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WORLD SCENARIO SERIES

Russia and the World: Scenarios to 2025 Executive Summary

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Executive Summary

Vozrozhdenie Long March

Oil's Curse

Russia and the World: Scenarios to 2025

Executive Summary
For decades Russia, as the dominant constituent of the Soviet Union, was indisputably a superpower. The reality today is very different. With a population of 144 million, Russia has approximately as many inhabitants as Pakistan (which, like Russia, possesses nuclear weapons), and an economy about the size of the Netherlands (population 16 million). Russia has gone through major changes since the break up of the Soviet Union, with a 30% decrease in gross domestic product (GDP) from 1992 to 1998 and challenges to Moscow’s rule in some provinces. In addition to that, declining birth rates combined with emigration and disease have shrunk the working-age population. However, at the start of the 21st Century, the indications from Russia are more favourable, not least because it has experienced a strong real GDP growth in the past five years that has created large current account surpluses and reserves. The economic boom has been supported by high oil prices—but the benefits of this increased economic prosperity are shared only among the elite, while the income gap between regions and groups within society continues to grow. While the upturn in itself is not enough to ensure sustained economic development, it has provided President Vladimir Putin with a window of opportunity, which he has used to introduce a number of reforms, including a flat income tax, a new land and legal code, and legislation on currency liberalization. Indeed, his most significant achievement has been to balance the budget and dramatically reduce IMF borrowing. Different scenario paths for Russia up to 2025 are represented in figure 1, in which the axes reflect different possible outcomes with respect to the key questions. A number of factors will influence Russia’s response to these questions : The Key Questions for the Scenarios Among the many challenges confronting Russia, two questions are key to how Russia will look in the next two decades : More recently, a number of issues have started to become more pressing, including inflation, ethnic tensions and some slowing in economic growth just to mention a few. It is thus appropriate to ask whether the combination of these different demographic, economic, social and political elements will eventually have a negative impact, or if Russia can successfully turn itself around.

Executive Summary

Will Russia be able to develop legitimate and effective governance, based on the rule of law ?

How effectively can Russia develop a broad-based economy given its extensive energy resources ?

The nature, openness and leadership qualities of the Russian elite, and its interest and ability to impose the rule of law ;

The choice of economic policy, and the extent of the freedom granted to private capital in the energy and non-energy sectors ;

The challenge of maintaining social cohesion given the country’s geographic spread and its serious demographic problems ; and,

Russia’s relations with the rest of the world.

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Russia and the World: Scenarios to 2025 Executive Summary

Figure 1: Russia and the World: Scenarios to 2025

Vozrozhdenie Long March

Oil's Curse

The Long March scenario covers a situation in which Russia continues to leverage its natural resources, to the detriment of the full development of other sectors. A gradual transition takes place to a system of governance based on the rule of law. In this scenario, Russia is able to achieve relative prosperity, but a far less benign future is also possible. In Oil’s Curse, a political class bent on its own enrichment is in charge, resulting in slow growth, poor levels of investment in infrastructure, capital flight, increased corruption

and a decline in the competitiveness of domestic industries. A radical departure from the past is also possible, in which Russia would gradually achieve real economic and social progress. Vozrozhdenie (“Renaissance” in Russian) foresees initially gradual but eventually widereaching governance reforms combined with market reforms leading to strong GDP growth, an increase in real income, and general improvement in the quality of life for the population at large.

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Long March
Russia and the World: Scenarios to 2025 Executive Summary

Long March describes a Russia that is still highly dependent on natural resources. Increasingly moderate and pragmatic conservatives make investments in oil infrastructure so as to fully leverage the advantages Russia derives from its natural resources while struggling to enforce a greater rule of law. In other sectors of the economy, international competitiveness remains limited. This scenario is set out in the notional form of a transcript in the Dupree Quarterly—an investment journal—of a keynote speech at its annual meeting in New York City in 2025.

Oil’s Curse

In Oil’s Curse Russia continues to rely heavily on natural resources. With high oil prices worldwide and strong demand for energy, the implementation of far-reaching institutional reforms and investment in oil and public infrastructure are neglected, in part due to ineffective leadership. The scenario is told as an article (by Russian sceptics) in The Online Newsletter of the Russian Development Group, aimed at potential investors.

Vozrozhdenie
(“Renaissance”)

Vozrozhdenie describes a Russia that implements a series of bold reforms under the leadership of a democratically elected President. These reforms lead to the economic, political and social rebirth of Russia. The scenario is narrated in the Online Encyclopaedia of the World (OEW) and provides a factual account of what Russia has achieved over a 20-year period.

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2006-2010: Following a period of economic upswing, inefficiency and declining productivity in the energy sector become increasingly apparent, as oil and gas production start to trend downward. Inequality and corruption levels increase, while social spending on healthcare and education is underfunded. The 2008 elections bring leadership changes and new vision to Russia. A model emerges, similar to Canada, where energy and natural resources are seen as a strategic asset that can be leveraged for both economic development and geopolitical aims. 2011-2020: The new President (2008-2016) and his successor maintain Putin’s approach to a managed democracy and a managed economy, while committing to the redistribution of revenues from the state-controlled energy sector to the population at large, improving their living standards through increased social spending. Despite the lack of serious structural reforms in the economy and public governance, the government is relatively successful in fighting corruption and reforming the military, while its focus on the energy sector ensures much-needed investment and gradual improvement in efficiency and productivity in that sector. Other industries remain underdeveloped despite their

potential, because of limited access to financing and human capital and the absence of a free-market dynamic. Energy also shapes foreign policy, drawing Russia closer to China and improving its relations with both the European Union and the United States. 2021-2025: Russia follows essentially the same path, maintaining a benign authoritarian regime and a strong involvement of the state in the economy, primarily focused on the energy sector. Advances in the rule of law and a solid increase in real income for the population in general encourage the development of a middle class that, at this point, begins to resent the state’s stranglehold on all areas of public and economic life. Non-oil industries are growing, but over the years their competitiveness on the international scene is affected by the lack of exposure to a real market economy, the strengthening of the rouble, and the protectionist attitude of the state. This in turn sparkes pressure for market-friendly reforms. Furthermore, the regions, which have benefited from more efficient administration, are beginning to question the role of the state, while ethnic tensions are on the increase. On the international scene, Russia is seen as a stable and reliable oil provider.
Russia and the World: Scenarios to 2025 Executive Summary

2006-2010: The conservatives reinforce their power in the Kremlin as despair and apathy spread among the population and high oil prices reduce the sense of urgency for the need for substantial economic reforms. Efficiency and fiscal discipline appear less important, given the revenues flowing into the state’s vaults. However, the lack of reforms, as well as uncertainty and instability, affect the economy, bringing about a substantial decrease in productivity and efficiency in all sectors—including energy, where insufficient investments in exploration and extraction affect oil production growth. As corruption undermines the rule of law, elections do not lead to any change in power or policy. Ethnic tensions increase, and the international position becomes tenser and more difficult. 2011-2020: The deteriorating economic situation spurs a number of short term measures.The loosening of fiscal policy as the government withdraws from the Stabilization Fund, without backing the withdrawals with the necessary structural reforms, actually worsens the situation by fuelling inflation and inefficiency. The state reacts by reinforcing its industrial policy and increasing its hold over the energy sector. More companies are brought under state control, encouraging an internal political struggle over the control of natural resource

companies. As the state is unable to improve the economy, more and more industries are subject to government directives. The private sector has only limited access to finance, human capital, fixed capital and management, whilst capital flight soars. Eventually, a new wave of privatization creates a second generation of oligarchs. Protectionist measures in favour of weaker domestic companies and dwindling oil production contribute to the souring of international relations. 2021-2025 : Alarmed by a potential collapse of the Russian economy, international financial institutions try to pump in funds—but these are mostly squandered without achieving any real effect. The state does not follow a long-term social policy, and welfare expenditures are crisis-driven, unsustainable and inadequate, while the number of those dependent on the state for survival—pensioners, unemployed, the poor— grows. Businesses continue to be hampered by loss of competitiveness, low productivity, and an unfavourable market environment. Internally, Russia experiences mounting centreperiphery and ethnic tensions, which often erupt into violent clashes. Externally, international relationships deteriorate as Russia unsuccessfully attempts to recreate an imperialist state, further alienating its neighbours, and eventually turns inwards, becoming more and more isolated.

2006-2010: Decreasing oil and gas production, low efficiency and productivity in all sectors, and a worsening of the business environment cause a slowdown of the economy, after years of relatively high GDP growth. Corruption and poor governance reach into virtually all areas of public and private life, and social services, such as health and education, are suffering from years of insufficient budget allocations. After the 2008 elections, conflicts flare inside the Kremlin between conservatives and market reformers, and a new Prime Minister closer to the latter group is chosen. He begins some much-needed reforms, but is eventually ousted by conservatives. As the economy continues to shift downwards, the “traditional” measures—state intervention, dirigisme, political pricing, etc.—prove unsuccessful. 2011-2020: Popular opposition following the slowing of the economy (and of income growth) and the scandals surrounding a failed anti-corruption campaign builds up ahead of the 2012 elections, and enables the ousted Prime Minister to obtain the Presidency. Over the two terms of his mandate, he succeeds in implementing some radical reforms both in the public sector (progression towards greater democracy and division of powers; civil service and army reform ; greater independence of regions vis-à-vis the centre) and in business (establishment of the free

market and gradual withdrawal of the state from the economy ; reduction of red tape and trade barriers ; encouragement of diversification to non-energy sectors), whilst also addressing the health and the education systems. Corruption is tackled, and confidence in state and business grows as the economy starts to recover, with improvements in productivity across all sectors. Internationally, Russia strengthens its ties with the EU and to some extent with the US, while its relationship with China is good in the context of the supply of energy, but tenser elsewhere. 2021-2025 : The succeeding Presidency builds upon the strong foundations created over the previous years, although with a stronger emphasis on social aspects and regional development. The diversification achieved ensures a solid and sustainable economic growth, despite the slowing in oil production, while insulating the economy from energy shocks and increasing the financial independence of the regions. The rise of a burgeoning middle class also ensures the emergence and development of a strong civil society. Abroad, Russia is positioning itself as the growth engine for the Eurasia and Central Asia region, and is perceived as a major power, with the ability to counter-balance both China and the US.

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Vozrozhdenie

Russia and the World: Scenarios to 2025 Executive Summary

Long March

Oil's Curse

Comparing the Three Scenarios
This table provides a comparison of some of the most important aspects and developments of the scenarios, with further analysis presented in the following Annex Long March
Economic performance • Strong investment in oil infrastructure, improvements in public infrastructure, limited growth elsewhere • Higher but inefficient social spending stabilizes income gap • Civil society remains embryonic—but pressures for ‘independence’ grow • Mildly benign attitude towards the West, focus on China & India • Russia has positioned itself as a crucial supplier of energy in a world where security of supply is major issue • Power maintained by increasingly moderate and pragmatic conservatives • Successful war on corruption legitimizes the central state Oil’s Curse • Strong state regulation and protection of the economy from outside forces lead to slow and fluctuating GDP growth • High social tensions due to prevailing corruption and growing inequalities • Quality of life worsens and social services close to collapse • Relationship with China thrives on the back of growing energy trade • Closer relations with EU driven by security of energy supply • US relationship grows distant • Power maintained and concentrated by small elites at national and regional levels • Dissatisfaction with ineffective governance Vozrozhdenie • Push to diversify the economy away from energy, leads to healthy and stable balanced GDP growth • Social spending and improved efficiency has reduced inequality • Greater involvement of the population in political life • Russia becomes increasingly active on the world stage and in international organizations • Greater readiness to substantially align with EU and US views. • Full development of a more effective and democratic form of governance • Transparency, personal rights and public accountability are greatly improved

Social development

External relationships

Leadership & governance

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Russia and the World : Scenarios to 2025

Annexe : Comparing the Three Scenarios
The following section allows a side-by-side comparison of the evolution of some key economic and social indicators as featured in each scenario. The underlying economic modelling and analysis has been developed, with contributions from several experts, in order to ensure that the storylines and the development of their different dimensions are both plausible and consistent with each other. Using the data The main objective of the above data is to help develop leading indicators to determine which of the three scenarios is actually unfolding. Scenario users should keep in mind that the scenarios and the related analysis are descriptions of only a set of possible outcomes, as seen from the current perspective. They should not be seen as predictions or forecasts. The data provided therefore should only be seen as a guide, and should be applied with careful judgement.

Annex: Comparing The Three Scenarios

Key indicators considered : 1. World GDP growth 2. Russia GDP growth 3. Export growth (excluding oil) 4. Export composition - Export breakdown by destination - Export breakdown by industry 5. Oil exports 6. FDI inflows 7. Percentage of people living under “subsistence level”

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Percentages

Percentages

Russia and the World: Scenarios to 2025 Annex: Comparing The Three Scenarios

1. World GDP growth
Figure A.1

World GDP Growth

World real GDP % growth p.a. (moving 5-year averages)
Long March 5 4 3 2 1 0
Actual Projected

Oil’s Curse

Vozrozhdenie

2000

2005

2010

2015

2020

2025

Source: World Economic Forum

In Long March, global integration progresses worldwide and global growth peaks in 2008 ; however, in the long run, scepticism and nationalism emerge, preventing the global economy from fully reaping the benefits of globalization and slowing down growth. In Oil’s Curse, a difficult international environment, characterized by lack of trust and instability, undermines international cooperation and integration, leading to a global recession in 2010-2014. In contrast, in Vozrozhdenie, the global economy benefits from increasing globalization and a more harmonious external environment, reaching annual growth rates of up to 4 %.

2. Russia GDP growth
Figure A.2

Russia GDP Growth

Russia’s GDP growth p.a. (moving 5-year averages)
Long March 8 6 4 2 0 Actual 2000
Projected

Oil’s Curse

Vozrozhdenie

2005

2010

2015

2020

2025

Source: Moody's Economy.com

Following the 2002-2006 period of high growth, mostly driven by oil prices and consumer demand, Russia’s GDP growth starts to slow. In Long March the maintained reliance on energy is backed by substantial investments and efficiency improvements in the sector, while in the non-energy economy, small but efficient investments lead to moderate growth. In Oil’s Curse, on the other hand, the dependence on energy is not sustained by the necessary investments; as decreasing rule of law and negative business environment affect economic performance in all sectors, GDP growth is minimal. In Vozrozhdenie, after an initial period of mediocre performance, the economy picks up thanks to encouraged diversification

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and increased rule of law, attaining higher and sustainable growth levels.

Russia and the World : Scenarios to 2025 Annex: Comparing The Three Scenarios

3. Export growth (excluding oil)
Figure A.3

Export Growth Excluding Oil

Export excluding oil (nominal, moving 5-year averages)
Long March 350 300 250 200 150 100 50 0 Actual 2000
Billion US$

Oil’s Curse

Vozrozhdenie

Projected

2005

2010

2015

2020

2025

Source: Moody's Economy.com

In all scenarios, export growth slows down significantly in the period 2006-2011, to stabilize at lower levels as of 2012. In Long March, growth remains the same throughout the rest of the period, as domestic companies remain less competitive than their international counterparts. In Oil’s Curse, not only does growth not pick up, but it remains, comparatively, at the lowest level. In Vozrozhdenie, the level at which growth stabilizes is relatively higher than in the other scenarios; moreover, growth picks up again in 2019 thanks to increasing diversification of the economy.

4. Export composition Export breakdown by destination
Figure A.4
CIS

Export Breakdown by Destination 2005 and 2025
Europe China Asia ex China Americas, Australia and Oceania Middle East & Africa Percentages

In 2005
Russia in 2005 17 54 6 15

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4

In 2025
Long March Oil’s Curse Vozrozhdenie 18 20 12 40 54 47 10 20 13 8 14 10 15

Percentages

4 2 5 5 3

Source: World Economic Forum

In Long March, the importance of the countries of the European Union as trading partners is maintained, driven by energy exports. The breakdown of export destinations in Oil’s Curse shows a slight reduction in the amount of exports towards the EU, mostly absorbed by Asia. Vozrozhdenie offers a more balanced profile of export destinations, as differentiation and globalization encourage Russia’s integration in international trade.

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Million Bpd

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Russia and the World: Scenarios to 2025 Annex: Comparing The Three Scenarios

5. Export breakdown by industry
Figure A.5

Export Breakdown by Industry 2005 and 2025
Machinery, Equipment, and Transportation Related Goods Consumer and Other Goods Services

Mined and Mineral Products Forest and Paper Products Metals, Precious Gems, and Their Products Chemical and Rubber Manufacturing

In 2005
Russia in 2005 54 3 18 5 7

Percentages

3 9
Percentages

In 2025
Long March Oil’s Curse Vozrozhdenie 36 42 21 3 18 3 23 4 27 14 18 11 12 7 7 8 20

3 13 3 9

Source: Moody's Economy.com

Long March and Oil’s Curse both depict an ongoing reliance on natural resources for their external trade. In Vozrozhdenie, differentiation and higher competitiveness of Russian businesses are reflected by a more varied export composition.

5. Oil exports
Figure A.6

Oil Exports

Crude oil export p.a. (volumes)
Long March 9 8 7 6 5 4
Actual Projected

Oil’s Curse

Vozrozhdenie

2000

2005

2010

2015

2020

2025

Source: Moody's Economy.com

The quantity of oil exports is higher in the Long March scenario. In Oil’s Curse, it is lower, due to insufficient investments and inefficiencies. In Vozrozhdenie, a greater proportion of the oil produced fuels the growing economy.

Russia and the World : Scenarios to 2025 Annex: Comparing The Three Scenarios

6. FDI inflows
Figure A.7

FDI Inflows
Long March Oil’s Curse Vozrozhdenie
Projected

Billion US$

30 25 20 15 10 5 0

Actual

1996-2000

2001-2005 2006-2010

2011-2015 2016-2020

2021-2025

Source: World Economic Forum

In Long March, Russia attracts a higher level of FDI in the period 2006-2010—directed predominantly towards the energy sector—than in any of the other scenarios. In the period 2011-2025, however, the greater differentiation and the market economy in Vozrozhdenie see a greater inflow of FDI. The negative business environment and poor rule of law discourage the majority of potential investors in Oil’s Curse. 7. Percentage of people living under “subsistence level”
Figure A.8

People Living Under “Subsistence Level”
Oil’s Curse Vozrozhdenie

Share of people Long March
Percentages

30 25 20 15 10 5 0
Actual Projected

1995

2000

2005

2010

2015

2020

2025

Source: World Economic Forum

Both Long March and Vozrozhdenie see a decrease in poverty. While in Long March this is due to the state, which ensures a redistribution of wealth through social policies and spending, in Vozrozhdenie, it is the market mechanism that guarantees a greater participation of the people in the improvement of the economy. In Oil’s Curse, poor economic performance, coupled with the absence of proper redistribution mechanisms and minimal rule of law, causes many to remain trapped below subsistence levels.

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