No one is more gloomy than President Vladimir V. Putin's economic adviser Andrei Illarionov, who recently coined the term "Venezuelaization" to describe the fate he fears awaits Russia's economy. "Today we decided to join the Third World," he told reporters last December, following the controversial renationalization of the core production subsidiary of oil giant Yukos. The growing role of the state in Russia's oil sector adds to the risk of economic mismanagement. In Venezuela, oil was eventually dubbed "the Devil's excrement" in the 1970s because of the massive corruption, waste, and shortsightedness that turned Venezuela into a classic example of how to wreck an economy.
Illarionov is well known for his provocative statements. But he's not alone in warning that, unless properly managed, Russia's oil wealth could end up doing more harm than good. Economists warn of the "resource curse," the surprising but statistically valid theory that, more often than not, abundance of natural resources damages a country's economic growth.
One concern is that, like many oil-rich countries before it, Russia may decide to blow its oil windfall on profligate government spending, risking an unpleasant fiscal and economic crunch when oil prices fall. To guard against that temptation, Russia wisely created a Stabilization Fund last year, a nest egg to protect the budget against drops in the price of oil, following the successful example of Norway. But political pressure is growing to use the rapidly accumulating fund, already worth $28 billion, to boost expenditures. Under the original plan, tax revenues on oil that fetched more than $20 a barrel were funneled into the Stabilization Fund, but in April the Cabinet decided to hike that threshold to $27, releasing an extra $10 billion for the budget this year. "That may sound very low right now, but if you look back, finding years in which oil prices averaged above $27 is not at all easy," says William Tompson, senior economist at the Organization for Economic Co-operation & Development in Paris.
The revised policy toward the Stabilization Fund is just the latest sign that advocates of tight fiscal discipline, led by Finance Minister Alexei Kudrin, are losing ground to Prime Minister Mikhail Fradkov and other champions of more populist policies. In January, Moscow was forced to hike pensions and other social outlays by $7 billion -- around 1% of gross domestic product -- to sweeten the pill of controversial social-benefit reforms that were designed to replace in-kind benefits with cash payments. The changes sparked mass protests.PRICES RISING
Finance minister Kudrin has publicly slammed recent moves to weaken the Stabilization Fund and loosen fiscal policy. "The government is doing stupid things" he told daily Rossiskaya Gazeta on Apr. 25. The International Monetary Fund is also sounding the alarm. "If this policy continues, Russia will miss an opportunity to advance its modernization," Poul Thomsen, head of an IMF delegation to Moscow, said on June 3 -- a day after the Cabinet voted to dip into the Stabilization Fund to fund extra social spending
True, Russia's public finances look so strong and oil prices so firm that the risk from higher spending seems manageable. In 2004, Russia ran a budget surplus equivalent to 4.1% of GDP, and the government forecasts a surplus of 1.5% this year. Much depends, though, on oil prices, which are notoriously unpredictable. And the risks for Russia don't end with the possibility of cheaper oil.
Looser fiscal policy will boost inflation, which already shows signs of spiking upward. In the first quarter of 2005, consumer prices rose 5.3% from the previous quarter, jeopardizing the government's target of bringing annual inflation down from 11.7% last year to 8.5% in 2005. Rising costs will exacerbate one other well-known ailment associated with high oil prices, the so-called Dutch Disease, named after Holland's experience in the 1970s, when a strengthening currency made it impossible for local manufacturers to compete. As well as pushing up the value of the currency directly, a flood of petrodollars may also undermine manufacturing competitiveness by stoking inflation. In the past year the ruble has risen by 10% against the dollar in real terms and is forecast to appreciate even faster in the coming year.
Yet macroeconomic problems such as boom-bust cycles, rising inflation, and the strengthening ruble aren't even the biggest concerns connected with oil. More serious are the pernicious long-term effects of oil riches on a country's social institutions and its political stability. Natural resources generate large "rents," easy money that fuels corruption and state interference in the economy, as well as often sparking serious political strife among rival interest groups. The resource curse "has more to do with politics than anything else," says the OECD's Tompson.
Russia seems to be no exception. The most serious crisis of recent years, the state's crackdown on Yukos, shows the problems that can arise when rival factions battle for control over oil revenues. The Yukos affair, and an accompanying big tax hike on oil companies, has discouraged oil executives from making new capital investments. That's the main reason Russia's economic growth is slowing, economists say, even though oil prices have risen. Costly oil may also be to blame for slow progress on key economic reforms in the past two years. "Bureaucrats get a false sense of security with high oil prices. They think they can afford to postpone unpopular but important reforms," says Peter Westin, chief economist at Aton Capital brokerage in Moscow.
So is Russia doomed to repeat the experience of Venezuela? The jury is out. According to historical experience, the chances of overcoming the curse are greatest in countries with well-developed political and civic institutions, such as Norway or Canada. An independent judiciary, free media, and lively political parties act as checks against the corruption and abuse of power that often lead to resource wealth being squandered. The bad news is that Russia scores poorly on all counts. The good news is that it has nevertheless kept a tight budget. "The problem is not that a country is rich in resources, but that countries rich in resources are more likely to be fiscally irresponsible," says Alexei Moisseev, chief economist at Moscow investment bank Renaissance Capital.
So it's troubling that Russia's fiscal grip, while still impressive, has begun to loosen. "They've really started to spend," says Moisseev. The pressure on the budget is sure to intensify in the years to come. Presidential elections are in 2008, and the Kremlin is desperate to ensure the victory of a loyal successor to President Putin, who is due to step down. At least Russia can learn from the mistakes of its predecessors. Let's hope it takes the lessons of history to heart. By Jason Bush in Moscow