Europe: the only source for Russia’s modernisation

Since at least 2014, Russia’s economic and technological cooperation with Europe (and with the West altogether) have been in decline. Both Russia’s government and its people tend to underestimate the long-term consequences of this decline, because they fail to appreciate the fact that in previous decades and even in previous centuries, the paradigm of Russia’s development was based on close relations with Europe. In short, Russia was incapable of achieving economic growth if its relations with Europe were damaged. We should also remember that Russia’s governance is still despotic in nature, even though by the end of the twentieth century it had transformed from a Bolshevist regime to semi-authoritarian (now fully authoritarian) with the predominance of a state-run economy.

This despotic nature came to define the classic Russian approach towards such relations: Russia efficiently exploited both the political contradictions within Europe and the frictions between Europe and America. That approach provided the impetus for economic and technological modernisation, but also allowed the Russian authorities to prevent significant European influence on Russia’s political system.

However, the principles and values of institutional Europe (as well as the principles of trans-Atlantic unity) such as human rights and freedoms, the market economy and democracy, an independent judiciary and so on, pose a challenge to the domestic political order of Russia, especially after these principles came to be implemented in most Eastern European states.

So, it became harder for Russia to play its old-fashioned political game, and the essential tensions in Russia–Europe relations became apparent in 2008 when Russia’s post-Soviet political and economic model faced deadlock: in 2008, Russia’s annual GDP exceeded $1.6 trillion, and in 2017 it was less than $1.58 trillion.

Moreover, Russia’s annual economic growth has hovered around 1.5–2% since 2017 (after another recession in 2015–16), less than the average growth rate across the European Bank of Reconstruction and Development countries. At the same time, ties of cooperation between Russian and Western companies were damaged due to both the disillusion of foreign investors and the imposition of sanctions. So, even if Russia is growing, the development gap between Russia and Europe will only expand in the coming years.

It is in this context that Russia decided to rely on military power, in order to find a new path but also to prevent its near-abroad from gaining access to any competitive/ alternative political and economic institutional model. The reason was clear: any potential success story in the democratisation of post-Soviet states poses a threat to Russia’s domestic order.

Without the extended cooperation with Europe, Russia faces long-term and growing underachievement in its economic and technological performance.

This was the perspective which guided Russian aggression against Ukraine in 2014. Nevertheless, sooner or later Russia will need to make a choice between reconciling itself to all the necessary domestic political steps towards a market economy, democratic governance and peace in its relations with Ukraine, including the withdrawal from Crimea and Donbas on the one hand – and the irreversible loss of its relatively high status in world politics on the other.

The second option will be just as probable, as Russia will not be able to use Europe as the technological and financial source for its modernisation. The main challenge here is that without the extended cooperation with Europe, Russia faces long-term and growing underachievement in its economic and technological performance.

This underachievement creates problems even for Russia’s military capacity, which is one of the main tools for Russia’s foreign policy. For instance, Russian defence industry is incapable of producing advanced satellites, warships and aircraft and many others without access to European technologies.

History does matter

In the twentieth century, Russia’s most important achievements in the area of modernisation came from Europe and the United States. In 1922, soon after the Bolsheviks took full power in Russia, they signed the Rapallo Treaty with Germany which gave them access to German arms manufacturing technologies. Later Moscow obtained much industrial equipment and technology from the Soviet occupation zone in Germany after WW2, and some of this equipment was used in Russian factories until this century. Supplies of industrial equipment and technologies from the United States, in the 1930s through commercial contracts, and in 1941–5 through the Lend-Lease Act, also played a crucial role in Russia’s modernisation. However during the second half of the twentieth century Europe remained the main driver for Russian economic and technological development. During the Cold War, the USSR used both legal ways and espionage to get equipment and technologies from Western Europe, including Great Britain, Germany and France. Moreover, rising oil prices and higher demand for petroleum from European countries, along with the discovery of huge oil and gas fields in Siberia, allowed Soviet Russia to increase its trade with Europe. Russia mostly exported raw materials and mostly imported machinery and equipment, other goods and technologies.

However, the Eastern European states inside the Soviet bloc were even more important for Russia’s modernisation. The Council for Mutual Economic Assistance (CMEA) was established to this end in 1949. During the decades Eastern Europeans were not only consumers of Russian raw materials, but also supplied the machinery and equipment that Russia needed. Moreover, their workers and engineers helped Russia in the construction of crucial facilities such as gas pipelines.

Europe and Russia before and after 2014

After the end of the Warsaw Treaty and CMEA, and the collapse of the Soviet Union, the ties of cooperation with European states also changed, although Russia became even more dependent on the whole of Europe. Nevertheless, in the post-Soviet era, before the annexation of Crimea, Russia’s access to Western technologies and investments was also limited due to the grand corruption and poor institutional environment in the country.

Later, in the 2000s Russia was able to support its economic ambitions with huge amounts of petrodollars as it had done in the 1970 & 1980s. The modernisation and the trade and cooperation with European states as Russia’s main partners certainly benefited it a great deal.

The problem is that up to 70% of all FDI (Foreign Direct Investments) in Russia are FDI round tripping. So, actually they are not direct foreign investments but come back from the offshore subsidiaries of the Russian corporations.

However the other 30% are real, and most of them come from Europe. There were two peaks in the balances of FDI in Russia: $74,783 billion in 2008 and $69,219 billion in 2013. After that Russia lost many European investors; some of them have decreased their work in Russia since President Putin returned to power in 2012.

Of course, there are still European investors working in Russia, but they have definitely become much more prudent in their business strategies. Although the post-Soviet modernisation of Russia has not been completed, some competitive companies have appeared in the fields of telecommunications, IT, banks and retail.

Once again Europe was a source of knowledge, technologies, capital and equipment. Moreover, Russia cooperated with European companies in order to modernise its defence industry and armed forces. For example, in the 2000s Russian authorities tried to interest EADS (currently Airbus) and AugustaWestland (currently merged with Leonardo) in manufacturing aircraft in Russia.

The German defence company Rheinmetall supplied a training centre for the Russian army, the Italian company Iveco supplied armoured vehicles, and a couple of Mistral helicopter carriers were ordered from France (these ships had not been supplied due to the European sanctions in response to Russia’s actions against Ukraine). One more example: as one of the leading space powers, Russia was unable to develop and produce advanced communication satellites without cooperation with European aerospace companies such as Thales, Airbus and others.

So, Russia needed such cooperation in order to maintain its ambitions to world-power status. All the examples above mean that the annexation of Crimea and the war in Donbas have impacted Russia’s economics hard. This situation suggests that the country will be unable to develop successfully before it withdraws from Crimea and European investors come to trust Russia again.

This scenario will be unavoidable if the EU and the US maintain their positions towards Russia’s trouble-making foreign policy. Therefore Moscow’s model of economic growth, with its typical authoritarian practices of limiting private initiative and its aggressive foreign policy, is bound to fail – there are just no drivers for sustainable development in Russia, so the country will likely only be able to maintain its current status projection as a political winner for a limited time.

Reasons for measured optimism

So, more than five years of confrontation between Russia and the West have resulted in the long-term decline of Russia’s economy. The economic gap between Russia and the developed countries is increasing, and there is no hope of Russia managing sustainable development within the current political circumstances.

Nor can China replace Europe as Russia’s main trade partner. In 2017, the trade between Russia and six European countries presented in Table 3 was 1½ times higher than that between Russia and China that year. Also, China cannot give Russia the investments that the European countries gave before the Crimean annexation or even still give now, even if it were just because Russia is not a priority market for Chinese companies.

At the same time though, Beijing is trying to keep Moscow as a strategic partner. For instance, China has secured itself a longterm supply of oil and gas from Rosneft and Gazprom.

Also China is gradually entering the Russian telecommunications and transport sectors, and will hardly stop there. However, what China needs is a predictable neighbour which will definitely not join any anti-Chinese coalition. This is China’s main objective in its relations with Russia. All that means that China has no interest in Russia’s sustainable development, as it has no interest in Russia’s domestic political situation. So, the cost of confrontation is growing for Russia.

With Western sanctions in place, Russia is unable to modernise its economy. Due to the absence of significant sources for development in ‘fortress Russia’, it is fated to decline in its political and economic sustainability, which makes scenarios of domestic turbulence much more probable.

Also the number of people in Russia who have benefited from its authoritarian regime is decreasing. Consequently, we will see a significant transformation of the regime in the coming decade, with the option of transition towards democracy and market economy. In order to restore itself as a trustworthy actor and partner, Russia will need to undertake huge domestic reforms and withdraw from Ukraine, and possibly from Georgia and Moldova (that depends on the political circumstances of the future transition of power in Moscow in the coming decade).

Also, Russia will have to reconsider its trouble-making tactics towards the Western states and its adverse approach towards NATO and the EU enlargement process. Nevertheless, if this happens, some day Europeans will be the first to support Russian efforts towards economic and political modernisation.

Enter the dragon: Rising Chinese influence in Serbia

Since the People’s Republic of China began its One Belt One Road (OBOR) initiative, there has been much discussion on how this initiative would affect the countries it covers. The main goal of this project, as proclaimed, is to increase connectivity between China and other markets through the development of infrastructure and eliminating transport choke points.

This would enable a higher level of economic cooperation by reducing the costs of freight transport and the time necessary for the goods to reach their target markets. However, does this economic project come with political strings attached? Would China be able to leverage this new influence in Serbia and the Western Balkans, and thus gain a strong foothold in Europe?

Would China be able to leverage this new influence in Serbia and the Western Balkans, and thus gain a strong foothold in Europe?

I argue that much of the discussion in this area is either misplaced at present, or overlooks the real reasons why Chinese influence is rising in the WB and particularly Serbia; and I offer a list of policy recommendations that would make Serbia more resilient to this influence.

Loans passed off as investments

Whenever Serbia’s President Vučić discusses infrastructure projects that involve Chinese partners, he always depicts them as ‘investments’. In a country where media freedom is severely limited at best, these reports have been picked up by the media and widely disseminated, without any fact-checking. One should also understand why the country’s president – a figure who has no constitutional role in the conduct of economic or foreign policy – has been so vocal in promoting Chinese influence: Mr Vucić, as the president of the most important party in the country, has been able to dismantle almost all institutional checks and balances and put almost all state institutions under his political control ‘à la Orbán’.

Hence, Chinese investments in the country seem to be multiplying; this sheds a good light on the current regime, which bases its legitimacy on economic issues, making public finances stable and promoting economic growth. Growth is probably the most pressing issue in the country; public opinion polls show that the vast majority of citizens regard the overall economic situation, unemployment and low salaries as the most pressing matters to be addressed.

Furthermore, the sluggish growth in the previous decade stemming from the weak rule of law means that Serbia was only able to regain its 2008 pre-crisis GDP per capita level in 2016. However, in reality the true level of Chinese investments in Serbia is very low. Apart from two already completed acquisitions (the Smederevo steel mill in 2016 and the Bor mines in 2018) and one big investment that has been announced for the near future (a car tyre factory in Zrenjanin), there are few Chinese investments in the country.

But these investments are strategically located; the cities of Smederevo and Bor are almost completely economically dependent on these facilities. Since these two companies incurred substantive losses when in government hands, the state was more than happy to sell them off to interested investors. However, it seems that this process was not transparent or fair, since the names of the buyers were effectively already known before the tenders were completed. Although the Chinese companies are there to make a profit, their influence can also reach higher political levels, as they are among the most important economic players in that region of Serbia.

But since their total stock is very limited, the Chinese economic presence in Serbia is overall rather modest in actual numbers… Serbia is just a springboard for reaching the more developed, and therefore more important, markets in the EU. This is well reflected in the fact that Serbia, which is not yet a member of the WTO (so its trade barriers are higher than in other comparable countries), has signed free trade agreements with all its important political and economic partners (including the EU, CEFTA, Russia and Turkey), in addition to China.

Less bureaucracy, more appealing loans

For the time being the loans from the Chinese government are being used to fund infrastructure projects. The overall infrastructure in the country needs to recover after two decades of low investments: during the 1990s, military conflicts swallowed up most of the state’s financing capabilities, and public investments were the first to be cut after the 2008 economic crisis.

This is well portrayed in the Global Competitiveness Report 2018, which ranks the quality of the roads in Serbia as 95th in the world (out of 140 economies listed). To respond to this need for infrastructure investment, multilateral financial institutions such as the World Bank, the European Investment Bank and the European Bank for Reconstruction and Development have provided significant assistance and loans. However, these institutions were more concerned with projects of international importance, such as the international E10 highway running from Budapest to Sofia or Thessaloniki, than with those of local importance, such as the E11 highway from Belgrade to Bar.

Furthermore, these institutions have rather strict regulations, including financial supervision and auditing, while construction companies need to pass well-designed tender procedures. Therefore, there is little room to siphon off funds. Meanwhile, the public procurement system in Serbia is notorious for its corruption scandals, many of which have been connected to government-sponsored infrastructure projects. China does not labour under these constraints.

The only condition Beijing has is that a Chinese company will get most of the construction work at the price determined beforehand, without submitting to any tender procedures. A smaller part of the work goes to local sub-contractors, also without a public tender, so that the local partners can also gain a (smaller) piece of the pie. For a political elite well-versed in political clientelism, this is a win-win situation. This is what mainly explains the attractiveness of the Chinese investment loans in the region. The interest rates on the Chinese loans are not that important.

For most of the loans the interest rate applied is 2-3%, a figure similar or just slightly higher than the rates applied by the international financial institutions. The interest rates on government bonds have recently also declined significantly (Eurobonds for 10-year loans in 2014 carried a rate of 5.5%, while in 2018 the rate was 3.5%, and the most recent Eurobond carried 1.6%).

So, since there is no big difference between direct state financing and Chinese loans, the latter are actually probably more expensive, because there is no pressure on costs from the competition, in the absence of tender procedures.

The actual level of Chinese loans is still low

In some countries, the Chinese infrastructure investment loans were renegotiated when the total debt level became unsustainable. Since the Chinese took over the Sri Lankan port of Humbantota in 2017 in a debt/equity swap, there has been rising concern over whether this situation could also occur in other countries, such as Zambia, but also in Serbia. If the government proved unable to meet its rising obligations to its Chinese partner, would the latter then take over some important infrastructure, or increase their political leverage in the country in some other manner?

The level of Serbia’s public debt is still high, but it is not yet at an alarming level. The fiscal consolidation measures put in place in 2014, together with the higher growth rates of the economy that followed curbed the level of public debt, whose share in GDP significantly decreased. Furthermore, the share of Chinese loans in total government debt is rather low, making up just €895 million euros, or just under 4% of the total public debt. But if the lack of bureaucracy or checks on how the money is spent makes Chinese loans appealing, why have there not been more of them?

The answer is: because the level of discretionary power which politicians have over regular loans financed through the international market is already significant – they can spend the money only in line with local regulations, which are easy to disregard or circumvent. Therefore, the Chinese loans are only being used in place of financing from international financial institutions.

A strong economy with limited soft power

Chinese soft power in the country is still weak. Many different initiatives regarding cultural, educational and scientific cooperation have been started, but these are restricted to a rather limited number of experts. The two Confucius Institutes in the country (in Belgrade and Novi Sad) are active in these fields (especially regarding language training), and have for the time being avoided entering into political debate.

Chinese state media does not have a local media affiliate, but is content with a cooperation agreement with a local radio station in Belgrade, which rebroadcasts their programmes on Chinese culture. The number of Serbian nationals working or living in China is also rather limited (most of them are teachers of English), so their perspective on the country does not affect how most Serbs perceive China.

The main drivers of Chinese soft power in Serbia are the fact that the Asian giant is perceived as a strong and growing economy, as well as the political support that China has provided to the Serbian government by not recognising Kosovo as an independent entity. Therefore, the wider population perceives China as a benevolent actor that supports Serbian interests – something which could easily be used as political leverage.

Serbia as a future Trojan horse inside the EU?

An important argument mentioned by regional policy experts, and even by high-ranking politicians such as Johannes Hahn, the EU Commissioner for European Neighbourhood Policy and Enlargement Negotiations, is that the rising Chinese influence in the country could make Serbia a Trojan horse within the EU. This is a valid argument, but it is based on false premises: Serbian accession to the EU lies in the rather distant future, and the Chinese have much more important friends who are already inside ‘fortress Europe’. First of all, there is rising anti-accession sentiment within the most important EU countries, such as France. As Nathalie Loiseau, the top candidate of La République en Marche party for the EU elections stated during her visit to Belgrade as French Minister for European Affairs in March 2019, there would not be a new wave of EU accession any time soon.

This is not only because of Serbia’s lacklustre track record in meeting EU criteria, but mostly because the EU itself is not ready for the accession of new members. Furthermore, if one wants to look for Chinese Trojan horses, one should not look at the gates, but beyond the walls. The two most important candidates for this title are Viktor Orbán’s Hungary and Matteo Salvini’s Italy.

Both these countries are dissatisfied with certain EU policies, and are trying to establish strong political connections with non-Western stakeholders. Both countries are also vying for Chinese investments and loans, although this economic segment is probably more important for the Italian government, due to the sluggish performance of the Italian economy and weak public finances.

Hence, overemphasising Serbian cooperation with China as a political problem could seem simply hypocritical and insincere, bearing in mind the much higher levels of cooperation between the EU core countries and China.

How can the West take on the Chinese challenge?

For the time being, it seems that the West has not been able to counteract China’s rising influence in Serbia, as well as in the Western Balkans. Brussels needs to make some strategy changes. It needs to communicate with the Serbian people (who still wrongly believe that Russia is Serbia’s most generous donor!), not just their government – something the US seems to have acknowledged too: the US Embassy in Belgrade has recently stopped focusing on the painful past or on Kosovo, and turned to future fruitful cooperation.

Overemphasising Serbian cooperation with China as a political problem could seem simply hypocritical and insincere, bearing in mind the much higher levels of cooperation between the EU core countries and China.

It should also not come as a surprise that few EU flags were spotted during the street protests against Mr. Vučić’s government in recent months. It is hard for Serbians to see the EU as a supporter of freedom, when the president of the European Council Donald Tusk called Vučić his ‘friend’ and ‘soulmate’ at a press conference.

The very technical language of accession reform conditionalities is hard to understand for the general public, whereas EU support for Vučić is plainly clear. The EU should place more emphasis on the rule of law and media freedoms in the country (most programmes so far have not produced any significant outcomes), as well as the centralisation of political power, which could be tackled through changes in election system and judicial appointments.

The Kosovo issue should be resolved as soon as possible, but on a more inclusive and participatory basis, in order for a long-term compromise to be reached. These changes would eliminate most of the factors that enable China, Russia and other external factors to exert their influence in the country. Mutually beneficial cooperation with these countries could still take place, but Serbian society would then be able to distinguish between opportunities and traps.

For the time being, the EU’s actions as an external factor in the region are not strengthening or developing local resilience to foreign influence, but are in fact supporting the very forces that are undermining it.

Exploring Putin’s strategic narrative

By Iulia-Sabina Joja | Berlin

Russia’s foreign policy is President Vladimir Putin’s foreign policy. It’s a one- man show. This is partially due to the super-presidential system of the country. However, it is also a one-man show because Vladimir Putin himself, now in his fourth term, has a firm grip on his country and a strong vision for foreign policy. Hence, when endeavouring to scrutinise Russian foreign policy, we have to analyse Putin’s discourse and actions.

‘New World Order’: The “natural family” franchise goes global

First gay marriage, then liberal democracy… As a global ultra- conservative movement brings its war of values to the Balkans, autocrats are paying attention.

At Saint Spyridon the New Church, the largest Orthodox church in Bucharest, the priest had an important message for his congregation.