russia and the world: scenarios to 2025: executive summary

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Russia and the World: Scenarios to 2025

Executive Summary

60111_couv_Russia.qxd 17.1.2006 15:35

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Long March

Vozrozhdenie

Executive Summary

Oil's Curse

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For decades Russia, as the dominant constituent

of the Soviet Union, was indisputably a

superpower. The reality today is very different.

With a population of 144 million, Russia has

approximately as many inhabitants as Pakistan

(which, like Russia, possesses nuclear weapons),

and an economy about the size of the

Netherlands (population 16 million).

Russia has gone through major changes

since the break up of the Soviet Union,

with a 30% decrease in gross domestic product

(GDP) from 1992 to 1998 and challenges to

Moscow’s rule in some provinces. In addition

to that, declining birth rates combined with

emigration and disease have shrunk the

working-age population. However, at the start

of the 21st Century, the indications from Russia

are more favourable, not least because it has

experienced a strong real GDP growth in the

past five years that has created large current

account surpluses and reserves.

The economic boom has been supported

by high oil prices—but the benefits of this

increased economic prosperity are shared only

among the elite, while the income gap between

regions and groups within society continues

to grow.

While the upturn in itself is not enough to

ensure sustained economic development, it

has provided President Vladimir Putin with a

window of opportunity, which he has used to

introduce a number of reforms, including a flat

income tax, a new land and legal code, and

legislation on currency liberalization. Indeed, his

most significant achievement has been to

balance the budget and dramatically reduce

IMF borrowing.

More recently, a number of issues have started

to become more pressing, including inflation,

ethnic tensions and some slowing in economic

growth just to mention a few.

It is thus appropriate to ask whether the

combination of these different demographic,

economic, social and political elements will

eventually have a negative impact, or if Russia

can successfully turn itself around.

The Key Questions for the Scenarios

Among the many challenges confronting Russia,

two questions are key to how Russia will look

in the next two decades:

• Will Russia be able to develop

legitimate and effective governance,

based on the rule of law?

• How effectively can Russia develop

a broad-based economy given its

extensive energy resources?

A number of factors will influence Russia’s

response to these questions:

• The nature, openness and leadership

qualities of the Russian elite, and its interest

and ability to impose the rule of law;

• The choice of economic policy, and the

extent of the freedom granted to private

capital in the energy and non-energy

sectors ;

• The challenge of maintaining social cohesion

given the country’s geographic spread and

its serious demographic problems; and,

• Russia’s relations with the rest of the world.

Different scenario paths for Russia up to 2025

are represented in figure 1, in which the axes

reflect different possible outcomes with respect

to the key questions.

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Executive Summary


The Long March scenario covers a situation

in which Russia continues to leverage its

natural resources, to the detriment of the full

development of other sectors. A gradual

transition takes place to a system of governance

based on the rule of law. In this scenario, Russia

is able to achieve relative prosperity, but a far

less benign future is also possible.

In Oil’s Curse, a political class bent on

its own enrichment is in charge, resulting

in slow growth, poor levels of investment in

infrastructure, capital flight, increased corruption

and a decline in the competitiveness of domestic

industries.

A radical departure from the past is also

possible, in which Russia would gradually

achieve real economic and social progress.

Vozrozhdenie (“Renaissance” in Russian)

foresees initially gradual but eventually wide-

reaching governance reforms combined with

market reforms leading to strong GDP growth,

an increase in real income, and general

improvement in the quality of life for the

population at large.

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LongMarch

Vozrozhdenie

Oil's Curse

Figure 1: Russia and the World: Scenarios to 2025


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Long March describes a Russia that is still highly dependent

on natural resources. Increasingly moderate and pragmatic

conservatives make investments in oil infrastructure so as to

fully leverage the advantages Russia derives from its natural

resources while struggling to enforce a greater rule of law.

In other sectors of the economy, international competitiveness

remains limited.

This scenario is set out in the notional form of a transcript

in the Dupree Quarterly—an investment journal—of a keynote

speech at its annual meeting in New York City in 2025.

In Oil’s Curse Russia continues to rely heavily on natural

resources. With high oil prices worldwide and strong demand

for energy, the implementation of far-reaching institutional

reforms and investment in oil and public infrastructure are

neglected, in part due to ineffective leadership.

The scenario is told as an article (by Russian sceptics) in The

Online Newsletter of the Russian Development Group, aimed

at potential investors.

Vozrozhdenie describes a Russia that implements a series of

bold reforms under the leadership of a democratically elected

President. These reforms lead to the economic, political and

social rebirth of Russia.

The scenario is narrated in the Online Encyclopaedia of the

World (OEW) and provides a factual account of what Russia

has achieved over a 20-year period.

Long March

Oil’s Curse

Vozrozhdenie(“Renaissance”)

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2006-2010: Decreasing oil and gas production, low efficiencyand productivity in all sectors, and a worsening of the businessenvironment cause a slowdown of the economy, after years ofrelatively high GDP growth. Corruption and poor governancereach into virtually all areas of public and private life, and socialservices, such as health and education, are suffering from yearsof insufficient budget allocations. After the 2008 elections, conflictsflare inside the Kremlin between conservatives and marketreformers, and a new Prime Minister closer to the latter group is chosen. He begins some much-needed reforms, but iseventually ousted by conservatives. As the economy continuesto shift downwards, the “traditional” measures—state intervention,dirigisme, political pricing, etc.—prove unsuccessful.

2011-2020: Popular opposition following the slowing of theeconomy (and of income growth) and the scandals surroundinga failed anti-corruption campaign builds up ahead of the 2012elections, and enables the ousted Prime Minister to obtain thePresidency. Over the two terms of his mandate, he succeeds inimplementing some radical reforms both in the public sector(progression towards greater democracy and division of powers;civil service and army reform; greater independence of regionsvis-à-vis the centre) and in business (establishment of the free

market and gradual withdrawal of the state from the economy;reduction of red tape and trade barriers ; encouragement ofdiversification to non-energy sectors), whilst also addressing thehealth and the education systems. Corruption is tackled, andconfidence in state and business grows as the economy startsto recover, with improvements in productivity across all sectors.Internationally, Russia strengthens its ties with the EU and to someextent with the US, while its relationship with China is good inthe context of the supply of energy, but tenser elsewhere.

2021-2025: The succeeding Presidency builds upon the strongfoundations created over the previous years, although with astronger emphasis on social aspects and regional development.The diversification achieved ensures a solid and sustainableeconomic growth, despite the slowing in oil production, whileinsulating the economy from energy shocks and increasing thefinancial independence of the regions. The rise of a burgeoningmiddle class also ensures the emergence and development of a strong civil society. Abroad, Russia is positioning itself as thegrowth engine for the Eurasia and Central Asia region, and isperceived as a major power, with the ability to counter-balanceboth China and the US.

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ary2006-2010: Following a period of economic upswing, inefficiencyand declining productivity in the energy sector become increasinglyapparent, as oil and gas production start to trend downward.Inequality and corruption levels increase, while social spendingon healthcare and education is underfunded. The 2008 electionsbring leadership changes and new vision to Russia. A modelemerges, similar to Canada, where energy and natural resourcesare seen as a strategic asset that can be leveraged for botheconomic development and geopolitical aims.

2011-2020: The new President (2008-2016) and his successormaintain Putin’s approach to a managed democracy and amanaged economy, while committing to the redistribution ofrevenues from the state-controlled energy sector to the populationat large, improving their living standards through increased socialspending. Despite the lack of serious structural reforms in theeconomy and public governance, the government is relativelysuccessful in fighting corruption and reforming the military, whileits focus on the energy sector ensures much-needed investmentand gradual improvement in efficiency and productivity in thatsector. Other industries remain underdeveloped despite their

potential, because of limited access to financing and human capitaland the absence of a free-market dynamic. Energy also shapesforeign policy, drawing Russia closer to China and improving itsrelations with both the European Union and the United States.

2021-2025: Russia follows essentially the same path, maintaininga benign authoritarian regime and a strong involvement of thestate in the economy, primarily focused on the energy sector.Advances in the rule of law and a solid increase in real incomefor the population in general encourage the development of amiddle class that, at this point, begins to resent the state’sstranglehold on all areas of public and economic life. Non-oilindustries are growing, but over the years their competitivenesson the international scene is affected by the lack of exposure to a real market economy, the strengthening of the rouble, and theprotectionist attitude of the state. This in turn sparkes pressurefor market-friendly reforms. Furthermore, the regions, whichhave benefited from more efficient administration, are beginningto question the role of the state, while ethnic tensions are on theincrease. On the international scene, Russia is seen as a stableand reliable oil provider.

2006-2010: The conservatives reinforce their power in theKremlin as despair and apathy spread among the populationand high oil prices reduce the sense of urgency for the need for substantial economic reforms. Efficiency and fiscaldiscipline appear less important, given the revenues flowinginto the state’s vaults. However, the lack of reforms, as well asuncertainty and instability, affect the economy, bringing abouta substantial decrease in productivity and efficiency in allsectors—including energy, where insufficient investments in exploration and extraction affect oil production growth. As corruption undermines the rule of law, elections do notlead to any change in power or policy. Ethnic tensionsincrease, and the international position becomes tenserand more difficult.

2011-2020: The deteriorating economic situation spurs anumber of short term measures.The loosening of fiscal policyas the government withdraws from the Stabilization Fund,without backing the withdrawals with the necessary structuralreforms, actually worsens the situation by fuelling inflationand inefficiency. The state reacts by reinforcing its industrialpolicy and increasing its hold over the energy sector. More companies are brought under state control, encouragingan internal political struggle over the control of natural resource

companies. As the state is unable to improve the economy,more and more industries are subject to government directives.The private sector has only limited access to finance, humancapital, fixed capital and management, whilst capital flightsoars. Eventually, a new wave of privatization creates a secondgeneration of oligarchs. Protectionist measures in favour ofweaker domestic companies and dwindling oil productioncontribute to the souring of international relations.

2021-2025: Alarmed by a potential collapse of the Russianeconomy, international financial institutions try to pump infunds—but these are mostly squandered without achievingany real effect. The state does not follow a long-term socialpolicy, and welfare expenditures are crisis-driven, unsustainableand inadequate, while the number of those dependent onthe state for survival—pensioners, unemployed, the poor—grows. Businesses continue to be hampered by loss ofcompetitiveness, low productivity, and an unfavourable marketenvironment. Internally, Russia experiences mounting centre-periphery and ethnic tensions, which often erupt into violentclashes. Externally, international relationships deteriorate asRussia unsuccessfully attempts to recreate an imperialiststate, further alienating its neighbours, and eventually turnsinwards, becoming more and more isolated.


LongMarch

Vozrozhdenie

Oil's Curse

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Comparing the Three Scenarios

This table provides a comparison of some of the most important aspects and developments of the

scenarios, with further analysis presented in the following Annex

Long March

• Strong investment in oilinfrastructure, improvementsin public infrastructure,limited growth elsewhere

• Higher but inefficient socialspending stabilizes incomegap

• Civil society remainsembryonic—but pressuresfor ‘independence’ grow

• Mildly benign attitude towardsthe West, focus on China &India

• Russia has positioned itselfas a crucial supplier ofenergy in a world wheresecurity of supply is majorissue

• Power maintained byincreasingly moderate andpragmatic conservatives

• Successful war on corruptionlegitimizes the central state

Oil’s Curse

• Strong state regulation andprotection of the economyfrom outside forces lead toslow and fluctuating GDPgrowth

• High social tensions due toprevailing corruption andgrowing inequalities

• Quality of life worsens andsocial services close tocollapse

• Relationship with Chinathrives on the back ofgrowing energy trade

• Closer relations with EUdriven by security of energysupply

• US relationship grows distant

• Power maintained andconcentrated by small elitesat national and regional levels

• Dissatisfaction withineffective governance

Vozrozhdenie

• Push to diversify theeconomy away from energy,leads to healthy and stablebalanced GDP growth

• Social spending andimproved efficiency hasreduced inequality

• Greater involvement of thepopulation in political life

• Russia becomesincreasingly active on the world stage and ininternational organizations

• Greater readiness tosubstantially align with EUand US views.

• Full development of a moreeffective and democraticform of governance

• Transparency, personalrights and publicaccountability are greatlyimproved

Economic performance

Social development

External relationships

Leadership & governance


The following section allows a side-by-side comparison

of the evolution of some key economic and social

indicators as featured in each scenario. The underlying

economic modelling and analysis has been developed,

with contributions from several experts, in order to

ensure that the storylines and the development of their

different dimensions are both plausible and consistent

with each other.

Key indicators considered:

1. World GDP growth

2. Russia GDP growth

3. Export growth (excluding oil)

4. Export composition

- Export breakdown by destination

- Export breakdown by industry

5. Oil exports

6. FDI inflows

7. Percentage of people living under

“subsistence level”

Using the data

The main objective of the above data is to help develop

leading indicators to determine which of the three scenarios is

actually unfolding. Scenario users should keep in mind that

the scenarios and the related analysis are descriptions of

only a set of possible outcomes, as seen from the current

perspective.

They should not be seen as predictions or forecasts.

The data provided therefore should only be seen as a guide,

and should be applied with careful judgement.

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Annexe: Comparing the Three Scenarios


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In Long March, global integration progresses worldwide and global growth peaks in 2008; however, in the long run, scepticism

and nationalism emerge, preventing the global economy from fully reaping the benefits of globalization and slowing down growth.

In Oil’s Curse, a difficult international environment, characterized by lack of trust and instability, undermines international cooperation

and integration, leading to a global recession in 2010-2014. In contrast, in Vozrozhdenie, the global economy benefits from increasing

globalization and a more harmonious external environment, reaching annual growth rates of up to 4%.

Source: World Economic Forum

World GDP Growth Figure A.1

World real GDP % growth p.a. (moving 5-year averages)

5

4

3

2

1

0

Perc

enta

ges

Vozrozhdenie Long March

Actual Projected

Oil’s Curse

2000 2005 2010 2015 2020 2025

Source: Moody's Economy.com

Russia GDP Growth Figure A.2

Russia’s GDP growth p.a. (moving 5-year averages)

8

6

4

2

0

Perc

enta

ges

Vozrozhdenie Long March Oil’s Curse

2000 2005 2010 2015 2020 2025

Actual Projected

Following the 2002-2006 period of high growth, mostly driven by oil prices and consumer demand, Russia’s GDP growth

starts to slow. In Long March the maintained reliance on energy is backed by substantial investments and efficiency

improvements in the sector, while in the non-energy economy, small but efficient investments lead to moderate growth.

In Oil’s Curse, on the other hand, the dependence on energy is not sustained by the necessary investments; as decreasing

rule of law and negative business environment affect economic performance in all sectors, GDP growth is minimal.

In Vozrozhdenie, after an initial period of mediocre performance, the economy picks up thanks to encouraged diversification

and increased rule of law, attaining higher and sustainable growth levels.

1. World GDP growth

2. Russia GDP growth


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Export Breakdown by Destination 2005 and 2025Figure A.4

Long March

Oil’s Curse

Vozrozhdenie

Russia in 2005

18

20

12

17

14 4 2

10 5 5

20 315

15

8

13

10

6 5 4

54

47

40

54

Percentages

Percentages

CIS Europe China Middle East & AfricaAsia ex China Americas, Australia and Oceania

In 2025

In 2005

3. Export growth (excluding oil)

In Long March, the importance of the countries of the European Union as trading partners

is maintained, driven by energy exports. The breakdown of export destinations in Oil’s Curse

shows a slight reduction in the amount of exports towards the EU, mostly absorbed by Asia.

Vozrozhdenie offers a more balanced profile of export destinations, as differentiation and

globalization encourage Russia’s integration in international trade.


Export Growth Excluding Oil Figure A.3

Export excluding oil (nominal, moving 5-year averages)

350 300 250 200 150 100

50 0

Billio

n US

$


Actual Projected

2000 2005 2010 2015 2020 2025

In all scenarios, export growth slows down significantly in the period 2006-2011, to stabilize at

lower levels as of 2012. In Long March, growth remains the same throughout the rest of the period,

as domestic companies remain less competitive than their international counterparts. In Oil’s Curse,

not only does growth not pick up, but it remains, comparatively, at the lowest level. In Vozrozhdenie,

the level at which growth stabilizes is relatively higher than in the other scenarios; moreover, growth

picks up again in 2019 thanks to increasing diversification of the economy.

4. Export composition Export breakdown by destination


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Oil Exports Figure A.6

Crude oil export p.a. (volumes)

9

8

7

6

5

4

Milli

on B

pd


Actual Projected

2000 2005 2010 2015 2020 2025

Long March and Oil’s Curse both depict an ongoing reliance on natural resources for their

external trade. In Vozrozhdenie, differentiation and higher competitiveness of Russian businesses

are reflected by a more varied export composition.

The quantity of oil exports is higher in the Long March scenario. In Oil’s Curse, it is lower,

due to insufficient investments and inefficiencies. In Vozrozhdenie, a greater proportion of the oil

produced fuels the growing economy.


Export Breakdown by Industry 2005 and 2025 Figure A.5

Long March

Oil’s Curse

Vozrozhdenie

Russia in 2005

36

42

21

54

11 12 3 13

8 3 9

18 73 20

5

23

27 7

14

3 3 97

3

4

18

18

Percentages

Percentages

Mined and Mineral Products Forest and Paper Products Metals, Precious Gems, and Their Products Chemical and Rubber Manufacturing

Machinery, Equipment, and Transportation Related Goods Consumer and Other Goods Services

In 2025

In 2005

5. Export breakdown by industry

5. Oil exports


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FDI Inflows Figure A.7

Billio

n US

$

2006-2010 2011-2015 2016-2020 2021-20251996-2000 2001-2005

30

25

20

15

10

5

0


Actual Projected


People Living Under “Subsistence Level” Share of people

Figure A.8

30

25

20

15

10

5

0

Perc

enta

ges


1995 2000 2005 2010 2015 2020 2025

Actual Projected

In Long March, Russia attracts a higher level of FDI in the period 2006-2010—directed predominantly

towards the energy sector—than in any of the other scenarios. In the period 2011-2025, however,

the greater differentiation and the market economy in Vozrozhdenie see a greater inflow of FDI.

The negative business environment and poor rule of law discourage the majority of potential

investors in Oil’s Curse.

Both Long March and Vozrozhdenie see a decrease in poverty. While in Long March this is

due to the state, which ensures a redistribution of wealth through social policies and spending,

in Vozrozhdenie, it is the market mechanism that guarantees a greater participation of the people

in the improvement of the economy. In Oil’s Curse, poor economic performance, coupled with

the absence of proper redistribution mechanisms and minimal rule of law, causes many to remain

trapped below subsistence levels.

6. FDI inflows

7. Percentage of people living under “subsistence level”


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russia and the world: scenarios to 2025: executive summary

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