The bear's Achilles heel

The bear's Achilles heel

Opinion piece (The Guardian)
15 August 2008

For many American commentators, plucky little Georgia has been the victim of Russian imperialism. The Guardian's Seumas Milne takes an simplistic view: Russia is blameless for a war caused by US "expansion". Both schools of thought agree that Russia has been the conflict's big winner. In the long run, I am not so sure. Russia has much more to lose from a period of frosty relations with the west than either the Americans or the Europeans.

Russia's Achilles heel is its economy. This has been growing fast, at over 7% a year. Wealth has spread out from the energy companies and the government, helping to create a prosperous middle class. But the economy remains dangerously dependent on energy and raw materials. Russia has very few high-tech industries, its record on innovation is appalling, it has too few small and medium-sized companies and its service industries are backward.

President Dmitry Medvedev and his advisers, who have close links with many business leaders, understand that Russia needs to diversify, and that autarkic policies will make that harder. More foreign investment in Russia would help to produce the kind of broad-based economy that China enjoys. The leading Russian companies want to emulate western multinationals by taking over foreign firms, raising money on international capital markets and hiring the best talent. But if Russia makes life difficult for foreign investors, its own companies will find doors closing against them.

Even Russia's oil and gas companies, whose output is beginning to decline, cannot thrive without foreign technology, expertise and capital. Although profitable, they lack the financial muscle that would enable them to invest in major exploration projects or overseas acquisitions without the help of foreign bank loans.

On a recent visit to Moscow I was struck by widening divisions within the Russian elite. Business leaders have become much more critical of Vladimir Putin - occasionally in public - than they were six months ago. That is hardly surprising, given the impact of Putin's policies and comments on business confidence and the stockmarket. His personal attack on the leadership of Mechel, a leading steelmaker, hit share prices badly, as did the assault on Georgia. The market had already been unsettled by the fight between BP and AAR for control of TNK-BP. The fact that several state agencies have intervened on AAR's side may - Russian businessmen are well aware - deter some potential foreign investors.

Many Russian business leaders worry that Putinism - and especially its anti-western foreign policy - will in the long run damage the economy. Some senior figures in the security establishment seem oblivious to the economic consequences of their actions. Putin's and Medvedev's advisers have started to spar in public. Putin, of course, is still in charge for now, but Medvedev's clan and its allies in the business world are not without influence.

China's leadership is pursuing a long-term strategy of not alienating the US while the Chinese economy grows big and strong. Russia's leaders are making a mistake in choosing a different strategy. Although US power is in relative decline, it will remain the world's most powerful country for many years. The war in Georgia has transformed the way Americans view Russia. Until now George Bush's genuinely warm relationship with Putin has prevented a tougher US policy from emerging. But whoever wins the presidential election, US policy on Russia will harden. For many years Russia's leaders have assumed that the US intends to encircle, weaken and dismember their country. That paranoia, largely built on fantasy, will now become more real.

The US will step up efforts to thwart Russia in its near abroad, prevent sensitive technologies from reaching the country and curb the international aspirations of Russian companies. Although John McCain's scheme to exclude Russia from the G8 is impractical, the G7 - which still exists for economic policy, and excludes Russia - will take on a larger and a more political role.

Since the US trades very little with Russia, it can afford to take act tough. The Europeans, some of whom depend on Russian energy, cannot. The EU will remain divided between those who want to confront Russia and those who prefer a soft touch. But events in Georgia have shifted the centre of gravity of the European debate in a more critical direction. German public opinion, with its pacifist tendencies, has been shocked to see Russian tanks and warplanes in action. A few days before the fighting broke out, I met a German banker who works a lot in Russia and sits on the boards of several Russian companies. He normally defends Putin from all criticism. But on this occasion he told me that Russia's leaders had become so arrogant and greedy that he feared they would make serious mistakes. If Putinism continues on its current course, Russia risks alienating Germany, its best friend in Europe.

The EU cannot do much to 'punish' Russia. If it blocked Russia from WTO membership, or stopped the talks on a new partnership and co-operation agreement, it would damage the moderates within the Russian system. But the EU could - and in the long run probably will - do two things. The first, as my colleague Tomas Valasek argues in a recent CER policy brief, is to strengthen ties with countries in the common neighbourhood. The EU should offer more trade and aid, encourage them to take part in many of its policies, and hold out the longterm prospect of membership, when they are ready. The second is to make clear to Moscow that the EU has a red line: if Russia tried to take over sovereign and independent states in the common neighbourhood, it would pay a price. The EU cannot and would not stop trading with Russia. But it could cut off political contacts, make it harder for some kinds of Russian to get visas, and discourage Russian businesses from entering the EU.

Plenty of senior Russians are concerned at the prospect of a new Cold War, partly because of growing worries about China. Superficially, Russia's and China's leaders get on well, often teaming up against the west at the UN. But the Chinese, focused on the US, do not take Russia and its economy very seriously. The Russians are aware of relative strengths of their economies (in 2030, according to the Economist Intelligence Unit, China will make up 22.7% of world GDP, against Russia's 2.7%. They also fear Chinese encroachment into Russia's under-populated Asian territories.

Throughout its history, Russia has had a poor record of making friends with its neighbours. In the multipolar world that is emerging, the country will be too weak - diplomatically and economically - to flourish on its own. It will need allies. Medvedev's people understand that splendid isolation offers no future for Russia.