Russia’s ‘oil sickness’ erodes urgency for reform, critics say

MOSCOW — It can take Moscow residents two hours in dense traffic to drive the first 10 miles on the highway to St. Petersburg, in the direction of their country cottages surrounded by lakes and birch groves. Then the road’s real limitations become apparent.

The potholed two-lane route connecting Russia’s two largest cities has never been upgraded into a proper highway. Anyone who cares to drive its entire 440-mile length — mostly truckers — will need at least 12 hours.

But 5,600 miles away, the government spent more than $1 billion on less than a mile of bridge connecting Vladivostok with Russky Island, previously inhabited only by a military garrison so isolated that four soldiers starved to death in 1992. An additional $5 billion was lavished on the speck of land to host the 2012 Asia-Pacific Economic Cooperation summit, including a new university campus and an as-yet-unfinished presidential residence.

Visions of a North Pacific tourist destination have proved illusory, however. Few people care to vacation in a place where the temperature is below freezing half the year.

Such spending priorities reflect President Vladimir Putin’s effort to project power and engineering prowess through the showy style of today’s Kremlin.

Massive oil and gas profits allow the leadership to finance pet projects, many of which benefit those in Putin’s inner circle but contribute little to the general welfare. They suck up money needed for modern highways, regional airports, hospitals, courthouses and other infrastructure, analysts say.

State-owned factories still dominate production. Bureaucracy stunts the small businesses that are the engine of growth elsewhere. Private wealth generated in Russia is often spirited abroad, to countries where banking and investment are more trustworthy. Efforts initiated by former President Dmitry Medvedev to streamline the economy have sputtered since Putin engineered his return to the top job two years ago and shifted the focus to enhancing state control and ensuring public order.

As economic growth has flat-lined over the last six months, a sense of unease has emerged, even among state economic advisors who see more risk to stability from an economic crisis than a political one. Putin’s seizure of the Crimean peninsula from Ukraine, causing a sharp deterioration in relations with the West, is likely to make matters worse.

Some megaprojects like the 2014 Olympic Winter Games in Sochi, which cost more than $50 billion to host, were from the outset matters of prestige that few expected to turn a profit. A city of about 400,000, Sochi now has stadium seating for 200,000, four new ski resorts connected by rail, 50,000 hotel rooms and a seaport that can accommodate 300 yachts.

More broadly, critics say Russia has proved itself vulnerable to the “oil sickness” — letting short-term affluence erode any sense of urgency for reform.

“It’s like casino money. If you lose it, it’s no big deal, because you didn’t have to work hard to get it,” said Vladimir Milov, founding director of the Institute for Energy Policy in Moscow and a former deputy energy minister during Putin’s first presidential term. “The majority of the government’s investments go into projects that don’t generate further economic activity.”

Russia earns as much as 80% of its state budget revenue through commodity sales and the services they underwrite.

Oil and oil-related exports have soared over the last decade, from $50 billion a year to $390 billion, said Ivan Grachev, the State Duma lawmaker chairing the Energy Committee. But GDP growth has dropped to near zero from the double-digit boom of the 1990s, and the Finance Ministry acknowledged late last year that provincial governments’ budgets were $70 billion in the red.

Grachev disputed arguments of other politicians that a rising tide of oil revenue lifts all economic sectors. Major energy companies like Gazprom and Rosneft, in which the state is majority shareholder, spend only about 1% of their income on research and development that can create associated industries and jobs.

In a recent article for the Russia & India Report, Grachev argued for tax breaks and investment incentives to make Russia a world leader in applied mathematics, aerospace and biotechnology.

Russia ranked 28th of 58 countries in an index meant to evaluate how effectively resource-rich countries use profits for the public good, in the company of countries such as Iran, Libya, Turkmenistan and Zimbabwe. The analysis, by the Revenue Watch Institute created by the nonprofit Open Society fund, scored Russia’s resource management at 56 out of 100 points, reflecting concern about its lack of transparency and rampant corruption.

Russia earned praise for establishing a Natural Resources Fund in 2004 in which all profit from petroleum trade above 3.7% of GDP was to be set aside for future development needs. But in 2010, the institute reported, the government suspended most public disclosures of the fund’s finances, citing emergency powers needed to cover budget shortfalls during the global recession.

Leonid Grigoriev, a professor of economics and senior strategist at the Russian Federation Analytical Center, said government economists are no less concerned about Russia’s resource dependence than their private counterparts.

“We all hate this dependency on oil and gas, but the Soviets built this system and we inherited it,” said Grigoriev, who has parsed Russian finances from the time of Communist Party leader Leonid Brezhnev.

Russia’s ability to diversify is hampered, he said, by severe weather and huge distances that separate major cities from resource-rich areas where new industries could be developed. Sixty percent of Russian territory is permafrost, he said.

Sparse population east of the Ural Mountains discourages investment in roads or cost-effective air connections, often forcing those who want to travel between Siberian cities to fly via Moscow. To fly from Yakutsk, in the depths of Siberia, to Ulan Ude near Lake Baikal, a distance equivalent to that between New York and Miami, takes a minimum of 23 hours and a route through Moscow.

The economy also suffered in the breakup of the Soviet Union in 1991. Ukraine was the Soviet breadbasket and center of the arms industry. Kazakhstan inherited the Baikonur space center and Semipalatinsk nuclear complex. The Baltic states were centers of technology and light manufacturing.

A generation later, however, entrepreneurship is still in its infancy.

Timur Atabayev is a 38-year-old engineer who has designed a device that can turn off an apartment’s water supply when pipes burst. In Russian cities, where most people live in aging apartment complexes, preventing floods and neighbors’ lawsuits could well be worth the $500 that Atabayev’s Waterstopper system costs. But he has had to order custom parts and circuitry from China because there are no Russian manufacturers with the versatility to fill his relatively small orders.

It’s not feasible to build his own factory because of the bureaucracy involved, he said.

Igor Yurgens, director of Moscow’s Institute for Contemporary Development, said the country still has time to change course — about three decades, according to the International Monetary Fund and Russian experts. But it needs to get started now.

“We should care a little less about political stability and a little more about efficient management of the economy,” Yurgens said. “The state produces more than 60% of output in Russia. More than 70% of investment comes from the state. Private money is fleeing the Russian market; there was a $20-billion decline in deposits in the last quarter. This is all very dangerous.”

Putin has improved law and order, Yurgens said. And the Ukraine crisis notwithstanding, he has provided a modicum of predictability for foreign investors.

“But we long ago passed the golden middle,” he said. “This strategy of financing a bloated state sector with $100-a-barrel oil at full production can’t and won’t last forever.”

carol.williams@latimes.com