How to avert a Russian catastrophe

By Jim Jubak

The death by polonium poisoning of an outspoken critic of the regime. The assassination of the corruption-fighting deputy chairman of the central bank. The culmination of a blackmail campaign that forces a Western oil company to turn over control of a Siberian energy field to the Kremlin's candidate.

It's not exactly the ideal way to get into a club that has kept your membership stalled on the sidelines for 13 years.

This week, as the World Trade Organization meets, it is taking another look at allowing Russia into the organization that sets the rules for world trade. Since Russia first applied in June 1993, Albania and China have joined. The former Soviet republics of Latvia, Lithuania, Estonia and Georgia have joined. Vietnam will join in January 2007. And Ukraine stands a good chance of beating Russia through the clubhouse door.

I think it's vital that the World Trade Organization wrap up its negotiations -- tough but speedy would be my motto -- and get Russia into the club as quickly as it can in 2007. Not because Russia's economy is no longer a lawless jungle ruled by the guns of criminals in and out of the government. Not because investors, Russian and Western, are suddenly finding a signed contract protection against expropriation of their property. Not because the government of President Vladimir Putin has shown sudden interest in a truly free-market economy.

On the contrary, it's precisely because none of that has happened and none of it is likely to happen that membership in the global club is so important. Getting Russia inside the World Trade Organization, where it will have to pay some modicum of attention to the rules of the global marketplace, is Russia's best chance at saving its economy from a potential meltdown in the near future.

And the last thing the world needs at this point in time is another failed nation-state.

'Profoundly troubled'

Warning about economic Armageddon in a country expected to grow its economy 7% in 2006 may seem, well, odd. Russia is now the world's second largest oil exporter after Saudi Arabia, and soaring oil prices have made the government, if not the average Russian, wealthy. Russia is no longer the economic basket case that it was when, in the late 1990s, it signed those profit-sharing deals so profitable to Western oil companies. The deal with Royal Dutch Shell (RDS.A, news, msgs) that Moscow just forced the company to repudiate was but the most glaring example of Russia's former desperation. According to the terms of the Sakhalin-2 deal, Shell was entitled to recoup all its costs before Russia saw a penny from the oil and gas fields off its eastern coast.

But away from the current prosperity in the extractive sectors -- oil and gas, uranium, nickel, etc. -- the economy is profoundly troubled in a very obvious way. According to a recent World Bank study, no Russian industry outside the raw materials sector is capable of competing on the world market. Take a look at the Russian aviation industry, for example, which was once a leading sector in the Soviet economy.

The industry's long-range products -- the Il-96, Tu-204 and Tu-214 -- are proven and dependable. But the designs are 20 years old, and they cannot compete on fuel costs with the current generation of planes from Airbus and Boeing (BA, news, msgs). Even Russian airlines won't buy them. A new plane that its makers claim is world-class in fuel efficiency, the SuperJet, badly lags new designs from Boeing. The SuperJet isn't set to go into static testing until January.

What's the problem with the Russian economy? Start with underinvestment in research and development. According to the World Bank, private companies in Russia spend just 0.5% of their profits on research and development, compared with 1.1% in India, 1.5% in Brazil and 5.8% in China. Then add in the inefficiencies of overly centralized economic planning. President Vladimir Putin has replaced old-style Soviet industrial planning with a new style of centralized decision making that allocates capital, contracts and favors among sectors and individual companies. Finally, to finish off the list, Russia has an aging population that doesn't offer the same pool of young, cheap labor that has been the basis of growth in India, China and Vietnam.

The raw-materials sector isn't in such great shape, either, if you look past the boom created by soaring commodity prices to the health of infrastructure. For example, this winter there's a looming natural-gas shortage in Russia. That's right: a shortage of natural gas in the country that sits on the world's largest reserves of natural gas. You see, in an effort to keep its citizens happy, the central government has kept the price of natural gas inside Russia artificially low -- even as Gazprom, Russia's natural-gas giant, has ramped up to export gas at world market prices. The result: lots and lots of gas for export and not very much for internal consumption. (For my take on how Russia could set off the next oil price spike, see my Oct. 17 column, "Oil prices will leap again -- blame Russia.")

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