By Yong Kwon

Vladimir Putin was ceremoniously reinstated as Russia’s head of state last week. The country is relatively more stable and prosperous than when he first assumed power in 2000. Nonetheless, Putin’s six-year term will still be wrought with serious challenges to the welfare of the nation and tenuous economic growth.

In his short inauguration speech, Putin noted that the Russian Federation was “entering a new stage in [its] national development” which depended on, among other things, the country’s “determination in developing its vast expanses from the Baltic to the Pacific”.

Indeed, Moscow affirmed its intentions to foster developments east of the Urals when it signed 27 contracts, collectively worth US$15 billion, with Beijing during Chinese Vice Premier Li

Keqiang ‘s visit to Russia in April. This, alongside Russia’s aspirations to increase energy exports to South Korea and Japan, sets the stage for the new Putin administration’s active economic engagement in the far east.

Exploitation of Eastern Siberia and the far east is a national imperative because the wealth beneath the unforgiving landscape could propel the Russian economy forward for decades to come. In fact, output of natural gas from Asian Russia will exceed that from European Russia by 2030. [1]

With Northeast Asian economies voraciously seeking energy supplies, the opportunities for development and cooperation in the region are boundless. It is simply the matter of policymakers in Moscow effectively taking advantage of the resources and conditions before them.

China will be Russia’s key economic partner in the region and trade between the two countries is booming. The Wall Street Journal reported that trade between the two countries increased by over 40% in 2011, amounting to $12.6 billion. However, as Ambassador M K Bhadrakumar noted last week, Russia does not seek to be a mere resource appendage to China. China sets out on Putin presidency, Asia Times Online, May 5, 2012.)

Although the recent deal with Beijing included projects in transport, communications, and other investments, until further development takes place around Vladivostok, energy exports will dominate Russia’s economic interaction in Northeast Asia; and Moscow will seek to diversify its clients. Having controlled the export of resources from Central Asia since the dissolution of the Soviet Union, Russia recognizes the power of monopsony better than any other country.

And timing could not have been better. The general insecurity that plagues the oil supply from the Middle East is driving up the demand for Russian suppliers. In addition, Japan will be more reliant on oil and natural gas as its 54 nuclear power reactors are currently offline for safety checks. While Prime Minister Yoshihiko Noda appears intent on reactivating the nuclear plants after the inspections, with more than half the population opposing such measures and 80% distrusting government safety measures, it will be politically difficult for Tokyo to return to nuclear energy in the near future. [2]

The Noda government is certainly aware of the need to develop energy relations with Russia. Earlier this month, Democratic Party of Japan policy chief Seiji Maehara and the vice president of Russian natural gas company Gazprom, Alexander Medvedev, agreed to study the possibility of laying a gas pipeline linking Hokkaido and Sakhalin Islands. [3]

Some analysts have raised concerns about the state of economic cooperation between North Korea, South Korea and Russia after Pyongyang’s rocket test in April of this year. [4] However, the double attacks on South Korea in 2010 did not derail proposals for a trans-Korean gas pipeline, which was given a nod of approval by both Korean governments in 2011.

Although Moscow has the difficult task ahead of enticing investors from the South while also maintaining a good relationship with the North, growing economic ties with Seoul and continued cooperation with Pyongyang show Kremlin’s adroitness in the balancing game.

There are also many other challenges ahead; however, the key obstacle to Russia’s success in the far east is not going to be external factors such as North Korea’s provocative behavior but Moscow’s own inefficiencies created by heavy handed state intervention in regional development.

In 2006, presidential envoy to the Russian far east, Kamil Iskhakov, suggested creating a state commission on the far east that was directly overseen by the prime minister (which would have placed Putin in charge of the project when he took over the premiership in 2008).

This April, the Economic Development Ministry finalized a bill to create a state corporation that will control the distribution of licenses for mineral extraction in 16 regions in Eastern Siberia and the Russian far east. [5] Nicknamed the “Far Eastern Republic”, the corporation will be partially exempt from federal legislation, receive massive tax breaks, operate outside regional state control, and receive shares of other state companies as investment.

The corporation is similar to Iskhakov’s original proposal – only this time the project is subordinate to the president who will have the power to appoint the head of the company and name the supervisory board. Clearly Vladimir Putin is bent on staking his reputation on the development of the Russian far east. No doubt, the new president intends on highlighting Russia’s role in Asia-Pacific when he hosts the Asia Pacific Economic Cooperation summit in Vladivostok later this year.

Despite the dedication that the Russian state is showing with its involvement in the growth of its most underdeveloped regions, former finance minister, Alexei Kurdrin, heavily criticized the “Far Eastern Republic” as something that will devastate the investment climate in the country.

According to Kudrin,

The creation of such a market player capable of implementing any private project, considering the state’s administrative resource and [special preferences], means that any other investor in this area must be aware that another player with special preferences, special administrative resources and special access to finances may come to the market at any moment.

State intervention is particularly damaging for the Russian far east because conditions appear very favorable for free enterprise to be more active. When 73% stake in the Vanino seaport in Khabarovsk Krai was privatized and auctioned in May 2011, the successful bid offered 10.8 billion roubles (US$354 million) after the bid started at 934 million rubles ($30.6 million). [6] Although the winning company is mired in lawsuits resulting from its inability to make the down payment on the seaport, it is an example of how much the assets in the Russian far east are in demand.

The problem is rooted in the ill repute that privatization gained in the 1990s, when oligarchs and corrupt government officials drove the country to the ground. Many public figures point out that the chaos of the 1990s did not bring development to the far east, thus they argue that the state must spearhead and command projects in the region.

The government certainly has a role to play in curbing both criminal activities and corruption in the region, but adding hierarchy and bureaucracy will not jump start the entrepreneurship necessary for the whole region to become more dynamic. [7] In fact, simply pouring resources into the region might make the existing problems worse.

The Putin administration is probably unwilling to allow development to occur organically because it recognizes the deep correlation between domestic support for the government and real gross domestic product growth; and Russia’s economic is intrinsically tied to energy exports. [8]

In its impatience and shortsightedness, the Kremlin is going to dictate the pace of development in the region so that Russia can more rapidly tap into its reserves of natural resources. But if Russia wants sustained development in the far east, then its companies must become more productive.

Such change will require the government to allow for more competitiveness in the domestic market which will foster both efficiency and entrepreneurship among businesses. President Dmitry Medvedev’s administration had taken small steps towards lessening state control over energy companies, but it is unlikely that President Putin will continue these measures alongside his massive plans for the far east.

For now, Moscow will probably relegate development to bulking up the infrastructure of Vladivostok as a showcase for the 2012 Asia-Pacific Economic Cooperation summit. Improvements in infrastructure and establishment of industry in the depressed city will be lauded, but there won’t be a model that the rest of the region can adopt. The Russian state may have enough resources to invest in the region’s most important city, but it cannot bankroll the development of a region that makes up 60% of its entire national territory.

For the sake of Russia’s future, Putin should consider giving privatization a second shot; it may be the only shot that Russia has for a prosperous future.

Notes

1. Adam Stulberg, “Russia’s Energy Security Dilemmas in Northeast Asia”, PONARS Eurasia Policy Memo No 170, September 2011.

2. “Asahi poll: 80% distrust government’s nuke safety measures”, Asahi Shimbun, March 13, 2012.

3.“Maehara, Gazprom eye laying gas pipeline”, Daily Yomiuri Online, May 5, 2012.

4.Troy Stangarone, “What Happens to the North Korea Pipeline Now?”, KEI, April 24, 2012.

5. “Russian Gov’t Plans ‘Far Eastern Republic'” RiaNovosti, April 20, 2012.

6. “Watchdog allows Mecheltrans to acquire seaport”, RAPSI, March 21, 2012.

7. Gilbert Rozman “Strategic Thinking About the Russian Far East: A Resurgent Russia Eyes Its Future in Northeast Asia”, Problems of Post-Communism 55, 1 (January – February 2008).

8. Andrew Barnes “The Political Economy of Oil in Russia” PONARS Eurasia Policy Memo No. 168, September 2011.

Yong Kwon is a Washington-based analyst of international affairs.

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