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13 February 2017

Budgetary gaps

Do Russian regions need money?

The President of Tatarstan Rustam Minnikhanov made a statement in the republic’s Parliament in late December 2016 during which he accused the federal government of siphoning off money from regions which boast of the most economic resources as well as unfairly redistributing money to numerous regional outsiders. Not only is this practice widely known to be employed by the federal authorities (several donor regions feed approximately 75-77 recipients whose budgets lay in tatters), it’s also supported by the majority of the country’s population. Nearly two-thirds of regions suffer from debt overhang and are operating with budget deficits.

During the 2008-2009 crisis, on a relative par with the current downturn, the federal government had far greater financial resources at hand and was able to settle the deficits of beneficiary regions through a variety of subsidies. Hence, problems connected with falling incomes or social security were successfully avoided. Amidst the ongoing crisis, the authorities are unable to rely on such a federal financial cushion. Moreover, regional revenues have dwindled enormously in real terms. The statement made by the leader of the, relatively unscathed, Tatarstan, addressed at neighbors with far lesser resources, must have felt like something of a kick in the teeth.

On the other hand, the statement of the head of the republic underlined the problem concerning the relationship between regional budgets and the federal center. The redistribution policy is a fundamental of the Russian system. In practice, this means that the lion’s share of regional revenue is transferred to the central budget as profits tax base and as little as 40% remains at the regions’ disposal. The federal authorities subsequently distribute funds among all regions according to a certain formula. This redistribution process was designed to level out the playing field occupied by poorer regions which operate at a loss, and their more prosperous neighbors from the point of view of economic well-being.

This strategy, known as “the alignment strategy”, is nothing new. It is the mirror image of another mechanism under which key resources are allocated to the most profitable territories. Many researchers who study processes of federal redistribution of powers are advocates of the latter approach. The redistribution of funds to a lower tier sits well with market laws: the most advanced regions succeed, while less profitable regions are incentivized to actively develop their hubs of economic growth for fear of being denied help from the center.

Such an approach is most widespread in classic democratic federations. The issue of budget decentralization, as posed by Minnikhanov, is no longer practiced in the US, Canada or India as their regions have their own, vast resources and, most importantly, their own tax base. However, a different problem concerns the agendas of the above mentioned countries: the ratio of tax revenues from the regions to allocations from the federal budget in the form of loans and grants. The regions, spoiled by budgetary inflows (from their own and federal budget), no longer meet the economic requirements of efficiency and their budgets are no longer spent rationally. On the other hand, the regions start playing by the rules introduced by the center, given increasingly meager tax revenues and rising federal handouts in the form of loans and grants. This is not too bad in economic terms; territorial units strive to implement federal policy most effectively in order to qualify for additional grants.

Some semblance of these rules of the game exists in Russia as regions can obtain loans from the federal center, but the means by which the funds are transferred is entirely different. Regions do receive loans from the federal budget, yet many of them have no intention nor are capable of repaying these loans. Moreover, the reasons for allocating such loans are less than transparent and are often based on informal arrangements. In other words, regions are not forced to engage in economic competition to get a hold of federal funds. Budgetary gaps between regions are bridged on an ad hoc basis, taking into account economic and political conditions considered to take priority, for a variety of political reasons, by the center.

Why does Russia have to play by these rules? To begin with, the rules currently in place are most strongly affected by the existing political regime. Only a system that recognizes the existence of many political players can foster the establishment of competitive federalism with functioning economic rules. In other words, governors and mayors are sovereign politicians to whom heed should be paid and whose opinions must be heard. This does not mean that the federal center is inevitably weakened as modern democratic federations define discretionary powers of the regions in many ways ranging from limited powers in the case of Austria to virtual all-out freedom, as in Belgium. Still, in both cases, the regions are afforded their say and the federal center has no other option than to take these opinions into account. It is therefore only logical that such an approach cannot be implemented in a political system governed by a single politician and under which other politicians assume the roles of officials, appointees, and scapegoats.

This is not only about the direct threat posed by the political and budgetary discretion of the regions to the authoritarian regime, but also the lack of transparent mechanisms of such a system. All negotiations and decisions take place behind closed doors and the observance of formal rules is seen as of secondary or even tertiary importance. In other words, the Russian federative system only advances in “manual drive”. There is a rational explanation for this: it is risky to use general rules in relation to problematic regions. Chechnya is obviously one of these regions. However, Tatarstan is part of the “at risk” group for other reasons, too. For Chechnya, decentralization would mean the discontinuation of financial inflows which would render it an ordinary, poor region. Judging by formal, transparent rules, it is impossible to explain why this region should receive the lion’s share of federal handouts, although this can be explained intuitively. The problem with Tatarstan lies in the strong mobilization potential of this region. In the 1990s, this republic proved to be a rebel, an instigator which refused to play by the general rules both due to its resourcefulness and ethnic mobilization. Subsequently, the federal center drew its own conclusions based on lessons learned two decades ago.

Few regions are afforded the opportunity to openly criticize the federal center precisely because of rigid centralization. Similar statements to that made by the dissatisfied Tatarstan have also been made by the head of Chechnya, Ramzan Kadyrov, who complained that curtailed subsidies to his republic undermine social development in the region. It is clear that nearly all of the regions have encountered economic problems at some time or another. However, none of them – apart from the most “dangerous” sub-national territorial entities – has openly voiced displeasure regarding federal budget allocations. Statements by Tatarstan and Chechnya are indicative of the unstable situation surrounding the current system of federative relations in Russia. On the one hand, economic mechanisms of budgetary control over the regions help tackle possible political challenges on the ground while, on the other hand, all-too-familiar problems emerge against the backdrop of the budget deficit.

How long will this system continue given the economic downturn? Could an alternative system be introduced which would operate more efficiently and, at the same time, pose no threat to the integrity of the country? – this is the question. At some point, the status quo will have to be addressed for both political and economic reasons, although this is not the most important thing. The instability and inefficiency of the system are rather more pertinent issues. The system is stuck in “manual drive” and available solutions and resources are finite. Russia could learn a lot about regional competition from other federations. The politics of allocating grants and loans to regions which successfully implement federal strategies kills two birds with one stone as the federal government establishes its own rules by employing the carrot approach rather than the stick approach. In addition, the redistribution policy remains in place while objectives become more clear-cut. The status quo will only be addressed in the face of widespread publicity as the voice of the elites is not being heard. The fact that Rustam Minnikhanov has been silenced serves to further support this theory. 

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