Reference no: EM132151691

Putin's Russia

The modern Russian state was born in 1991 after the dramatic collapse of the Soviet Union. Early in the post-Soviet era, Russia embraced ambitious policies designed to transform a communist dictatorship with a centrally planned economy into a democratic state with a market-based economic system.

The policies, however, were imperfectly implemented. Political reform left Russia with a strong presidency that-in hindsight-had the ability to subvert the democratic process. On the economic front, the privatization of many state-owned enterprises was done in such a way as to leave large shareholdings in the hands of the politically connected, many of whom were party officials and factory managers under the old Soviet system. Corruption was also endemic, and organized crime was able to seize control of some newly privatized enterprises. In 1998, the poorly managed Russian economy went through a financial crisis that nearly bought the country to its knees.

Fast-forward to 2015, and Russia still has a long way to go before it resembles a modern democracy with a functioning free market-based economic system. On the positive side, the economy grew at a healthy clip during most of the 2000s, helped in large part by high prices for oil and gas, Russia's largest exports (in 2013 oil and gas accounted for 75 percent of all Russian exports). Between 2000 and 2013, Russia's gross domestic product (GDP)Page 60 per capita more than doubled when measured by purchasing power parity. The country now boasts the world's ninth-largest economy.

Thanks to government oil revenues, public debt is also low by international standards-at just 9.2 percent of GDP (in the United States, by comparison, public debt amounts to 70 percent of GDP). Indeed, Russia has run a healthy trade surplus on the back of strong oil and gas exports for the last decade.

On the other hand, the economy is overly dependent on commodities, particularly oil and gas. This was exposed in mid-2014 when the price of oil started to tumble as a result of rapidly increasing supply from the United States. Between mid-2014 and March 2015 the price of oil fell from $110 a barrel to around $50. This drove a freight train through Russia's public finances. Much of Russia's oil and gas production remains in the hands of enterprises in which the state still has a significant ownership stake. The government has a controlling ownership position in Gazprom and Rosneft, two of the country's largest oil and gas companies.

The government used the rise in oil and gas revenues between 2004 and 2014 to increase public spending through state-led investment projects and increases in wages and pensions for government workers. While this boosted private consumption, there has been a dearth of private investment, and productivity growth remains low. This is particularly true among many state-owned enterprises that collectively still account for about half of the Russian economy. Now with oil prices tumbling, Russia is having to issue ever more debt to finance public spending.

Russian private enterprises are also hamstrung by bureaucratic red tape and endemic corruption. The World Bank ranks Russia 92nd in the world in terms of the ease of doing business and 88th when it comes to starting a business (for comparison, the United States is ranked 4th and 20th, respectively).

Transparency International, which ranks countries by the extent of corruption, ranked Russia 136th out of 175 nations in 2014. The state and state-owned enterprises are famous for pushing work to private enterprises that are owned by political allies, which further subverts market-based processes.

On the political front, Russia is becoming less democratic with every passing year. Since 1999, Vladimir Putin has exerted increasingly tight control over Russian politics, either as president or as prime minister. Under Putin, potential opponents have been sidelined, civil liberties have been progressively reduced, and the freedom of the press has been diminished.

For example, in response to opposition protests in 2011 and 2012, the Russian government passed laws increasing its control over the Internet, dramatically raising fines for participating in "unsanctioned" street protests, and expanded the definition of treason to further limit opposition activities. Vocal opponents of the régime-from business executives who do not tow the state line to protest groups such as the punk rock protest band Pussy Riot-have found themselves jailed on dubious charges.

To make matters worse, Putin has recently been tightening his grip on the legal system. In late 2013, Russia's parliament, which is dominated by Putin supporters, gave the president more power to appoint and fire prosecutors, thereby diminishing the independence of the legal system.

Freedom House, which produces an annual ranking tracking freedom in the world, classifies Russia as "not free" and gives it low scores for political and civil liberties. Freedom House notes that in the March 2012 presidential elections, Putin benefited from preferential treatment by state-owned media, numerous abuses of incumbency, and procedural "irregularities" during the vote count.

Putin won 63.6 percent of the vote against a field of weak, hand-chosen opponents, led by Communist Party leader Gennadiy Zyuganove, with 17.2 percent of the vote. Under a Putin-inspired 2008 constitutional amendment, the term of the presidency was expanded from four years to six. Putin will be eligible for another six-year term in 2018.

In 2014, Putin burnished his growing reputation for authoritarianism when he took advantage of unrest in the neighboring country of Ukraine to annex the Crimea region, and to support armed revolt by Russian-speaking separatists in eastern Ukraine. Western powers responded to this aggression by imposing economic sanctions on Russia.

Taken together with the rapid fall in oil prices, this pushed the once booming Russian economy into a recession. In 2014 the economy grew by just 0.6 percent, while the Russian ruble tumbled, losing half of its value against other major currencies. Despite economic weaknesses, however, there is no sign that Putin's hold on power has been diminished; in fact, quite the opposite seems to have occurred.

Sources: "Putin's Russia: Sochi or Bust," The Economist, February 1, 2014; "Russia's Economy: The S Word," The Economist,November 9, 2013; Freedom House, Freedom in the World 2014: Russia, www.freedomhouse.org/report/freedom-world/2014/; K. Hille, "Putin Tightens Grip on Legal System," Financial Times, November 27, 2013.

Case Discussion Questions

Why did the Russian economy perform well during the 2001-2013 period? Why did it run into trouble in 2014? What does this tell you about the efficacy of post-communist economic and political reforms?

How has Vladimir Putin been able to accumulate so much political power in Russia?

At this point, how secure do you think Putin's hold on power is? What might change things?

After the collapse of communism, many Western businesses started to invest in Russia. How do you think the current political and economic climate is impacting on the profitability of those investments?

Given what is happening in Russia today, what do you think will happen to foreign direct investment in Russia going forward? Is this a country where a Western enterprise would want to do business?