Russia’s Uneven Drive Toward Economic Self-Sufficiency

02-Jul-2018

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The Kremlin is trying to steer Russia’s economy toward a more self-sufficient model by decreasing the country’s reliance on imports of food and manufactured goods. At the same time, the country is taking fledgling steps to wean itself off its dependence on the cash derived from energy exports, a volatile source of income that has sent the Russian economy on a rollercoaster ride over the years. The economic rebalancing efforts have met with mixed results so far, but as the process continues, the Russian economy that emerges will be significantly more self-sufficient than it has been in previous decades, at least in some respects.

This most recent drive toward self-sufficiency and rebalancing can be traced to the 2009 document “Russia’s National Security Strategy to 2020,” in which the Kremlin laid out its intentions for the coming decade. Among its directives were to increase food security; foster competitive domestic industries in pharmaceuticals, telecommunications, computer technologies, electronics and programming; and de-emphasize the importance of the raw materials export model. To put these directives in context, it is necessary to understand something of the development of the Russian economy, which as in all cases is a product of its challenging geography.

Distribution of Natural Resources in Russia

Russia’s Geographic Challenges

Russia’s population is clustered in its milder European west, while its center and east is dominated by permafrost, which covers about 65 percent of its landmass. What’s more, Russian rivers for the most part run north and south, making them unsuitable for ferrying goods across the country. Although Russia has some of the most valuable natural endowments of any nation in the world, they are spread across such vast distances and are often located in such inhospitable environments that the logistics involved in their extraction and export create massive inefficiencies. Much of its abundant reserves of metals and oil and gas are spread out across Siberia, the rugged territory that alone makes up a 10th of the world’s land surface. Those resources are augmented by some of Europe’s richest soil, the famous humus-rich chernozem that stretches across Russia’s south from the Ukrainian border to the Kazakh-Mongolian border. But it cannot take full advantage of those riches, as harsh winters and unpredictable weather makes large sections of this territory hard to farm. The exception rests in the Northern Caucasus region, where the Black Sea creates a climate optimal for growing wheat in the incredibly fertile black soil while also providing the means by which to transport it to market, a rare gift indeed in a country where transport costs are often ruinous. Even in that breadbasket, complications stemming from ethnic political divisions create some hazards for farming.

Through the centuries, Russia’s rulers have struggled to cope with the country’s geography. With a predominantly rural population, under the Rurik and Romanov dynasties that ruled until the 1917 Russian Revolution, Russia was a major exporter of wheat and other grains. In Siberia, industrialization shifted the economic focus from furs and timber to metals and coal, and, ultimately, to oil and natural gas. Transport logistics and the harsh terrain always undermined Russia’s manufacturing competitiveness, and though it industrialized in the late 19th century it never quite entered the first rank of developed powers.

The Soviet Union’s socialist policies further accentuated these inefficiencies. Its command economy prioritized locating manufacturing as close to raw materials as possible, while also attempting to balance the country’s regions so that none were dominant over the others; these policies often involved forced migration from the milder parts of the country to harsher areas. This resulted in the creation of numerous small cities in inhospitable areas, with remote populations between 100,000 and 300,000 persons that needed to be fed and clothed using the country’s tenuous logistics network. The legacy of that era persists; one study has estimated that there are 14 million more people in Russia’s east (35 percent of the region’s population) than would have settled there had market forces instead of state dictates been the driving factor (the study used Canada for comparison). Russia also now has a significantly more dispersed population than its peer countries, meaning it misses out on all the advantages and efficiencies that concentration in large cities can create.

Most goods manufactured under the Soviet system were viewed with contempt by consumers both inside and outside the country, as the inefficiencies created by geography combined with a lack of competition to result in notoriously poor products across most industry lines. With those weaknesses, the economy that emerged in Soviet times — and which largely still persists today — came to rely on exports of raw commodities, mainly energy resources, for income. Currency garnered from such exports was spent on foreign-manufactured goods, the defense industry and, increasingly, on grain imports, as a lack of investment in the agricultural sector resulted in dwindling returns. As these costs mounted, Russia eventually found its energy revenue insufficient to cover them, and the resulting balance of payments crisis and inflationary money-printing ultimately contributed significantly to the Soviet Union’s collapse.

In the years since the Soviet Union’s downfall, Russia has shifted to more of a market economy, revealing its overdependence on energy export revenue. Its free-floating currency has made it apparent how the value of the ruble directly tracks the price of oil. Russia’s economic crises — hitting in 1997, 2008 and 2014 — have exactly intersected with collapses in oil prices, while good times have been linked to sustained high energy prices. Even in the good times, though, Russia’s dependence on oil revenue has created a drag on the rest of the economy. The current account surplus that results from Russia’s energy exports increases demand for the ruble, driving up the currency’s price. That makes the rest of the economy less competitive in international markets, and as a result Russia’s other sectors have continued to wither, with the country becoming ever more reliant on hydrocarbon export. That is, until the latter half of the 2000s.

With its 2009 National Security Strategy, the Kremlin looked to reawaken dormant sectors such as agriculture and technology while moving away from the raw materials export model. Following from that initiative, in 2010 the Russian government set specific food sustainability targets for 2020. These entailed ensuring self-sufficiency in staples such as grain and potatoes by satisfying 95 percent of demand with domestic production. Other domestic production targets included milk and dairy production of 90 percent; meat and meat products and edible salt at 85 percent; and sugar, vegetable oil and fish products of 80 percent each. Under normal circumstances, some of these targets may have exceeded Russia’s grasp, but later developments have helped it exceed almost all of those targets ahead of schedule.

Russian Food Security Targets

A Crisis of Opportunity

When oil prices dropped by half in 2014, the ruble fell with them. In the same year, Russia’s annexation of Crimea inspired Western sanctions on some Russian products, and Russia responded in kind, making the most of the opportunity to reach toward its food sufficiency goals by embargoing European imports in the sector. This confluence of events had a sharp rebalancing effect. By 2015, the weaker currency and the new scarcity of foreign products sent food prices through the roof. As a result, imported fruits and dairy products became less of a part of the Russian diet, and the demand for domestically produced food increased. Meanwhile, the weaker ruble bumped up demand for Russian agricultural commodities, especially wheat, in international markets. The growing internal and external demand has resulted in a Russian agricultural resurgence (though it must be noted that some of the factors contributing to the boom may also be temporary). This has meant that six years after the food security targets were set, seven of the eight had been hit, with only dairy still lagging behind. In 2017, Agriculture Minister Alexander Tkachev announced plans to create 800 more large dairy farms in an effort to reach that target by 2020. Wheat in particular has boomed, in 2017 registering its highest production since 1978 (when figures reflected the Soviet Union as a whole, rather than just Russia). The highly favorable growing conditions in the Northern Caucasus coincide with easy access to the massive wheat-importing markets of North Africa and the Middle East, and as a result, in 2017 Russia became the world’s largest wheat exporter by volume, while the Black Sea region as a whole is now responsible for 23 percent of global wheat production.

Attempts to increase self-sufficiency in manufactured goods have been less successful. The weaker ruble has made Russia’s domestic market more competitive, but preexisting constraints have stunted its efforts to move away from foreign products. At first glance, the automotive sector may seem like a success story, with the average share of imports having dropped by 22.5 percent in 2015, but a closer examination reveals that foreign companies have been relying more on their Russian joint ventures as a result of the currency weakness diminishing the country’s import power. So while the increase in consumption has been for vehicles manufactured in the country, Russian brands have not necessarily benefited. Metallurgy is another sector in which imports have fallen, but that is likely a direct result of deteriorating relations with Ukraine, where much of Russia’s previous metals production took place.

Of the industries mentioned in the 2009 National Security Strategy, however, the weaker ruble and import substitution drive seemingly had a reverse effect in pharmaceuticals and electrical equipment, with imports actually increasing in those areas in 2015. Unlike in agriculture, where Russia could use its native resources to replace European produce, the country does not have similar homegrown capabilities in pharmaceuticals or high-technology equipment to step into the breach. A lower gross domestic product per capita and lagging education levels over the course of years have left Russia incapable of the same level of development in those industries as its external counterparts.

The Kremlin is now looking to make some of the shifts the economy made after 2014 permanent. The danger under the preexisting model would be that, when the oil price recovers, the ruble would rise with it, blunting the edge that a weaker currency has given to Russia’s agriculture sector and likely leading to the downfall of some farms. The Russian solution to this has been the tentative introduction of a new fiscal rule over the past 12 months. Under the policy, the government will treat any oil price over $40 a barrel as a windfall and will use the income derived from any price above that to either reduce its budget deficit or put it in one of its rainy day funds for future spending. This maneuver breaks the direct link between oil price and economic health, and it appears to be working, with the ruble for the first time defiantly resisting the trend of higher oil prices over the past six months.

The Kremlin hopes that the lower ruble will not only help Russian agriculture maintain its newfound strength but also that, given time, Russian manufacturing might come to take advantage of the global competitiveness its currency price bestows. But the Russian consumer will pay the price for that strategy. Already the diminished domestic purchasing power of Russians has led to reduced consumption of some higher-quality goods such as fresh dairy, meat and fruit. Under the old model, with the ruble tracking stronger oil prices, Russian consumers would hold increased spending power abroad, allowing GDP growth via consumption. If the fiscal rule holds, this no longer would be the case. Finally, and more broadly, Russia’s increased self-sufficiency in agriculture will give it more freedom in international affairs. When a country is reliant on food imports, it becomes more susceptible to sanctions pressures. A more self-sufficient country by comparison can take more risks without fear of reprisal. In the short term, then, increased self-sufficiency will leave Russia poorer, but also more independent.

https://worldview.stratfor.com/article/russias-uneven-drive-toward-economic-self-sufficiency

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