Russia’s ability to reclaim its great power status on the international stage is dependent upon the strength of its economy, and not merely its military ability to defeat the Republic of Georgia, a small neighbor along its southern borders.

The Russia of today is vastly different from the Soviet Russia of the 20th century. It is true that the Russian government under then President and now Prime Minister Vladimir Putin has used its power to eliminate virtually any opposition parties from the parliament. Any news media critical of the regime has been brought under informal government censorship. And state control has been reasserted over major sectors of the economy.

But people no longer fear the infamous knock on the door in the middle of the night that resulted in the victim disappearing into the black hole of the GULAG slave labor camps. The Russian market is heavily regulated and manipulated by the plundering political elite. Nonetheless there is an emerging middle class within the system of managed private enterprise that is starting to live Western-style lives, particularly in places such as Moscow and St. Petersburg.

In the larger cities practically any consumer item available in the West can now be bought – if the Russian consumer has the money, that is, to buy it. The communist-era system of long lines and very scarce and poor-quality goods in state-owned stores is a thing of the past. A growing number of Russians now have the financial ability to enjoy something that was only a fantastic dream for the average Soviet citizen: the ability to freely travel to the West for business and pleasure.

These gains and improvements cannot be discounted. They have created a real revolution in the conditions of daily life for many Russians. To use a Marxian phrase, the 75-year communist catastrophe has been relegated to the “dustbin of history.”

All of the outward indicators suggest a vibrant and growing Russia on the track for continuing economic improvement and prosperity. The table below shows this very clearly, looking over the period between 2003 and 2008.

 But looking beneath the surface of these aggregate statistical numbers shows a different reality.

For the first few years under Putin’s presidency the implementaion of a variety of pro-market policies made the economic gains possible. The policies included lower business taxes, a 13 percent flat income tax, reduced regulation of private sector activities, and better fiscal management.

The one persistently negative factor throughout this period has been highly excessive monetary growth (ranging between 35 and 50 percent annual rates) and the resulting high levels of price inflation.

Putin began to reintroduce the heavy hand of the state over economic and social affairs in 2004. The adverse affects that might have been expected were counteracted by the dramatic rise in international commodity prices, especially for oil and natural gas.

This huge infusion of export earnings (reflected in the growing dollar trade surpluses) has supplied the Russian government with the money for economic development as seen in the annual rates of investment in fixed capital.

There has also been a significant inflow of direct foreign investment into the Russian economy, mostly in the raw materials sectors.

The following graph shows where these foreign investment funds have been coming from in 2006 and 2007.

Despite the increase, direct foreign investment in Russia has lagged far behind similar investment into developing countries such as  China or India. This is partly because of  the difficulty of traveling to Russia, even in the post-communist period. A foreign traveler must still obtain an invitation from a private or corporate host to apply for a visa to enter the country. The visa specifies for what purpose and where in Russia the foreigner will be traveling, Once in Russia, a traveler must register with the police through the hotel at which he or she is staying.

The investments in fixed capital that trade surpluses and foreign investment have facilitated remain predominantly in enterprises owned by or under the control of the Russian government. At least 80 percent of fixed investment is in state property, according to the Russian State Statistical Service

Russia’s is heavily dependent upon oil and natural gas exports for the inflow of hard-currency reserves. Almost 65 percent of its export earnings come from this sector of the Russian economy. Another 16 percent of its export earnings come from the international sale of precious metals and other raw materials.

In this sense, Russia is practically a caricature of the stereotypical third-world country that has nothing to sell on the global market except its natural resources. Any longer-term diversification of the Russian economy is hampered by the pervasive presence and grasping hand of the state.

The billions in oil revenues have not been used to modernize or maintain the infrastructure of the energy sector. Many sources report that drilling equipment, pipelines, and refineries are deteriorating from lack of repair and care.

The agricultural sector in Russia is even worse. The collective farms created during Stalin’s time in the 1930s were never fully privatized following the demise of the Soviet Union in 1991. In fact, the “privatized” land is not really the property of their private owners. Russians hold the land in the form of long-term leases. This has hampered private farmers from acquiring bank loans since the land cannot really be used as collateral.

While in the United State less than 3 percent of the working population are employed in agriculture, in Russia more than 10 percent of the people still work the land.

Foreigners are not allowed to “own” farm land. In cities such as Moscow, a foreign investor may have formal title to a building, but the land on which it sits remains the property of the municipal government. This means, of course, that the local government is an unwelcomed partner in every foreign enterprise undertaken in Russia.

Russia also faces a demographic crisis. The average life expectancy in Russia is 67.7 years at birth. This is 10 years shorter than the average life span in the European Union. In 2007, life expectancy for Russian males was 61.5 years, and for women 73.9 years.

The country's population has been falling over the last 15 years at an annual rate of 0.2 percent.. The United Nations has predicted that if current trends were to continue, by 2050 Russia’s population will be one-third less than its present 143 million people. In fact, the absolute level of the population would have declined over the last 15 years if not for the immigration of millions of ethnic Russians from surrounding former Soviet Republics.

Russia’s bid for great power status under Prime Minister Vladimir Putin and his handpicked presidential successor, Dmitry Medvedev, is therefore built on extremely weak foundations. A long-term decline in global oil and gas prices would quickly show that Russia’s current appearance of growth and economic strength was mostly an illusion.

As the Moscow Times reported on August 22,  the federal budget recently approved by the cabinet of the Russian government assumes that the world price of oil will be as low as $88 a barrel in estimating future tax revenues. This is a price signficantly less that current world levels.

Russia's financial minister, Alexei Kudrin, said that the recent windfall tax revenues from international oil and gas sales have probably peaked. As a result, by 2015 the Russian government will have to begin dipping into its accumulated reserve fund if planned increases in the Russian government's annual expenditures are to be covered.

This reserve fund, however, may have to be drawn upon sooner than Kudrin thinks. According to the Russian Central Bank, in the week following the start of the war with Georgia, foreign investors withdrew more than $16 billion from the Russian market. This is larger than the combined 2007 investment into Russia from Germany, France, and the U.S. 

A huge expansion of the Russian money supply also  has stimulated the illusion of a booming economy. In every other country that has turned to the monetary printing press to finance private sector and government activities, this boom eventually leads to a bust.

Putin’s authoritarian and nationalistic insistence on a strong, centralized, and intrusive government that brooks no dissent or disagreement is and will remain the inescapable barrier to a truly normal and prosperous Russia.

But in the shorter-run, dollar and euro revenues from a energy-hungry world will enable the political masters in Moscow to play for their place in the sun.

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