Gorbachev said Putin told him, "because you can't have democracy and
fight crime and corruption if criminal elements are able to infiltrate the
ranks of the government in such a way."*
Is Putin a man who would be drawn to democracy if crime and corruption
were largely eliminated, or is he just an effective debater on the side of
authoritarianism? Gorbachev seems to believe the former. Certainly a significant
part of the Russian economy under Putin continues to throw off
*In the same March 1, 2006, interview, Gorbachev said, "As a country in transition, it is inevitable
that some freedoms are impinged on and that some mistakes are made. But I am convinced that
our president is not trying to install any sort of authoritarian rule." Ironically, he made these
remarks on Radio Free Europe, the American broadcasting system created to counter Soviet
propaganda. He added in an August 18, 2006, interview, also on Radio Free Europe: "There are
frequent accusations that democracy is being suppressed and that freedom of the press is being
stifled. The truth is, most Russians disagree with this viewpoint. We find ourselves at a difficult
historical juncture. Our transition to democracy has not been a smooth one. ... When Putin
first came to power, I think his first priority was keeping the country from falling apart, and this
required certain measures that wouldn't exactly be referred to as textbook democracy. Yes,
there are certain worrying antidemocratic tendencies.... However, I would not dramatize the
situation."
325
THE AGE OF TURBULENCE
the shackles of Soviet central planning, an indication of an acceptance of
greater freedoms.*
Putin behaves as though he believes free markets are fine for most of
Russia's economy. But he likely also believes that de facto state control of
major energy assets would prevent continued exploitation of Russia's economic
crown jewels by the oligarchs. Those crown jewels, of course, have
become immensely more valuable as oil and gas prices have risen to several
times their 1998 levels.
No longer bolstered by the Soviet Union's cold war military prestige,
Russia at the beginning of the twenty-first century found itself relegated to
being a distinctly lesser player on the world scene. Ukraine, Georgia, and
other former Soviet republics had drifted out of Russia's orbit and control.
To address that, Putin may be strategically employing an asset that in many
ways is more potent than the Red Army: a huge presence in world energy
markets. The USSR's military was restrained by potential U.S. counteraction.
But Russia does not see itself threatened with massive retaliation
should it use natural gas as an economic or political weapon. Because Russia
is a critical supplier of gas to Western Europe (and to so-called nearabroads
like Ukraine), its market power is largely uncontested. In addition,
Russia has also become a major player in the world crude oil market, although
its leverage there is weaker than in the market for natural gas because
oil cannot be monopolized as easily.
I suspect Putin was puzzled by the West's reaction to his management
of the negotiation over Gazprom's request for higher prices for natural gas
in Ukraine—he was roundly denounced for Soviet-style bullying when his
intervention resulted in a brief shutoff of supplies. But, he must have wondered,
aren't capitalists supposed to charge what the market will bear and
not hesitate to exploit economic advantage for profit? Besides, he was
merely removing the subsidy Ukraine had been getting from Russia for
years—the related shortfall in delivery of gas to Western Europe was inadvertent.
Wouldn't nineteenth-century America's Vanderbilt or Carnegie
*A glaring exception is Russia's natural-gas monopoly: Gazprom, created in 1992. Its pricing and
its rationing of supplies are reminiscent of Soviet central-planning opaqueness and inefficiencies.
Its huge pipeline infrastructure, as a consequence, is not fully maintained and is aging.
326
RUSSIA'S SHARP ELBOWS
have behaved this way? I think not. True capitalists protecting their long-
term profitability would have sought a gradual adjustment in the name of
good customer relations and maximum long-term profitability While it appears
that; since the gas shutdown, Ukraine has become more accepting
of Russian near-abroad policies, the incident has prompted customers in
Western Europe to seek alternatives to Russian gas, especially liquefied
natural gas and other piped sources. That will not serve Russia's long-term
interests.
But in the short run, Putin's gas and oil policy has succeeded impressively.
Less than two decades after its fall as the leader of the Soviet behemoth,
Russia has regained a full measure of global attention. And while
Putin has gradually dismantled significant parts of the democracy that
evolved under Yeltsin, I'd like to believe that, as Mikhail Gorbachev said in
August 2006, "Russia has changed to such an extent that going back now is
impossible."
There is no denying that Putin has selectively encouraged market openings
and has initiated significant improvements in the rule of law. He has
supported drastic revisions of the remnants of the collectivized Soviet legal
system. The role of judges and the Russian courts, which were notoriously
corrupt, has been redefined to reduce opportunities for bribery and the
political manipulation of verdicts. For instance, laws promulgated in 2001
removed many economically meaningless requirements for businesses to
obtain licenses, inspections, and product certifications—red tape that had
been an open-ended invitation for official corruption. (Low-wage bureaucratic
jobs were thus in great demand.) Property rights have been extended
in recent years, though struggles over rights to buy and sell farmland reflect
much the same Communist ideological hangover that exists in China. Except
to challenge the power of the Kremlin, the Russian people are free—to travel,
to congregate, and to engage in all the trappings of democratic societies.
The Russian economy is today best described as a market economy
backed by a still-imperfect rule of law. A significant segment of the nation's
most valued assets is in the hands of the state or of Kremlin allies. Political
control has been reinforced through control of the major media operations,
with most of the remainder "encouraged" to censor themselves. Putin and
his policies remain immensely popular. Objections from the Russian public
327
THE AGE OF TURBULENCE
are few; apparently the chaos of Yeltsin's democracy—including financial
defaults that savaged people's savings—left a residue of profound discomfort.
A poll in 2006 reported that almost half of the Russian people value
material well-being over freedom and human rights: democracy and freedom
of speech are not high priorities. Given a choice between the democratic
freedoms and economic instability of the Yeltsin years and the
stability and authoritarianism that have emerged under Putin, for now
most Russians prefer Putin.
This saddens me, but I am not surprised. Perhaps we in the West were
too sanguine in expecting a radical reversal in people who for more than
seven decades had been indoctrinated in collectivism. As Gorbachev once
wrote in the Financial Times (July 12, 2006): "The economies of the major
western countries took many decades, indeed centuries, to develop and
mature. Russia is still less than 20 years on from a totalitarian state based
on central planning, and our path to reform requires a little longer, even for
us." But history suggests that just as Russians rebelled against the chaos of
the 1990s, so too will they tire of restrictions on political freedom. Human
nature in this regard is highly predictable. A reaction is not a question of
whether, but when.
S
S
ince its collapse into bankruptcy in 1998, Russia's economy has recov
ered beyond most every analyst's expectations. Real per capita GDP
has moved well above the precrisis level. The unemployment rate, hovering
around 13 percent in 1998, declined to less than 7 percent by early 2007.
The inflation rate has fallen to single digits from a twelve-month peak of
127 percent in July 1999, and Russia's foreign-exchange holdings rose from
$8 billion at the end of 1999 to nearly $300 billion by 2007. The govern
ment's foreign debt has been paid down substantially.
Most of the credit for this sterling economic performance, of course,
goes to the dramatic surge in the prices of oil and natural gas. Growth in
the value of oil and gas exports accounted for a fifth of the growth in nominal
GDP between 1998 and 2006. However, few natural-resource bonanzas
arrive without a Faustian bargain. Russia's economic policymakers are
confronted with a daunting dilemma: a faster rise in the ruble exchange
328
RUSSIA'S SHARP ELBOWS
rate will foster the spread of Dutch disease, but foreign-asset purchases to
slow the rising foreign-exchange value of the ruble may uncork inflation,
depending on the mechanism used. Either would undo much of the economic
progress Russia has made since the dissolution of the Soviet Union.
Dutch disease symptoms are already evident. As oil and gas exports
surged, the value of the ruble rose and the value of Russian noncommodity
exports lagged. Between 1998 and 2006, the value of the ruble relative to
the currencies of Russia's trading partners doubled, after adjusting for their
relative inflation rates. The impact was predictable: exports excluding oil
and gas went up only half as fast in real terms as oil and gas exports.
Fully cognizant of the danger they face—and having watched Dutch
disease cripple the economies of many OPEC oil producers—the Russians
are in a battle to counter its effects. The standard treatment for Dutch disease
is to buy foreign currencies with the country's domestic currency and
thereby attempt to fight the market-driven rise in the country's exchange
rate. The hope is to avoid, or at least mitigate, the negative competitive effects
of the higher exchange rate on domestically produced goods. In the
case of Russia, the central bank uses rubles in vast quantities to buy dollars
or euros.
But this increases the monetary base, the raw material of money-
supply creation, and risks inflation. Between 1998 and the end of 2006, the
money supply—currency plus bank deposits—rose at a 45 percent annual
rate. Unit money supply—that is, money supply divided by output—rose at
a 35 percent annual rate.* That even the relatively high Russian inflation
rate of almost 10 percent a year has been running far short of the rate of increase
in unit money supply is doubtless puzzling and worrying to Russian
monetary authorities who fear a resurgence of inflation.
Of course, the Central Bank of Russia, like all central banks, has the
ability to destroy as well as create money. It does so by selling ruble-
denominated debt to the public and then extinguishing the proceeds. But
the CBR is limited by the lack of a broad ruble debt market and of a sophis
*Over the long run, the general price level tends to track unit money supply, since prices are defined
in terms of money—for example, $4 per bushel of wheat. In simple terms, the more
money outstanding to purchase the flow of produced goods and services, the higher the average
price.
329
THE AGE OF TURBULENCE
ticated banking system to facilitate debt sales, a heritage of these institutions'
lowly status in the USSR. Without ready means of sopping up and
destroying the excess rubles created by CBR purchases of dollars and other
foreign currency Russia would soon have to curtail its foreign-currency
purchases and allow the ruble to rise faster—triggering a Dutch disease
relapse.
Finance Minister Alexei Kudrin and his colleagues addressed this challenge
starting in 2004. They have been designating a long-term nominal oil
price, which, when exceeded, triggers the diversion of oil-related revenue
from the Russian budget into a special fund administered by the Ministry
of Finance. This so-called stabilization fund can be invested only in designated
foreign assets (largely foreign-government debt). Purchasing foreign
assets directly with the budgeted "excess" oil revenues denominated in foreign
currencies avoids increasing the monetary base and hence reduces
the potential for inflation. By the spring of 2007, the fund had exceeded
$117 billion, 97 percent of which was in foreign currencies (almost all in
U.S. dollars and euros, roughly equally divided). For Russia's politicians, the
downside of the stabilization fund is that it puts out of reach a great deal of
cash. While it is true that government spending has risen significantly with
the explosion of oil- and gas-related revenues, Kudrin has succeeded, so far,
in fending off pressure to feast on the oil bonanza. I had many occasions to
meet with Kudrin when he appeared as a guest at G7 meetings of finance
ministers and central bankers. He is very able, but I fear he is facing an uphill
battle. It is unclear to me how much sway he has with Putin, other than
on technical financial issues.
Russia is still a developing nation whose oil and gas resources dominate
its GDP. According to the World Bank, Russia's per capita gross national
income in 2005 was below that of Mexico and about the same as Malaysia's.
The ability to handle the stress of Dutch disease is obviously affected
by the severity of the virus relative to the overall size of an economy.
Yet why should Russia care if it has created an economy beholden to
oil and gas? It is using some of its export revenues to import high-quality
consumer goods from the rest of the world. Does it matter if those goods
are produced at home or abroad? Indeed, it would not matter at all if oil
