Putin's Third Way

Putin's Third Way

Mini Teaser: With the rise in oil prices and a conservative fiscal policy, Russia turned from a debtor nation into an economic powerhouse, creating a compromise between the excesses of the free market and the inefficiencies of a command economy

by Author(s): Clifford G. GaddyBarry W. Ickes

SPEAKING TO a group of foreign investors on October 20, 2008, Russia's prime minister, Vladimir Putin, boasted that in contrast to policy makers around the world, including those in the leading international financial institutions, he had not been caught unawares by the present financial crisis. While "all of them" were unprepared, he said, "we did not allow ourselves to be caught by surprise. When we formulated our long-term economic and financial policy, we took into account potential risks and threats." Alluding to his insistence on building up huge financial reserves, Putin noted, "We were sometimes even criticized for being too conservative. Well, I think that conservatism proved justified."

Was Putin really so prescient? The simple answer is no, Putin anticipated neither the exact timing nor the nature of this crisis. But in a more important sense, he did prepare. For eight years Putin pursued two main economic-policy priorities. One was to set up a system that could maximally exploit the advantages of the market economy while ensuring that the interests of private business owners would always remain subordinate to the strategic interests of the state. The second priority was to make the Russian economy robust to crisis. The dual policy objectives of optimal efficiency and maximum robustness to short-term shocks are inherently in tension. They cannot be permanently reconciled. Rather, they require continual balance. Until now, the balance has been struck such that there is a firm commitment to market methods and an openness to the global economy. But whether this can continue in the face of a much deeper and prolonged crisis has implications not only for Russia's short- and long-term economic development-especially in the critical oil sector-but also for the country's geopolitical behavior.


AS RUSSIA'S leader for the past nine years-in the posts of prime minister, president and then again prime minister-Putin has presided over one of the fastest-growing economies in the world. Until very recently everything seemed to go his way. When he began his tenure, the economy was on the rebound from the 1998 financial collapse. That crisis had briefly paralyzed the economy, but because it also resulted in a fourfold devaluation of the currency, it gave a boost to domestic goods-producing sectors, like the food, auto and consumer-appliance industries, that had previously been swamped by foreign imports. By the time Putin took over, the recovery was already under way. Later, as it slowed, the oil boom took off. The rise in the world oil price from its 1998 low of under $10 a barrel to over $140 in 2008 transferred a vast amount of extra wealth to Russia. During Putin's eight years as president, Russian oil and gas companies earned over $650 billion more from their exports than in the previous eight years under Boris Yeltsin.

The oil and gas wealth was leveraged to other sectors, mainly through the channel of consumer spending. Strong growth in personal incomes boosted the retail, construction and real-estate sectors. The stock market's rise reached bubble proportions. In the spring of 2005, the market value of the companies on the country's benchmark stock exchange, the Russian Trading System (RTS), was around $300 billion. A little more than three years later, the figure was nearly $1.4 trillion. Predictably, the global crisis-and especially the oil-price collapse-hit the stock market with a vengeance. As the price of oil has fallen back to its early 2005 level of under $50 a barrel, so too the RTS capitalization is rapidly falling down to the value it had previously.

As in the rest of the world, the severity of the current global crisis and especially its effects at home were slow to be acknowledged in Russia. Most of that complacency is gone now. Across the economy, from the federal and local governments to companies and households, Russians are scaling back on expectations they held only weeks earlier. Politicians in Moscow and in regional centers do not hesitate to refer to the situation of the past three or four years as a bubble, and warn that budgets will have to be revised and personal incomes will not grow.

It is impossible to predict whether there will be serious long-term ill effects. As in any bubble, economic agents at all levels made mistakes; that is, they made consumption and investment decisions that would not have been justified in nonboom conditions. But the bubble period was relatively brief at only three years. Whatever mistakes were made in that time pale in comparison with the misallocation of resources that took place during seven decades of Soviet management of the economy. Overcoming the structural legacy of communism remains the long-term problem. Here, far too little has been accomplished under Putin. This is the other side of the "conservatism" in economic policy of which Putin boasted. While Putin and his associates regularly devote much rhetoric to the need to address the deep-seated problems of the Russian economy-the inadequate and deteriorating infrastructure, outmoded physical capital, and the demographic and health crises-it has ended up being largely lip service. There has been little action. Most of the problems remain worse now than they were at the beginning of Putin's tenure.


THE STATISTICS relating to Russians' health and mortality are well-known, but they continue to shock. Life expectancies remain among the lowest in the industrialized world. The situation is worst for males, and especially those in the younger, potentially most productive age groups. Russian men between the ages of eighteen and thirty die at rates equal to those of men twenty to thirty years older in the United States, Western Europe and Japan. And even after nearly a decade of economic growth, things are not better now than they were ten or fifteen years ago. On the contrary, death rates for males twenty-six to fifty-five years old are higher under Putin than under Yeltsin. Russia's total population shrank 13 percent faster under Putin than under Yeltsin.

Whatever policy measures the government has taken to improve the population's health have been swamped by what it has failed to do in combating such obvious problems as excessive drinking and smoking. Per capita alcohol consumption is up 29 percent since 1999. Tobacco use is up 88 percent. The Putin government claims success for its pro-natalist programs, and indeed birth rates have risen in the last couple of years. But it is likely that much of the increase is due to the general rise in living standards in the boom. If so, the current crisis will bring them down again.

Despite the rhetoric, the growth and health of the population, like rebuilding an ailing infrastructure, have simply not been the main priorities of Putin's economic policy. Unwilling to force citizens to make difficult changes in attitudes and behavior, the government promoted consumption today at the expense of investment for tomorrow, and opted for stability instead of dynamism and mobility. The priority was not to invest in long-term growth but to invest in enhancing Russia's resiliency to short-term shocks. The most urgent undertaking was to restore Russia's financial sovereignty. The steps taken were the ones that characterized Putin's conservative approach: pay off the foreign debt and build financial reserves.


WHEN PUTIN assumed the office of president in January 2000, Russia had only $8.5 billion in foreign-currency reserves. The government's external debt was $133 billion. For Putin, paying off that debt was an imperative if he was to achieve his stated goal of restoring Russia's status as a sovereign nation. This was the lesson he took from the demise of the Soviet Union. For all the underlying weaknesses of the Soviet economy, the USSR did not collapse because it had been defeated militarily. It collapsed because it lost real political sovereignty as a result of losing all financial autonomy. Once it had become dependent on loans from first Western banks and then Western governments simply in order to import enough food to prevent hunger, it no longer could claim to control its own political destiny.

In Putin's view the Russian state must never again surrender its autonomy to foreign interests. The state must have the financial reserves to withstand any future crisis. This is why financial stability was a priority. The turnaround that he presided over during the next few years was remarkable. By the end of 2007 government foreign debt was down to $37 billion. A critical turning point was in January 2005. At the end of that month Russia paid off its debt to the International Monetary Fund (IMF), three and a half years ahead of schedule. The Russia that earlier had been one of the IMF's largest debtors was now free of all financial obligations to that body. It was also at that point that Russia began accumulating funds in a newly created oil-stabilization fund and into its foreign-exchange reserves at a far faster pace than before, a rate that would grow exponentially. In 2005, $55 billion was added to the currency reserves, with another $120 billion in 2006 and $170 in 2007 bringing the total to nearly $600 billion in mid-2008. Only China and Japan had more. And with a substantial amount of those funds held in the form of U.S. government securities, Russia joined those countries as a leading financer of the U.S. current-account deficit. It was a dramatic reversal of fortune over the course of a decade.

Essay Types: Essay