Reason‘s December special issue marks the 30th anniversary of the collapse of the Soviet Union. This story is part of our exploration of the global legacy of that evil empire, and our effort to be certain that the dire consequences of communism are not forgotten.
The Soviet Union has been gone for 30 years now, having passed away without ceremony as the red flag was lowered from the Kremlin on December 25, 1991. It was created by a small but disciplined and fanatical sect who saw their chance and made their move in October 1917, when Russia was broken and starving from World War I and nominally governed by a wobbly coalition after the overthrow of the tsar eight months earlier.
“Power was lying in the streets, and we picked it up,” said Vladimir Ilyich Lenin, the revolutionary leader and founder of the Soviet state.
After promising “bread and peace,” Lenin launched one of the most repressive political and economic systems ever devised. Over a century later, its shadow still looms over Eurasia. For societies held in its grip, reform has proved risky and complex. In Russia, efforts to unravel Lenin’s handiwork are incomplete and have partly backfired, helping spur the creation of a new kind of authoritarian structure.
Lenin and his successor, Josef Stalin, conducted a strange and vicious experiment on the populations of Russia and an expanding realm of captive nations. Claiming that private enterprise inevitably leads to exploitation of workers, they sought to eradicate it, using all the violence and terror they could muster. Factories were nationalized. Farmland was confiscated. Livestock and seed were seized.
As his comrades routed the resistance, Lenin vowed that “we will make our hearts cruel, hard, and immovable, so that no mercy will enter them, and so that they will not quiver at the sight of a sea of enemy blood. We will let loose the floodgates of that sea.”
And so they did. Historians and statisticians debate the final tally of the dead from the terror campaigns, show trials, summary executions, induced famines, and concentration camps. But they are certainly responsible for one of history’s most lethal chapters of mass murder. Stalin biographer Simon Sebag Montefiore attributes about 20 million killings to the Stalin era alone. Yale historian Timothy Snyder estimated 6 million deliberate killings for Stalin, 9 million if other foreseeable deaths are included. Robert Conquest of Stanford put the total deaths for Lenin and Stalin at no less than 15 million.
The Soviet regime was built by men like Vasily Blokhin, awarded the Order of the Red Banner for his “skill and organization in the effective carrying out of special tasks,” most notably, delivering a bullet point-blank to the back of the head for 7,000 prisoners in just 28 days. Blokhin worked in a brown leather butcher’s apron. It helped with the mess.
The mass violence and terror served to build a new society, in which all significant assets were in the hands of the state and virtually all economic activity was supposed to be controlled by central command. All production, farming, and distribution for the largest country in the world, spanning 11 time zones, were directed from an office complex in Moscow, housing an economic planning super-agency called Gosplan.
Colossal waste and misallocations caused periodic famines and constant shortages. Even in the best of times, ordinary people waited in lines stretching around city blocks to buy necessities and bartered with family and friends to get by. Meanwhile, the communist elite were served by well-supplied shops with display windows discreetly covered in long gray curtains and with admission by invitation only.
Some of the greatest cruelties came after Soviet leaders discovered how much buried treasure there was in the country they ruled. The richest prizes of minerals and fossil fuels were locked tightly in the permafrost of the Arctic Far North and the Siberian taiga. To break through the frozen ground and extract this treasure with ordinary wage labor would have required massive investment upfront in heavy machinery, transportation, housing, and facilities, as well as high wages to attract workers to endure the hardships and risks of life in places not fit for human habitation.
The Soviet leadership found a cheaper way. They developed a network of “corrective labor camps,” which provided forced labor to build railways, dig canals, construct factories, and work in mining, processing, and shipment of ores and fossil fuels, as well as in logging and other industries requiring heavy and dangerous labor, particularly in remote areas with the most brutal climate. According to historian Anne Applebaum, writing in the June 15, 2000, New York Review of Books, high-level planning discussions among Soviet leaders in 1929 about expansion of the camp system focused on “how many prisoners would be needed to extract the resources of the ‘underpopulated areas,’ a euphemism for the barely habitable far north.”
The network of camps that was created came to be known as the gulag, an acronym of the Russian words for “main administration of corrective labor camps.” Some of the prisoners sent to corrective labor camps were common criminals, but the majority were people convicted of “political” or (even more commonly) “economic” crimes, which came to be very broadly defined. It is likely that these crimes became so broadly defined and enforced in part to assure an adequate supply of labor for the gulag.
As Applebaum recounts, getting caught twice for being 10 minutes late for factory work could be considered “desertion” and garner a 5-year sentence. According to Alexander Solzhenitsyn, an audience at a political conference vigorously applauded the name of Stalin for 10 minutes, with everyone afraid to be the first to stop because secret policemen were there; a local factory director who was finally the first to stop clapping was arrested and sentenced to 10 years. After 1929, being identified as a kulak—a peasant farmer who had prospered enough to own land and several head of cattle or horses—was enough to be condemned as a class enemy and dispatched with a bullet or sent to the gulag.
A sentence to the gulag carried a high risk of death, especially for the old and weak. Among the worst was the Butugy-chag Corrective Labor Camp in the Kolyma mountains of northwestern Siberia. Prisoners there mined uranium without protective equipment. Life expectancy was reportedly measured in months.
Can a people escape a history like this and make a normal life? Now that a full generation has passed since the collapse of the Soviet system, a preliminary assessment can be made. At least for Russia—just one of the 15 countries formed from the vast territory of the Soviet Union—it does not look promising.
But perhaps it could all have been different. In the effort to build a prosperous economy and free society from the husk of the Soviet system in the 1990s and afterward, serious mistakes were made, and some seriously misguided ideas prevailed. While the Russian people are responsible for their own fate, it must be said that some of the mistakes and bad ideas came from the United States.
Buried Treasure in the Frozen Ground
To understand what happened after the Soviet collapse, it helps to track the development of one enterprise, now called Norilsk Nickel, a mining operation named after the city where it was founded. Located deep inside the Arctic Circle, Norilsk is today the northernmost city in the world with more than 100,000 in population. With savage windstorms and temperatures averaging negative 23 degrees Fahrenheit in January, Norilsk appears unfit for human life and work.
But as Stanford historian Simon Ertz relates in the 2003 book The Economics of Forced Labor: The Soviet Gulag, in the early 1930s, the young Soviet regime discovered signs of untold wealth in the barren area that would become Norilsk. A geological survey team identified vast deposits of nickel as well as copper, cobalt, and platinum. Nickel was the most valuable prize for its use in making stainless steel for military production. Estimates of the size of nickel deposits there were regularly raised as new measures were taken, and by 1939 the regime concluded that perhaps more than a quarter of the world’s recoverable deposits of nickel were in the area. Large deposits of coal were also conveniently nearby to provide power for smelting and transportation.
But how to recover all of this bounty? Development of the complex was initially under the jurisdiction of the Ministry of Heavy Industry, but little progress was made in building infrastructure. In 1935, responsibility was transferred to the People’s Commissariat for Internal Affairs—the notorious predecessor of the KGB—which was responsible for administering the gulag. The site was renamed the Norilsk Corrective Labor Camp (abbreviated Norillag in Russian). The first contingent of more than a thousand prisoners arrived almost immediately.
Prisoners who had to break through the permafrost worked with only pickaxes and wheelbarrows. Most did not have boots. A 1936 report from Norillag unearthed by Ertz—sent to Moscow to explain the slow progress to an impatient Stalinist administration—vividly describes the conditions. Prisoners “work under permafrost conditions, under the most severe snowstorms, which dissipated their energy and mental state. Only a person who had experienced it himself knows what it means to preserve the necessary vitality and working energy after months of constant winds with a force from 18 up to 37 meters per second that blow continuous clouds of snow, so that visibility is about 2 meters. Stray workers were lost due to loss of orientation. They had to work in temperatures reaching 53 degrees below zero [Celsius].”
According to Ertz, the timing of this report—at the outset of Stalin’s Great Purges—proved unfortunate for the general manager of Norillag. In that mass political repression from 1936 to 1938, in which about a million Communist Party functionaries, military officers, managers, and others were killed, the Norillag manager too was arrested, tried, and sentenced to death for dereliction. Although his sentence was later commuted to incarceration, he died a prisoner.
In the mid-1950s, after the death of Stalin, the gulag system was mostly dismantled. While political repression continued, and dissenters remained vulnerable to arrest and imprisonment, the system of slave labor organized through the gulag was no longer a cornerstone of the Soviet economy.
With these changes, the mines and supporting enterprises of Norilsk ceased being operated as a penal camp. But many of the “free laborers” who lived and worked there after the Stalin era were former prisoners with nowhere to go, no means to leave, or no permission to relocate under the Soviet internal passport and migration system. So they remained, many for the rest of their lives, stranded in one of the coldest and most polluted places on Earth.
Meanwhile, the Soviet system as a whole, after impressive economic growth rates in the 1950s and 1960s under Nikita Khrushchev, slid into a period of gray stagnation under Leonid Brezhnev and his successors.
After the reformer Mikhail Gorbachev became general secretary of the Communist Party in 1985, there was some loosening of the command economy, with cooperatives allowed to operate businesses with more independence, and with more flexibility for managers of enterprises.
At Norilsk, operations were restructured and combined with other nickel mining ventures in the far northwest of the country to become, by 1989, the Soviet enterprise known as Norilsk Nickel. Norilsk Nickel, built at such enormous cost in human suffering, would be at the center of struggles for power and wealth in Russia over the next decade. Its fate illustrates what has become of Russia, and why.
Freedom and Chaos
The period from 1989 to 1991 saw one of the largest and most peaceful geopolitical transformations in world history. First the Soviet satellite states in Eastern Europe seized by Stalin in World War II broke away. Unlike in 1956 and 1968, when Hungary and Czechoslovakia tried to set their own courses, the Soviet Union did not send tanks and troops to quell the freedom movements.
Then, starting with the declaration of independence by the Baltic Soviet Republic of Lithuania in March 1990, the Soviet Union itself broke apart, with final dissolution happening at the end of 1991. The 15 former Soviet republics, with their state-controlled economies commanded and coordinated from Moscow, became independent countries.
There was a chance for freedom. But there was also an immediate need to continue feeding populations that had just seen the only system they ever knew dissolve into nothing. All that was solid melted into the air.
The 1990s in Russia and throughout most of the former Soviet Union were a time of dizzying change, new freedoms, disorder, banditry, and widespread hunger. In June 1991, Boris Yeltsin became the first democratically elected president of the Russian Republic. He would become the leader of an independent Russian Federation after the Soviet Union collapsed later that year. Soviet strictures on private property ownership and business operations were reformed, new enterprises flourished, and media and entertainment, already increasingly free under Gorbachev, were unleashed. Many of the young and entrepreneurial seized new opportunities. Foreign investment and Western advisers flowed in.
But the cradle-to-grave employment and benefits provided by the Soviet command economy also disappeared. The elderly and children were particularly vulnerable, as Soviet support systems collapsed and pensions and savings evaporated.
As price controls were lifted and the money supply increased, inflation exploded. In 1992, Russian inflation was about 2,000 percent, with another 1,000 percent inflation the following year. Life savings disappeared almost overnight. In major cities, the elderly could be seen selling their books, clothes, and furniture on the street to buy food or rummaging through garbage.
According to World Bank figures, the mortality rate from 1990 to 2000 jumped from 11.2 per 1,000 people to 17.1. Life expectancy for Russian men plummeted from about 65 in the late Soviet period (1987) to 55.5 in 1994, with a less dramatic drop for women. Much of the increased mortality was attributed to alcoholism, suicide, and other causes associated with destitution and despair.
Russians also started having far fewer babies. Between 1989 and 1999, fertility in Russia declined from 2.01 to 1.16 births per woman, an historically unprecedented drop signaling demographic collapse. And large numbers of children were abandoned, some left at woefully undersupplied orphanages and others ending up on the street. By the end of the decade, based on estimates from the Russian government and the United Nations, there were about 3 million homeless Russian children.
These plummeting social indicators were all tied to the disastrous performance of the Russian economy, a chaotic mix of large enterprises still under state control, a central government heavily in debt and in arrears for pensions and wages, liberalized consumer prices, and burgeoning new private enterprises (some legal and some not).
Some prospered, none more than the “New Russians,” a rising class of businesspeople who built new enterprises and amassed quick fortunes, sometimes using criminal methods to take advantage of the tumult and lawlessness of the time. The most successful of the New Russians grew into the oligarch class of the superrich who dominate Russian business and politics to this day. But much of the population was left bewildered, sidelined, and underfed.
The ‘Crown Jewels’
The fall in living standards and increasing misery for much of the Russian population in the early and mid 1990s led to bitterness. Nostalgia grew for the old Soviet system, which had provided meager but reasonably reliable sustenance in its last decades, particularly among older Russians who were unable to adapt and fend for themselves.
After the 1995 parliamentary elections, the reconstituted Communist Party led by Gennady Zyuganov and allied parties controlled almost half of the seats in the Russian parliament, or Duma. Meanwhile, President Yeltsin’s approval in opinion polls fell as low as 6 percent. The Communist Party had a serious chance to retake control of Russia in the 1996 presidential elections. That prospect alarmed both the Yeltsin government in Moscow and its supporters in Washington. Both concluded that dramatic action should be taken to stave off a Communist political victory and prevent a return to Soviet-style state ownership and central command.
Although the Yeltsin government had experimented with privatization measures, the “crown jewels” of the former Soviet economy—in sectors such as oil and gas, mining, and steel production—remained under state control. Many large enterprises were controlled by so-called “red directors,” holdovers from the old system who sympathized with the Communist Party, resisted modernization, and were often accused of feather-bedding and corruption.
A young banker and rising oligarch, 34-year old Vladimir Potanin, had a bold idea that he sold as a way in one fell swoop to fund the cash-strapped Russian government, support the reelection of Boris Yeltsin, defeat the Communists, eject the red directors, establish private ownership and modern management in the crown jewels, and thus take Russia on an irreversible path to capitalism.
Under the scheme, called “loans for shares,” the Russian government would borrow large sums of money from banks to help pay its arrears on wages and pensions and would post shares in the crown jewels as collateral. The lending banks were given the temporary right to manage and profit from the industrial assets posted as collateral. Presumably, the lenders would restructure and modernize management (eliminating the red directors along the way) to maximize their profits. And if the government did not repay the loans, the industrial assets would be sold at auction. The lending banks themselves would serve as auctioneers.
But—and this was crucial—the auctions of shares would not occur until after the 1996 presidential elections. And as everyone knew, if the Communist Party won, the auctions would never happen. The Communist Party would never allow the crown jewels to be released from state ownership.
As a mechanism to assure reelection of the deeply unpopular Boris Yeltsin and defeat of a resurgent communist movement, the plan succeeded masterfully. The oligarchs who lent to the government and wanted permanent ownership of the enterprises they took as collateral had a powerful incentive to fund and promote Yeltsin’s candidacy. Indeed, much of the mass media in Russia at the time was owned by these same oligarchs, so they used their TV and print media to promote Yeltsin and vilify his Communist opponents in saturation coverage, often by tying the Communists to the gulag and other aspects of their brutal past. In the end, although there were accusations of election fraud, Yeltsin beat Zyuganov handily, 54–41.
But as a method of privatization and transition to an efficient and fair market economy, the loans-for-shares scheme was a world-historic disaster. Predictably, the government did not repay the loans. The scheme left the banks free to manipulate the ensuing auction process, and they took full advantage.
For example, Vladimir Potanin, who devised the loans-for-shares scheme and participated by lending to the government through his bank, ultimately sold the enterprise shares posted as collateral through an “auction” to his own bank. The name of the enterprise that Potanin’s bank acquired? Norilsk Nickel.
Potanin’s bank took control of Norilsk Nickel for $171 million, half of what a rival Russian bidder was willing to offer. Foreigners were excluded entirely from the process, which assured that a price below market would prevail even if the bidding had not been rigged. Although conditions have obviously changed, the company Potanin secured for $171 million now has a market capitalization of about $50 billion.
The other oil-and-gas and metals enterprises privatized through the loans-for-shares program were similarly “auctioned” for small fractions of their value in rigged transactions, to the benefit of oligarchs who, like Potanin, had cultivated connections with the Yeltsin administration. Although the sales process was anything but transparent, the fraud was open and notorious.
The Russian loans-for-shares scandal is now largely forgotten in the United States. But in Russia, it is well-remembered and often associated with economic advisers from Harvard University who were funded by the U.S. Agency for International Development (USAID) and close to the Yeltsin government. While they disavow the corrupt execution, these American advisers encouraged at least some aspects of the scheme, while allegedly also in some instances enriching themselves.
As David McClintick wrote in the January 13, 2006, edition of Institutional Investor, “while still holding oil shares, [Harvard economist Andrei] Shleifer wrote a memorandum to Russian officials advocating the inclusion of oil stocks in a program to distribute Russia’s energy assets to rich entrepreneurs in exchange for loans to the government.” Former Moscow Mayor Yuri Luzhkov and current Russian President Vladimir Putin have both reminded Russian audiences of the perceived American role in the despised loans-for-shares scheme.
In the end, there is no dispute that the crown jewels of the Soviet economy were essentially stolen. In a touch of bitter irony, some Russians referred to these events as “primitive accumulation,” Karl Marx’s term for the processes that enabled land and other productive assets in late feudal England to be concentrated in the hands of a few while others were dispossessed.
Little wonder that polling by Pew Research Center found that support among Russians for a free market economy fell from 54 percent in 1991, the year of the Soviet collapse, to 42 percent in 2011. Similarly, Gallup found that in 2007 only 35 percent of Russians thought “creation of a free market economy that is largely free from state control” was “right” for the country’s future, with 41 percent saying it was “wrong.”
Predictably, the drop in support for economic freedom has been accompanied by increasing support for political authoritarianism. According to Pew, support for “democracy” instead of a “strong leader” among Russians declined from 51 percent in 1991 to 32 percent in 2011.
A majority of the Russian people were eager for free markets and democracy in 1991. That support was lost in the ensuing decade of disorder, hunger, and colossal theft, perhaps forever.
Vulgar Coase-ism
Did privatization have to be dirty? Russia in the 1990s was tumultuous, violent, and highly corrupt. It was (and still is) a land without rule of law. It would likely have been impossible to design a process for selling off valuable industrial assets using the institutions in place at the time to assure fairness and transparency.
Another approach might have been to postpone privatization of the crown jewels, foster growth of the small-business sector through low taxes and light regulation, and wait until the rising class of self-made small business owners were able to force creation of honest institutions to support their sector, including reliable courts.
In an influential 1990 book, The Road to a Free Economy, Hungarian economist János Kornai had warned against “the offensive and irresponsible liquidation of state ownership,” noting that “there are a number of institutions that can evolve soundly only as the result of an organic historical development.” Perhaps if Kornai had been heeded, privatization of the crown jewels could have been accomplished later, without gargantuan theft.
But surprisingly, an idea in wide currency at the time held that the gargantuan thefts through privatization just didn’t matter. The theory, which purported to derive from the ideas of the late British economist Ronald Coase, went something like this: Anyone who comes to own an enterprise will want to extract the maximum value from it. If the owner knows how to operate the enterprise most efficiently to maximize profit, he will keep it. If he doesn’t, he will have every incentive to sell the enterprise to someone who does know how to maximize profit, because that buyer will pay premium dollar for the opportunity.
Thus, no matter how dirty the process necessary for getting productive assets away from the state, it should be done immediately. All that matters is that the assets get into the hands of someone who can resell them for profit. Economic incentives will naturally move the assets from one owner to another until they land in the hands of someone with the skills to use them for greatest profit, thus extracting maximum value for himself and also for society.
Potanin was still offering the Coasean defense in a 2018 interview with the Financial Times. He conceded that the loans-for-shares deals were unfair and had made him “incredibly rich” (with a net worth at the time of the interview of about $16 billion) but argued that the “choice was not between being fair and open or creating oligarchs. It was whether to leave these companies in the hands of [former Soviet] red directors and forget efficiency forever, or sell them in any way possible.”
It should be noted that Coase, who was alive and working at the time of the loans-for-shares scheme, is not known to have ever endorsed this alleged corollary of his famous theorem, which posits that parties with conflicting property rights should be able to come to efficient arrangements through bargaining. Indeed, he was always careful to emphasize the severe limiting conditions of his theorem, including perfect information between the parties, competitive markets, zero transaction costs, and a costless court system.
Such nuances were lost on proponents of fast and dirty privatization in Russia. Skeptics, including the Hungarian economist Kornai, dubbed their thinking “vulgar Coase-ism.”
Robber Barons for Rule of Law
A similarly optimistic notion in the mid 1990s held that getting productive assets into private hands, however accomplished, would create demand for rule of law and would ultimately lead to the rise of clean courts, better government, and a more limited state. The idea was that putting Soviet assets into private hands would help trigger a process replicating the rise of the bourgeoisie in Western countries, but in compressed time.
Private owners would want a reliable system of property rights and courts for adjudicating them to protect what they had acquired. And as the wealthiest members of society, they would have the power to assure that appropriate institutions were built. All of society would then benefit from the just and efficient institutions they pushed to create.
As Maria Popova of McGill University drily observed in the Spring 2017 issue of Daedalus, “the robber-barons for rule of law transformation has been expected for two decades; but we have yet to see any indications that it will happen.”
Apparently, the proponents of fast and dirty privatization were missing something. In fact, they misunderstood the nature of private property, rule of law, and the state.
To be stable, property rights require public legitimacy, institutional backing, and incentives for elites to support and uphold them. The loans-for-shares scheme assured that Russia would have none of these. “When you buy state assets in such a dubious backroom deal and at such a steep discount to market, chances are your property rights will never be truly secure,” the late American journalist Paul Klebnikov wrote in the November 17, 2003, Wall Street Journal. “You will always be regarded by the population as a crook and by the government as more of a custodian of state assets than an owner.”
Further, oligarchs who acquire industrial assets through dirty privatization will likely have a vested interest in preventing development of the rule of law or limits on the role of the state. Oligarchs invest resources to foster a comparative advantage in activities such as bribing judges and currying favor with parliamentarians and officials, and also sometimes build their own private means of enforcing contract and property claims through hired agents of force.
Why would oligarchs push to reform the lawless system they have mastered, at substantial cost? Well-defined property rights and a fair and neutral system for adjudication would deprive them of the benefits they can accrue from their position of advantage. The situation is wasteful and curbs broader economic development, but according to University of Chicago economist Konstantin Sonin, “if the rich [in Russia] have enough political power to choose the level of public property rights protection, the economy may be locked in a stable long-run equilibrium with weak public protection of property rights.”
Klebnikov was right that oligarchs who acquire assets in dirty privatizations will always be regarded “by the government as more of a custodian of state assets than an owner.” After assuming the Russian presidency in 2000, Putin moved aggressively to reassert the state’s prerogative over the crown jewels of the Russian economy in the extractive industries, regardless of who formally owned them after the 1990s privatizations.
As described by energy industry experts Andrei Belyi and Samuel Greene in their 2012 paper, “Russia: A Complex Transition,” Putin arrived at a settlement with the oligarchs resting on “two interlocking rules.” First, private ownership of major Russian enterprises does not confer permanent enforceable rights; rather, “all resources within the economy belong to the system as a whole” and “can be redistributed by the state in order to maintain balance in the system.” Second, bases of power independent from the state will not be tolerated; “no player may seek to mobilize resources from outside the system (whether political or economic) to gain leverage or comparative advantage.”
Fealty is expected: “Those who play by the rules know that they may be deprived of their assets, but maintain a high degree of certainty that they will be rewarded for their loyalty with other assets in return.” But if any resist? They are “removed from the game permanently,” according to Belyi and Greene.
As examples of the fate of resisters, they cite the fallen oligarchs Vladimir Gusinsky, Boris Berezovsky, and Mikhail Khodorkovsky, who were famously forced into exile (or in the case of Khodorkovsky, into a modern-day penal labor camp) after crossing Putin. As additional assurance against challenges to his power, Putin also took most of the major mass media companies under state control.
To be fair, Putin restored a measure of stability to the country and oversaw some improvements in living standards for much of the population, particularly in the early years of his presidency. Teachers’ salaries that had gone six months in arrears under Yeltsin were paid on time. The real value of pensions increased. And maternity and child benefits were enhanced, in part to stem the demographic collapse.
Those efforts have been at least partly successful. The number of births per woman rose from about 1.2 in 2000 to about 1.78 in 2015. Life expectancy for men has risen back to about late Soviet levels, and life expectancy for women appears to be higher than in late Soviet times. Some of these improvements may be attributed to the steep rise in global oil prices that began early in Putin’s rule, which fattened state coffers and funded higher wages in the oil-dependent Russian economy. But progress on social indicators seems to have been mostly maintained even as oil prices have fallen and international economic sanctions have been imposed on Russia since 2014.
But that stability and relative prosperity have come at a cost. According to a 2021 country report from the think tank Freedom House, “Power in Russia’s authoritarian political system is concentrated in the hands of President Vladimir Putin. With loyalist security forces, a subservient judiciary, a controlled media environment, and a legislature consisting of a ruling party and pliable opposition factions, the Kremlin is able to manipulate elections and suppress genuine dissent. Rampant corruption facilitates shifting links among bureaucrats and organized crime groups.”
The current corporate ownership arrangements in Russia, in addition to being politically authoritarian, seriously retard the country’s economic growth. “Owners” who can be expropriated at any time have an incentive to extract as much short-term profit as possible and not to invest in innovation and long-term growth. They will tend to pursue unproductive activities that prevent expropriation, such as bribing officials and judges and cultivating relationships with superiors in the hierarchy.
“In the real world, bad initial owners loot enterprises…and corrupt the government while they’re at it,” noted Bernard Black, Reinier Kraakman, and Anna Tarassova in a July 2000 article in the Stanford Law Review. “Call it the triumph of [Friedrich] Hayek over Coase—of Hayekian respect for endogenously developed traditions over the abstract promise of the Coase-influenced mass privatization schemes.” Or we might call it the vindication of János Kornai and his warning of the need for “organic historical development of institutions” over the advice of the Harvard economists funded by USAID. Either way, fast and dirty privatization did not lead Russia to democracy and free enterprise.
Doing Business Under Putin
Despite skewed incentives, some Russian business leaders do aspire to transform their enterprises into efficient and well-managed world-beating competitors. An interesting and perhaps surprising example appears to be Vladimir Potanin, instigator of the loans-for-shares scheme and part owner of the highly profitable former slave-labor enterprise Norilsk Nickel.
Starting in 2001, Potanin and his then-partner Mikhail Prokhorov (future owner of the Brooklyn Nets) began a business restructuring with the goal of competing with global mining giants such as Rio Tinto, BHP Billiton, and Anglo American. As recounted in the journal Resources Policy by David Humphreys, a British mining industry expert and former chief economist for Norilsk Nickel, the company sought to raise its governance, transparency, management quality, and internal processes to “win the respect and trust of international investors” and “compete on the world stage.” Over time, its investments in modernization rose to $1 billion a year. The company also brought in new talent with world-class expertise, including Humphreys and Leonid Rozhetskin, a Russian-American financier and graduate of Harvard Law School.
For a while, Potanin and Prokhorov succeeded. They managed to diversify by acquiring Montana palladium producer Stillwater Mining, then additional assets in the U.S., Finland, Australia, South Africa, and Botswana. By 2008—which Humphreys views as “the high-water mark” of Norilsk Nickel’s transformation—the company achieved a market capitalization of $60 billion, ranking as the sixth-largest mining company in the world by that measure.
But like every major Russian company, Norilsk Nickel had to pay tribute to survive. In August 2008, the company hired Vladimir Strzhalkovsky as its chief executive. A longtime associate of Putin who served with him in the KGB, Strzhalkovsky had no background in mining; his prior business experience was in promotion of tourism. When he left the CEO position in late 2012, Norilsk Nickel paid him a $100 million severance package, the largest in Russian history.
The same year that Strzhalkovsky was hired, the oligarch Oleg Deripaska acquired a major stake in Norilsk Nickel through his aluminum company Rusal, triggering a feud over control between Deripaska and Potanin that continues to this day.
Putin, the ever-present arbiter in the background, has occasionally intervened. When Potanin and Deripaska were battling over the size of the company’s dividends in 2010, Putin paid a visit to the company’s Arctic headquarters and mentioned that it had paid “unusually high” dividends the previous year, thus signaling that Potanin’s push to lower dividends should prevail. Such is corporate governance in the Russian Federation.
As long as Putin stays healthy, the current system is probably stable. The rules of the game have been established. Occasional transgressors are dealt with severely and publicly as deterrence.
These arrangements certainly depress productivity. Feeding a population of 145 million, the Russian economy is today the 11th largest in the world, smaller than Canada’s, which has only about 38 million people. And in GDP per capita, Russia has fallen far behind its fellow former Soviet republics in the Baltic region, with output per person about half of Estonia’s and about 40 percent less than Lithuania’s and Latvia’s. Not coincidentally, the Baltic countries all rank in the top 30 in the world in the Heritage Foundation’s 2021 Index of Economic Freedom (with Estonia at No. 8), while Russia ranks 92nd. But other former Soviet republics, including Ukraine and Moldova, lag well behind Russia in output per person, aggravated by Putin’s intrusions and aggression.
Putin’s economic governance is at least better than Soviet central planning. The key to the system, though, is an established and accepted central arbiter. Putin, now 69 years old, appears to have done nothing either to cultivate a successor or to build rules of succession into the game he created. Russians are left with a stagnant society and the fear that the ruinous instability of the 1990s could return.
Could it all have been different? Many believe that Russia is driving in the well-worn grooves of its history and that the only alternative to chaos and hunger for Russia is the grip of a strongman at the wheel. It is indeed eerie how much Putin has emulated the tsars, controlling the distribution of wealth and power among the modern aristocracy to assure that his absolute rule can never be challenged.
But those who think this was inevitable seem to have forgotten the spirit of 1991. There was so much hope. And there was good reason for it. At the time of the Soviet collapse, Russia had arguably the best-educated population in the world. It had unquestionably the world’s largest science and technology community, with more engineers than any other nation and a tradition of excellence that put the first man in orbit and built the Mir space station. It had the world’s richest literary heritage. It had produced moral leaders of astonishing strength and courage who stood up to the Soviet regime, including Solzhenitsyn, Andrei Sakharov, and Yelena Bonner. And it had vast wealth in natural resources to fund a better future, in some instances developed at appalling human cost by people like the prisoners at Norillag.
A young foreigner who had the good fortune to spend evenings drinking and talking with Russian friends in a cramped Moscow kitchen during the late Soviet period could feel that a great destiny would unfold for Russia as soon as communism was discarded. These people were ready, and they deserved it.
But the decade that followed was a tragedy and a farce. It became so because of the choices made by powerful people, from American advisers with misplaced priorities to a disengaged and dissolute leader in Boris Yeltsin—notorious for showing up drunk at summits—to predatory oligarchs pulling off the greatest heist in history. From the high hopes of 1991, the disasters that followed nearly broke Russia and made Russians aim low, with many willing to forfeit their freedom for stability and sustenance. Promises of bread and peace won again.
Could it have been different? We can never know. But the people who might have given Russia a chance let everyone down.
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