Russia's Crony Capitalism

by Anders Aslund

  Putin reacted most strongly against the release on April 3, 2016, of the Panama Papers, which revealed his offshore holdings of at least $2 billion through his cellist friend Sergei Roldugin. Andrei Soldatov and Irina Borogan have chronicled the Kremlin response. Putin’s spokesman Dmitri Peskov commented on them immediately. On April 7, Putin himself attacked the journalists who had released the Panama Papers: “What did they do? They manufactured an information product. They found some of my friends and acquaintances. . . . There are many, many people in the background—it is impossible to understand who they are, and there is a close-up photo of your humble servant in the foreground.” Putin continued: “Besides, we now know from Wikileaks that officials and state agencies in the United States are behind all this!” The next day, Putin convened the Security Council. On April 14, Putin again brought up the Panama Papers to defend his friend Roldugin in public. “Who is engaged in these provocations? We know that there are employees of official US agencies.” Putin saw the release of the Panama Papers as a US attack against him personally.47

  Putin tried to belittle the sectoral sanctions, but he has said comparatively little about them in public. The countersanctions on food imports, by contrast, have received great media attention and been presented as successful import substitutions, even though they have hit the Russian population the hardest. The April 2018 sanctions clearly shook the Kremlin. Sanctions were no longer seen as a joke, and they hit the stock market hard. A view might have developed that Trump was Russia’s and that he would not permit additional sanctions against Russia. The Kremlin might also have been scared by an obvious popular approval of the US sanctioning of both billionaires and people close to Putin.

  Putin has pursued a vicious economic war against Ukraine. His approach to Ukraine has been far more severe than his tactics with the West; as a smaller economy, Ukraine is highly vulnerable, and Russia was by far its largest trading partner. These two countries have hit each other with one sanction after the other in a steady escalation after Russia started blocking imports from certain pro-European Ukrainian businesses in August 2013. In January 2016, the EU and Ukraine provisionally applied their Deep and Comprehensive Free Trade Agreement. Russia responded by suspending the existing multilateral free-trade agreement among the members of the Commonwealth of Independent States with regard to Ukraine, thus imposing import tariffs on Ukraine, and Ukraine responded by leaving the CIS.48

  The two countries have gradually intensified their many trade sanctions, and mutual trade plummeted by 80 percent from 2012 to 2016, though it recovered substantially in 2017. This cruel trade war has hurt Ukraine the most, but Russia has lost a significant market and important military supplies. Russia’s share of Ukraine’s trade fell from 29 percent in 2012 to 11.5 percent in 2016. These trade disruptions have caused great damage to Ukraine’s economy, and 2016 marked the nadir. Ukraine’s trade expanded sharply in 2017, although the Russian sanctions did not ease.49

  As discussed in chapter 4, Gazprom is Russia’s favorite geopolitical tool, manipulating both prices and supplies for political aims. In the first quarter of 2014, Gazprom charged Ukraine $268.50 per 1,000 cubic meters (mcm) in accordance with an agreement between Presidents Putin and Yanukovych on December 17, 2013. On April 1, however, Gazprom hiked the price to $385 per mcm, announcing that it would no longer give any special Yanukovych discount. Two days later, Gazprom raised the price again, by another $100 per mcm, to $485 per mcm, arguing that since Russia had annexed Crimea, it was no longer obligated to offer any discount for Russia’s lease of the Sevastopol naval base, as Putin had agreed with Yanukovych in Kharkiv in April 2010. Kyiv responded by not paying, and on June 16, 2014, Gazprom stopped supplying gas to Ukraine.50

  Gazprom and Ukraine’s Naftogaz sued each other in the Stockholm Arbitration Institute, and in June 2017, Naftogaz won an extraordinary victory, relieving it from Gazprom claims valued of as much as $75 billion. Since November 2015, Ukraine has not imported any gas from Russia. Naftogaz also won a great victory over Gazprom over gas transit through Ukraine. The Stockholm Arbitration Court obliged Gazprom to pay Naftogaz $2.56 billion. However, Gazprom refused to pay, prompting Naftogaz to state that it would go after Gazprom assets abroad to cover its award.51

  Ukraine has banned its previously substantial military supplies to Russia, and it has stopped trade with Crimea and, in March 2017, also with occupied Donbas. Russia has restricted transit of Ukrainian goods through Russia, while Ukraine has banned Russian flights over its territory. To add insult to injury, Russia also imposed transit restrictions on Ukrainian exports to Kazakhstan and Kyrgyzstan, which eliminated 0.4 percent of Ukraine’s total exports.52

  What about China? After the collapse of the Soviet Union, Russia and China drifted apart. The Chinese leadership was appalled by the Soviet demise, and the Kremlin looked to the West, while Russia’s economic crisis led to a sharp decline in the two countries’ mutual trade. Gradually, Russia and China have restored and expanded their political and economic relations. In 2009, China became Russia’s biggest trading partner, and its lead has continued to rise, even if Russia’s trade with the European Union as a whole is much larger.53

  As the West closed to Putin, he attempted a pivot to China, but the Russia-China economic relationship is quite unbalanced. Russia exports raw materials, primarily oil, and arms to China, while China supplies Russia, and the rest of the world, with manufactures. Chinese investment in Russia has been remarkably small, because the Kremlin has hardly allowed Chinese state companies to invest in Russian raw material extraction, and mutual suspicions prevail. The ultimate Russian fear is that millions of Chinese will invade its depopulated Far East and exploit its vast natural resources. These worries have impeded commercial integration.54

  Russia has been most comfortable with China in high-level politics. Russia and China tend to act together in the United Nations Security Council. In 1998, Russia joined the Asia-Pacific Economic Cooperation forum. The Shanghai Cooperation Organisation, created in 2001, was a big step forward. In 2009, Russia convened the first summit of the BRICS, but most important are bilateral summits.

  After its annexation of Crimea, the Kremlin attempted a pivot to China. This was a textbook case of realpolitik, or how not to pursue foreign policy. Russia was cornered, whereas China could choose among Russia, the United States, and the European Union, and it has several times more trade with the two latter markets. In May 2014, Putin traveled to China and he was all in. His prime ambition was to conclude an agreement with China on Russian delivery of gas to China. He did so, but on Chinese conditions. Russia wanted to use gas from Western Siberia, but China insisted on the development of new gas fields in the Far East, which would be exclusively for China. The Kremlin wanted to deliver that gas to a new liquefied natural gas plant in Vladivostok, which would give Russia the flexibility to sell to other countries as well, whereas China preferred a pipeline going only to China. After having won on these two accounts, China had gained a monopoly on this future gas production and could do nothing but win on the last issue, the price.55

  It would get worse. Within two months, Russia suffered two major blows, the collapse of oil prices and Western financial sanctions. The agreement on gas deliveries to China had not been final, and ample energy supplies cooled China’s interest. The Chinese government had promised to provide $25 billion in credits toward building the large Russian gas pipeline the Power of Siberia in the summer of 2014, but after the US financial sanctions were imposed, the Chinese state banks with substantial exposure to the United States refused to provide the credit, fearing US fines for violating its Russia sanctions. Neither was China helpful to Russia on Ukraine. In the IMF board, China has persistently voted for IMF funding of Ukraine since 2014, leaving Russia as the lone dissenter. Ukraine had become China’s biggest supplier of corn and its second biggest provider of arms after Russia.56

  Many years ago, former first deputy minister for foreign affairs Anatoly Adamishin told me that
Russia had refused to become a junior partner to the United States. Instead, it had become a junior partner to China. Although Russia-China relations are arguably better than ever, Russia is the weaker partner.

  Independent Russia is an odd fit in the global order, and it has been unable to find its place. The Kremlin sees only the United States and China as its equals, but neither returns the compliment. Although the European Union accounts for almost half of Russia’s trade, the Kremlin continues to treat the member countries as separate entities. Its foreign economic policy can be summarized as an odd combination of increasing protectionism in trade and remarkably liberal capital flows.

  In substance Russia might not have changed its policies much, but its ambitions have switched from increased international integration to isolation and protectionism. Sergei Guriev puts it succinctly: “The Ukraine crisis changed everything. Russia’s March 2014 annexation of Crimea and the resulting Western sanctions brought about a clear division in Russia between ‘us’ and ‘them.’” Putin’s foreign economic policy must be seen in the light of Ukraine, which Putin perceives as the elusive geopolitical jewel in his crown.57

  Other economic developments have not contributed to international integration. The strongest force is the global price of oil. When the price of oil was high in 2011–2013, oil and gas accounted for two-thirds of Russia’s exports. When it was low, as in 2016, their share fell to half of the exports. Thus, lower oil prices drive diversification, but other exports have not increased in absolute terms. The main beneficiary has been agriculture, while poor investment conditions have hampered manufacturing. The government has consistently blamed the poor economic results on the West, which makes a lot of political sense, but it might not be quite correct.

  The Russian leaders seem most comfortable with the G-20 and BRICS, which are exclusive and treat Russia as an equal. The G-8 was always a misfit, because the other countries were wealthier, more democratic, and less corrupt than Russia. These constellations, however, are clubs rather than institutions, having minimal impact on the real economy. The WTO is the most important organization for world trade. Although Russia became a member in 2012, the WTO has not influenced the Russian economy much, as the government has not attempted to use it for diversification or modernization. On the contrary, Russia has turned more protectionist since it joined the WTO.

  Instead of using the WTO to reform its economy, the Kremlin has focused on the EAEU and cooperation with China. The EAEU is currently Putin’s main focus, but it is difficult to see what good it can bring. For all the five countries involved, it amounts to trade diversion rather than trade creation. To Russia it is costly, since it tempted the other members with material incentives. The unequal rules of the EAEU arouse hostilities rather than affinity among the member states. And it contributes to Russia’s increasing isolation. Even the Kremlin seems to have lost interest in the EAEU.

  Import substitution is currently the leading Russian slogan, and protectionism appears to have increased in the Russian economy, though these tendencies should not be exaggerated. In comparison with the high customs tariffs of other BRICS countries, the Russian economy remains quite open. The Soviet Union cherished the Latin American arguments of the need for infant industry support through protectionism, but such protectionism nurtures state enterprises that pursue selective procurement.58

  Increasingly, the Kremlin has become preoccupied with national security. In 2008, Russia enacted the Strategic Sectors Law, which restricted foreign investment. Originally, this law specified forty-two sectors of strategic significance, in which foreign investment required special government permission. Most of these sectors are of obvious importance for national security, but not all, notably broadcasting and publishing. The law has repeatedly been amended and expanded to forty-five activities that require government approval for significant foreign investment. The October 2014 law “On Mass Media” restricted foreign ownership of any Russian media company to 20 percent. Large sectors, such as energy, telecommunications, and media, are closing up to foreign business, depressing the market prices of such assets.59

  Internet companies face particular problems in Russia. The FSB has two important demands. It insists on having access to all data, including ciphered information, and it wants all computer servers used in Russia to be stored in the country. This nationalizes the Internet and separates Russian from international Internet companies, harming such Russian companies as the excellent search engine Yandex, which had outcompeted Google in Russia, but now it has been barred from Ukraine. Before the Russian elections in March 2018, Russia adopted two laws ending Internet anonymity. Admittedly, in all these regards, Russia appears quite liberal in comparison with China.60

  In contrast to the increasing protectionism for trade in both goods and services, Russia has maintained free capital flows since 2006. The official tolerance to capital outflows is remarkable, given the great and sharp capital outflows in 2008 and 2014. The best explanation is that the main beneficiaries of these capital outflows are the rulers themselves, as discussed in chapter 5.

  The policy conclusion for the West is that it makes more sense to go after the money of the cronies, sanctioning them and their capital flows and freezing their assets abroad, while trade sanctions hurt the population as a whole. This is in line with the selective sanctions of cronies and their companies, but those assets need to be uncovered and frozen.

  E • I • G • H • T

  Liberalism versus Statism, or Reform versus Corruption?

  To divine where Russia’s economic policy may be moving, we need to examine the public debate. In comparison with discussions about politics and law, the economic debate is quite open, even if it has become less so in the past decade. The economists are divided into two big ideological camps, classical liberals versus statists and nationalists. A new strand focuses on combating corruption.

  In this chapter I shall assess the current state of economic thinking. A first bout of economic policy debate occurred in 2012–2013, when a new chair of the Central Bank of Russia was about to be appointed. In May 2016, Putin invited a new round of economic debate in preparation for the presidential elections scheduled for March 2018.

  In the early 1990s, the Russian economic debate was intensely ideological. The liberal market reform program was driven by three men: President Boris Yeltsin, First Deputy Prime Minister Yegor Gaidar, and Deputy Prime Minister and Minister of Privatization Anatoly Chubais. They embraced the ideas of the Washington Consensus and the Polish Leszek Balcerowicz program, which both embraced a normal market economy with reasonably stable prices, a free exchange of goods and services, dominant private ownership, free trade, and the rule of law. In this economy, taxes would be low and stable and public expenditures limited, while the state would provide a reasonable social safety net. The state would set the rules for the market rather than interfere directly in the market.1

  Yeltsin, Gaidar, and Chubais carried out a first reform wave in the years 1991–1994, building the essentials of a market economy with private enterprise, but they failed to stabilize the economy, build the rule of law, or carry out social reform.

  The financial crash of August 1998 brought about a second reform wave, 1998–2002. The crisis made it politically possible to eliminate the large Russian budget deficit, and a wave of second-generation reforms ensued. These included reform of the tax system and the judicial system, deregulation of small enterprises, land reform, and pension reform.

  Throughout these years, a few important liberals held key positions in the Russian government. Although the specific individuals varied, they were all friends and formed a tight group of like-minded thinkers, whether inside or outside government. Gaidar and Chubais remained the informal leaders of this group.2

  After Putin became president in 2000, the two most important liberal ministers were Finance Minister Alexei Kudrin and Minister of Economic Development and Trade Herman Gref. Prime Minister Mikhail Kasyanov (2000–2004) and preside
ntial chief of staff Alexander Voloshin (1999–2003) were perceived as close to big business, but they supported the liberals most of the time. In 2007, Gref left the government to become CEO of Sberbank, the former Soviet savings bank, leaving Kudrin as the leading economic liberal, which he still is. In September 2011, Kudrin resigned from the government in protest against Dmitri Medvedev’s becoming prime minister and against increasing military expenditures. Unlike most of his colleagues, Kudrin has not departed for big business but stays involved in the policy discussion as head of a nongovernmental organization, the Civil Initiative, and since May 2018 as chair of Russia’s Auditing Chamber.

  The Russian liberals have always faced severe opposition. Although communism as an ideology died with the Soviet Union, its ideas have lingered in various remnants. From 1992, old-style communists and Russian nationalists formed a so-called red-brown coalition in the Russian parliament. They embraced a statist ideology, combining ideas of dominant state ownership, extensive state intervention, protectionism, and macroeconomic stimulus.

  Throughout this period Gennady Zyuganov has led the Communist Party of the Russian Federation. He has maintained old Soviet ideas, lauding Stalin, the Russian Orthodox Church, and Russian nationalism simultaneously. The Communist Party even displays icons with Stalin as a saint. It operates as a trade union for retirees, constantly demanding higher pensions. It favors maximum public expenditures and a very loose fiscal and monetary policy, evincing no interest in balancing the books.