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Moscow Tribune
June 28, 2002
IS CAPITAL FLIGHT BAD OR GOOD?
Putin and his adviser seem to disagree
Stanislav Menshikov
So far, most people in the government and the country believed that capital flight were bad for the Russian economy. It is no secret that fixed capital stock is ageing and badly needs replacement and modernisation. By now, everybody seems to know the scary story about the economy falling apart due to massive breakdown of industrial capacity in the fateful year 2003. Experts keep insisting that only massive injection of international capital would put Russia on the road to recovery.
A few years ago, it was discovered that the economy in fact generated more capital than it used domestically and that between $20 and 30 billion was annually fleeing abroad. Estimates of total capital that has left the country in the last decade range from $150 to 300 billion. If wisely invested inside the country these moneys would have helped add to its production capacity and substantially raise its overall growth rate. In addition to asking transnational corporations to invest more in Russia the government could find effective sources of growth by inducing domestic businesses to reinvest their profits at home.
Apart from political instability, capital flight before 1998 was driven by depressed economic conditions. But since 1999, the economy is on a strong upturn, and the new president, Vladimir Putin, has clearly demonstrated that business has no reason to fear de-privatisation of illegally acquired former government assets. Yet, capital flight continues.
Last week, Putin made a personal appeal to Big Business to stop running away and to bring back part of the money that was stashed abroad. Using the carrot and stick approach, he promised amnesty for illegally exported funds and a low tax on capital that is repatriated voluntarily. Only 13 percent of the total would be taxed and the owners would be permitted to continue keeping 75 percent abroad. He also warned that offshore funds might be frozen at some point in the future. Since most of the exported capital is not criminal money according to foreign law, it is not clear what Putin meant by that menace.
Perhaps in order to demonstrate that the boss's initiative is already bearing fruit, Alexei Kudrin, the Finance Minister, and Sergei Ignatiev, the new Central Bank chairman, told an investors' conference the other day that, for the first time in a long while, more capital entered Russia than left it in the second quarter of this year. Because the quarter has not ended, this announcement is preliminary. Even if it proves to be true, it does not necessarily show that new capital coming into Russia is of domestic origin. It is too early to claim that a definite turnaround has occurred.
The problem with capital flight is deeply rooted and structural and needs more than presidential admonishment to cure. Most of the excess capital is generated in export industries, which earn a large superprofit. Some of it is re-invested by the oil, gas and metals companies, but a large part flees abroad because no efficient banking and security market infrastructure exists for channelling it into other, capital starved industries.
For instance, In 1999-2001, investment in export oriented industries increased by 86 percent, but only by 6 percent in machine-building and electric power, while in the food industry it fell by a third. In the same years, $124 billion of fixed capital was invested in the Russian economy while another $79 billion (mostly from export industries) left the country. Given adequate banking and security market facilities, a large part of that capital could have fecundated critical sectors of Russian manufacturing, which have good market potentials but are short of investment funds. Unless banking and the money market are thoroughly reformed. Putin's pleas to invest at home will not help. Those, who have extra funds, will not do so while those who do not have extra capital can neither invest at home nor stash money abroad.
Paradoxically, Andrei Illarionov, Putin's economic adviser, whose usual role is to castigate the government, publicly disagreed with the president this time around. Capital flight, he told the investors' conference, was helping reduce domestic money supply, mitigate inflation and stimulate growth. Unlike the government that was stupidly spending too much and failing to save for the leaner years ahead, the exporting oligarchs were the real patriots who were helping stabilise the economy by sending their excess profits for safe-keeping abroad.
Illarionov's idea that domestic investment is bad for the economy because it tends to aggravate inflation and decelerate growth is a discovery in the dismal science of economics that deserves a prize for absurdity, if there was one. But why this sudden disagreement with the man who pays his salary? Could it be that the president is playing the bad cop who is displeased with the oligarchs for not caring for the Russian economy while leaving the good cop role to his employee, who praises them for the same reason? If this game is meant as a pre-election ploy, it is hardly convincing. Keeping a strange adviser is certainly not a vote getter.
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