Putin 2.0: Repeating the Soviet Union’s Mistakes

(Corrects fourth paragraph to indicate that oil prices are adjusted for inflation.)

June 12 (Bloomberg) -- In his second incarnation as Russian president, Vladimir Putin looks set to repeat some of the mistakes that brought down the former Soviet Union, including a nuclear arms race he can’t afford. He should change course for his own sake, if not Russia’s.

Putin recognizes the challenges of demography, technological backwardness and overdependence on natural resource extraction that his country faces. He certainly knows the deep impact that a euro-area depression could have on Russia’s economy. But so far he appears unwilling to do what’s needed to address these threats. Today, as Russia marks its day of independence from the USSR, it’s worth revisiting some lessons from the fall of the Soviet Union.

During his first two terms as president, Putin repeated a critical error from the 1970s, failing to use the wealth produced by high oil prices to institute structural reforms. The price of Russia’s benchmark Urals crude rose almost fivefold from 2000 to 2008. According to the government, the oil and gas industry accounted for four percentage points of the 7 percent average annual growth rate that Russia enjoyed for the last decade, money that created a middle class that is now demanding more political freedoms.

High oil prices had similarly cushioned Leonid Brezhnev from the need to reform an inefficient Soviet economy and raised popular expectations. When the price of a barrel of oil fell from more than $100, adjusted for inflation, to $20 and below in the early 1980s, it was too late to whisk Soviet industry into the age of consumer technology. Soviet efforts to match U.S. spending on its so-called Star Wars missile defense program, and to project power in Afghanistan, helped tip the Soviet Union into bankruptcy.

Despite frequent government pledges to diversify Russia’s economy away from hydrocarbons during Putin’s boom years, too little was done. About half of this year’s Russian government budget is dependent on revenue from the oil and gas industries. Russia’s continued vulnerability became clear in 2009, when a slump in oil prices after the Lehman Brothers Holdings Inc. crisis triggered one of the sharpest contractions experienced by any major economy. Only Finance Minister Alexei Kudrin’s prudent siphoning of energy industry revenue into a strategic reserve fund softened the blow. That fund has shrunk to $60 billion today, from $140 billion in 2008.

So what will Putin do now? In what passed for a re-election campaign this year, he said that by 2020, Russia should create 25 million new high tech jobs and move to 20th place, from 120th, in the World Bank’s ease-of-doing-business rankings. By 2018, he said, Russia should be investing 27 percent of gross domestic product, up from 21 percent today, and its labor productivity should rise by half.

These are admirable, Stakhanovite goals. It’s also highly unlikely that Putin will achieve them. Doing so would require a single-minded, almost revolutionary, determination to change Russia’s economic landscape, of which he shows little sign.

Instead, Putin appears to be trimming reforms already in place, for example by restricting the scope of privatizations and undermining a law reintroducing popular elections for regional governors. Putin reappointed a quarter of Russia’s governors just before that law took effect. On Friday, he signed another bill into law, which raises the fine for taking part in unauthorized demonstrations to 300,000 rubles ($9,000), about the average Russian’s annual salary. These moves demonstrate Putin’s concern about ensuring political control, at the expense of reform.

The most obvious echo from the past is Putin’s plan for higher defense spending. Kudrin was fired last fall, after he objected publicly to the government’s plans to triple the military budget as a share of gross domestic product by 2014. Kudrin warned that this would entrench Russia’s oil dependence and make the economy vulnerable to a downturn. Putin, in a Foreign Policy article titled “Being Strong” that appeared before the election, described such fears as “profoundly delusional.”

Russia has underspent on conventional military. Much of the new money is to go for a new generation of ballistic missiles, in direct response to the North Atlantic Treaty Organization’s planned missile defense system. This is a Cold War reflex to a system that, even if directed at Russia, could only nibble at the edges of its still vast nuclear arsenal. Putin should use those resources instead to encourage the business and educational infrastructure needed to create the diverse, high-value-added economy that Russia’s protesting middle classes want to see.

Putin is a captive of his own past and of the system of state-controlled capitalism he has built. He appears to believe that such a huge increase in defense spending will kill two birds with one stone: shore-up Russia’s great power status and, as he wrote in Foreign Policy, “feed the engines of modernization in our economy, creating real growth.”

If anyone is delusional, it’s not Kudrin.

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