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«Abstract: Two prominent American specialists on the Russian economy present a fundamental analysis of basic economic factors explaining how the ...»

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Russia after the Global Financial Crisis

Clifford G. Gaddy and Barry W. Ickes1

Abstract: Two prominent American specialists on the Russian economy present a fundamental analysis of basic economic factors explaining how the global financial crisis has played out

in Russia and its implications for the country’s future. More specifically, the authors examine

the consequences of Russia’s dependence on and addiction to resource (oil and gas) rents

and of the management system put in place under Vladimir Putin to maintain, secure, and distribute these rents. They then investigate how each of these factors has emerged from the crisis and how it might evolve in the years ahead. Focusing on the distinction between rent dependence and addiction, the authors question the conventional wisdom that diversification of Russia’s economy (away from oil and gas) is a desirable objective that will render it less vulnerable to external shocks. Journal of Economic Literature, Classification Numbers: E020, F020, G010, O130. 15 figures, 44 references. Key words: Russia, global financial crisis, oil, natural gas, rent, rent-sharing, rent addiction, rent management system, economic diversification, protection racket, dissipation.


ell over a year and a half into the global economic crisis, it is still not clear how W events will ultimately play out. It has been a dramatic time for all countries, including Russia. Prior to the start of the crisis, many in Russia thought that they were “decoupled” from what happened in the leading industrial economies. But the Russian economy was hit hard. The world financial crisis and the bursting of the asset bubble presented Russia with a double shock. Oil prices collapsed, which had a huge direct impact. And capital was withdrawn from Russia in the flight to safety. Both of these shocks were primarily due to events abroad. It is important to stress this point, because some observers have argued that Russia’s crisis is home grown. It is not. Russia’s structures and policies have determined how the shock played out in Russia, but the shock itself was external.

On the surface, this is similar to what happened a decade earlier, as oil prices in 1998 plunged in response to the Asian Crisis of the previous year, and Russia suffered a financial crisis with near-catastrophic consequences, including a twofold real devaluation and a default on domestic debt. But the current crisis differs significantly from the one 10 years ago. Then, Russia’s inability to deal with its own fiscal crisis allowed the external shock to have the particular effects it did. In 2008, Russia was fiscally prepared for an external shock, something that spared the country from a much worse outcome than it might otherwise have suffered.

Respectively, Senior Fellow, The Brookings Institution, 1775 Massachusetts Avenue, N.W., Washington, DC 20036-2103 (cgaddy@brookings.edu), and Professor and Acting Head, Department of Economics, The Pennsylvania State University, University Park, PA 16802 (bwickes@psu.edu). The authors are grateful for financial support from the Human Capital Foundation to the Center for Research on International Financial and Energy Security (CRIFES, www.crifes.psu.edu), where Ickes is Director and Gaddy is Senior Scientific Fellow. They also thank the Smith Richardson Foundation for financial support.

Eurasian Geography and Economics, 2010, 51, No. 3, pp. 281–311. DOI: 10.2747/1539-7216.51.3.281 Copyright © 2010 by Bellwether Publishing, Ltd. All rights reserved.


Still, there have been some serious effects. It is important to sort out which are transitory and which are likely to last.

In this paper, we will describe the causes and consequences of the crisis in Russia. But our main purpose is to focus on the fundamental factors that explain these developments, and which allow us to understand Russia’s economic future—both the structure of the economy and the policies that the leadership will pursue in light of the lessons they draw from recent events. We organize our analysis around three fundamental points.

First, the crisis has reminded us of how thoroughly dependent Russia is on oil and gas.

Looking at the period before the crisis, during the crisis, and now in the rebound, the picture is unambiguous. Very few important developments, positive or negative, cannot be traced back to fluctuations in the volume of wealth—the rents—that accrue to Russia from these resources. This dependence will continue.

Second, Russia is addicted to the resource rents. This is a point distinct from the first. Our concept of addiction means more than dependence alone. Addiction refers to a specific condition in which there is an imperative to allocate rents to the backward production structure that Russia inherited from the Soviet Union. Addiction’s most pernicious feature is that it is self-reinforcing, which means that it continually deepens and reproduces backwardness and inefficiency in the Russian economy.

Third, Russia, like all resource-abundant economies, has a specific system of management of its resource rents. Because of the overwhelming importance of the rents in Russia, the rent management system is key to the entire political economy. Fundamental changes in the political economy of Russia are necessarily changes to the rent management system. In its history, Russia has had a number of distinct systems. For the past 80 years they have all been inseparably linked to the phenomenon of addiction mentioned above. Russia’s current system was designed and implemented by Vladimir Putin and his closest associates. We refer to it as Putin’s Protection Racket. This is a concept we will explain in some detail below. But we can note already here that, despite the name, this is not purely an exploitative scheme. Rather it is a mutual defense pact that benefits all participating parties. It has proven to be robust in the crisis and is likely to continue.

In the following, we will expand on each of these points, showing how the three factors—rent dependence, rent addiction, and rent management—were manifested before and during the crisis. We will conclude by asking how each was affected by the crisis and how they might look in the future. We will argue that Russia’s experience is more than just oil and gas dependence. Many countries have this. What makes Russia unique is the combination of resource dependence with addiction and its specific rent management system.


Oil and gas have shaped Russia since the first discoveries of oil in Baku in the 19th century.2 These resources were of critical importance for the Soviet economy. From early on, the fact that oil and gas were domestically produced allowed the command economy to develop without the imperative of a balance of payments constraint to limit waste and inefficiency.

More recently, the discovery of oil in large amounts in Western Siberia in the early 1970s, together with the sharp rise in world prices that raised the value of the new Soviet oil, altered The first oil well to be mechanically drilled anywhere in the world was in Baku in 1846, 12 years before Drake

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Fig. 1. Soviet (1970–1990) and Russian (1991–2009) oil and gas rents. As explained in Appendix A, rent is calculated as quantity produced times market price less cost of extraction. Quantities of oil and gas for 1970–1990, which are for the USSR, are from various annual editions of Narodnoye khozyaystvo SSSR (the USSR statistical yearbooks). Quantities of oil and gas for 1991–2008 are from the Central Statistical Database (TsBSD; www.gks.ru/dbscripts/Cbsd/DBInet.cgi) of the Russian Federal State Statistics Service (Rosstat). Quantities of oil and gas for 2009 are from Rosstat (2009). Oil prices for 1985–2009 are from IMF (2010, “World Price of Crude Oil”), and prices for 1970–1984 are from EIA (2009b). Gas prices for 1985–2009 are from IMF (2010, “Russian Natural Gas, in Germany”), and gas prices for 1970–1984 are from EIA (n.d.). All prices are converted to 2009 dollars using the GDP deflator of the Bureau of Economic Analysis (BEA, 2010).

the course of the Soviet Union. And the collapse of oil prices in the mid-1980s had just as dramatic an impact.

The importance of oil and gas to the political economy of Russia, as well as its behavior and influence in the world, is suggested by studying the fluctuation of resource rents over time.3 Figure 1 shows the aggregate oil and gas rents (in real terms) from 1970 to the present and demarcates eras by their respective leaders.4 In the 1970s, rents became abundant and rose sharply; this was also a period of Soviet expansionism.5 In the early 1980s, rents began a nearly 20-year decline. During those two decades, the Soviet Union collapsed under Mikhail Gorbachev as rents deteriorated. Newly independent Russia under Boris Yel’tsin experienced the lowest oil prices of the century, combined with a collapse in production. Consequently, Russia was more dependent on the West in this period. Beginning in 1999, rents revived. At It is important to understand why we emphasize rents rather than income or profits from oil production. Rents are much larger than income as they include not only formal profits but also excess costs of extraction and other forms of informal rent distribution that normally are considered costs. The distribution of rent thus has a much larger impact on the economy than just the income from oil and gas production. See the Appendix for more discussion of the notion of rent and rent-sharing.

All figures in the paper are based on the authors’ calculations. Their sources and the methodologies used in their compilation are explained in the respective figure captions.

Of course Brezhnev et al. had access to all Soviet rents, not just those from Russia alone. On the other hand, the

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Fig. 2. Russia’s stock market and the world oil price, January 2000–March 2010, in current dollars.

The stock market value is the RTS dollar-denominated index at mid-month [from www.rts.ru/ru/index/ rtsi/], whereas the oil price is the average monthly price for Brent from EIA [from tonto.eia.doe.gov/ dnav/pet/hist/rbrteW.htm].

first, rents were rising but were still not close to their 1970s level. Russia began to pay back some of its foreign debts and started to build some reserves. As oil prices soared, and rents reached historic highs, Russia’s reserve growth accelerated and Russia began to reassert its will in international affairs.

We do not mean to imply that Russian history has been mechanistically determined by resource rents. But the message of Figure 1 is that any examination of the Russian economy ought to take oil and gas as its starting point. If nothing else, this crisis is a reminder of that fact. During the boom that preceded the crisis, the importance of oil and gas was to some extent hidden from view by the rapid growth in virtually every sector in the economy, not just oil and gas and related industries that supplied inputs to or performed services for the resource sector. Also apparently unconnected sectors such as retail trade, real estate, telecommunications, and others saw their sales, profits, and share prices rise sharply. Some observers argued that this was evidence of the emergence of a non-oil economy.6 But the abrupt collapse of oil prices in the summer of 2008 made it hard to ignore how dependent these other sectors had been on the high oil prices.

One obvious way to see the importance of oil to the Russian economy is the correlation between oil prices and stock prices. The benchmark RTS (Russian Trading System) stock market index has tracked the oil price for the past 10 years, but never more closely than in the most recent 18 months (see Fig. 2). The oil price reached record heights in the summer of Thus, in June 2008, Peter Rutland could write that “Russia has a diversified economy with a substantial manufacturing sector.… The non-tradable sector of the Russian economy (construction and services) has been booming and the OECD and World Bank estimate that oil and gas accounts for half of the growth since 1999 (which means that non-energy sectors account for the other half )” (Rutland, 2008, p. 3). This was the seeming consensus at the time, although Rutland followed with the observation that “only time will tell if this optimistic interpretation of the sustainability of the Russian economic boom is correct” (ibid.).

GADDY AND ICKES 285 Fig. 3. Annual sales revenue of Russia’s top 100 non-oil and gas companies and the world oil price, 1999–2009, in current dollars. Data for 1999–2008 sales are from Ekspert magazine’s annual rankings, from 2000 to 2009 (Reyting, annual). The 2009 sales figure is an estimate calculated by the authors from a sample of corporate third-quarter and full-year reports. The oil price is from IMF (2010, “World Price of Crude Oil”).

2008, collapsed by about 70 percent by the end of the year, and since then has risen back to a price roughly half of what it was at the peak. The RTS index followed the same path.

One might object that because such a large share of the index’s value is from oil and gas companies, it is not surprising that it is strongly correlated with the oil price. In fact, as of the fourth quarter of 2009, oil and gas companies accounted for only slightly more than half of the index. Sectoral indices for the non-oil and gas industries have behaved largely the same as oil and gas. Perhaps even more persuasive evidence for the “everything is oil” argument we are making is in Figure 3, which shows the annual sales revenues of Russia’s largest (by sales) companies outside the oil and gas sector, matched with the annual average oil price.

Not only financial indicators but also the physical economy followed the oil price. The relationship between oil prices and the production of railway freight cars is an example. As is evident in Figure 4, the pattern is again the same. At first, more and more of these cars are produced each year as oil prices are on the rise. Then output plummets as oil prices collapse in the summer of 2008. Then, as soon as the oil price rises again, freight car production rebounds.

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