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Playing Nice With Russia Failed

Prof. Peter Morici - 8/26/2008

Russia’s invasion of Georgia should compel the United States and Europe to alter their policies of economic engagement to promote democracy. After the Cold War, the United States and Europe sought to integrate Russia, China and their satellites into the western market economy. Policymakers believed this would encourage democracy, human rights and a peaceful demeanor toward their neighbors.

Policymakers believed robust foreign commerce and free markets—privatization, private property and western business law—would expose these societies to western culture and instigate expectations for personal freedoms and free elections. Market economies function best when individual initiative and property rights are protected by elected governments. Democratic capitalism had decidedly outperformed autocratic communist and fascist regimes. Prosperous nations, invested in global commerce, are less inclined toward aggression.

Russia instigated wide-ranging privatization and other market reforms, opened to foreign investment, and had a rocky experiment with democracy. From 1990 to 1995, GDP dropped 50 percent, thanks to falling prices for oil and metal exports, inadequate commercial law, cronyism and corruption. Output stabilized for a few and then output sank further after the 1997 Asian financial crisis. Boris Yeltsin, largely discredited, turned over the presidency to Vladimir Putin in 1999.

Mr. Putin may be a capitalist but is no democrat. He maintained essential elements of a market economy but compromised elections, asserted control over regional governments and the judiciary, squelched personal freedoms, and sought to reassert Russian influence, when possible, in former Soviet republics.

Putin reasserted state control in the petroleum industry and pushed out foreign investors. His government sized Yukos, once Russia’s largest oil producer, on trumped up tax charges and threw its CEO in jail. This preempted investments by ExxonMobil and Chevron. Similarly, Shell was forced to sell half its gas rights in Sakhalin to state-controlled Gazprom, and now Russian investigators are forcing BP out of its Russian joint venture.

Yet, Russia benefits from global capitalism. It supplies 25 percent of Europe’s natural gas. LUKOIL purchased Getty, owns 2000 U.S. gas stations, and is looking to expand into refining.

Now, Putin is imposing new tough limits on foreign investment in mining and screening foreign purchases in other “strategic” industries. Since most of Russia’s steelmaking and other metals industries are vertically integrated, limitations on investment in mining will circumscribe foreign participation in metal production.

Yet, Severstal, Evraz and others have acquired about 10 percent of U.S. steelmaking. NLMK is acquiring tube and pipe manufacturer John Maneely. Severstal is buying U.S. metallurgical coal producer PBS. Moscow is forming a state trading company to cartelize Russia’s grain exports.

Putin enjoys good fortune Yeltsin never had. Since 2002, oil prices are up 500 percent, and GDP is growing about 7 percent annually.

At home, Putin is widely popular for delivering stability and prosperity. Russians have significant access to western media and culture but do not appear widely distressed about their loss of civil liberties or genuine democracy.

Despite the compromise of democratic freedoms and property rights, Russia’s peculiar market economy is growing faster than any industrialized democracy and most former communist states.

Putin’s success has inspired nationalism. With Russian tanks in Georgia, Russia looks like a shadowy resurrection of the Soviet Union bent on bringing neighbors into its orbit, as circumstances permit.

All this confounds U.S. assumptions that economic engagement will foster a democratic and nonthreatening Russia, but these circumstances are best explained by two sets of factors.

Rapidly rising prices for oil and other resource exports have powered growth. If price increases slow or reverse, growth will slow or Russians could relive the Yeltsin nightmare, less the luxury to express dissent.

The United States and European Union have given Russia nearly a free ride on the western economic system. Russian exports enjoy fairly open access to western markets, while Moscow maintains higher tariffs and nontariff barriers on imports. Generally, Russian enterprises invest freely in the West, while western investors are increasingly excluded and their property is far from safe.

Emboldened, the bear has shown its teeth in Georgia, and other adventures cannot be ruled out. European dependence on Russian gas and the absence of consensus within NATO make this a broad menace to regional security.

It is high time the United States and EU reevaluate open commerce and dependence on Russian resources. Russian exports and investment should be welcome only to the extent U.S. and European investments are welcome in Russia. Europeans need to find alternatives to Russian natural gas.

A new realism should guide U.S. and European policy.