RD Interview: Oleg Buklemishev, former assistant to the Finance Minister and the Prime Minister, decodes the Russian economic puzzle and explains what needs to happen if the Russian economy is going to start growing again.

"More economists are speaking about an L-type crisis. It will be a long stagnation with small ups and downs but nevertheless, the direction is unclear." Pictured: The Moscow-City business center. Photo: RIA Novosti

It has now been a year since Russia has been forced to adjust to a new economic reality due to economic sanctions, low oil prices and the absence of serious fundamental reforms.

The current situation in Russia might be seen as a last chance to undertake true reforms and rethink the nation’s overall economic policy. During a crisis, it is possible to see clearly what one’s weaknesses are, and even at the current stage, Russia can actually turn itself into a new and successful economy – provided there is the political willpower at the very top.

Read more articles from Oleg Buklemishev at Russia Direct

Russia Direct sat down with Oleg Buklemishev, associate professor in the Department of Economics at Lomonosov Moscow State University (MGU) and the former assistant to the Finance Minister and the Prime Minister, to talk about the Russian economy after a year of crisis and what actually needs to be done to improve it.

Russia Direct: What do you see as a main trend in Russia’s economic development?

Oleg Buklemishev: Frankly, the main trend is the absence of a trend for the time being, just because nobody sees a concrete direction of further economic development. Of course, some sectors continue to fall down, including construction, including consumption, some sectors still are doing better than others, such as agriculture.

Nevertheless, the overall trend is quite different from what we saw in 2008, when the global economic crisis touched the Russian economy in a very peculiar way: We had a so-called V-type crisis.

Nowadays, more and more economists are speaking about an L-type crisis. So, it will be a long stagnation with small ups and downs but nevertheless, the direction is unclear, and this is the problem, in my opinion. Stagnation in certain respects is even worse than a downfall, it is even worse than recession, just because it is  a permanent state that does not incur development.

RD: So, given these circumstances, during the Sochi Investment Forum Prime Minister Dmitry Medvedev announced a new Economic Strategy-2030, which is concentrated on four priorities: investment activity, import substitution, the quality of state governance, and budgetary policy. Do you see this new attempt to revise the strategic view of Russian economic development timely? Or is it just empty words?

O.B.: It is both. It is timely but, unfortunately, we cannot see any real signals that these words are going to be implemented into real actions. Actually, sometimes these statements made by the government are quite rational and quite reasonable, and I agree with several statements that were made during the Sochi Forum, especially concerning governance and the public sector.

Oleg Buklemishev, Associate professor in the department of Economics at Moscow State University (MGU)This refers not only to somewhere in the regions where we have bad management, but also to the higher echelons of power and the fact that the management of the economy currently is very poor. Moreover, the management of overall society, public life, is in a very poor state.

Whatever plans you can imagine or draw up under any slogan or strategy, they fall apart if you do not pay attention to the real needs of people and reestablish a system of feedback between the government and the people. Unfortunately, in my opinion, this system has been broken and further momentum is impossible in the absence of restoring some form of this feedback.

RD: What do you think should be fixed in the Russian economy in the first place?

O.B.: Of course, it is the problem of public management and it should be stated as one of the first priorities for sure. But then when it comes to reelection, I cannot see any further developments which could be considered realistic.

This system of merger between the public and the private sector continues to exist, the dominance of the state-owned companies (inefficient state-owned companies) and inefficient management of the state sector continue to exist, corruption unfortunately continues to exist as well and no one speaks about how to uproot these dangerous developments. So far we hear only words.

Some radical changes are needed in order to improve the situation here.

Speaking about investment and import-substitution, unfortunately, these are not parallel lines, these are perpendicular lines. Import substitution is impossible in this current environment just because investments are closed. And investments are impossible in the current environment – the private sector does not want to invest in its own assets and in its own economy.

This is the main problem. Sources of such investments are closed because we deliberately closed access to the Western markets, we cannot find proper substitution for this money in the Eastern markets. . That is the picture.

And the key for this is private business behavior. Unless we improve the mood, unless we show the better image of the future Russian economy for the time being, private businesses see it as a mere continuation of the current situation, which is not a very positive picture.

RD: There is an opinion that the government is a bad investor and the Russian government an even worse one. But on the other hand, it is the only guarantor of stability for investors, it provides certain guarantees and security of investments. Why is it so? Do not you see a paradox here?

O.B.: I do not see any paradox here. The state really should be a guarantor but just the fact that it is a poor guarantor of economic activities is one of the main factors why private investment is not flowing in Russia. The fact that the state also tries to contribute a lot to the investment sector, it even pushes out private investors in many spheres.

For example, if Gazprom comes to invest, no other investment is possible in any particular field. Many of such state-owned enterprises have become multisector, multifunctional holdings and they really control the economy. Therefore there is no space for genuine private activity in many spheres: only risky spheres and spheres with no guaranteed results are left for some venture capitalists.

It could work if those fields were for ten percent or five percent of businesses, but if all business is oriented there, business of course prefers not to invest.

RD: Do you see any way out of how to change this balance?

O.B.: I do. This is a strange story. I often recall the discussions which were 10 years ago when I was in the government. And one of the discussions I remember particularly well. It happened in 2001. it was admitted that oil and gas companies control the majority of revenues of the Russian economy.

Nowadays, if I am not mistaken, RBC released a report a month ago that the number was 98 percent of profits for industry was oil and gas only. It means that in order to diversify our economy, in order to make it more efficient, you need for sure to somehow transfer this huge amount of money to non-raw material spheres. And here a simple dilemma comes at play: either you do it through the public sector or via markets. And the decision was made to do it via the state mechanisms.

Read the Q&A with Dean of MGU's Department of Economics Alexander Auzan: "Why Russia won't be able to modernize economy in times of crisis"

So, you have a big state with the tax mechanism which extracts extra revenues from the oil and gas sphere. But then to keep some of this money in the reserves, some other part could be invested in other spheres of the economy. This was the initial idea but it did not work.

After almost 15 years, we can definitely say that this idea did not work. Just because the investments made by many of the state-owned companies and investments from the public sector was not as efficient as we assumed.

Now only one alternative is left. Somehow, start to redevelop markets, the banking sector, financial markets, the stock market, with the state as a guarantor to start moving funds from oil and gas to another industry. These funds should be not state funds it should be done in a very different way.

What the state did with that money: it accumulated huge reserves which were spent in half during the global economic crisis of 2008-2009. And because these funds existed, we had no restructure of the industry at all. Other countries survived the crisis but they restructured their internal economies and have become more efficient after the crisis. We just paid for everything. We just compensated for the failures and inefficiencies of the industry and the state itself.

Today another crisis comes and we are running out of funds. What can we do? We need to deeply restructure the state, its budget and, of course, relations between the state and economy, this strange merger of big business and the state, and, of course, make our private companies also more efficient. This job of adjustment nowadays will be much more painful because in 2008 we did nothing to do that.

RD: There is enough understanding and expertise in the Russian government about what steps should be taken to achieve certain results in economic development of the country. Moreover a group of distinctive experts and economists are consulting our country’s leadership on how to better conduct economic policy. Then what are the main obstacles for economic underperformance?

O.B.: It is happening just because of too many redlines which appeared during the previous years. There are redlines, nobody knows where these redlines are, but there are several things which cannot be discussed or they can be discussed but realistically they cannot be improved.

For example, the issue of state-owned companies, the secrecy around them, all attempts to measure their efficiency in a normal way, etc. It just goes without saying that government is absolutely dysfunctional on this arena. This significant part of the Russian economy lives its own life. And as far as I can assume nobody – not even the President - can run this portion of the Russian economy for the benefit of the economy itself and our people.

There are others as well, issues associated with distribution of authority and responsibilities between the regional and federal level, because the regions are blamed for everything but they lack resources, they come to the federal state and the federal state for whatever reason considers it an optimal scheme when they ask us for something but responsibility is at the same time on them. This way of management has become typical and most popular.

What is economic policy? It consists of two things: priorities and principles. Firstly, you set priorities, and secondly, you define principles according to which you go and look at these priorities as your orientation.

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Nowadays we can speak a lot about, say, human capital or whatever, but we have corresponding items in the government budget decreased and the priorities are elsewhere. However, we do not speak about priorities such as the administrative system, security and defense. These are real priorities.

So we give up on our economy and we are for security instead. So, state it openly and do not speak about priorities which do not exist. It destroys the economic policy.

The second principle is that there is no principle that can be untouchable. The Prime Minister of the Russian government wrote an article not so long ago where he states that we should develop financial markets and two weeks later, we see another freeze of the accumulated pension funds. In more realistic words – money was confiscated from people.

According to the law, these people are not the owners of that money but nevertheless this is people’s money. Instead of this money being invested in some real sectors of the economy, the government spends the money to finance current expenditures. So, the government already forgot about the priorities stated in the article of the Prime Minister.

This shows an absence of principles, which means there is no economic policy. No principles and no priorities.

RD: It is been already a year since the sectoral sanctions are in place. What are the main changes in Russian economy? Are they negative or positive?

O.B.: Frankly, I cannot see any positive results. To tell you frankly, in my opinion, the main negative effect is a signaling effect. This is a signal that there is a hidden risk in the Russian economy, in Russian assets, in Russian companies.

There is hidden risk because nobody knows who can be under the sanctions next. Anybody, any company and the overall economy could be touched by further sanctions if something happens in Ukraine or Syria. If something happens there might be new sanctions – that is the main message we are sending now to foreign investors and foreign partners. And this risk is embedded in the prices of the assets, in the investment climate.

But at the same time there is a slight upside of this story: nobody believes, realistically speaking, that sanctions are going to be cancelled soon. So it is a strange situation when there is only a downside.

There is no positive result for the Russian consumer who got, thanks to counter-sanctions, a significant decrease of the quality of products and an increase of prices. The few stories we are aware of, there are some Russian companies who managed to fill the niches. But they are very few. But again, nobody knows if tomorrow or day after tomorrow sanctions are released, are these companies in a position to keep those niches? I am not sure.

Of course these companies were eager not only to replace foreign competitors but also to raise prices. So it comes to a point when Russian consumers are getting products of lower quality for higher prices. This is the general picture, nobody can deny it.

RD: In the course of the year the word import-substitution has become something like a mantra of the government’s policy. There are different assessments of its effectiveness. How can you describe it: Does our economy benefit from it? Or does it suffer from it?

O.B.: There are several issues here. First of all, I do not see what can be qualified as a successful import-substitution. If it happens successfully it should happen in the normal market environment. So people are ready to invest and import-substitution, if it happens during this period of time, it happens mainly due to a huge national currency devaluation.

"What we need is to formulate the will that addresses the real needs of the Russian people." Photo: RIA Novosti

Thus, national companies get a boost in competitiveness thanks to this devaluation. But at the same time this devaluation is harmful to the consumer, so this kind of import substitution is probably the worst kind of import-substitution one can imagine.

If you take the defense industry, probably there are good cases, but frankly I am not aware of them, when a company replaces imported parts with domestic parts. But again we have to look into the details: Defense is not a market-oriented sphere and who knows how much it costs now, what is the price difference. Probably we substituted something with our own parts which are again of lower quality and higher price. So, efficiency cannot be measured here. It requires special analysis.

As for other industries, again there are some cases it could work, but nevertheless, the atmosphere in the situation when access to investments is absent and investment is much more expensive than it was previously is that new production lines, new facilities can get investments only from the funds of these same enterprises.

RD: The Russian government has launched its own sort of support program, so it tries to give money to small and medium enterprises.

O.B.: I’ve heard about that but again we came to the previous point: the government is an investor and it has to choose, because people come to get cheap money, cheap loans. And there are a lot more people than money available. It means the government has to choose and it chooses here not much better in my opinion than in principle.

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It is pretty strange when one part of the economy receives cheap loans for a five or six percent interest rate and another part cannot get any funds at all - or gets it at best for a 20 percent interest rate per year. It is very strange “competitive” situation.

RD: In your opinion, how does the Russian military campaign in Syria burden the budget?

O.B.: There are different estimates. But I’d like to draw your attention to another important issue – the growing secrecy of the state budget itself. You cannot analyze the federal budget in a way you could five years ago. Nowadays about a quarter or even more of the budgetary items is secret. You can have one estimation or another, but the fact is that you cannot analyze the figures.

For example, it would be very interesting to see how much money was spent on Crimea and on Donbas. Everyone is interested to see, but no one can really analyze it. Syria, in my opinion, is a minor problem when compared to Crimea or Donbas it is much cheaper.

RD: To wrap up, could you please summarize the main problems in Russia’s economy and what should be resolved in the first place?

O.B.: What should be resolved in the first place is quite clear in my opinion – it is a radical overhaul of policy. Again, what does policy mean? It means priorities and principles, and we live without principles and with wrong priorities.

What we need is to formulate the will that addresses the real needs of the Russian people. Many things which are being done during the current period of time are out of my picture. Although I am not a representative member of Russian society, I feel that people need something different than airstrikes in Syria, than advances in Ukraine.

People do not need closed hospitals, bad schools and high prices – these are the priorities the government should address, not some other fantastic things which are not on the horizon of an ordinary person.

Frankly, I would like to wake up tomorrow in a country that looks at its own problems and somehow this realistic view could be transformed into a policy action.

In a continuation of what I said previously, let me say about some positive sides of the story if compared to the previous periods. We have three reasons to hope.

First of all, we now see what needs to be done: people in the government, people outside of the government see and know what needs to be done. As recently Alexander Auzan said, “Everyone knows what has to be done but nobody believes it can happen.”

RD: So it is like a dichotomy between necessity and expectations?

O.B.: Exactly. The path from expectations to necessity could be very short. Frankly, it could happen overnight. Just some preconditions need to be fulfilled, but it could happen overnight.

Secondly, we now have a very different human capital. If, at the end of the 1990s, there were no people to fill even a simple position, a very low position, nowadays the new generation of people knows how a normal market economy works, how democracy works.

People want to work honestly, people want to work in a very different situation from what we have now, and they know how to work. And if you just change the system of promotion and promote people by their merit, not by their connections to certain groups or individuals, very soon you will see that the quality of staff in the state apparatus and private sector as well will dramatically improve.

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And third, it is about magic. I often recall the year 1999 when nobody expected that after the 1998 crisis, the Russian economy would start growing the same year, or that the Russian government would achieve a non-deficit budget the same year. Neither the World Bank, nor International Monetary Fund (IMF), nor domestic or external experts, nobody believed.

At that time, a Communist government was in place and it was a disaster: it was a dramatic devaluation, it was a dramatic crisis. The economy was just flattened by that crisis. When the Communist government came to power they understood that it could do nothing and that was the start of the economic miracle that lasted for 10 years – nobody expected that.

I do believe that something similar could happen today. But again, what kicked off that miracle was the deep economic crisis and serious political reshuffle. But it is not absolutely necessary to be hit hard in order to understand something.

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