For the latest meeting of the Exclusive National Club of Top Managers we invited Andrey Illarionov, a Russian economist who became more fashionable after his recent fall from Vladimir Putin’s good graces. He came to Kazakhstan in order to participate in the conference on risk management organized by Eurasia Insurance Company. His opponent in the present discussion, as it turns out, has become his Kazakhstani analogue, professor Arystan Yesentugelov. The theme of the discussion was political and economic risks in Kazakhstan.
The “natural resource curse” is not real
A significant portion of the economic potential concentrated in the sector of natural resource production and export is connected with a complete set of so-called macro risks. Since both Kazakhstan and Russia are countries with such potential, and consequently those macro risks can be applied to both nations. Many publications have been devoted to the analysis of how this alleged natural resource curse acts. Practically all observers have found the following strong connection: countries in which oil production contributes a significant portion to the economy grow considerably slower than those that import oil. However, the traditional economic model predicts the opposite. Later on, oil exporting countries, as was discovered, have much worse indices as regards macroeconomic policy, namely huge volumes of funds reallocated via the state budget. The same countries suffer from high rates of inflationary pressures and populist policy, while the primary institutions of civic society are subject to destructive tendencies to an incomparably higher degree than in those countries that are oil importers, and so on. All of these phenomena are described by the natural resource curse.
Many specialists in political science have dedicated a lot of time for research into how and why this happens. My minor contribution to this work has been done under the premise that no natural resource curse exists, as oil and gas do not differ in any of their physical, chemical or natural characteristics from coal, gold, or ferrous and non-ferrous metals. They differ only by the authorities’ approach towards these particular resources. If officials make a decision to monopolize or nationalize production, processing, transportation and export of oil and gas, then what has been described by all those authors as the natural resource curse happens. Yet, if the authorities carry out a policy of privatization of those resources, then nothing special happens to them to create a difference from any other natural resource, be it coal or agricultural produce.
And so, here are some simple recommendations. If one wishes to have problems, one should follow a policy of nationalization and establishment of state control. As a matter of fact, the list of such countries is quite self-expressive. In 1958, Venezuela became the first country to take this action, and as a result has undergone 50 years of nonstop regression. Further on there were Iran, Iraq, Saudi Arabia, and others. This list is quite well known. The other group includes those countries which privatized their oil resources: the USA, Canada, Great Britain, Holland, Australia… Norway is the most interesting example. Having begun in the 1970s with a 100% state-owned oil sector, this country sells [the rights to] new blocks each year.
I know that the decision to privatize energy resources is accompanied by long discussions, and a large amount of disagreement exists within the political and public spheres. Energy resources are assessed as a national treasure, national reserves and national pride, which under no circumstances should be transferred to any private or foreign company. This is a very severe, dangerous and harmful prejudice that has led to impoverishment, as well as economic and institutional decay, in many countries. Fighting this is not easy. Both for you, and for us in Russia, reacting to this is often quite difficult. Nevertheless, the objective reality is as described.
We have improperly used [Michael] Porter
First of all, I completely agree with the statement that resources turn into a curse if wrongly utilized. It is enough to say that in Mexico during the 1960s the curse was caused not through oil resources, but by agricultural produce, the export of which resulted in a significant inflow of U.S. dollar revenue. Chile has suffered from an excess of copper. And, so on… With regards to privatization and nationalization, the process of privatization began in Kazakhstan in 1993. I participated as a member of the working group appointed by the government for negotiations with Chevron. At present, very few people remember how difficult times were in Kazakhstan then: no funds, no appropriate human resources, no equipment, no forex, no currency reserves… This is why the state decided to privatize a number of its oil companies.
At present, many young people who received their education in the USA and Europe ask me, “Why do we not nationalize our oilfields?” they are motivated by the fact that we do not have private investment into the processing industry, while foreign companies receive the lion’s share of the revenues. To be honest, just in 2005 investors exported US$5.2 bln. And what would Kazakhstani investors do with such an amount. Earlier, I thought that Russia, which allocated its oil reserves to domestic investors had won. But alas, today Andrey Illarionov has brilliantly proven the opposite using the numbers.
He has also said warm words about the economy of Kazakhstan and the effectiveness of natural resource utilization. I agree with him, if we speak about the period from 1994 up to 2002. However, unfortunately, research shows that starting from the second half of 2003, especially during 2005, changes occurred in the form of the active involvement of the state in the economy. This immediately led to the weakening of budget and credit policies. The state began to invest into the production and processing industry, agriculture, and, naturally, into infrastructure, which has been accompanied by a policy of active protectionism. The stage of benefits and special economic zones has started. These had been thrown off at the end of the 1990s, but are now considered as a major factor in increasing the competitiveness of industries and for the building of [industrial] clusters.
Interestingly enough, by inviting Michael Porter, we were able to harness his authority, but ignored his recommendations, which excluded the creation of free economic zones and the increasing of competitiveness by allocating privileges. But, now all we have is protectionism. Where protectionist policy occurs, there is growth in corruption. These two are inseparable. As an outcome, a serious threat has occurred in the form of macroeconomic destabilization. First of all, due to the large growth in available capital, in which oil dollars have played a significant role, the National Bank [of Kazakhstan (NBK)] has shown its inability to manage such a flow. Moreover, implementation of such an expansionist fiscal policy creates more difficulties. Banks are trying to minimize the money supply, through carrying out a stricter credit policy, while fiscal policy is heading in a completely different direction. If one speaks about budget expenses as a share of GDP, the State Statistics Agency announced that in 2005 this number was 26%, in 2004 – 23.9%, and in 2003 – 23.2%. As per data from the Ministry of Finance, in 2004 this index was 30% of GDP. In comparison with 2002, changes in fiscal policy are quite apparent.
Only private investment is effective
Your comments only confirm my conclusions. And thus I am surprised why Western specialists recommend nationalization to me. Seeing the state of Europe over the past 50 years as it has slowly lapsed into economic uncompetitiveness is enough. With regards to those US$5 bln, which were taken out of Kazakhstan, let us assume that this amount had been invested inside the country. Under the same conditions, if this had been done by the private sector, as a rule positive results would emerge. However, if such was done at a rate significantly exceeding the possibility for the national economy to absorb those investments, this could really lead to an increase in the exchange rate of the national currency and in the general level of expenses within the economy, as well as to a decrease in the rate of national growth. Consequently, resulting in uncompetitiveness. This is why two contradictory trends exist, and finding the golden midpoint is quite complex. At least one thing is quite definitely clear, if such investment is made by the state, the rate of return is very low, sometimes even negative.
With regards to state investment within economic policy since 2003, unfortunately that positive return reached by Kazakhstan in the 1990s has gradually been eaten up, and in turn Argentine disease is arriving in the form of the industrial innovation development strategy. It is important to pay attention to the fact that during the past few years there has been an average growth rate of 10.4%, whereas returns should have been much higher with oil prices being at three to four times their previous levels. Yet instead of increasing this [growth rate] has decreased. If we speak about Kazakhstan, the potential rate of economic growth is 12-14%, even if oil prices were US$20-30 per barrel. Taking into account current prices, the growth rate should be around 20%. The fact that these rates are not fantastic can be proven by the example of Azerbaijan, with growth in GDP last year of 22%. So, from both the theoretical and practical points of view, the growth rates of our economies could have been significantly higher. The difference between the current 9% and the potential 20% shows what possibilities had not been realized.
I would like to draw your attention to the point at which you said that Russia allocated its natural resources to private investors, and to what this led. Even during the Russian “economic miracle” in the oil sector during the period of 1993-99, when the major share of oil produced was done so by private companies, the investment growth rate into the industry averaged 20% per year. And, those were investments by private companies. Rosneft increased its investment level by very little. However, when the state began to take back private assets, investment fell by 20% in 2004, and by an additional 4% in 2005. Consequently, if business activities are carried out in a private sector that feels confident of its future, investments do grow by ever increasing rates. The same patterns occur both in Russia and Kazakhstan.. But, to be honest, this disease is not so deep and widespread as in Russia. The additional aim of my visit here is again to warn you about those problems that can be avoided, or acquired, if you continue in such a direction.
I have a potentially provocative question. Let us assume that you, Andrey Illarionov, are president of Russia, what immediate steps would you take? I ask the same question of you, Arystan Yesentugelov.
To your provocative question, I will give a like answer. Naturally, however long we were to talk, we would move in one and the same direction. We will not say anything principally new, which is not known within the science of economics. We can provide further arguments and examples, additional historical peculiarities, national realities, industry specifics, and so on. Nonetheless, all of this is known to the world and to economics. This is not the first century of civilization. However, in some countries there are people who are not aware of the science of economics, but still they possess political power. A question arises: why in some countries are correct decisions taken more or less regularly, while in other countries erroneous ones are frequently made? And then, rich countries grow to be richer, while poor ones become more penury? In reply to your question, I will provide such a provocative answer. And, I would suggest that we all consider it together.
I have already answered a similar query in one of my interviews. Under the conditions in Kazakhstan, creating a competitive economy is very difficult. Within our programs, we make assumptions based on the world economy always having available niches, but in reality there are none. The only variant is to push someone out. But, our competitors are not just sleeping – they also work. Besides, we have not been lucky concerning them. We have China on one side, and Russia on the other. Yet, we do not have the opportunity to choose [our] neighbors. Thinking that we can defeat China in very labor intensive industries would be foolhardy. Outdoing Russia would be more difficult, as it exceeds us as regards scientific and technical potential. A colleague of mine from the USA, Boris Rumer, a professor at Harvard University, believes that we have arrived at a dead-end. When I participated in the creation of the industrial innovation development strategy, I placed a lot of hope on setting up of joint ventures with foreign companies. We want to arrive at the level of social and economic development prevalent in those European states with mid-level development. This has already become a declared plan. However, we build everything along Asian lines. We study the experience of Malaysia, Singapore, South Korea, and now even that of Mexico. The second action I would take is the removal of barriers to business development by liberalizing economic policy.
I did not hear a reply to my provocative question, only another provocative question. Here I can draw the following analogy. An influenza epidemic can happen in any country, and so each maintains its own position, each prescribing a slightly different course of treatment. Everything just depends on the immune system of the patient himself, as well as the professionalism of the doctor. Therefore, I would like to inquire of this experienced doctor, Andrey Illarionov, what he would prescribe to his own country. And, our country would, as usual, copy this.
(Forum of Entrepreneurs of Kazakhstan – FEK):
In recent times, inflation has been growing in our country. Is this a macro risk for Kazakhstan? Secondly, it is believed in our country that second-tier banks, as well as long-term infrastructure projects, create inflationary pressures – how harmful is this? Does it mean that we should forgo such projects, as well as in some way limiting those activities involving the provision of credit by second-tier banks? What in reality do we consider as our strategic goal? Is this a fight against inflation, or still economic development? One more thing, in my opinion a high rate of economic growth is not the final goal, with the most important thing being the achievement of steady growth. What, in your opinion, threatens high rates of economic growth in Kazakhstan, aside from inflation?
Better to be rich and healthy
No doubt, inflation is a risk. However, we should understand what it represents. It is an inflationary tax on the balances in the bank accounts of legal entities within the country. This means that all your savings are depleted by the applicable tax at the then respective rate, translating into making you poorer by [say] 7-8% annually. With your own funds, literally, you are financing those projects about which you spoke, and is a decision not made consciously, but one taken for you. And, when a person enquires as to what an acceptable inflation rate is, the scene is reminiscent of one from an old western film – a dead enemy is the best enemy. Having no inflation is the best inflation rate. Is this possible or not? It is. Should somebody say that inflation and economic growth are inseparable, do not believe him. This point of view has no scientific basis.
The next question is whether second-tier banks influence the rate of inflation. This opinion is proof of a deep lack of knowledge about monetary theory and the nature of inflation. Let us all recollect Friedman’s formula once more: inflation is the result of three major factors – money supply, velocity, and real output. Velocity is the major factor in the growth rate of the money supply. This is why second-tier banks cannot influence inflation, however much they might wish. If any party holds sway over inflation, it is the National Bank, which is responsible for issuing currency.
What is more important: high growth or sustainable growth?
A large amount of research devoted to economic growth has confirmed as a rule that high growth rates are sustainable. As regards low rates, they are the least sustainable. This is why I would say that it is better to be rich and healthy, than to be poor and sickly.
Finally, something about corruption. A statement well known to each of us struck me: there are lies, there are big lies, and then there are statistics. One may rephrase this to read as: there is corruption, there is massive corruption, and then there is profit motive. We all know that all big projects are formally announced for certain purposes, yet anyone who is more or less familiar with what goes on behind the scenes understands that such projects are begun for a completely other reason – the division and reallocation of state revenues. Though this process is not commonly referred to as corruption, in reality the phenomenon is much worse than ordinary graft, as in such cases resources are wasted in the form of added costs, instead of being used to produce additional value. As well, such behavior is focused on allocation, reallocation and consumption. Here again arises the same question: why do some countries follow one behavioral pattern, while others stick to the opposite. There could be many answers to this query, yet the key one is in the nature of institutions. Corruption has in fact two major enemies. The first is the limitation of geographical size. In making allocations from the state budget, the smaller a nation is, the less regulation it will have in place. Consequently, less power is available for state authorities in making allocations.
The second major enemy of corruption, which scares it to death, is the level of freedom available to mass media and advanced civic and political institutions. The point is not that the U.S. and Switzerland do not have corruption scandals (as they certainly do), but they are all made available for public debate. A system of moral assessment develops, and therefore those who have demonstrated corrupt behavior must resign.
Growth in the money supply and loose fiscal policy are believed to be the two causes behind inflation and strengthening of the exchange rate. I consider that external borrowing as completely normal. Under the conditions of a market economy, everyone does what is most profitable. I do not think that private banks disregard the issue of risk when borrowing funds, though our observations prove that only 5% of the charter capital of businesses is funded via credit. At the same time, the amount of credit continues to grow. Over the previous three years, the mortgage volume has leapt by 71 times, and that of credit in general by 22 times. However, this is not dangerous. We have the National Bank to oversee the situation. In all developed countries, the refinance rate influences economic growth, the inflation rate, and the forex rate. Though, unfortunately, it does not play such an important role in our country. Why does our economy not react to the refinance rate? This is the issue. Regarding state investments: I would like to, add to Mr. Illarionov’s statement, they enhance inflation, since the large amounts of money coming in create a surplus in the national budget to form state savings, which is then thrown into the market, with a portion entering general circulation. As regards private investment, the situation is the opposite, as capital that had been in circulation becomes tied up.
(BankTuranAlem – BTA):
I would like that statement to be noted – finally, we have heard from these respected economists that banks are not to blame for inflationary pressures, as domestic banks have begun to suffer from an inferiority complex. Having made such an effort in order to gain trust on the international markets, we now hear that the traditional responsibilities of the banks are the source of all evil. With regards to the statements that we all want to live in a rich country and make the correct decisions. And concerning the statement that the credit volume has increased, we had started from zero, Mr. Illarionov. Not surprising is that instead of one dollar, we have begun to take in one-hundred dollars at once. This is not such brisk progress in the drive to meet the demands of our population. We still have a long way to go in order to reach that level. The amount of loans is still quite low, which is a consequence of the fact that other industries are still lagging behind the banking sector as regards development.
Vladislav Li (Bank Cc):
When we speak about what has or has not been developed in the banking sphere, we need to take into account that the assets of the banking sector of Kazakhstan comprise 62% of GDP. The number is much lower than, for example, Eastern Europe. The index in Poland is 70%, in the Czech Republic – 90%, and it is even higher in the eurozone. This means there is still much left to do as regards this issue. Concerning growth in retail banking, the standard market rules also apply here. Competition between companies is increasing, and the situation among the companies has reached such a point that they are capable of borrowing both domestically and abroad. This is why banks are transferring to the retail banking side, turning from the most highly profitable segment to the mass one. Secondly, banks in Kazakhstan are actively applying their competitive advantages in moving onto other markets. And, why not? In my opinion, we speak about one thing, though assume another. Actually, the situation is quite simple. And, to me it seems that the state should be doing it own work…
(Association of financiers):
Mr. Illarionov, can you please give us an example of a country with a similar economic structure, in which the living standards have increased and where there has been a massive updating of technology and equipment? As, our officials go either to South Korea or to Mexico. Perhaps they should be going to a completely different country?
There are many examples. Two countries qualify as textbook examples, which had similar per capita GDP at one time: South Korea and Ghana. Over the past 50 years, Ghana has regressed in development by 30% in comparison with the level of 1955. While, South Korea has become much richer. Botswana is country in the middle of the African continent, with no access to the world’s oceans, a small population and quite limited domestic market, and shares borders with complicated neighbors; but, it has a resource purse in the form of diamonds. Are they at a dead end? Nothing of the kind. Why? They have adopted a very applicable and reasonable policy. As regards the economic growth rate, it has been included into the list of global leaders over the past 30 years. The country’s per capita GDP is much higher than many other, richer African nations, and even Russia. This was a very unpleasant discovery for Russian citizens: a number of African countries have a much higher per capita GDP than Russia. If we are to speak about the number of global record breakers, Taiwan has been one of these over the past 50 years. In 1949, this country had 6 mln illiterate people, a third of which was the Chinese army. Nobody can imagine a worse situation. Nevertheless, thanks to the implementation of a reasonable economic policy, Taiwan is one of the most economically developed states. Also, there is a “small” country known as continental China. In the 1950s, following the civil war, China had the lowest per capita GDP in the world. During the last 25 years, the country has completely changed. So, if you want hope – here it is. If we look at the Irish, their country was the poorest in Europe. And, then they decided to change this, and eliminate the dependence on Great Britain. Over the past quarter of a century, they not only became a Celtic tiger, but also have had an average growth rate of 8%, surpassing Great Britain. Can you imagine what a slap this is for British, who consider themselves to be the core of Anglo-Saxon capitalism, the motherland of the Parliament, and of many other things?
There was a period in the history of modern Kazakhstan, from the mid-1990s up to 2000, which will be included into all economics textbooks as an example of the implementation of a quite decent economic policy, though this was not as brilliant as those of Ireland and Taiwan. To me, it seems as if you have diverted from that course. Today, the major question before the Kazakhstani authorities is: whether to continue along the route that leads to destruction, along which Russia has already preceded you, or still try to make a return to that trajectory chosen in 1995?
I wish you luck and success, and not the opposite.