Why Moscow Should Beware Beijing

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Russia's burgeoning friendship with China is a neat match of the world's biggest energy producer and its biggest energy consumer. And not only does China have the cash to buy Russian oil, gas, steel, and aluminum just as fast as it can be pumped or mined—but it attaches no tiresome lecture on the evils of fossil fuels or authoritarian rule to its payment. Why wouldn't Russia choose friends in Beijing rather than in Europe?

Simple: a year ago, President Dmitry Medvedev correctly diagnosed Russia's basic malaise as overdependence on exporting raw materials—which breeds a multitude of sins, chief among them a bloated, corrupt bureaucracy and an economy at the mercy of the world's commodities markets. He argued that Russia's future lies not in "a primitive economy based on raw materials and endemic corruption" but in a knowledge economy based on Russian brainpower. But hitching Russia's economy ever more closely to China's achieves the exact opposite: instead of breaking Russia's dependence on its mineral wealth, it deepens it.

One can't blame Medvedev, of course, for accepting Beijing's dime. Russia needs new customers for its most important exports. The new Skovorodino-Daqing oil pipeline, built by Russia's Transneft and China National Petroleum Corporation (CNPC), China's own state hydrocarbon giant, and opened last week by Medvedev and Chinese President Hu Jintao, is just the first in a series of oil and gas links planned between Siberia and China. A $5 billion oil refinery is being built by the Russian state-owned oil company Rosneft and CNPC in Tianjin. And last week saw deals signed for two 1,060-megawatt Russian nuclear reactors to be built near Shanghai.

Long term, however, the structure of these deals will entrench all that's most flawed about the Russian economy. Most of these deals are being concluded between state-owned companies rather than between private businesses. That may be inevitable—only state giants have deep enough pockets to fund the kind of $25 billion, 15-year deal that created the Skovorodino-Daqing pipeline—but many analysts blame the growth of Russia's state sector for the current sluggishness of its recovery from the economic crisis. Russia's private oil companies raised production by 50 percent from 1999 to 2004 thanks to investment in modernization—but after the Kremlin's seizure of the largest of them, Yukos, that growth dried up. Now, despite grand talk of investment by state giants like Gazprom and Rosneft, Russia's net oil and gas production is forecast to sink steadily by between 0.29 percent and 1.24 percent year-on-year.

China's deal to buy nuclear reactors—a product where Russian brain-power create added value—was certainly good news. But when Medvedev suggested the Chinese invest in Skolkovo, his "innovation city" outside Moscow, Hu made polite noises, but demurred. The Chinese, understandably enough, prefer to develop their own electronics, aerospace, and biotech industries rather than invest in someone else's. Indeed, since 2007 China has cut back dramatically on purchases of Russian military hardware—largely because the People's Liberation Army had worked out how to produce its own close copies of Russian military aircraft, space-launch vehicles, submarines, and warships. In other words, China has used Russian know-how and Russian energy to turn Russian steel and aluminum into high-tech products—relegating Russia to a simple provider of raw materials, while China adds the value, trades with the world, and makes the big bucks.

Having Russia as a convenient and reliable supplier of energy and metals is of course highly advantageous for China. Russia is also arguably China's most important ally: it supplies oil and natural gas, provides support in stabilizing Central Asia, and lends diplomatic assistance in Iran and especially North Korea, where its influence is a close second to China's. China also carefully cultivates the illusion that this is a partnership of equals, but it's not. Serving China as its gas tank is a road to stagnation. Big deals with China will make a lot of big Russian bureaucrats rich, and boost Russia's headline growth numbers. But that's not going to help Russia modernize. Hitching Russia's economy to China's may be the easy choice. But if it's to remain at the top table of developed countries in generations to come, Russia should be honing its competitiveness to do business in Europe.