The Kazakhstan Economy 2008. A Year When Dreams do not Come True?
The current liquidity and solvency crisis, high inflation rate and economic slowdown suggest that the next few years will be a period of full-scale risk management. I use the term ‘full-scale’ because in the light of global instability, the countries that are efficient in overcoming economic, institutional and political risks will have the greatest competitive advantage. The participants of the 4th International Risk-Management Conference, which was organised by Eurasia Insurance Company, presented their views on the possible solutions to the problem. This article deals with the opinions of just three of these: the Russian economists Yegor Gaidar and Aleksandr Illarionov and the Kazakhstani political scientist Dosym Satpayev, whose speeches we found to be the most interesting and relevant.
No time to relax!
The former acting Head of the Government of the Russian Federation, currently the Director of the Institute for the Economy in Transition (IET), Yegor Gaidar spoke about the current risks the countries face. In the beginning of his speech he noted that the information he presented primarily concerned Russia, but much of it would be relevant to Kazakhstan as well. This is logical because even though both countries are undergoing diversification, the respective rates of their growth in raw material processing and manufacturing industries are higher than in the mineral resources extraction sector; both economies are highly dependent on raw material export. In addition, both Russia and Kazakhstan are emerging markets. With the current slowdown in global economy, the above characteristics automatically place our countries in the high risk zone.
Mr Gaidar pointed out that global economic development is a cyclic process where the periods of growth are succeeded by the periods of recession, and this presents a serious threat to the countries which are dependent on mineral reserves markets. In the last 15 years, the world has seen two instances of similar global economy recession: in 1998 and in 2001. Both periods were marked by significant decrease in prices for oil, petroleum products, gas and metals, which did not occur directly after the decrease in demand, but with a time lag. For example, in 1998 the Russian economy went from growth, which became visible in 1997, to sharp decline, and after 2001 amid the crisis in South-East Asia, the economic growth rate in Russia decreased twofold. In Kazakhstan, the effect of the changes in global trends at that time was not so pronounced, but still noticeable. Indeed, this does not imply that the current slowdown in the global economic growth would necessarily be followed by a decrease in oil and metal prices, but "we should at least take this risk into account" when developing our economic policy.
One more important factor that will seriously affect national economies in the situation of deteriorating global market conditions is the changes in the investment flow. As shown by previous periods of recession (and the current financial crisis, too), there will firstly be a sharp decline in the investment flows to the emerging markets. According to Mr Gaidar this is because investment and financing institutions operate with borrowed money, and in the event of turbulence in the global economy so-called ‘margin-call’ institutions appear. This is why investors are forced to move to more liquid and secure markets.
The Russian economist drew our attention to the fact that the global financial system as we know it (global capital market, floating rates for major currencies and waiver of gold currency equivalent) has existed for a relatively short period of time (about 30 years), and therefore its pattern of change is still difficult to explain. It is not an accident that all the latest financial crises were not predicted and came as much of surprise. "Following this, we understand that we are dealing with the risks of unpredictable changes in investment flows which can have an immense effect on the national economies". For example, it is unlikely that anyone could have foreseen that the mortgage crunch in the USA would cause insolvency in the Russian and Kazakh bank systems.
This may sound like a paradox, but the success our countries achieved during the preceding period may prevent them from responding efficiently and managing risks of the current situation. Russia and Kazakhstan have ten years of dynamic growth behind them; we have accumulated considerable gold reserves and established funds for future generations. However, one gets used to the good things very easily. This is the situation where "politicians so much want to relax, to believe that all problems are taken care of, and to hope that their next step is simply to manage this growth in prosperity and to think about personal popularity"; as a result the risks of weakened financial policy materialise when the time is least fitting, right when the world is in a state of turbulence.
The head of the IET used Russia as an example, where in 2000-2005 financial policy was highly conservative and strong. "We were quick to return debts, accumulated gold and foreign exchange reserves and had large budget surplus. The problems was that in the real world amid a positive trend it is extremely difficult to stick to this policy for a very long time, because there is always some rogue who comes out of the crowd and says that we have some problem or other and that those strange people do not want to invest a single dollar in resolving them. This can be dealt with for a year or two even three, but not forever". This is why in 2006 Russia showed the signs of slackening budget policy and by 2007 in the midst of presidential elections these signs became rather dangerous, as can be seen from the growth rate of budget expenditure in real terms.
Mr Gaidar thinks that "market economy has an unpleasant quality for the governments; it immediately responds to current events and does things in a clear fashion. Whilst for the last few years the inflation rate was decreasing, or at least not growing, at present with a 20% increase in budget spending it is a turning point in inflation dynamics". An enormous inflow of capital combined with increasing prices for raw materials also contributed to the buildup of inflation and ultimately to the ‘overheating’ of the economy. "In such situations it is a serious mistake to increase government expenditure faster than the growth of the economy, but, unfortunately, in reality, this is what politicians do" Yegor Gaidar continues. "On the up side, in view of the changed global trend, obviously there will not be so much capital inflow. The question is in the scale of adjustments <…> in the event of significant capital outflow, the banking system will face a problem that will be very difficult to overcome".
The Kazakh banks have found themselves in a similar situation today, however we face other risks, which so far have not received as much notice as the problems of the second-tier banks. Referring to the example of Russia, the head of the IET notes that at one point Russia made the very good decision to pay off state debts. "However, this is still difficult to comprehend: why we let state-owned corporations whose debts are considered quasi-public, to rapidly increase their own indebtedness. Of course, this a serious risk, because at present they need to refinance, whilst those are short-term debts".
At present, our officials have to seek solace solely in the fact that oil prices remain high, which has major impact on the payment balance and the budgets of Russia and Kazakhstan. Officials argue that demand from China and India is growing and the world’s largest oil fields have entered the phase of diminishing production. In Mr Gaidar’s opinion "all of this would have been very interesting if we were to discuss the oil market of 30 years ago". Today’s market is totally different; it is completely new and changed from being purely a commodity market to being a financial one. This especially became obvious in the last five years, when futures have grown very rapidly. In their report, the International Energy Agency (IEA) sounds slightly puzzled by this phenomenon as there are no fundamental factors that would explain this dynamics in futures. "When dealing with futures there is always a risk of a ‘bubble’ crisis which could end in catastrophe. The main problem is that financial market has more difficulty in establishing a bottom price. Where commodities are concerned everything is clear: we have an oil field with a certain cost of production. Financial market fluctuations are caused by factors which are not directly tied to the industry itself, <…> but rather to the broker’s disposition, the result of yesterday’s football match or to how well brokers can read each other’s moods".
As a conclusion to his speech, Mr Gaidar stated that he did not mean that countries such as Russia are bound to face economic collapse in the event of economic slowdown. Still, they may face some serious challenges. Therefore they should be more careful when implementing their economic or financial policies. Improving the quality of institutional reforms may be useful, but in any case, slackening financial policy under conditions of global turbulence would be a serious mistake.
Mr Gaidar’s old opponent, the former Economic Advisor to the Russian President and the President of the Fund under the Institute of Economic Analysis, Alexander Illarionov is of the opposite opinion, namely that the institutional reforms are the token of the long-term social and economic development of the country. He said that in the last few decades, growing attention was paid to the analysis of the connection between prosperity and institutional development indicators. As a result, a universal view of the general direction of social evolution was formed. A statistical correlation was established between GDP growth and indicators such as indices of political rights and civil liberties, economic freedom and law and order.
In other words, richer countries are also more institutionally developed. And to the contrary, countries that abolish political democracy and law and order, at the same time develop a condition that eliminates economic prosperity.
However, Mr Illarionov notes that this pattern whilst applicable to the rest of the world, does not apply to Russia and Kazakhstan. On the one hand there is improvement of the economic indicators and public well-being, which the government, elite and population can be really proud of. On the other hand, from the institutional development standpoint, the trend is completely the opposite. "The GDP growth is not accompanied by improvement of the quality of institutions, and moreover civil liberties are self-extinguishing. This is what we call the Russian and Kazakh puzzle or paradox, which is clearly contradicts what we have seen in the most of the countries in the world: from Estonia and Sierra Leone to Saudi Arabia and Zimbabwe".
As a result, in 2007 Russia came in 69th and Kazakhstan 76th place in the rating of the countries in terms of economic development. At the same time, they were at the bottom of the list according to indicators, such as government performance, and indexes of judicial independence, corruption, law and order, etc. In average, all main indicators of institutional development in our countries are twofold, threefold and sometimes even four times lower than should be at this level of the economic development. Consequently, Alexander Illarionov concluded that Russia and Kazakhstan recently entered a "deep institutional crisis".
The situation with political rights and civil liberties is also quite gloomy. According to the President of IEA, today the institutional indicators in Russia and Kazakhstan fall below the world average level, but are even lower that in the Middle East countries, which were ‘champions’ in this area for the last few years. "What we are dealing with today can be called the ‘Zimbabwean syndrome’, or a disease when institutions of modern civil society and state are being abolished. Russia is still doing a little better than Zimbabwe and Kazakhstan, but it compensates the difference by higher rate of elimination of political rights and civil liberties".
Of course it could be argued that oil is to blame for institutional crisis, especially given the high prices for hydrocarbons. “There is large and rapidly developing theory of the ‘resources curse’ which stipulates that countries which are rich in oil and gas are doomed to elimination of political freedom, civil liberties, democracy and law order." However, the example of other states that export raw materials indicates that this is not entirely true. And we are not talking about developed democracies such as Norway, the United Kingdom, Canada, Australia and the Netherlands. In the OPEC, for the last five years the indicators of institutional development have been gradually growing and this growth, though unsteady and not too remarkable, was still significant. Many of these countries are young states where the political elite and institutions are just emerging.
In the meantime, in Mr Illarionov’s opinion the low quality of civil and political institutions may slow down the economic development in our countries. As an example, he discussed Kazakhstan where institutional changes in the 2000s led to serious slowdown of GDP growth per head. "From 1991 to early 2000, Kazakhstan had been closing this gap between our countries quite quickly and had been reaching the Russian level. In the 2000s, this rate has become significantly lower and, according to the economic growth data in the first quarter of 2008, Kazakhstan has now started to lag behind".
The impact of institutional problems is visible when comparing the dynamics of economic growth in the former Soviet countries. “In 1999-2000, we were in 3rd and 4th place, respectively. Today, Kazakhstan holds 7th place and Russia 12th place. We have been outstripped not only by countries rich in natural resources, but also by pure importers, which do not benefit from the oil market trend". Because of this, the institutional crises that Russia and Kazakhstan face at the moment "poses the greatest risk".
What came first?
Dosym Satpayev, the Director of the Associated Risk Group (ARG), believes that the most serious problem before Kazakhstan is the lack of an efficient political system. This is the main reason why many economic issues have surfaced. Therefore in his speech, Satpayev focused on the specifics of the political system in our country, dealt with the zones of vulnerability, identified the risks of losing marketability and explained how this affects the economic situation in general.
"There is a well-known postulate which has been announced by practically every official from high tribunes that the economy comes first and politics second. In Kazakhstan this looks more like some kind of mantra. Some people are trying to compare this to a kind of national ideal. Few people dwell on the question as to what kind of economic or political model we are actually building or have already built". According to Mr Satpayev, only by choosing one of these models can we overcome the political and investment risks which affect the marketability of political systems.
The main problem is that in Kazakhstan there is no common understanding on this matter among politicians or economists. According to the ARG director, during one of the discussions, local bankers named the economic model in the country ‘corruption capitalism’. This sounds similar to ‘totalitarian democracy’ or some similar oxymoron. If even bankers hold this opinion of the real situation, it means that it is fundamentally deficient. "The system of distributing the social product is unfair. The competition is underdeveloped, economic ideology is blurred and economic boom accompanied by low productivity is dangerous, and this is what we are witnessing at the moment".
According to Satpayev, similar difficulties arise if we try to define the political model of the country’s development. At first glance, Kazakhstan may appear to be a classical totalitarian regime with the dominating principle that "everything but politics are allowed". This often entails quite successful market reform, the establishment of more or less efficient economic systems, which sooner or later start to conflict with political conservatism. However, the country in Mr Satpayev’s opinion does not have a fully-grown market economy, but rather some elements thereof. "In addition, given the specific nature of the political development in the country, the prospects for this type of economy to emerge are dubious. The line between business and power was always transparent, whilst favoritism, ‘roofing’1 and corruption lead to deficiencies in the development of market competition".
1.TN: The term refers to illegal practice of protection of business by law enforcement or other agencies.
Mr Satpayev presented his opinion on the local political system in the form of a SWOT-analysis of strengths and weaknesses; prospects and risks. Amongst the benefits Satpayev mentions political loyalty towards the president and the support he receives from key groups in ruling elite, although "recent developments indicate the problems emerging in this area". As the second benefit, the political scientist mentions the stable channeling of social energy to the economic sphere, "i.e. encouraging political apathy amongst population". The lack of serious external enemies and in particular the low risk of terrorism is an indisputable advantage. Another strong point is the importance of Kazakhstan in the energy sector in the eyes of the international community, which can be described as a prosaic deal made on oil and gas in exchange for loyalty. An important factor here is the favourable trend in the raw material markets. And the last point which can be classified as positive is "certain social connection of the president with different social groups".
Amongst the main weaknesses of the social system, Dosym Satpayev mentions the lack of certainty regarding the mechanisms of power succession, and the large number of competing elite groups, high levels of centralisation and predominance of shadow segment over public policy. Other shortcomings are inefficiency of the bureaucratic machine, disparity between economic development and political conservatism, high level of corruption, narrow channel for joining the elite and tendency towards social stratification, which in light of the latest economic processes is more likely to strengthen in the future.
The list of existing prospects is shortest. Kazakhstan can use authoritarianism as a basis for modernisation. Favourable internal conditions can have a positive impact on the stable development in the country, and the president still has time to create an efficient mechanism for succession of power. Finally, Kazakhstan unlike other Central Asian states is inclined towards integration to the international community, which automatically increases the requirements to the functioning of our political and economic systems.
When describing the risks, Mr Satpayev emphasised that a centralised political system cannot become decentralised all by itself; there is a need for motivating factors. Global experience indicates that this may happen "either in a top-down or bottom-up direction". At present, the region has witnessed the realisation of “bad” models where the government is overturned using violent methods, and for Kazakhstan this is not the desired scenario. Another risk is strengthening of social inequality which is linked to the shrinking of middle class and the increased unemployment rate due to the crisis in small and medium sized business. "Of course this leads to an increased number of political and economic outsiders. Zones of potential conflicts become wider". According to Mr Satpayev the main problem of the new political cycle is "intensified sense of social justice".
Satpayev paid particular attention to the tendency in the changes of state policy with respect to the real economy and financial sector. "As a matter of fact, Kazakhstan is undergoing socialisation of the economy by tightening laws and buying out shares. This is happening in energy sector, mining, and almost complete in the IT space of Kazakhstan, and soon to start in the financial sector. Mr Satpayev emphasised that "amid high-profile corruption scandals, constant budget under-spending, inter-departmental conflicts and inefficient anti-inflation measures, the ability of the Kazakhstan government to be a good manager of market process is called into question".
Global practice shows that development of political system has three phases: institutional, mobilisation and stabilisation. After that we enter the most complex modernisation stage. It is not clear where the trigger point for the transformation to modernisation begins. The most likely trigger is the collision between certain rate of economic development and inability of the political system to respond to the requirements of the economy. It seems that the political system in Kazakhstan is already losing its competitive ability.
Consequently, Mr Satpayev outlined a number of measures which are necessary for ensuring the effective economic development and increasing competitiveness. These include political modernisation, new channels for recruiting political elite and existence of filters for the access to the political decision making. "We should draw a clear line between business and politics and establish the institute for electing local authorities, and ensure the growth of the middle class, formation of the electoral form of support of the authorities, efficient mechanism for succession and diversification of the economy".
Of course, Gaidar, Illarionov or Satpayev are not characters from the famous Russian fable about the swan, pike and the crawfish and their views do not contradict but rather complement each other and form comprehensive and unfortunately not a pretty picture. This picture makes us realise that the times when Kazakhstan government’s dreams came true very quickly due to the historic situation are over. The future requires complex, hard, but fundamental decisions.
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