Milken Institute Review 2Q10 Page 44

The Milken Institute Review

of keeping a largely privatized economy on a
short leash, offering little prospect of better
governance or high productivity, which typi-
cally evolves organically from decentralized
markets and open economic competition.

Putin's strategy is, in part, a reaction to the

currency crisis of 1998, in which Russia
found itself at the mercy of foreign creditors.

To avoid such dependence in the future, pri-
vate enterprise must defer in choosing be-

tween profit maximization in risky global
markets and the broad interests of the moth-
erland as interpreted by the Kremlin.

An obvious question here is why Putin

bothers with the facade of capitalism. Why
not just go back to government ownership
and Soviet-style planning? Clifford Gaddy, an
economist at the Brookings Institution, ar-
gues that Putin sees himself as a corporatist
rather than a socialist that he is the chief ex-
ecutive of Russia Inc., not the chief function-
ary of a centrally planned economy. The goal
is to keep the economy on a course broadly
mapped by the government, but to leave the
operations to the private sector in order to
avoid the wretched inefficiency characteristic
of state ownership.

Like the CEO of a large corporation, Putin

apparently sees himself free to change the op-
erations of subsidiaries and to fire operating
managers who fail to meet his expectations. So

while Russia remains a nation of laws on paper,
control of the private sector is based less on
formal regulation than on extralegal threats

as in, "we can dismantle your company just as

we did Yukos," the giant oil company that was
buried under a blizzard of tax claims and
criminal prosecutions in 2004 to 2006.

In an environment of minimal economic

freedom, no real protection under the law
and immense oil revenues, the owners of
large enterprises were presented with a unique
ultimatum: You can keep your properties if
you make them productive. Of course, you
must also be prepared to share your wealth
with the government and with other private
parties favored by the government. Last but
hardly least, you must defer on strategic deci-
sions that could affect Putin's power or Rus-
sia's interests as interpreted by the Kremlin.

Once Putin consolidated authority, the

way the strategy would work in practice be-
came clearer. The government took advan-
tage of the oil boom to pay off its foreign
debts. And it consolidated its grip over busi-
ness, demanding an increased share of the
earnings of raw material exporters, which
were reaping the fruits of the broader global
commodity boom. The government thereby

accumulated a vast war chest, with $200 bil-
lion set aside to support domestic investment
and to sustain the Kremlin's power to reward
compliant businesses. Most of the accumu-
lated reserves, it should be noted, were held as
the short-term debt of Western governments

an effort, presumably, to give the govern-

ment clout in central banking circles and to
contain the ravages of currency appreciation

(i.e., Dutch disease). This, ironically, opened

up a large market for Western investors to
supply capital to Russian businesses suffering
from a shortage of domestic credit.

The Kremlin judged Western financial in-

stitutions to be better at finding productive

ike the CEO of a large corpo-

ration, Putin apparently sees
himself free to change the op-
erations of subsidiaries and

to fire operating managers who
fail to meet his expectations.

r u s s i a 's p r o s p e c t s