Russia’s Interconnectedness To The Global Economy

Abstract

This paper seeks to examine and analyze Russia’s connectedness to the global economy. It does so by exploring how oil prices affect social, political and economic outcomes. The argument is that specialization in the single industry of oil and gas has made it possible for individuals to embrace corruption and cheating. The research uses literature from the Economist and the BBC in exploring Russian integration into the global economy. It denotes that low oil prices have adversely affected Russia’s position as a powerful emerging market economy. Low prices also force the Russian government on military adventures and increases the levels of corruption. Case examples like the release of the Panama Papers shows that corruption is deeply entrenched in the Russia economy which affects free market performance. President Putin’s close friends laundering billions of dollars into Panama. This shows the vast network of corruption at work that hinders global economic integration. The diversification of industries help with reducing economic downturns associated with low demand of oil.

Introduction

On April 3, 2015, Ramon Fonseca who worked for a Panama based law firm released offshore business documents now known as the “Panama Papers”1. The Panama Papers revealed a deeper integration of Russia in the global economy, albeit a troubling one. The leaked papers contained information about tax evasion from businesses and politicians across the globe contained information on the investments by Russian President Vladmir Putin’s friends. Even though the papers tell a story of plutocracy and corruption in Russia, they also reflect on the interconnectedness of the Russia to the global economy. This paper seeks to examine and analyze Russia’s connectedness to the global economy by looking at how oil prices changes both international and domestic politics. The paper also looks at Russia’s powerful industries such as the oil and gas industry and its contribution to the Russian society as well as global economy.

The paper proceeds first by examining the current status of the Russian oil economy economy. The second part explores the role played by Russia’s major industries in making it a critical economic player on the global scale. Thirdly it will explore the effect the changes in global economic price has on the economy and the Russian society. The fourth part examines problems inherent in Russian politics and economy that inhibit growth and development such as corruption and a broken political system. The conclusion draws on the fluctuating oil prices and how they affect Russia’s economic performance in the future.

The Oil Economy

Russia relies heavily on oil for the sustenance of its economy. About two-thirds of the Russian exports come from the oil and gas industry. This means that the supply and demand of oil and natural gas often define the how Russia’s economy will perform in a particular year. The Economist’s Data Team reported that most of Russia’s aggressive military campaigns can be linked to the global oil price. An example of this link is the invasion of Afghanistan in 1979 when oil prices were more than $100 per barrel.2 This goes to show that oil is critical to Russia’s politics and economic standing.

During periods of oil boom, the Russia economy performs over expectations and at times when the price go down, the economy contracts and political problems exacerbate. After the recession of 2007-08, Russia was able to recover faster than Western economies due to increases in oil prices. The government was able to manipulate prices through taxes and regulations that boost oil production.3 In addition it also owns the largest oil producing companies in Gazprom Neft and Rosneft. The goal of the Russian government is to be able to control global oil prices and enable a stable price that can fuel its economy. This is however difficult in a global economy with diverse players and countries that are advancing the idea of renewable energy. Fossil fuels are still used and important but the drive towards more renewable energy provides challenges to economies like that of Russia.

Russia’s economic performance has been greatly affected by reduction of global oil prices. Since 2014, the price of oil has hovered below $100 per barrel.4 The oil industry enables Russia to be economically connected to the larger world economy. Much of government revenue comes from oil and gas. The drop in global oil prices affected the Russian economy the most. An economy that was growing at a very fast pace did shrink by at least 4 percent in 2015.5 At the same time, inflation rose in Russia to double digit levels of 13 percent. Because Russia depends heavily on the oil industry, it has not been able to fully recover from the economy contraction of late 2014 and 2015. As the Economist reports, Russia’s economic growth model is driven by both local and global energy demands. The movement towards energy self-sustenance by countries like the United States had deprived Russia of energy markets leaving it to rethink its growth strategy.

Even though Russia’s economy has performed below expectations, some aspects of the economy are vastly improving helping it to integrate more easily with other economies. The economist notes that Businesses in Russia have health finances and limited foreign debt. This is an advantage for economy since the availability to surplus money is critical to diversifying the industries that perform. Together with health finances, the Russian banking sector has outperformed other industries such as the dominant oil industry. This is due to reduced oil prices and changes made to the Russian central bank to ensure speculation is removed from the market. An important facet of integration or connectedness is how the oil companies do their banking. According to the Economist, oil companies expenses are calculated and paid in local currency of roubles while revenue streams in in US dollars. The Economist observes that Russia has to contend with capital outflow and bad oil prices. This situation is made worse by the difficulty to access foreign markets. The argument is that the Russian economy is in a difficult place to the point where no policy action or fiscal measure can fix it. Citing a former Russian finance minister, the economist argue that the main problem with Russia’s economy is the lack of competence in the market forces and government’s prevention of market competition.6 This ultimately means that the post-Cold War market economy of Russia has been eroded and replaced by dangerous government activism in the economy. The Russian government’s political actions of centralizing power have left little room for the market to flourish. In the current system, only businesses with ties to the central government perform better because of political incentives and corruption.

The fall in oil prices has exposed the cracks in Russia’s economic performance. Because oil prices were rising in the early 2000s, Russia’s economy performed well above expectations. The drop in oil prices shows the effect of easy to access money and credit that was spurred by the booming oil industry. The growth in spending was enabled by the high oil prices and it was spending mostly on imports rather than locally manufactured products. The trade off for Russia was to invest in other industries or ride the oil boom wave. It rode the oil boom wave and the economy suffered when prices of oil began to fall. With dropping oil prices, Russia has to diversify its economic activities, something that the government has failed to do. The Economist note that “Russia’s only way out is to restructure the economy in order to restore the role of markets.”7 Restoring the role of the market also means having to maintain working relations with other global leaders. This is complicated by Russia’s involvement in conflicts in Syria and Ukraine. Politics easily gets into the way of free trade.

While the economy shows signs of promise, the Russian government has had problems stabilizing the economy. The price of oil fell by half in 2015 and produced a three percent deficit. The Economist argue that “ the arithmetic of Russia’s public finances is unforgiving, the deficit rises by roughly 1% of GDP for every $5 drop in the price of oil.”8 Like China, Russia tries to game the international markets by changing the price of oil and natural gas. This however is met with little success. Some of the solutions that are available to Russia include, the printing of unlimited amount of roubles. This is a method to contracting economy that has resulted in economies collapsing due to high levels of inflation. As The Economist rightfully observes, printing roubles has the adverse effect of eroding the power of the local currency and leaving the economy vulnerable.9 The government can also not afford to make spending cuts on other industries that are not oil based. This has the potential of further complicating the economic troubles at hand and making Russia noncompetitive on global economic scale.

Effect of Low Oil Prices on Society

The trouble of a single industry based economy like Russia’s oil based economy is that when the demand for oil is low, individual lifestyle and the health of communities can be affected. Citing a research done by the Independent Institute for Social Policy, The Economist observe that over the past two years, wages have drastically been reduced in Russia, dropping by at least 9 percent in the year 2015. Poverty rate have increased in Russia and growing inflation eroded the purchasing power of salaries. This shows that a deeper and connected global economy can favor the reduction of prices of certain goods but mainly at the expense of some country’s key sector. Despite efforts by individuals like Putin to control the economy, he has been unable to control oil prices and in the end, the lifestyle of Russia has been greatly affected.

Russia also depends on consumer spending for health economic development. Because the purchasing power of the local currency is down and inflation is high, many Russians are no longer unable to go shopping. A 13 percent reduction in sales has not been helped by the reduction of foreign travels by as much as 30 percent.10 This situation is complicated by the increase in drug and alcohol abuse. Drugs like cocaine and heroine are becoming readily available and middle aged men often find themselves hooked to one drug or the other.

Corruption and the Future of Russia’s Economy

A recent document leak revealed that Vladimir Putin’s close associates laundered money and evaded paying taxes by creating offshore accounts in Panama. This is just one of the few cases of corruption leveled against Putin’s administration. One of the individuals identified as a money launderer by the Panama Papers is Vladimir Putin’s friend Sergei Roldugin.11 Rodulgin owns two offshore companies, namely, International Media Overseas and Sonnette Overseas. Through his companies, Roldugin received large amounts of money and these amounts were quickly written off to destroy evidence. The case of Vladimir Putin and Sergei Roldugin brings to the fore another aspect of Russia’s connectedness to the global economy which is the interconnectedness of corrupt rings. President Vladimir Putin denied wrongdoing on the part of Roldugin but the evidence is to to the contrary. A report by the BBC notes that Putin’s friends channeled billions of dollars into their offshore businesses and he was aware of the practice.12

Corruption in Russia’s economic system is not only observable at the central government level. Local authorities also participate in high networks of corruption that affect the outcome of Russia’s economy. An example of local economy corruption is the effort by the city of Moscow to bulldoze little shops in the city as part of a clean up and violation of city building codes campaign.13 This however was identified by those affected as an act by the local government to remove small businesses and replace them by big businesses that have the capacity to pay better bribes. It is apparent that corruption is an integral part of the Russian economy.

Conclusion

Since the end of the Cold War, Russia has gone through an economic transformation that was driven by an adherence to market principles. Low oil prices has forced the Russian government to abandon the free market for cronyism and protectionism. Russia depends on the global demand for oil and natural gas. It is imperative that the government does not get involved in the distortion of the market. Such distortions will only make it difficult for the economy to recover from the oil price slump. It is the price of oil that also defines the Russian state’s military aggression. Military aggression together with corruption prevents the full integration of the Russian economy. Economic sanctions damage the performance of the economy since they reduce market access.

Bibliography

  • A.O. and P.K. “Oil Price and Russian Politics: The Ebb and Flow of Federal Fortune”, Economist.com, last modified, January 16, 2015, http://www.economist.com/blogs/freeexchange/2015/01/oil-price-and-russian-politics
  • “Panama Papers: Putin denies any wrongdoing” BBC.com, last modified, 7 April, 2016, http://www.bbc.com/news/world-europe-35991263
  • “Phase Two: Russia’s Economic Problems Move from the Acute to the Chronic”, Economist.com, last modified January 23, 2016, http://www.economist.com/news/finance-and-economics/21688932-russias-economic-problems-move-acute-chronic-phase-two
  • “Russia’s Battered Economy: Hardly Tottering By” Economist.com, last modified, http://www.economist.com/news/europe/21639557-russian-economy-will-take-long-time-recover-it-badly-needs-structural-reforms-i
  • The Economist Data Team, “Oil Price and Russian Politics: A History” Economist.com, last modified, January 21, 2016, http://www.economist.com/blogs/graphicdetail/2016/01/red-and-black
  • The Economist, “The Panama Papers: A Torrential Leak. Economist.com, last modified April 9, 2016 ,http://www.economist.com/news/international/21696497-huge-trove-documents-has-revealed-secrets-offshore-business-presaging-tougher
  1. The Economist, “The Panama Papers: A Torrential Leak. Economist.com, last modified April 9, 2016 ,http://www.economist.com/news/international/21696497-huge-trove-documents-has-revealed-secrets-offshore-business-presaging-tougher
  2. The Economist Data Team, “Oil Price and Russian Politics: A History” Economist.com, last modified, January 21, 2016, http://www.economist.com/blogs/graphicdetail/2016/01/red-and-black
  3. Ibid
  4. “Phase Two: Russia’s Economic Problems Move from the Acute to the Chronic”, Economist.com, last modified January 23, 2016, http://www.economist.com/news/finance-and-economics/21688932-russias-economic-problems-move-acute-chronic-phase-two
  5. Ibid.
  6. Ibid.
  7. “Russia’s Battered Economy: Hardly Tottering By” Economist.com, last modified, http://www.economist.com/news/europe/21639557-russian-economy-will-take-long-time-recover-it-badly-needs-structural-reforms-it
  8. Ibid.
  9. Ibid.
  10. A.O. and P.K. “Oil Price and Russian Politics: The Ebb and Flow of Federal Fortune”, Economist.com, last modified, January 16, 2015, http://www.economist.com/blogs/freeexchange/2015/01/oil-price-and-russian-politics
  11. “Panama Papers: Putin denies any wrongdoing” BBC.com, last modified, 7 April, 2016, http://www.bbc.com/news/world-europe-35991263
  12. Ibid.
  13. Ibid.

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