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Estimating Russia's Impact on the Economic Performance of the Commonwealth of Independent States since 1991 - The Cases of the Kyrgyz Republic, Tajikistan, Armenia, Georgia and Ukraine

Working papers

Context of Research

The assumption that the economic policy and performance of Russia have a strong impact on economic growth and development in the rest of the Commonwealth of Independent States (The CIS includes Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine and Uzbekistan). (CIS) is widely made. However, justification for this assumption is often simplistic, mainly based on comparable periods of economic contraction and recovery across the region since the fall of the Soviet Union. Empirical analysis of the origins, relative importance and evolution of the transmission mechanisms linking Russia's economic policy and performance to those of the CIS is lacking. The aim of this paper therefore is to provide an empirical assessment of 'Russia's influence' on CIS economic growth since the collapse of the Soviet Union in 1991 and the onset of transition.

It is clear that the transmission mechanisms linking Russia's economic policy and

performance to CIS growth evolved considerably during the 1990s. Whereas prior to 1991 the Soviet satellites were tightly bound to the centrally planned economy, the dissolution of the Soviet system and the gradual integration of the CIS into the global economy have changed the structure and strength of CIS economic ties with Russia. It appears that the clearest impact of Russia's economic performance and policy on CIS growth occurred in the immediate aftermath of the break-up of the Soviet Union when the collapse of the trade and payments system and the cessation of fiscal transfers from Moscow led to substantial decline in output throughout the region. Variations in economic performance across the CISsuggest that some countries and sub-regions have been more successful in overcoming inherited economic distortions than others. In many cases, the traditional strength of Russia's influence on CIS economic performance appears to be declining, whilst new linkages (such as economic migration and remittances and political gains through CIS dependence on Russian energy supply and transit) are emerging. New growth hubs, such as the EU and China are becoming, or are already, important trading partners for many CIS countries. Hence the perception of 'Russia's regional economic influence' should become more nuanced in order to reflect these new realities.

Research Questions

The question of the extent to which Russia's economic policy and performance impact on

CIS growth is very broad and the analysis requires a set of key research questions and tight methodology in order to produce clear and robust conclusions. As it is difficult to generalise for the whole of the CIS, the analysis in this paper is centred on five case-study countries (the Kyrgyz Republic, Tajikistan, Georgia, Armenia and Ukraine). The research questions are as follows:

# What were the main economic pillars of the Soviet system prior to its collapse and how and to what extent did they foster economic dependence of the Soviet satellites?

# How has the economic performance of the five case-study countries evolved since 1991, including the extent to which inherited Soviet structures have been overcome?

# What have been the key determinants of growth in the case-study countries since 1991?

# What has Russia's contribution been to these determinants? Specifically:

i. What was the impact of the collapse of the command economy on the key growth

determinants?

ii. How has Russia's contribution to the determinants changed over time?

# To what extent is the persistence of strong economic linkages to Russia a cause or a consequence of economic performance in the case-study countries?

Methodology for the empirical assessment

A growth simulation model for each country case study is suggested to assess the statistical significance by country of the key determinants of economic growth. The independent variables in the linear formation are: investment, export performance, the terms of trade, remittances and various forms of external finance (including short-term and long-term concessional and non-concessional flows).

The approach is to observe actual GDP (1995$) outcomes during the 1990s for the five case studies and compare this with GDP simulated through a linear relationship in which the coefficients on the determinants of growth are 'retro-fitted' to the growth performance actually observed. This calibration is done by trial and error as there are not enough data to estimate them econometrically. Only those models that produce a correlation coefficient above 90% are used. Robustness is tested by means of varying parameter estimates, including testing at extreme values.

Russia's influence is then calculated by identifying and quantifying Russia's contribution to the key determinants concluded via the simulation exercise, and is then measured by undertaking two counter-factual simulations, the first simulating a scenario in which the economic linkages with Russia are removed entirely from 1990 onwards, the second a scenario in which the economic pillars of the Soviet system (including trade and external

finance) are assumed to remain unchanged throughout the 1990s.

Key Findings

1. Economic dependence during the Soviet era: Prior to 1991, economic dependence

between Moscow and the Soviet satellites was fostered by means of several measures, the most notable of which were: the central economy-wide plan which geared production in the satellites towards the Soviet market; the construction of infrastructure primarily to transport goods, services and factors of production within the Soviet space; dependence on interrepublic fiscal transfers for investment and consumption in the satellites; trade diversion to serve the CMEA; price distortion to maintain exports above and imports below world prices; dependence on a mono-bank system and wide circulation of Russian currency. Overall, these measures meant that the institutions and structures of statehood across much of the CIS were underdeveloped at the time of the collapse of the Soviet system.

2. Economic performance since 1991: All the case-study countries experienced strong

economic contraction at the outset of transition, with negative growth rates for some persisting until late in the 1990s. From 1991 these countries endured rising external

imbalance (as the volume and value of trade within the CIS declined before new markets

opened up), a decline in domestic investment and internal imbalance (as the gap between domestic investment and savings widened). During the 1990s, their economic structures shifted away from industry and towards services and agriculture. Trade performance started to pick up and there has been some export diversification to non-CIS partners. However, FDI inflows remain disappointingly low outside strategic sector investments. Concentration of exports in primary commodities raises questions about vulnerability to external shocks such as fluctuations in global prices. There is also a question over whether these countries are in fact moving towards realising their comparative advantage by focusing on primary commodities as their main exports, or whether this represents a failure to diversify successfully through the transition process. Furthermore, concentration on primary commodities makes diversification, which is required for employment creation and poverty reduction, more of an uphill struggle. From 2000 onwards, growth performance across the region has strengthened, although from a narrow export base and limited domestic diversification. Informal economic activity remains prevalent, particularly in cross-border activity such as shuttle trade and migration (reflecting regional disparities in incomeearning opportunities). Most of the case-study countries remain dependent on flows of concessional external finance from bilateral and multilateral providers, with a sizeable part of external bilateral debt still owed to CIS creditors.

3. Key determinants of growth: The factors influencing CIS growth determinants appear to have changed radically from the end of the 1980s to the present. The case-study countries underwent transition from a planning system, in which investment and trade were essentially politically determined, to a system based on market signals. The respective importance of key growth determinants was found, through the methodology outlined above, to vary between the country case studies. Investment and exports were the key determinants for all the case-study countries, but other variables were found to be significant in varying degrees for each case study. Remittances were a significant growth driver for Tajikistan and the South Caucasus, long-term counter-cyclical concessional finance for the South Caucasus and Central Asia, FDI for Armenia and Georgia and shortterm bilateral flows for the Kyrgyz Republic and the South Caucasus.

4. Russia's contribution determined: For all case-study countries, with the notable

exception of Tajikistan, Russia's contribution to the key growth determinants has declined

over time. Following the methodology outlined above, simulated GDP under the

assumption that 1990 linkages with Russia remained constant produced an estimated

cumulative difference with actual GDP as follows: Kyrgyz Republic 13.57%, Tajikistan 12.9%, Armenia 27.69%, Georgia 7.7% and Ukraine 7.6%. In contrast, simulated GDP under the assumption of no economic linkages with Russia produced an estimated cumulative difference with actual GDP as follows: Kyrgyz Republic 7.27%, Tajikistan 19.8%, Armenia 14.8%, Georgia 2.4% and Ukraine 6.5%. Those countries inheriting stronger economic ties with Russia at the outset of transition (namely the Kyrgyz Republic, Tajikistan and Armenia) accordingly experienced the highest proportion of economic contraction attributable to Russia. Conversely, those that have undertaken robust policy and structural reforms and/or received large inflows of external finance from non-CIS sources, have reduced their dependence on traditional economic linkages with Russia.

Conclusion

The impact of the break-up of the command economy system appears to represent the

clearest and strongest example of 'Russia's influence' on case study country growth,

resulting in fiscal and terms-of-trade shocks that drove down domestic investment rates and export volume at the start of the transition period. The impact was most severely felt in those countries that were previously more tightly bound to the command economy through fiscal transfers, domestic production and export links (notably the Kyrgyz Republic and Tajikistan) and those sectors that were previously upheld by the command economy (such as military-related industrial production). Although the economic linkage through interrepublic fiscal transfers was relatively weaker in the other case-study countries, they still remained tightly bound to the Soviet economy through the inter-republic trade system. Their economic contraction was also exacerbated by civil conflict (in the South Caucasus) and absence of supportive institutions to manage the transition to a market economy.

The methodology used in this paper suggests that, on the whole, Russia's influence on casestudy country growth appears to have declined over time, with the exception of Tajikistan. This appears to have been mainly the result of their trade diversification, the structural break in external finance from Russia, and their domestic investment, plus the declining proportion of debt to Russia in their total external debt. The ability of the case-study

countries to overcome inherited economic ties with Russia has depended on two main factors: first, domestic policy, structural reforms and institutional strengthening in enabling them to achieve stabilisation and begin the transition to becoming market economies, and second, their ability to access non-CIS export markets, finance and technology. Those countries that are relatively more geographically isolated, have weaker infrastructure links and limited access to the outside world have been less successful in diversifying away from Russia than others.

New forms of economic linkage have evolved, particularly within the informal sector (economic migration, remittances and shuttle trade). Political economy levers have become a more mainstream form of Russia's influence, including through strategic investment in key sectors (particularly energy), debt-for-equity swaps or manipulation of energy pricing and supply. Russia would be able to influence case-study country growth significantly through these channels if it so chooses.

Overall, the methodology suggests that the strength and nature of the economic linkages between Russia and the case-study countries are still greater than might be expected in functioning market economies. The final question is whether this is a cause or a consequence of case-study country economic performance. The analysis suggests that there is no clear answer. On the one hand, the growth process in the case-study countries depends on the pace and nature of their domestic structural and policy reforms. On the other hand, Russia appears to influence the pace and nature of their reform process both directly and indirectly, particularly in those sectors of strategic importance.

In summary, traditional forms of Russia's influence on case-study country growth have generally declined during the transition. As a result, current economic policy and performance in Russia matter less, on the whole, than they did in the early transition phase. Those countries that have integrated into the global economy and have undertaken robust domestic policy and structural reforms have overcome inherited economic distortions and reduced their ties with the CIS and Russia to a greater degree than the slower reformers. However, for all the case-study countries new forms of economic linkage with Russia are emerging, most of which could have a significant impact on the key determinants of their economic growth.

Melinda Robson