Business is Business: Russia, Trade and the "Axis of Evil"

Celeste A. Wallander

On first glance, it might appear a puzzle that a Russia that supports the United States in the fight against terrorism in Eurasia (and that seeks membership in the World Trade Organization) would trade with North Korea, Iran and Iraq--all countries the U.S. believes pose a threat because they are seeking to acquire weapons of mass destruction. This apparent contradiction, some have suggested, indicates that Russia does not hold as a priority economic transformation, international integration and fundamental cooperation with the United States. It further indicates, some have argued, that Russia’s true objective is competition with the United States, even if determined by great power ambitions rather than Soviet ideology.

In fact, there is no contradiction. The same conditions and objectives that undergird improved relations with Europe and the United States - Russian efforts to join the WTO, Putin’s acquiescence to American bases in Central Asia and military assistance to Georgia - drive Russia’s relations with countries the United States includes among its greatest threats.

Russia understands one overriding reality: it has no future as a country without significant economic growth. This means trading what is in demand now while building new capabilities that fit the modern global economy. The Soviet economy did not leave Russia much: its few strengths are energy, metals and other exportable commodities, a space and satellite industry, a nuclear industry and conventional arms. In the past few years, a better business environment created by important reforms has resulted in some new growth sectors, including certain consumer goods, a developing information technology industry and some services. However, the main factors behind Russian economic growth rates of 9percent in 2000, 5 percent in 2001, and probably 4percent in 2002 are Russia’s energy exports and high global energy prices. The beneficial effects of Russia’s devaluation in 1998 are now gone: future growth will come only from increases in productivity and from selling abroad what is in demand at good prices. Increased productivity requires investment, which is still far below the level that is needed. Until Russia can generate a virtuous cycle of investment and increased productivity, economic growth in the short to medium term depends on energy. Analysts estimate that for each $1 change in the price of a barrel of oil, Russian GDP rises or falls 0.35percent. (1)

This is why Europe and the United States are so important for Russia. Both are important foreign markets for Russian energy exports, and American and European corporations and financial institutions will have to be major investors for significant productivity improvements. The Putin government seeks to join the WTO so Russian businesses can compete on international markets, so Russian business will face incentives to meet western standards, and so Russia will become an attractive investment environment.

Yet, the very same package of objectives and weaknesses are behind Russia’s trade and relationships with the "axis of evil." Russia’s long-term objective is an advanced economy worthy of a global power, but in the short to medium term, Russia needs to sell what is in demand abroad. This means primarily the Soviet legacy of fossil and nuclear energy as well as weaponry and stockpiles of manufactured goods for which there is little demand in the countries of the industrialized world. Trade relations with North Korea, selling nuclear reactors and conventional arms to Iran, investing in Iraq’s oil industry and exporting manufactured goods to Iraq is unfortunately part of the same policy and driven by the same factors, as selling natural gas to Germany or sending oil tankers to U.S. ports. It is to keep the weak Russian economy afloat so that it can be re-structured to support a strong Russia in the future.

Let us take a closer look at Russia's economic interests in Iraq. Russian oil companies stand to earn hundreds of millions and perhaps billions of dollars if they can realize promised commitments to develop Iraqi oil and natural gas fields. Several Russian companies are discussing building oil and natural gas pipelines in a post-sanctions Iraq, with contracts commonly worth $50 million or more. Yet, Russia's stake in Iraq is broader than oil. Russian exports to Iraq were nearly $187 million in 2001, and over $61 million in the first quarter of 2002. Commodities sold include Volga cars and grain harvesters, and therefore extend the benefits of trade with Iraq beyond Russia’s oil sector to its manufacturing industries. More significant than the amount is the concentration: Iraq buys manufactured goods that Russia for the most part cannot sell anywhere else.

Russia has another, less intuitive, but vital stake in Iraq’s future oil industry--in keeping it under wraps. A $6 per barrel fall in the price of oil would halve Russia’s GDP growth. While war in Iraq should lead to an increase in oil prices in the short term, the subsequent peace may bring substantial western investment and an opening of Iraq’s vast reserves, possibly resulting in a catastrophic decrease in global prices.

Russia’s relationship with Iraq, therefore, is rooted in the peculiarities of its distorted, essentially weak economy. Russia’s energy wealth, in the absence of any other dynamic and productive economic sectors, makes it vulnerable to a fall in global energy prices, which is one reason the government opposes a war that would lead to an American occupation of Iraq. On the other hand, the energy sector is one of the very few successful sectors of the Russian economy, so the logic of pursuing that advantage creates incentives to maintain relations with Iraq, even as the U.S. prepares for war. Russia’s interests in Iraq are, quite ironically, based on the same objectives of economic modernization and internationalization that have been at the root of the overall improvement in U.S.-Russian relations.

In addition to Russia’s national interests, global oil prices affect the government’s fortunes. Russia will hold Duma elections in December 2003, and presidential elections in the spring of 2004. Much of the government’s support comes from economic factors: lower inflation, balanced government budgets, prompt payments, and improving living standards made possible in an economy that has grown 4 percent to 9percent annually for the past four years. One of the main reasons for Russia’s fiscal responsibility has been tax revenues and energy export duties. The Russian government is so dependent on energy prices for the economic stability Russian voters value, that its government revenue projections include assumptions about global oil prices. If global oil prices fall more than a few dollars per barrel, the Russian government budget goes from a healthy surplus to deficit. With two very important elections coming up in just over a year, the government has a big stake in the performance of the economy. Russia is not only an energy economy; its government has to watch global oil prices in much the way Western politicians watch poll numbers.

Economic ambition and political calculation, not geopolitical competition, drives Russia to trade with the three countries of the "axis of evil." Certainly, many in Russia take pleasure in defying the United States when it demands that Russia cut off economic ties with Iraq and Iran, and in asserting an autonomous Russian foreign policy. But that is a side benefit, not the cause, of Russia’s economic ties.

In many of the issues truly important to the United States in its relationship with Russia in the past year (NATO enlargement, national missile defense, a new arms control treaty, American bases in Central Asia and military presence in the Caucasus), Russia has largely accommodated U.S. priorities. If Russia sought to counter the United States, it could have done so on issues far more important than oil contracts with Iraq or far less self-defeating than turning a blind eye to Iranian nuclear ambitions.

The key to U.S. policy in dealing with Russia on its relations with these countries should be to leverage Russia’s long-term strategic economic objectives. Where Russia’s policies with these countries threaten to harm U.S. interests, it is always because Russia is grasping for short-term benefits. It is in U.S. interests to focus Russia’s political and economic leadership on its long-term objectives, because these offer greater benefits. A single contract with Iran that benefits Russia’s nuclear industry is not worth as much as joint development of new oil fields and pipelines. Loss of lucrative nuclear contracts might be acceptable if Russian steel producers had the opportunity to compete on western markets, or if Russia’s higher value information technology sector benefits from competition and access after Russian accession to the World Trade Organization.

Most of all, U.S. policy would benefit if it did not put Russia’s relations with these three countries in the rubric of the "axis of evil." Russia’s relations with these countries are in conflict with U.S. interests, but Russia’s relations with them are not based on a Russian conflict of interest with the United States. While there is a common thread in Russia’s relations with them, it lies in Russia’s economic ambitions, which are more strongly drawing Russia into cooperation with the West. We only burden our own ability to use our considerable assets in engaging Russia’s interests in western investment and trade, and will find it easier to create incentives for Russian economic and security cooperation by recognizing the economic sources of its policies.

Celeste A. Wallander is a senior fellow at the Center for Strategic and International Studies and the director of its Russia and Eurasia Program (http://csis.org/ruseura/index.htm).

(1) Troika Dialogue, Russia Market Daily, April 15, 2002.