Postscript

In 2000, political scientist Timothy Frye surveyed 500 businesses in Russia, including firms large and small, in several regions. He asked them about the main obstacles to business development. Their responses explain much about the Russian government’s economic strategy since then (see table 1). Corruption was on the list of obstacles to business, but Russia’s corporate leaders said it was only the sixth-most-pressing problem. Far more worrisome, they believed, was Russia’s high tax burden, followed by legal instability, access to credit, and a lack of qualified managers....

Putinomics under Pressure

The war in Ukraine, Western economic sanctions, and slumping oil prices during 2014 and 2015 have renewed questions about the long-term prospects of Putinomics. Many Western analysts predicted that Russia’s economy and Vladimir Putin’s adventurous foreign policy would quickly fold after the imposition of sanctions. These predictions proved false, and Russian businesses have adapted to sanctions and lower oil prices without great difficulty. The real challenge to Putinomics lies not in financial crisis—Putin’s habit of saving in the good times mean that Russia has plenty of resources with which to fend off a financial squeeze—but stagnation. Will Russians tolerate GDP growth of only 1-2%? Such a rate is acceptable for a developed country, but far below Russia’s potential. If discontent surges, can Putin find a way to spark new growth to placate the population? It is difficult to predict the future course of Russian politics. But betting against Putinomics has rarely been a winning strategy.

Restructuring Russian Industry

As the macroeconomic environment stabilized, business rushed to invest. Westerners often focus on ‘capital flight’ out of Russia, but the reality is that the 2000s were a boom period for investment by Russian and foreigners. The results were widely evident, as new businesses opened and productivity shot up. In sectors such as retail and steel, for example, productivity levels doubled relative to the United States, the productivity leader. Russian firms still trail far behind, but during the 2000s they made great strides. Russia is often criticized for being overly dependent on oil and gas. Certainly the country would benefit from a more diversified economy. Yet it is wrong to credit economic growth during the Putin era simply to high oil prices. Windfall oil profits are capable of boosting consumption, but they do not increase productivity. The fact that Russian firms increased productivity so rapidly shows that other factors—a stable macroeconomic climate coupled with the tenacity of Russia’s entrepreneurs—were powering the economy forward.

Wages and Welfare

As Russia’s firms got more productive, living standards shot up. For one thing, companies started offering far more variety. The consumer paradise that advocates of a market economy had promised long-suffering Russians finally arrived. At the same time, higher productivity meant higher wages. Real wages increased every year of Putin’s presidency until 2014, averaging 15% per year from 2000 to 2008. At the same time, higher tax collection let the government boost pension payouts, helping older Russians, almost all of whom relied on state pensions as their primary source of retirement income. Yet higher pensions did not augur the return of an extensive welfare state, as the government eliminated many benefits. At the same time, the government kept labor protections weak, and Russia’s labor market continues to be far more flexible than many other European countries. Encouraged by his liberal economic advisers, Putin has implemented economically orthodox welfare and labor market policies, earning solid marks from the IMF. The tremendous wage growth of the 2000s, however, meant that most Russians were happy to ignore weak social protections in exchange for an ever-expanding paycheck.

Putin’s Economic Inheritance

This chapter examines the economy that Vladimir Putin inherited when he took power. During the 1990s, Russian President Boris Yeltsin had begun moving Russia toward a market economy, eliminating price controls and privatizing industries and real estate. Yeltsin’s reforms, however, were overshadowed by a deeper structural problem: the collapse of the Soviet state led to an enduring budget crisis. The tax system had stopped functioning; the government funded its deficit by printing money, causing high inflation; and the economy lurched from crisis to crisis throughout the 1990s. Given the disastrous macroeconomic climate, Yeltsin’s team made only halting progress in restructuring industry, rebuilding the state, or establishing a business climate that promoted investment. This was Putin’s economic inheritance.

From Crisis to Crisis

In 2008, Vladimir Putin reached the end of his second presidential term. Barred by the constitution from serving three consecutive terms, he appointed Dmitry Medvedev his successor and took the position of prime minister for himself. The political shift coincided with an economic crisis, as the financial crash in the United States spread to Russia. Oil prices slumped and financial markets froze up. Many in Russia predicted the end of Putinomics, and new president Medvedev touted his plans to diversify Russia’s economy away from energy. Little came of that. Instead, Russia used the huge financial war chest that Putin had built up to bail out businesses and plug holes in the budget while waiting for an economic recovery. Renewed growth came quickly, though with less vigor than before. Slower growth rates and continued corruption sparked anti-Putin protests in Moscow during late 2011 and early 2012, but Putin’s record of economic success during the 2000s gave him the support he needed to sideline opponents and reassert his control on power. He returned to the presidency in 2012.

Rise of the Energy Giants

Forcing energy firms to pay taxes was one of Putin’s greatest successes, but the methods he used exacerbated Russia’s most persistent problem: a corrupt and inefficient energy sector. Khodorkovsky’s Yukos company was handed over to Rosneft, a new state-owned oil champion controlled by Putin’s long-time associate Igor Sechin. At the same time, Putin established control over the natural gas monopoly, Gazprom, without taking serious steps to reform governance. The 2000s did see some positive steps in the energy sector, particularly with regard to a new tax regime that provided strong incentives for firms to increase output—and Russia’s oil and gas output surged forward as a result. Yet a significant portion of Russia’s energy windfall was wasted through corruption and mismanagement.

Reforging the Russian State

The persistent weakness of Russia’s state institutions was a major cause of the tumult of the 1990s. Yeltsin and his ministers took important steps to bolster government effectiveness, but the crucial changes were made by Putin. He employed a two-pronged strategy. First, he collected a group of economically liberal technocrats around German Gref, who implemented a wide range of governance reforms, most of which were applauded by investors and economists alike. Second, Putin initiated a crackdown on tax avoidance, the most important victim of which was Mikhail Khodorkovsky’s Yukos oil company. Khodorkovsky threatened Putin politically, but he also undermined Putin’s ability to collect taxes. After Khodorkovsky’s takedown, tax revenue spiked, and Putin followed the Yukos affair with a PR campaign to convince businesses that their investments were safe so long as they paid taxes and stayed out of politics. Most businesses accepted the bargain.

Stabilizing Russia’s Finances

The 2000s were boom years for energy, as prices skyrocketed and oil producers reaped windfall profits. Vladimir Putin’s Russia had its fair share of excess, yet what is more remarkable is how much Russia saved. Over the course of the 2000s, over half a trillion dollars were put in in long-terms savings funds. Putin had seen the tumult of the 1991 and 1998 crises, and knew that hard times would come again. He wanted a large stock of financial firepower to deal with any contingency. He also took steps to restructure the country’s banking system. High inflation had plagued Russia since 1991, but Putin assembled a talented team of managers at the Finance Ministry and Central Bank who managed to get inflation down and keep it fairly low. Though Putin’s government is often rightly noted to include many former KGB agents and judo buddies, it is also notable the extent to which the economic ministries recruited talented—and economically orthodox—managers. By the mid-2000s, Russia had the most stable financial environment it had ever known.