Surviving in the Global Economic Settings
Today Russia is obviously facing the wide range of global challenges, both in economy and politics. Another clear fact which aggravates the established situation as many domestic experts believe is that our country is itself an integral part of the global system. We have heard these opinions many times. However the general view would be incomplete without the opinions from abroad. Such as, for example, those expressed by Prof. Jeffrey Sommers in his lecture “Political Economy of Geo-Economical Forces Determining the Current World Order: a New Vision of the Russian Economic Development and More Sustainable World Order” delivered as part of the Russian Lectures international program of the Social Projection Institute. His view of the issue is particularly relevant as he discusses the availability of natural resources, including energy, as one of the key development drivers both of national economies and the political economy in global scale. For Russia with its continuing over-reliance on oil, these issues are of vital importance.
The worth of global economy
The global economic crisis has been lasting for almost forty years already. The recent years saw a clear sharp decline both in oil and gas prices. This decline is advantageous for the United States of America, save for large energy producers that are based in the States, and quite negative for other countries such as Russia. We can observe which trends are shown by exchange rates depending on the drop of oil process. It is obviously a serious issue for Russia.
It should be remembered that any significant change in prices generally or the price configuration of the global energy markets only often leads to the rearrangement of the global economy in its entirety. Price changes represent a kind of signaling events which may be followed by the transformation of the economic system in general.
In 1918, the world has faced an energy crisis. At that time, the energy was mainly generated from wood and coal, and the most developed world areas in economic terms were the North-Eastern Europe and China. These regions have taken the lead in economic development as early as in the late XVIII century.
The United Kingdom, for instance, owed its positions to the fact that coal, its key source of energy, was deposited close to cities. The wet climate raised an urgent issue: the coal mines were often flooded. To solve it, a steam engine was invented to pump out the water. Subsequently, the transformation of British economy based on this solution extended to the entire North-Western Europe. In China, coal deposits were remote from cities, and mines were not flooded. In this area, the methane explosions constituted the key issue which remains unsolved even now. As a result of changes in the energy sector, there emerged a large gap between the economic development of China and that of the North-Western Europe which changed the entire situation for long.
Further significant changes in the global history were connected with fluctuations of grain prices. Grain is another key factor with the potential of reconfiguring the world economic system. During the 1920-ies and the 1930-ies, the grain prices slumped. This slump influenced the development plans of the Soviet Union as regards industrialization. Through the grain supplies, the Soviet leaders were expecting to obtain funds for the purchase of required equipment. But due to the price slump the Soviet Union faced its widely known crisis in the 1930-ies. The industrialization was completed of course, though, but for the decline in grain prices, it would have been accomplished much smoother, probably more successfully and less sensitively for the Soviet people.
Back to the energy issues, in the 1970-ies the severe crisis has broken out in the United States of America, mainly because of the oil price change. They increased slightly lower than by 1000 %. It was a strong hurt both for American and European economy.
During the 1980-ies, the United States of America and Saudi Arabia have artificially created the oil crisis to affect the Soviet Union, and succeeded in this effort. The collapse of the Soviet Union was followed by a great economic boom in the United Kingdom, the USA, while Russia, accordingly, lost its capital. The exported money were settled in the pockets of owners of the former state assets and then sent to the United Kingdom and the USA through the offshore banking systems of Cyprus, Latvia etc. That money has contributed to the economic growth in the USA and the United Kingdom, and caused the stock market boom. In practical terms, it was the transfer of tangible values - and the resulting loss of the investment capital by Russia.
Oil as a core weakness
In one respect, the discovery of large oil deposits supports the economic growth. However in other respect, the overreliance on oil money has already become an Achilles heel for the Russian economy. We may see the extent of Russia’s dependence on oil revenues as compared, for instance, to the USA. In Russia, the state hydrocarbon revenues amount to approximately 50 %, while for the USA the same index is almost equal to zero.
In the USA, this misbalance is set off by consumer purchasing power and recovery of production capacities. Also, it should be remembered that oil production in the USA remains relatively cheap, even including the shale oil, the production of which, if taken alone, is not cheap at all. The Baken deposit as one of the main shale oil production drivers in the States generates profit at $42 per barrel. However the continuing improvement of drilling and production processes pulls this price down.
This boom in production of oil may negatively affect Russia in two possible ways. First, it may cause reduction in the state revenues. Second, Russia is striving to become a world leader in export of grains, but the grain prices will sooner or later go down driven by the negative dynamics of oil and gas prices.
Also, the higher production of oil and gas in the USA will cause the government to diversify the use of lands where the biofuel is produced to involve them into agricultural operations. This change will accordingly boost the reduction of prices at global food markets. There is some hope however that this trend will be slowed down by efforts of the US powerful agricultural lobby which possesses significant tools of political influence. However it will hardly manage to change the situation radically. There will be of course the attempts to obtain grants for the production of bio fuel, but at some stage the market self-regulating power will cause the government to redirect these lands towards agricultural uses.
Russia should learn to invest money in domestic economy and, what is of key importance, in research and development projects (R&D).
Global economy and geopolitics
The saying of Carl von Clauzewitz “the war is the continuation of politics by different means” is as relevant today as ever. It can be said that the modern war is made through the control over oil prices. It is quite probable that oil pricing and output terms are negotiated between the USA and Saudi. Both of them have been considering the reduction of prices since 2011. Both countries maintain the geopolitics intended to change the situation in Syria, and the overthrow of Bashar Asad is now also in their wish-list. Russia takes efforts to overcome this geopolitical situation, like in Ukraine, by the regulation of oil prices.
Another important point that should be emphasized is the fluctuation of prices for natural gas. Their variance is advantageous for the USA, especially where the natural gas from new shale deposits is used. On the contrary, prices in other countries have started growing after 2010, thus providing an enormous privilege for the USA in terms of gas costs and its economic benefits. In some cases, gas is cheaper in the States by one third than in certain European countries. It implies that consumer costs of electricity are also one third lower than somewhere in Europe. As a sequence, the United States of America started drawing the direct foreign investments for their production sector. Many West-European producers are launching their facilities in the U.S.
What about Russia? We also have a good chance to respond in favorable manner. I have no doubt that Russia uses its best efforts to start benefiting from low cost of electric power which seems to be almost the same as in the U.S. From the economic prospective, the industrial development and attraction of foreign investments provide conditions for successful operation in the settings of the current economic crisis. No profit will be generated in a short run of course, but it can be reasonably expected over a medium and long run. The Russian pricing policy is quite favorable for the growth of production, especially in automotive sector. On condition of its being applied expediently, the Russian Federation will certainly benefit from it.
In addition, the common interest for the States and Russia is to maintain low prices for natural gas in the USA. Exactly in the USA, because Russia will be able then to direct its efforts against the expansion of hydraulic fracturing process in the gas production sector. Russia has a potential to influence the mass media and shape the public opinion. This position strongly requires support of industrialists and the nationalist-minded groups within the USA in order to prevent the raise in domestic gas natural prices and exports.
The large energy producers are certainly interested in construction of LNG terminals for export purposes but it would not be beneficial for the countries at least because the provision of the port infrastructure will take too many years. If the US industrial community manages to freeze the current situation, they will be able to enjoy the favorable gas prices. The Russia’s advantage in this case will be that the cheap American gas will not reach the European markets and there will be no competition prejudicing the traditional Russian areas of interest. The same consideration applies to Japan and China. Russia may initiate the dialogue with American industrial community to convince them that their gas should remain inside the country instead of being liquefied and exported. This position would contribute to the development of American economy on the one side, but allow Russia to maintain relatively high gas prices and enhance its share in European and other gas markets on the opposite side.
The key force which would obstruct this plan is the so-called foreign policy “hawks” who desire to use the energy sources to weaken the Russia’s positions and anchor the USA strongly in the international energy markets. But today’s American society is rather interested in reduction of tensions and more relaxed relationship with Russia. U.S. people want cheaper energy and more jobs. This situation plays into the hands of Russia.
The drop in oil prices may boost the global economic development. The markets will see a growing demand both for renewable energy sources and fossil fuels. The metal prices may start growing accordingly in the long run, as the recovering world economy will be actuated by cheaper energy. In the meanwhile, however, we may observe the reduction in prices for energy sources and commercial metals which is disadvantageous for Russia as one of the world’s leading metal exporters. This situation will change as soon as the global economy steps out on the growth trajectory.
The Russian future
Considering Russia’s strengths and weaknesses, if it fails to raise more foreign capital or retain its own, or attract the best brains, its future wouldn’t look very good. Russia should learn to invest money in domestic economy and, what is of key importance, in research and development projects (R&D).
R&D and related innovations should be considered as the potential areas of economic growth. Since the crisis of the 1970-ies, the global economy has experienced the tremendous changes due to which the capital was transferred from manufacture and accordingly research and development to the finance sector.
The famous Ford’s economic model which, in its days, helped to develop very efficient methods and practices of large-scale industrial production based on a single company and had a prominent importance as an R&D funding paradigm was substituted by completely different approach. It offered an innovative organization of business and manufacture. Major corporations started disposing of their non-core assets and trying to concentrate on their key operations through outsourcing of majority businesses, focusing more on profitable financial transactions only, with low concern about what could be produced as a result of research and development, just because there was no room in that new model for R&D.
The said new model which is known as an “open distribution model” has produced new distributorship products instead, like Walmart. What we now observe is the Walmart-ization of the economy, with changing relationship between distributors and manufacturers. A distributor becomes so powerful that it may impose prices and all other terms on manufacturers. Thus the need in R&D as a key source of innovation for the development of new products is eliminated.
The deviation from the path of innovations and R&D generates a risk of their total destruction. For the time being, they are not totally destructed but moved to the areas of more favorable environment. Within the framework of the post-Ford model, American corporations transfer the R&D and innovation activities to public and state universities which become a kind of their last bastion. At the same time, by transfer of R&D under control of the government, these corporations obtain the reduction in their taxable base.
The situation is essentially controversial: it is impossible to provide support to R&D when the government cuts the funding of universities which create innovative products, because the general development vector is now changing. As a result, the support available to universities becomes progressively smaller. After the collapse of the Soviet Union, the funding of R&D projects has virtually stopped.
This is a global trend, with local differences however. The largest GDP portions are allocated to research and development projects in the USA, Finland, Japan, and Sweden. Many countries use the money intended to support R&D in applied and not fundamental studies. As a result, they do not prepare the necessary basis for investments. In fact, many companies only declare that they are engaged in researches but use them as a loophole to avoid taxes or have some tax credits and other privileges. As for Russia, it is almost in the bottom of this rating with just about 1 % GDP spent in R&D projects. Such a low level of R&D expenditure will hardly allow the country to survive in the modern global economy.
The choice of the most effective ways to fund this sector is a big issue closely related to a variety of tax escape practices. On the side of the USA, we can see that between the 1940-ies and late 1960-ies that country maintained the highest upper threshold of taxation and simultaneously the highest level of economic growth and well-being. That is not to say that there is a strong causal relationship but some kind of connection is obvious. The highest limit of taxation reached about 90% during that period: thus, it was a threshold for an income above USD 3.6 million. Ninety percent of such income should be returned to feed the economy. This policy allowed, first of all, generating funds for the infrastructure investments, and, second, employing money in R&D sector. It was actually based on a simple logic: nobody will want to give money for nothing, any businessman would prefer his 90 % to be used in the development of his own enterprise, innovations and R&D projects. Therefore, even escaping taxes, they were still creating the value.
What should be done then?
The solution invented in the 1970-ies to overcome the crisis was to increase the investment capital by reduction of tax rates. The released money was intended to fund R&D sector, but in reality it was used in anything else but research and development.
There are all grounds to believe that the economic ideas of the 1930-ies would fit the current crisis settings. We have more than sufficient resources at hand but do not use them appropriately.
During the 1930-ies, many economists and governments, regardless of their ideological attitudes, whether in the USA, the United Kingdom, the Soviet Union or Germany, believed that the economic thinking needs to be changed. The methods they were employing have overturned the conventional views of economy.
Here are some possible solutions for the future. It is necessary to develop and adopt the international agreements for the control of offshore banking systems. Further, a land tax must be introduced. Landowners should be encouraged either to use lands or pay tax on them at considerable rates. Property should not remain unemployed, it must generate income for the state. By the way, if such taxes are introduced, the prices for property will drop and this money will be released from financial sector. Where will they be used then? In the production sector. I am absolutely sure that this measure will be very easily implemented and render a significant positive effect on the economy. But its implementation requires first of all a political decision.
The public sector must be changed and transformed into the source of new technology development. Other measures should include the increase of wages, and also increase of taxes on capital and property so that they were not “standing idle” but could work for the state and economic development. As a last method, I would propose to deploy the dual currency system allowing the development of local industries.
It would be relevant to recall the principles of economic recovery that appeared in Germany during the 1930-ies. Unemployment causes poverty, jobs produce the material wealth. Capital does not create jobs, but jobs do create capital. These all are simple statements, but interesting.