia's Virtual Economy by Clifford G. s> Gaddy Barry W. Ickes (review)

Abstract

REVIEWS 785 can be warmly recommended to scholars and students of post-Communist transitionand foreign trade. School ofSlavonic andEastEuropean Studies Z. ADAM lUniversity College London Gaddy, Clifford G. and Ickes, Barry W. Russia'sVirtual Economy. Brookings Institution Press, Washington D.C., 2002. xiii + 306 pp. Tables. Notes. Appendices. Bibliography.Index. ?Io.95: $19.95 (paperback). THEepithet 'virtual'in relationto Russia'seconomy was felicitouslyextracted by CliffordGaddy and BarryIckesnot fromthe internetbut fromthe Russian Government's Karpov Commission on non-payments (I996-97), and was firstused by them in a widely cited article in Foreign AffairsI998, of which this book is a much expanded version. It is not without blemishes. The expansion is at times laboured and repetitious. Its 280 pages could with advantage be pruned by at least onethird . The authors are hidebound by academic correctness: they omit the parent articlefrom their bibliographyand locate the book's origin in stodgier material of more recent vintage. They also do not adequately relate their diagnoses of Russia to analogous occurrencesin Westerneconomies, whether developed or developing. Depressed areas, negative value added and rentseeking -cum-corruption-cum-personal-favoursare not new. What is special about Russia is the pervasive interconnectedness of these phenomena rather than theirmere existence or individualdefinitions. Basically,however, the workmarksa strikingadvance in ourunderstanding of Russia's economic condition. What Gaddy and Ickes have done is to develop a unifiedanalysisof elements noted by allthoughtfulRussia-watchers but hithertocatalogued in ratherseparateboxes. The solid foundations of the Russian economy are its mineralsproduction: oil and gas especially,but also some importantmetalsplus diamonds and a bit of coal. Exportsof these items, and correspondingimportsof consumergoods, have been a mainstayof Russianlivingstandardssincethe fallof Communism. This point is not part of the book's theme, but it needs mentioning because it representsvalid economic restructuring,albeit with no reshaping of physical plant. Moreover, the country has run an export surplussufficientto finance a vast accumulation of external assets, most of it accomplished more or less illegally by enterprises, but also some legally by households in the form of foreign-currency holdings. These external assets may be said to constitute domestic investmentcapitalin waiting. There is one other piece of good news. At the end of the I99OS, Russia's crude oil output, having fallen over the preceding decade by 40 per cent, began to recover. This happened not because of ruble devaluation or higher world oil prices, but because Russia's oil tycoons had completed their major corporate misappropriationsand the industry was therefore encouraged to turn more of its attention to oil-fieldmanagement. But don't cheer too soon. There are question marks over the country's ability to maintain its naturalgas output in the years ahead. And meanwhile 786 SEER, 8i, 4, 2003 the bad news begins with the extravagant under-pricing of fuel, and particularlyof naturalgas, in the domestic economy. The comparison here is notwith world market prices, even after netting back for internal Russian transportcosts. If world marketprices for oil and gas allow Russia (like Saudi Arabia)a marginof rent over and above extractioncosts, it is legitimate (even if not necessarilyoptimal)for the authoritiesto distributesuch rent, or part of it, across the population through lower fuel prices at home. What is indefensibleis to allow domestic sellingprices to cover less than the fullcost of extracting and processing the fuel. Yet this has been precisely the situation inheritedfrom the Soviet era, when output quantitieswere not determinedby prices and when the cost of capital in particular(i.e. interest)was ignored on ideological grounds. The inherent subsidyto households arbitrarilybenefits today's generations at the expense of future ones. Much more serious, however, is the wasteful supportaffordedto manypartsof manufacturingindustry.Here, otheraspects of the Soviet legacy become prominent. This is the core of Gaddy and Ickes's analysis.Largesections of Russian manufacturingare in a dire state:spawned by central planning and military considerations, hopelessly mis-structured, wrongly located and uncompetitive, incapable of conversion to market requirementsexcept throughwholesale dismembermentof enterprises.Helping them nonetheless to limp along in this condition has been an insidious network of personal and bureaucraticconnections, both horizontally among enterprisesand verticallythroughthe hierarchiesof politicalauthority.Gaddy and Ickes call it 'relationalcapital'.The Russianterm is blat.In Soviet times it enabled the industrial planning mechanism to function. Today it allows...