Hamish McRae: Here's how to build a bridge to Russia

The Russians are not easy to deal with, are they? The rough assertion of the country's perceived national interest by President Putin ahead of the G8 economic summit is public evidence of what one former EU commissioner told me. It was that of all the countries with which he had to negotiate the Russians were the most frustrating. It was not just that they were rude, kept shifting positions or would not stick to agreements; it was also that they would not act in their own long-term self-interest. They would do things that were stupid and that would damage themselves.

Now we all do silly things - countries, individuals, companies, whatever. But the relationship between Russia and the EU is crucial not just in the obvious political sense that we live alongside each other but also in terms of global economics. We are natural partners, with each needing and able to help the other. But what do you do when Russia threatens to use its energy supplies (which the EU needs) as a weapon? That is something that no major Opec member has done. For example Saudi Arabia has managed its production, sometimes cutting it back, but that has been to even out the price, not to deny supplies. Yet Russia has not just threatened to cut gas supplies to its customers: it has actually done so.

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Not clever. One thing Western Europe desperately needs is energy security. It now knows it cannot get that from Russia. It has to find alternative sources, to hedge its bets. While Russia will be able to sell its oil and gas at world prices, which will in all probability remain strong, it will not command the premium it might have done had it adopted a more co-operative stance.

That leads to a further point. It is very much in the self-interest of western Europe to have a successful economy in Russia. Thanks to its natural resources Russia seems likely to become the largest European economy within a generation - in practical terms Russia is indeed "European", for though some four-fifths of its land mass lies beyond the Urals, natural resources aside, some four-fifths of its economic output comes from its European territory. So four-fifths of its buying power will be on the EU's borders. If you look at the contribution that eastern Europe, the former Comecon countries, are now making to EU growth, you can catch a glimpse of the potential fizz that a successful broadly-based Russian economy could bring to all of us. But if Russia is to move beyond being principally a raw-material producer, it has to broaden its economic base.

Some 70 per cent of Russian export earnings come from raw materials; the exact proportion varies with oil and commodity prices. While this might appear an enviable position given the prospects for such prices, it carries a number of inherent dangers. You can see some of these already. Raw material economies tend to have large income and wealth inequalities, for the benefits of natural resource capital - unlike human capital - tend to accrue to a tiny number of people. Raw-material economies do not employ many people directly. Further, much of the wealth tends to be deployed abroad, as is happening not just in Russia but also in the Middle East.

By contrast, many of the eastern European countries are in the process of building competitive economies that owe nothing to natural resources. Thus Slovakia has become the most important regional centre for assembling cars. Hungary is rebuilding an electronics industry. These economies are not only growing solidly but because of their breadth are able to offer much better job opportunities for their people. Even the flood of eastern Europeans coming to Britain will ultimately benefit the donor countries as well as the hosts, because of the additional skills that the migrants will pick up and may well return to deploy at home.

But Russia shows little sign of becoming part of an integrated European economic space. Why? And how can we help, given that it is in our self-interest to do so?

Part of the problem is that the transition from a command economy to a market one was more mismanaged in Russia than in any eastern European country. It has a poor experience of the performance of Western advisers, particularly arrogant American economists who had ideological clarity but no practical experience of implementing policy. But that is past, and anyway it was not Europe's fault that the country was ill-advised.

A deeper problem was that the folk-memory of how to run a market economy was more embedded in countries such as Poland and Hungary than it was in Russia. The destruction of the ethical values essential to a proper functioning of the market, together with the need for regulation and protection of property rights, had been more complete.

So how can we help? It may sound trite but the starting point should surely be one of respect. One of the reasons why Vladimir Putin is so well regarded within Russia is that he has helped restore the country's pride in itself. Growling about the US wanting to put anti-missile sites in Eastern Europe goes down well at home, even if it scares the rest of us. It is ultimately a foolish stance, but you can see its attractions.

Beyond respect there has to be better economic co-operation. What Europe has to do is use its experience derived from the early years of the old EEC of using economic ties to overcome political suspicions. The EU may have its family quarrels, and will in all probability have to cope with growing internal tensions, but at least its original purpose has been achieved: of creating a Europe where war between the major nations has become unthinkable. So we need to use economics to make it unthinkable that Russia should target its nuclear weapons on its neighbours.

There is no magic wand here, just a series of incremental steps that bring cumulative mutual benefits. Obviously, you would not start with coal and steel co-operation, as the EU did. And I don't think you start at inter-government level: much better to work at a commercial level, then bring in government to clear roadblocks. A disturbing aspect of the run-up to this G8 meeting is that it seems to have increased scope for tension between members, rather than decrease it.

So let's keep the reintegration of the European economy away from the G8 and maybe even away from the EU. Rationally, there should be a single economic space from the Atlantic to the Urals, just as there was in 1914, before it was blown to bits. If the Russian authorities are hard to deal with, then so be it. General de Gaulle was not very easy to deal with but economic ties within Europe prevailed. The Chinese authorities are frequently not the easiest of negotiating partners but Western investment in China helped transform its economy. Now we have to figure out how to build a similar relationship with Russia.

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