The Russian democratic transition victim of the Ukrainian crisis

The Ukrainian crisis serves Putin's geopolitical vision of Russia's neighborhood at the detriment of its economy and economic environment, deterring the long-awaited emergence of the Russian middle class.  The threat of an isolation of the Russian economy combined to its low degree of diversification would lock the Russian middle-class down and do away with hopes of a liberal democratic transition, the best bid at a safe Eastern European neighborhood.     

Civil society in the democratic transition
A healthy civil society is a necessary condition for a transition to a democracy and acts as a check on authority, provides political society and the state apparatus with new members, and fuels economic activity. However, Russian civil society does not fulfill any of the above roles.

The Russian media lacks independence needed to reflect a plurality of opinions in a democratic society: Freedom House reports that “In the 2008 presidential election, state dominance of the media was on full display, debate was absent”.  This trend was in no way reversed as the Russian state’s control of the media deepened with a restructuring of the state media and a purchase of Profmedia by Gazprom, showing further formal control of the media by governmental authorities.

In the democratization process, citizens wielding economic power categorizing them as middle-class yet who are independent from the government are of key importance: they are able to provide a material base for democratic life.  For a country’s middle-class to develop, it is important that its income both grows and spreads rather equally among its citizens.  Russian GDP does show that the first criteria is met (see graph).  However, the increase in revenues has not resulted in the expansion of the middle class nor in the second criterion being met, a more equal spread of revenues: the GINI index, a measure of income inequality, has worsened in Russia (37 in 2004, 40 in 2010, 42 in 2012).  Despite the prosperity of its economy, the existence of a middle class is considered rather uncertain by analysts such as Lilia Ovcharova.  In the early 2000’s, 20% of the Russian population constituted the middle class.


Source: World Economic Outlook 

In 2008, well into the economic boom, the population share was identical although the composition of that middle class was quite different: business people were replaced by bureaucrats who exert considerable influence on the outcome of entrepreneurial activities in the Russian red-taped economy (Ovcharova (2012)).  This is illustrated well with the income in Russia stemming from entrepreneurial activity dropping steadily since a peak in 2000 (see graph with data from Ovchara (2012)).


Source: Lilia Ovchara's Russia’s middle class: at the centre or on the periphery of Russian politics?  European Union’s Institute for Security Studies

Why the middle-class is blocked
A 2013 IMF working paper has demonstrated the importance of the diversification of exports in the avoidance of the middle-income trap.  To put the economic reasoning simply, when many parts of society are contributing to the growth of its economic, more opportunities for technological spillovers from one sector to another are possible and the mobility of both capital and human factors of production is higher.  Not only is it necessary to diversify exports but also moving up the technological ladder is necessary to avoid the middle-income trap.

Nearly 70% of Russian exports in value stem from the energy sector (see graph below for a visual presentation of Russian exports).  The 2008 Economic Complexity Index of its exports is 0,314, which is very low compared to indexes of China and Mexico (0,982 and 1,156).  As such, Russia has neither the diversification nor technological added-value required to put the country on a path of sustained across-the-board development that would warrant the blossoming of a middle class.


Source: The Observatory of Economic Complexity

The high reliance of the Russian economy on the energy sector prevents it from achieving higher and more equal growth that would permit the blossoming of a middle-class essential to a democratic state.  For as long as the oligarchic kleptocracy will thrive on the current petro-dependent state of the economy, the long-awaited democratic transition of Russia shall remain wishful thinking.

How the Ukrainian crisis affects the Russian middle class
As CNN reports, Russian lawmakers drafted a law allowing Russia to confiscate foreign assets in the event that sanctions would be imposed on Moscow.  This climate of uncertainty and risk in the protection of foreign investments, combined with the track record of the arbitrary judiciary system under the control of political powers (e.g. the Shell 2006 Sakhalin-2 project) and risks of armed conflict, is likely to drive away foreign investments which are crucially needed diversify the Russian economy beyond natural ressources and strengthen the middle class.  A weak middle class and an economic dependence on the state-controlled energy sector are exactly what Putin needs to perpetuate the kleptocratic oligarchic political system.

In this context, de-escalation efforts by the United States and the European Union may be the best bid to ensure that a democratic transition will one day occur in Russia.  International economic isolation combined with a further dependence on the petro-industry will set the fragile Russian middle class back. Nervous knee-jerk muscle-flexing might appear as an attractive option in the short run but will set the Western agenda back on the long run: sacrificing the Russian middle class by entering into an economic and military conflict to protect Ukraine is not worth the candle.  Rather, a tense path towards a non-violent outcome of the Ukrainian crisis combined with a reduction of the European dependence on Russian energy are the West's ideal strategy, though it is an ambitious one that requires heaps of political leadership and cooperation between Western states.  In the long term, a Russian liberal democracy is the best bid for a safe Eastern Europe.



References
Aiyar, Shekhar et al. 2013.  Growth Slowdowns and the Middle-Income Trap.  IMF working paper.  Retrieved from http://www.imf.org/external/pubs/ft/wp/2013/wp1371.pdf on 2013-08-28.

CNN.  Kerry on Ukraine: Solution is tough, but situation better than yesterday.  Retrieved from http://edition.cnn.com/2014/03/05/world/europe/ukraine-russia-tensions/ on 2014-04-20

Eichengreen, Barry et al. 2013.  Growth Slowdowns Redux: New Evidence on the Middle-Income Trap.  NBER Working Paper 18673.  Retrieved from www.nber.org/papers/w18673 on 2013-08-27.

Jesus Felipe.  Tracking the Middle-Income Trap: What is It, Who is in It, and Why? Asian Development Bank.  2012.   Retrieved from http://www.adb.org/sites/default/files/pub/2012/economics-wp-306.pdf and http://www.adb.org/sites/default/files/pub/2012/economics-wp-307.pdf on 2013-08-27

Freedom House.  Freedom in the world.  2012.  Available at http://www.freedomhouse.org/report/freedom-world/2012/russia-0#.UujhTvk1jIV.  Consulted 2014-01-29. 

Daniel Kimmage.  Undermining Democracy: Russia – Selective Capitalism and Kleptocracy.  Freedom House.  2009.  Available at http://www.freedomhouse.org/sites/default/files/russia.pdf.  Consulted 2014-01-29. 

Juan J. Linz and Alfred Stepan.  Problems of democratic transition and consolidation.  1996.  Johns Hopkins University Press. 

The Observatory of Economic Complexity.  Country rankings (2008).  Available at http://atlas.media.mit.edu/rankings/.  Consulted 2014-01-29. 

Lilia Ovcharova.  Russia’s middle class: at the centre or on the periphery of Russian politics?  European Union’s Institute for Security Studies.  2012 February 16.  Available at http://www.iss.europa.eu/publications/detail/article/russias-middle-class-at-the-centre-or-on-the-periphery-of-russian-politics/.  Accessed 2014-01-29. 

Reuters.  Putin dissolves state news agency, tightens grip on Russia media.  Available at http://www.reuters.com/article/2013/12/09/us-russia-media-idUSBRE9B80I120131209.  Consulted 2014-01-29. 

The Telegraph.  Russia look to control world's gas prices.  27 Dec 2008.  Available at http://www.telegraph.co.uk/earth/energy/gas/3982543/Russia-look-to-control-worlds-gas-prices.html.  Accessed 2014-01-29.  

Trading Economics.  GINI index in Russia.  Available at http://www.tradingeconomics.com/russia/gini-index-wb-data.html.  Accessed 2014-04-20.

World Factbook.  Country comparison: Distribution of family income - GINI index.  Available at https://www.cia.gov/library/publications/the-world-factbook/rankorder/2172rank.html.  Accessed 2014-04-20.  

How to build a strawman in order to sneak in an austerian discourse: CASE/mBank public seminar #131

Andrzej Rzonca of the Civic Development Forum and Polish central bank's Monetary Policy Council presented his paper "The consequences of unconventional monetary policy: what central banks do not take into account in their models?" at the 131st mBank - CASE seminar.  What promised to be an insightful look at the shortcomings of central banks turned out to be a painful example of a bad modelling strategy.

Rzonca started his presentation by comparing the macroeconomic indicators in the United States and Europe, using debt data from both (?) the IMF's World Economic Outlook at Reinhart and Rogoff (Yes, the two Harvard professors who frauded their right-wing iconic paper on national debt and growth).  He then claimed that central banks used neo-keynesian models and stated that central banks should consider 4 phenomena that impact the economy: restructuring, uncertainty, credit and public debt.

Having claimed that central banks use neo-keynesian models, it is quite surprising that the IS-LM curves, central to neo-keynesianism and representing investment (and in great part credit) and money demand, aren't considered by the author as modelling credit in the economy.

Putting the credit issue aside, high public debt was presented as a factor reducing growth, which is in line with the Reinhart and Rogoff philosophy yet is inconsistent with empirical findings.  As a case in point, Japan's high debt amounting to 244% of GDP is not described as the cause for slow growth by any serious economic commentator.

Uncertainty surprisingly made its way on the list of grievances as if central banks had never considered the idea that the future might not look the way they imagine it.

Numerical models in macroeconomics are created in a way that allows predictions to be made.  However, the more variables you input in the model, the harder it is to construct it, use it, track it, and ultimately understand it.  Additionally, for statistical reasons, you want to keep the number of inputs the lowest possible without omitting any important one.  Furthermore, not everything can be inserted in a model: that which cannot be measured just can't find its way in a model.  This is why uncertainty is not included in such models (and uncertainty is NOT the same as risk): it can't be measured (unless you believe uncertainty to exist when it is mentioned in the media, which is ludicrous). Finally, there a nearly infinite amount of phenomena which may have an impact on the economy - they are not included in models of the economy because they have no empirically significant effect on it.

It is quite revealing  that the Rzonca paper focused on theoretical causal links rather than empirical ones. What we have at play, with Rzonca's paper, is not sound and novel macroeconomic thinking but rather the recycled European austerity discourse linking public debt to the confidence fairy which is presented as uncertainty (confidence in the market, defended by austerians in Europe, was never demonstrated empirically).  The austerian discourse is a bid to slash public deficits by reducing governmental redbuiistribution efforts.  Although the confidence fairy has never been demonstrated to exist, empirical research rather suggests that non-extreme redistribution of wealth favors economic growth (see the IMF study Redistribution, Inequality, and Growth).

Central banks certainly do use neo-keynesian models, but they mainly use DSGE (Dynamic Stochastic General Equilibrium) models.  Perhaps what Rzonca really meant to say (or did say - my Polish isn't that good yet) was that central banks should include financial frictions, transmission channels and risks in their models: in that case, he should have presented the Macrofinancial Modeling at Central Banks: Recent Developments and Future Directions IMF working paper that does exactly that,  which also happened to describe how central banks had actually started doing it in 2010, 4 years ago.  Andrzej Rzonca has either poorly attempted to discuss central bank modelling without doing basic literature review or poorly attempted to copy established publications in the field.  Either way, it's not pretty.