The Hunt for Russia’s Riches

Clamping down on oligarchs has been at the top of Vladimir Putin's to-do list. But his authoritarian agenda is holding Russia back. As much as Putin may resent the country's wealthy elite, Russia needs them to survive.

Driven by a popular urge to defeat corruption in recent years, Russian President Vladimir Putin has been a man on a mission. He cracked down on media mogul Vladimir Gusinsky for alleged embezzlement. Putin is trying to extradite tycoon Boris Berezovsky, who resides in exile in London, on criminal fraud charges. The Russian president's most notable crusade has been against the giant oil company Yukos, which was run by billionaire Mikhail Khodorkovsky. The government effectively confiscated Yukos in late 2004. Its former CEO was convicted of fraud and tax evasion in a kangaroo court and is currently serving an eight-year sentence in a Siberian labor camp.

Khodorkovsky is the most prominent member of the new oligarchs, the class of Russian businessmen who amassed great wealth and power after the collapse of the Soviet Union. In the mid-1990s, the government auctioned off key state assets to well-connected entrepreneurs. These young capitalists took on the challenge of transforming seemingly moribund Soviet smokestacks into beacons of industry. Businesses were able to grow by taking advantage of a weak legal system that failed to defend property rights and enforce contracts. Soon enough, the new magnates succeeded beyond all expectations, amassing fortunes that ran into the billions of dollars. And, because they had little faith in the Russian legal system's ability to protect their property, the new entrepreneurs took out their own version of an insurance policy -- paying off politicians, judges, and other officials.

The rise of these oligarchs puts Russia in a dilemma. The government needs to safeguard the generators of the country's unprecedented economic boom. Russia's gross domestic product has expanded by an average of 7 percent a year since 1999, and oligarch-owned oil companies have increased their production even faster. At the same time, shady deals in the world of big business are obviously never desirable, and they can mask widening corruption and economic vulnerabilities. But for Putin, it hasn't seemed like any dilemma at all. He has chosen to crusade against the oligarchs under a moral banner that promises to root out corruption among the wealthy few.

Driven by a popular urge to defeat corruption in recent years, Russian President Vladimir Putin has been a man on a mission. He cracked down on media mogul Vladimir Gusinsky for alleged embezzlement. Putin is trying to extradite tycoon Boris Berezovsky, who resides in exile in London, on criminal fraud charges. The Russian president’s most notable crusade has been against the giant oil company Yukos, which was run by billionaire Mikhail Khodorkovsky. The government effectively confiscated Yukos in late 2004. Its former CEO was convicted of fraud and tax evasion in a kangaroo court and is currently serving an eight-year sentence in a Siberian labor camp.

Khodorkovsky is the most prominent member of the new oligarchs, the class of Russian businessmen who amassed great wealth and power after the collapse of the Soviet Union. In the mid-1990s, the government auctioned off key state assets to well-connected entrepreneurs. These young capitalists took on the challenge of transforming seemingly moribund Soviet smokestacks into beacons of industry. Businesses were able to grow by taking advantage of a weak legal system that failed to defend property rights and enforce contracts. Soon enough, the new magnates succeeded beyond all expectations, amassing fortunes that ran into the billions of dollars. And, because they had little faith in the Russian legal system’s ability to protect their property, the new entrepreneurs took out their own version of an insurance policy — paying off politicians, judges, and other officials.

The rise of these oligarchs puts Russia in a dilemma. The government needs to safeguard the generators of the country’s unprecedented economic boom. Russia’s gross domestic product has expanded by an average of 7 percent a year since 1999, and oligarch-owned oil companies have increased their production even faster. At the same time, shady deals in the world of big business are obviously never desirable, and they can mask widening corruption and economic vulnerabilities. But for Putin, it hasn’t seemed like any dilemma at all. He has chosen to crusade against the oligarchs under a moral banner that promises to root out corruption among the wealthy few.

Unfortunately, it’s the wrong approach and fails to take Russia’s larger interests into account. Putin’s zealous pursuit to bring down the oligarchs is driven by political calculus — the populist dislike of the rich, plus a desire by rising businessmen and officials to grab the assets of oligarchs who are on their way down. It’s also driven by a desire to maintain his iron grip on the country’s politics. Khodorkovsky had once harbored great political ambitions, and Gusinsky and Berezovsky both operated media outlets that vocally criticized Putin. Those who haven’t been swept up by Putin’s campaign are those clever enough to cut a deal. For example, Russian billionaire oil magnate Roman Abramovich is believed to have struck some kind of Faustian bargain with the president, selling his oil company Sibneft to the state-owned Gazprom last fall for $13 billion. (In addition, Abramovich promised to finance a new national soccer stadium, handed his shares in a television company over to the Kremlin, and divested himself of large stakes in Aeroflot and RusAl, a Russian aluminum company.) One month later, Putin reappointed him governor of Chukotka, the northeasternmost region in Russia, even though Abramovich lives in London.

Of course, corruption should be confronted. But oligarchs are not as evil as Putin would have his compatriots believe. The emergence of the oligarchs is a natural consequence of the prevailing economic, legal, and political conditions in Russia today. Large-scale oil and metallurgical industries are booming as never before, thanks to local entrepreneurs who were given the chance to turn them around. It’s only natural that a handful of people have become rich, some immensely so. It is difficult to see how a market economy could be introduced under these conditions without generating a class of the superwealthy.

Do we accept the very rich or not? Ultimately, it’s a matter of ideology. History shows that mature capitalism accepts oligarchs, whereas lesser systems do not.

Robber Baron Redux
Oligarchs are by no means unique to Russia. Most countries boast a class of very wealthy and politically connected moguls. Western Europe certainly hasn’t seen a decrease in the ranks of its upper class. In South Korea, the family-run chaebols dominate the business world. Thailand’s most prominent tycoon, Thaksin Shinawatra, actually became prime minister. In contrast, misguided economic populism has flourished in parts of Latin America, much of it directed against the entrenched power of the oligarchs. Such sentiment is encouraged by Venezuela’s autocratic president, Hugo Chávez. Oligarchs have also proliferated elsewhere in the former Soviet Union, most notably in Ukraine and Kazakhstan.

Perhaps the most useful comparison for the rise of Russian oligarchs is one from the United States’ own past. The wealthy men who built the great American industrial and transportation empires of the late 19th century could be stand-ins for the Russian billionaires of today. Indeed, the economic conditions that gave rise to America’s robber barons, as they were called, are similar to Russia’s situation in the 1990s. The government encouraged private ownership of big enterprises. Great economies of scale sprouted up in particular industries, especially metals, oil, and railways. Such a concentration of wealth can only emerge in countries with large markets, such as the United States and Russia. Both 19th- century industrializing America and postcommunist Russia experienced rapid economic change, which also facilitated the accumulation of wealth.

Most of the original American robber barons made their money on railways. Others focused on natural resources, such as John D. Rockefeller’s oil and Andrew Carnegie’s steel empires. The rising Russian business class has similarly had a large stake in its country’s oil and metals markets. Out of 26 Russian billionaires identified by Forbes in 2005, 12 made their money in metals, 9 in oil, and 2 in coal. (Russia now ranks third, behind the United States and Germany, for the greatest number of billionaires.) Cheap credit and the free distribution of state assets, such as land around the railways, helped America’s robber barons launch their businesses — and line their pockets. Likewise, the cheap sale of old Soviet-era assets, either through direct privatization or on the secondary market, made men like Khodorkovsky fabulously wealthy in just a handful of years.

Billionaire Blues
Like the American captains of industry before them, Russia’s oligarchs generate great controversy. Of course, the most popular complaint is their excessive wealth, or more accurately, the public perception that they are making so much money at a time when the gap between Russia’s rich and poor is widening. In fact, the public perception on this point is mistaken. According to the World Bank, inequality in Russia is similar to the levels found in the United States, and far below the average of Latin American countries. Poverty is declining sharply, thanks to the country’s high growth — which is achieved in part on the back of the oligarchs’ business enterprises.

In Russia’s political circles, the criticism that most often targets these tycoons is the notion that their wealth stems from ill-gotten gains. Volumes have been written about the 1995 loans-for-shares privatization, in which oligarchs loaned money to the Russian government in exchange for shares in the country’s most valuable companies. The conventional wisdom among critics is that they made their fortunes on these privatizations. In reality, however, they were already wealthy. Most of these enterprises, notably Yukos and Sibneft, did extremely well, which led to the revival of the Russian oil industry. By 2000, Yukos was paying an annual $5 billion in taxes, as much in a single year as anyone possibly would have paid for the enterprise in 1995. Thus, economically, the Russian loans-for-shares privatization was an unmitigated success for Moscow and the Russian people.

Another common charge is that the oligarchs are parasites who don’t produce anything. But the oligarchs are actually caught in a bind: The more productive they are, the more unpopular they seem to become. Public opinion turned more negative in 2000, following the Russian financial crisis, and after several of the major oligarchs decided to become fully legal and legitimate, pay taxes, and spend substantial amounts on charitable donations.

Paradoxically, the real problem for oligarchs appears to be transparency. People do not rail against the rich when billions of dollars are spirited out of the state treasury, because they do not see it happen. Privatization seems much more detested than pure theft. The oligarchs have become subject to much greater public criticism, even when they no longer steal but produce, because the public sees their factories, railcars, and trucks, and draws its own conclusions about their personal wealth. The shadier the machinations on which oligarchs make their money, the safer they are from public condemnation. The more taxes they pay, the more exposed they become.

No one would argue that oligarchs have clean hands. The early years of postcommunist Russia were a Hobbesian world for business — a nasty and brutish landscape where as much was decided by muscle as money. In this environment, oligarchs bribed officials, stole property, and committed all kinds of crimes. And, when they could, they used their political connections to extract more state resources and undermine the property rights of others. But the underlying problem with Russia’s postcommunist society was its lawlessness, not the people who took advantage of the government’s retreat. Indeed, locking up people who have engaged in shady deals is no standard for putting a country on the right course when corruption is as pervasive as it is in Russia. In fact, the country’s public administration has become so corrupt that Russian ministerial posts and governorships are reportedly traded for multiples of $10 million. What is necessary is for Russian authorities to provide clear, certain, and reliable rules to govern business behavior. And, on this score, the fundamental demand of the oligarchs — a defense of their rights to newly acquired property — is a worthy one.

The Price of Success
Today, the chief enemy of Russian liberalism is no longer socialism, but uninformed populism. Politicians stir up populist sentiment against the rich as emerging big businessmen aspire to seize their property. But no sound capitalist order can develop without respect for property rights. When Putin imprisoned Khodorkovsky and punished Yukos with arbitrary taxes and penalties, his actions were met with popular applause. But, as a result, important tax and judicial reforms have been jeopardized, and the credibility of property rights has been further undermined. Even if Khodorkovsky had been guilty of the charges (which he was not), Putin’s extrajudicial methods and means would not have been worth what he put at risk for his country. To be sure, the origins of Western property rights are not pretty. But capitalism has succeeded in the West and hardly anywhere else because only the West guarantees property rights.

So what should the Russian government do instead? Simply put, preach capitalism. If the state wants to change the oligarchs’ status, it can pose reasonable demands upon them or alter the economic, legal, and political environment in which they operate. But Russia first must make a strong political commitment to the principles of economic freedom. That means property rights for everyone, including billionaires.

More practically, Putin must somehow find a way to bring the oligarchs into the fold. The oligarchs could be enticed to make substantial one-time tax payments to the state treasury. In return, their property rights should be guaranteed. Furthermore, as part of a grand bargain, the government could extend an amnesty to the oligarchs for prior violations of privatization rules. Putin floated the possibility of a three-year statute of limitations for privatization complaints in a meeting with Russian businessmen in early 2005, so he is probably still amenable to the idea, although his words have not yet been followed by actions. Such a deal would allow the state to collect substantial revenues — billions of dollars — which would give Putin a strong case before the public. The worst thing that Putin could do would be to maintain his campaign against the oligarchs. The Yukos affair cost Russia approximately $10 billion in lost oil output in 2005 alone, a disruption that Russia can’t afford to repeat.

The rise of oligarchs is a natural stage of a capitalist breakthrough in a large country with big factories and a poor legal system. The healthy development of many strong oligarchs in Russia suggests that it is on the road to sound Anglo-American capitalism. But fanning populist flames is likely to quell both a free-market economy and democracy. In the end, no political solution is likely to hold if it is not supported by a strong and broad ideological commitment to a free economy. However much Putin and the Russian people may resent the oligarchs, their rise is a harbinger of better days to come.

Anders Åslund is a resident senior fellow at the Atlantic Council and worked as an economic advisor to the Russian government from 1991 to 1994.

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