Russia’s position as a global energy power has been badly shaken since the global economic crisis of 2008 with the realization that its heavy reliance on hydrocarbons reserves would no longer lead the country towards economic prosperity in the coming decades. Steep declines in energy and metal earnings combined with wide-scale bank failure, the credit crunch and a big capital outflow resulted in economic stagnation for the country.
Russia’s heavy dependency on its energy sector, which accounts for more than 50 percent of the federal budget, will continue to make the country susceptible to fluctuations in energy price cycles. Nevertheless, given their extent, Russia’s political and economic future cannot be uncoupled from its natural resources. As political scientist, Professor of Political Science at the University of California, Daniel Treisman argues, “Russia’s future will be defined as much by the geology of its subsoil as by the ideology of its leaders.”
Recently, the most decisive factor that has contributed to Russian economic growth has been Russia’s energy exports, which roughly accounts for 50 percent of its total exports. Oil contributes 40 percent while natural gas makes up 10 percent of these total energy exports. As a result of higher energy prices, the Russian economy grew on average by 7 percent between 1999 and 2008. However, this growth rate has changed significantly, given lower energy prices as well as the decline in the production growth rate. Therefore, Russia’s excessive energy dependency has raised the question of whether economic growth based on high-energy prices will be sustainable in the long run.
There is no doubt the energy industry has been classified as a strategic industry for Russia, however, it has also increased the vulnerability of the Russian economy overall. To counter this energy overdependence, throughout the 1990’s and in the 2000’s, the Russian government was willing to diversify its economy by incentivizing Foreign Direct Investment (FDI) giving subsidies to manufacturing, telecommunication, banking as well as the automotive industry with the aim of strengthening Russian economic resilience against international economic volatility.
Economists have suggested that Russia needs to diversify its economic policy by focusing on other sectors such as equipment manufacture, tourism, construction, transportation, agriculture as well as logistics. In this way, the Russian economy would reduce over-reliance on its energy sector and would be less likely to be prone to energy price cycles. In order for Russia to achieve a more effective economy, the government has requested the creation of innovative plans and strategies for each sector while working closely and collaboratively with the representatives of these sectors in their planning for long-term development.
To avert the trend of heavy reliance on hydrocarbons, the government could encourage investors in different sectors as well as energy through tax incentives and the application of subsidies. This could provide a stable political and economic environment to attract more international investors in Russia. According to the Federal State Statistics Service, the lion’s share of investments between 2009 and 2011 went to the energy and manufacturing sectors, at 19.9 percent and 28.3 percent respectively.
In particular, the increased focus for FDI’s in the manufacturing sector stemmed from, firstly, the need to curb domestic demand and secondly the aspiration to re-export excessive supply. Within the same time period, however, other industries such as construction, wholesale, retail, real estate, and financial intermediaries did not appeal to international investors and therefore, foreign direct inflows remained relatively low in comparison to energy and the manufacturing sectors. Within this framework, the required market-friendly regulations for these sectors needs to be established to ensure economic diversification. This would eventually boost the local economy and strengthen small businesses because foreign investors in different sectors would be in need of local businesses for basic logistics in the region.
As long as the Russian economy depends heavily on the energy industry, Russia will not be able to take a role as a major economic power in an increasingly competitive world. It appears that Russia has not been able to diversify its economy to the desired level and thus its economy is still vulnerable to external shocks. In his presidential addressing in 2009, former President Dmitry Medvedev highlighted the fact that Russia can no longer rely on a natural resource-based growth strategy by saying, “instead of a primitive economy based on raw materials, we will create a smart economy.
