Misreading Russia, and Why China Should Care

Igor Shuvalov, Russia's first deputy prime minister, is honest enough and happy to discuss his country's problems with foreign journalists. But in looking at Russia's specific problems, he sees only material problems, and not those of the spirit. He looks at technology, but overlooks Russia's core problem: its own system. Without even this basic understanding, various "central plans" and "grand plans" not only lack substance but are unlikely to go very far.

Problems in the former Soviet Union were systematic. The failure of 30 years of economic reforms in the post-Stalin era from the 1950s to 1980s stemmed from an inability to fundamentally transform the system of a totalitarian, planned economy. This painful failure lasted two generations and eventually led to the disintegration of Soviet ideology, and its system.

Russia's problems today are still systemic. The chaos surrounding the dissolution of the Soviet Union, and superficial understandings of the country's systemic problems among the policymakers in the 1980s and ‘90s, transformed the totalitarian planned economy into a confusing, anarchistic and then oligopolistic, vastly unfair, non-competitive market economy lacking order.

Such a competition-suppressing, oligopolistic market system works against innovation and entrepreneurship. The door is narrow for innovations tied to market activities as well as managed, conceptual and technological innovations. Meanwhile, an oligopolistic government and extreme inequality corrode the country's youth. Their youthful pursuit of spirit is replaced by base desires for material wealth and privilege.

This explains why Russia, though historically replete with talented individuals in science, technology and the arts, has been reduced to a producer of oil and an exporter of energy. It has slipped in areas of higher education and scientific research, falling far behind many other world powers.

The speed of Russia's scientific and economic decline has been beyond imagination. On a technological level, its economy has fallen almost as far behind as those in Arab petroleum-exporting countries. Not only is innovation out of the question but, aside from weapons-making, Russia has little manufacturing to speak of. If it were not for the black gold under its soil, Russia would be one of the poorest nations in Europe, and the so-called BRIC nations, a term coined by Goldman Sachs for developing economies in Brazil, Russia, India and China, would be reduced to BIC, a French brand of ballpoint pen.

Shuvalov's blaming of Russia's systemic problems on "old industry" and other straw men is a clear misdiagnosis.

Turning to efforts to develop Moscow into a financial center, Shuvalov discusses its advantages over New York, but his reading is a bit shallow. International financial centers rely on their attractiveness to international investors and financiers. One important condition for producing sustainable appeal is a system that ensures investment safety, especially an independent and impartial judicial system. This is why financial centers throughout history have sprung up in cities with the best legal systems for the times, such as Amsterdam and London.

Today, each of the world's financial centers is widely recognized for having an excellent legal system. At one time, thinking the newly created euro would grow stronger than the British pound, Germany tried to turn Frankfurt into a financial center that surpassed London. But that effort has long since been completely forgotten. Of course, this argument also applies to efforts to turn Shanghai into an international financial center.

In short, when Shuvalov emphasizes President Dmitry Medvedev's modernization program, especially the five directions of modernization in Russia, he brings to mind China's "four modernizations." This was a program promoted by former Chinese Premier Zhou Enlai.  After the Cultural Revolution, China's economic reforms got under way. Thirty-odd years of lessons from economic reform since the Cultural Revolution have taught us that without systemic reform, and when human freedom and creativity are suppressed, a modernization program falls short of its goals.

Invention and innovation require freedom; entrepreneurs and investors need confidence; consumers need protection; modern economics and technology require clear and transparent information. All these require reforms to a system that impedes progress. These are my feelings after reading Shuvalov, and it's why I worry about stagnation and a retrogression of China's reforms in recent years.

The author is a professor at the School of Economics and Finance, Hong Kong University.