The Bear’s Lair: A tale of two countries
July 10, 2006
Vladimir Putin’s regime in Russia is corrupt and despotic. Mexico is a functioning democracy with an open economy and a well run recent election. They are roughly equally wealthy, both with large oil reserves. Yet it is Russia, not Mexico, whose economic potential inspires more confidence.
Russia and Mexico are at first sight two very dissimilar countries with entirely dissimilar histories. Yet their economic trajectory over the last couple of decades has brought them to very similar positions, and thus a comparison between the two is instructive.
In terms of Gross Domestic Product, Russia and Mexico are closely comparable. Russia has a larger population, 142.9 million compared to 107.4 million, so its GDP at market prices is also larger, but only by $741 billion to $693 billion. Russia is thus at market prices poorer per capita, but on the basis of purchasing power parity, Russia is slightly richer, at $11,100 per capita compared with Mexico’s $10,000. Really not a lot in it either way.
Both Russia and Mexico have benefited enormously from the rise in oil prices in the last few years, which has softened the effects of fundamental problems in their economic management. Russia’s exposure to oil is relative to population about 50% greater; its proven reserves are 69 billion barrels compared to Mexico’s 33.3 billion or 482 barrels per head compared to 310. However in terms of exports the contrast is much greater since Russia exploits its oil reserves more efficiently; Russia’s exports are a net 5.14 million barrels per day (13.1 barrels per head per annum) whereas Mexico’s are only 1.66 million (5.6 barrels per head per annum).
The reason for this is the more open ownership structure of Russian oil. While the Mexican oil company Pemex remains wholly state owned and closed to foreign investment, the Russia oil company Rosneft is currently in the process of doing an international initial public offering, and has entered into joint ventures with Western oil companies on several exploration properties. Admittedly, much of Rosneft’s asset base consists of properties seized from Yukos, whose unfortunate former Chairman, Mikhail Khodorkovsky, still languishes in a Siberian prison camp, but in a easy money atmosphere such as currently pertains internationally, foreign investors don’t seem to mind that. If further assets are sequestered, or contracts re-written, foreign investors may come to object, particularly if money is by then tighter, but by that time the Russian oil sector will have secured the foreign investment and know-how it needs.
More startling is the economic result of the recent sharp rise in oil prices. With a price rise between 2002 and 2005 of approximately $40 per barrel, Russia has received a windfall of roughly $75 billion per annum, Mexico a windfall of $24 billion per annum. Yet the two countries’ trade, budget and reserves positions in 2005 were quite different. Mexico, in spite of appropriating 85% of Pemex revenues to the state budget, ran a modest budget deficit, while Russia ran a $51 billion budget surplus. On the balance of payments, Mexico again ran a modest deficit while Russia ran a surplus of no less than $89 billion. No surprise then that at the end of 2005 Russia’s foreign exchange reserves were $181.3 million, more than 17 months’ imports, while Mexico’s were a mere $68 billion, little more than 3 months’ imports.
Another major contrast: in the Russian economy as a whole, labor productivity has been growing since 2000 at over 5% per annum, whereas Mexico has suffered negative labor productivity growth since 1990, in spite of the huge investments resulting from the North American Free Trade Agreement of 1995.
The difference in economic results between Russia and Mexico is partly due to differences in policy. In Mexico, corporate tax rates are a maximum of 35% and individual rates up to 32%, while tax evasion is rampant, particularly among the very rich. In Russia, the 2001 introduction of a 13% flat personal income tax hugely increased state revenues and the tax incentive structure is now as efficient as anywhere in the world. Until this month, Mexico had the advantage of a convertible currency, but on 1 July the rouble was also made almost fully convertible.
In some areas Mexico has an advantage. It is less corrupt, with a Transparency International score of 3.5 (equal 65th) in 2005 compared with Russia’s score of an appalling 2.4, equal 126th, down among the Africans. Its population is younger – median age of 25.3 compared with Russia’s 38.4, and its life expectancy is 75 years compared with 68.
However the statistic much cited by demographers, population increase, where Mexico’s population is increasing by 1.1% per annum while Russia’s is decreasing by 0.4%, is in all but the very longest run a weakness, not a strength. Population increase means more need for infrastructure and an ever fiercer struggle for resources; its corresponding advantage, a greater ability to pay old age pensions, can be attained fairly easily by simply postponing the retirement age, particularly in a country with a life expectancy of only 68.
Against Mexico, too is its inequality; the Gini (inequality) coefficient for Mexico is currently estimated at 55, high enough to damaging both economic growth and the social structure, whereas Russia’s is 40, close to the U.S. level and around the optimum for economic growth without excessive social conflict.
Neither country has covered itself in glory in the privatization field. Russia privatized its corporate crown jewels to insider oligarchs during Boris Yeltsin’s reelection campaign of 1995-96, and has been struggling to reverse the result ever since. In Mexico, when privatization has occurred, it has led to cartels not competition. The telephone company Telmex was privatized in 1990, but telecom prices have remained high, telephone density is only 15.2 lines per 100 persons and Telmex main shareholder Carlos Slim is now the world’s third richest man. It’s clear that even partial privatization on the Russian model could greatly improve the operations of Pemex and the electricity company Comision Federal de Electricidad (which completely failed to take advantage of its business opportunity in the 2001 California power shortage crisis) but a Mexican (or 1995 Russian) privatization-to-oligarch would not necessarily help matters.
In terms of property rights, both countries have their lacunae. Not only Yukos, but many small and medium sized companies with valuable assets have found themselves deprived by insiders operating through the Russian legal system, while private land ownership only became fully legal in Russia in 2003.
In Mexico, corporate assets are safer (though the courts are also highly corrupt). On the other hand, even though Mexico’s notorious 1915 system of “ejidos” – tiny communally farmed land holdings to which the holder did not have proper title, could not sell, and could not reliably transfer to heirs, was abolished in 1992, bureaucratic obstruction has prevented a shakeout and agriculture remains atomized and labor intensive. It’s probably easier to be a foreign investor or a small landholder in Russia, but as a small businessman I’d rather operate in Mexico.
In both countries, there’s a moderate political risk of things getting worse. In Mexico, leftist Andres Manuel Lopez Obrador came within a fraction of a percent of attaining the Presidency, and may still disrupt the system by street protest, legal challenges and refusal to accept the result. President-presumptive Felipe Calderon won’t help matters; he has promised to follow Fox’s economic policy, and has repeatedly opposed privatizing Pemex and CFE. However Lopez Obrador would undoubtedly make matters worse, and produce a genuinely hostile environment for foreign investors and business in general.
In Russia, the political risk is not so much change as continuity. If President Vladimir Putin retires as expected in 2008, even if he gives way to another ex-KGB hard man, it’s likely that Russian economic policy will not change much. Economic success is valued by Putin because it brings respect for Russia in the councils of the world; if a certain amount of foreign investment and private sector development is necessary to produce economic success a like minded Putin successor can live with it.
The real danger is that Putin himself succumbs to what must be a considerable temptation to alter the Russian constitution and run again in 2008, securing his repeated re-election by the usual dubious Russian means. At that point both Russian prosperity and the peace of the world would be in severe danger. A Putin in power for life would very likely be tempted by the power that prosperity brings Russia to engage in military adventurism. Foreign investors in such a case would have very little protection indeed, even if their head offices were not reduced to glowing rubble.
Nevertheless on balance the verdict is clear. Absent major political change, the outlook for investors and the economy in general is better in Russia than in Mexico. In terms of political freedom, Mexico is far ahead, having demonstrated last week admirable political maturity in that most difficult of democratic situations, a disputed election, while Russia’s claim to democratic legitimacy is shaky at best. However, economically, Russia’s better managed. Yes there are risks with the Russian approach, but it’s not clear that allowing corrupt local oligarchs to become the world’s richest men works any better than sending them to Siberia.
Thus even though Mexicans may politically be nicer guys, in economics as in life, nice guys very often Finish Last.
(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
Martin Hutchinson is the author of "Great Conservatives" (Academica Press, 2005) -- details can be found on the Web site www.greatconservatives.com
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