ECONOMY
Will Russian Business be Sacrificed to Build a New Economic Model?
January 9, 2024
Andrei Yakovlev
Associate, Davis Center at Harvard University
Economist Andrei Yakovlev looks at what could be motivating the series of cases involving the seizing of assets of several large Russian enterprises that has been launched by Russia’s Prosecutor General, and discusses the prospects for a transition to a mobilization economy.
A shorter version of this text was published in Russian on Forbes.ru.
Andrei Melnichenko. Source: Wiki Commons
The nationalization of assets of foreign companies that began in the spring – the most high-profile cases involving Uniper and Fortum, as well as Danone and Carlsberg – overall did not come as a surprise. For one, this was a response to similar actions taken by a number of European governments. Moreover, especially with Danone and Carlsberg, the interests of specific Russian players were plain. However, many more questions were raised by the actions of Russia’s Prosecutor General to seize the assets of large enterprises in July and August – not only foreign companies, but also completely Russian ones, and across a variety of industries.
The most high-profile story was that of billionaire Andrei Melnichenko, and by the end of the summer of 2023, about 20 such cases had been filed. Making this possible were several “innovations.”
Firstly, in a number of cases the current owners were alleged to be violating the “economic sovereignty of the Russian Federation” and thereby threatening national security. Such arguments, by the logic of the FSB, are radically different from those typically used to squeeze business in recent years, which had centered around alleged fraud. From the descriptions of recent cases, it remains unclear how exactly prosecutors supported the allegations, but in the current environment it would be naive to expect the courts to disagree with the prosecution.
Secondly, in a number of cases, the basis for the claims were “mistakes” in the documents for privatization carried out back in the 1990s. Importantly, contrary to practice and legal logic, the fact of an “offence” on which the claim to seize assets was based was marked not from the moment the “offence” was committed 30 years ago, but from when it was discovered in 2023.
The most high-profile story was that of billionaire Andrei Melnichenko, and by the end of the summer of 2023, about 20 such cases had been filed. Making this possible were several “innovations.”
Firstly, in a number of cases the current owners were alleged to be violating the “economic sovereignty of the Russian Federation” and thereby threatening national security. Such arguments, by the logic of the FSB, are radically different from those typically used to squeeze business in recent years, which had centered around alleged fraud. From the descriptions of recent cases, it remains unclear how exactly prosecutors supported the allegations, but in the current environment it would be naive to expect the courts to disagree with the prosecution.
Secondly, in a number of cases, the basis for the claims were “mistakes” in the documents for privatization carried out back in the 1990s. Importantly, contrary to practice and legal logic, the fact of an “offence” on which the claim to seize assets was based was marked not from the moment the “offence” was committed 30 years ago, but from when it was discovered in 2023.
“This approach essentially means that almost any privatization deal can now be revisited.”
Vladimir Putin speaks at the Eastern Economic Forum in Vladivostok, September 2023.
Source: Kremlin.ru
Source: Kremlin.ru
The reaction to these actions by the Prosecutor General was public statements by representatives of the business community and a number of officials. For instance, in early September, Alexander Shokhin, head of the Russian Union of Industrialists and Entrepreneurs, expressed his concerns. Economic Development Minister Maxim Reshetnikov called a possible revision of privatization “a path to nowhere.” Putin aide Maxim Oreshkin spoke in the same vein. Note that business ombudsman Boris Titov spoke rather neutrally on the issue, noting that there are only about 10 cases from the Prosecutor General involving assets being taken into state ownership and they “cannot be considered a systemic problem.”
The official line was laid out by Vladimir Putin at the Eastern Economic Forum. In response to a specially asked question, he ruled out deprivatization and stated that it was only a matter of individual cases and that businesses simply needed to comply with the law.
Then, the Prosecutor General withdrew three cases on which the courts had not yet made a decision, including one against the German company HeidelbergCement and another against Melnichenko. Nevertheless, on September 25, at a meeting with Putin, Prosecutor General Igor Krasnov pointed out that “as part of the deoffshorization of the Russian economy, as well as the protection of the interests of state property, over 24,000 of our claims relating to illegal loss state property, valued at more than RUB 187 billion, have been satisfied by the courts.”
The official line was laid out by Vladimir Putin at the Eastern Economic Forum. In response to a specially asked question, he ruled out deprivatization and stated that it was only a matter of individual cases and that businesses simply needed to comply with the law.
Then, the Prosecutor General withdrew three cases on which the courts had not yet made a decision, including one against the German company HeidelbergCement and another against Melnichenko. Nevertheless, on September 25, at a meeting with Putin, Prosecutor General Igor Krasnov pointed out that “as part of the deoffshorization of the Russian economy, as well as the protection of the interests of state property, over 24,000 of our claims relating to illegal loss state property, valued at more than RUB 187 billion, have been satisfied by the courts.”
Andrey Belousov, a first deputy prime minister. Source: Wiki Commons
In addition, Krasnov said that the Prosecutor General “managed to release from foreign control a number of key strategic enterprises that are essential to Russia’s economy and security.” This information was taken into account by Putin without comment – and there was no further review of cases involving the seizing of assets on which the courts had already ruled.
At the end of October, First Deputy Prime Minister Andrey Belousov made headlines with a derogatory comment about the typical strategies used by Russian business, comparing them to the behavior of wild animals (krysit’, khryuchit’, kopytit’).
Finally, in mid-November, a meeting was held between representatives of big business and Putin in which the former again expressed concerns about the prospects of “deprivatization.” This meeting was notable for including a wider range of participants than usual, and there Shokhin announced the readiness of business to raise the profit tax rate, which was “taken into account” by Putin. Another interesting outcome of this meeting was statements by a number of big Russian companies about “redomiciliation,” or the transfer of these companies’ parent holdings to Russian jurisdiction.
Who needs this and why?
To answer this question, let’s consider what interests could be the driving force behind the latest redistribution of property. For example, note that a number of enterprises whose assets were nationalized in July-August – Metafrax Chemicals, Uralbiopharm, Volzhsky Orgsintez, Dalnegorsk Mining and Processing Plant – operate in the chemical industry.
Meanwhile, a copy of a letter from the head of Ruskhim (formerly Russian Hydrogen) addressed to Putin has been circulating among businesspeople I know. The letter was dated the end of June and argued the need to consolidate the chemical industry by using Ruskhim as a “development institution.” It explicitly suggested that the Prosecutor General assess the legality of the privatization of enterprises that had not yet been included in the “consolidation perimeter.” There is very little publicly available information about Ruskhim, but people in the industry say it is connected to the Rotenberg brothers.
This explanation generally fits into the logic of the coerced redistribution of assets that has been characteristic of Russia over the past 20 years, when, with help from corrupt law enforcement officials, property passed into the hands of new private owners. The only relatively new thing here is the scheme – now, assets are taken over by the state and then transferred to the management of a private company (while remaining federal property). However, the companies whose owners have been sued in recent months have not been limited to the chemical industry.
In this regard, it might be assumed that this kind of pressure on business is being used as a more general signal for Russian companies whose parent holdings are still located in foreign jurisdictions to “come home on good terms if you do not want to lose your key assets.” And it seems that business has picked up this signal.
At the end of October, First Deputy Prime Minister Andrey Belousov made headlines with a derogatory comment about the typical strategies used by Russian business, comparing them to the behavior of wild animals (krysit’, khryuchit’, kopytit’).
Finally, in mid-November, a meeting was held between representatives of big business and Putin in which the former again expressed concerns about the prospects of “deprivatization.” This meeting was notable for including a wider range of participants than usual, and there Shokhin announced the readiness of business to raise the profit tax rate, which was “taken into account” by Putin. Another interesting outcome of this meeting was statements by a number of big Russian companies about “redomiciliation,” or the transfer of these companies’ parent holdings to Russian jurisdiction.
Who needs this and why?
To answer this question, let’s consider what interests could be the driving force behind the latest redistribution of property. For example, note that a number of enterprises whose assets were nationalized in July-August – Metafrax Chemicals, Uralbiopharm, Volzhsky Orgsintez, Dalnegorsk Mining and Processing Plant – operate in the chemical industry.
Meanwhile, a copy of a letter from the head of Ruskhim (formerly Russian Hydrogen) addressed to Putin has been circulating among businesspeople I know. The letter was dated the end of June and argued the need to consolidate the chemical industry by using Ruskhim as a “development institution.” It explicitly suggested that the Prosecutor General assess the legality of the privatization of enterprises that had not yet been included in the “consolidation perimeter.” There is very little publicly available information about Ruskhim, but people in the industry say it is connected to the Rotenberg brothers.
This explanation generally fits into the logic of the coerced redistribution of assets that has been characteristic of Russia over the past 20 years, when, with help from corrupt law enforcement officials, property passed into the hands of new private owners. The only relatively new thing here is the scheme – now, assets are taken over by the state and then transferred to the management of a private company (while remaining federal property). However, the companies whose owners have been sued in recent months have not been limited to the chemical industry.
In this regard, it might be assumed that this kind of pressure on business is being used as a more general signal for Russian companies whose parent holdings are still located in foreign jurisdictions to “come home on good terms if you do not want to lose your key assets.” And it seems that business has picked up this signal.
“However, given the arguments about threats to Russia’s national security and sovereignty made in the cases brought by the Prosecutor General, another, broader interpretation of this whole story is possible – one that suggests a transition to a different economic model.”
Here it is worth recalling the notable book Growth Crystal, published back in 2021. Its main author is Alexander Galushka, previously president of Business Russia and Far East development minister and now the deputy secretary of Russia’s Public Chamber. The main idea of the book is simple: from 1929 to 1955, the USSR set records for economic growth that have yet to be surpassed by any other country. According to the book, to drive such economic development we simply need to use this invaluable historical experience.
A convincing critique of the arguments regarding the effectiveness of the Soviet “mobilization economy” is given in a comprehensive review of Galushka’s book, “What the History of the Stalinist Economy Teaches,” by Professor Girsh Khanin, coauthor of the famous article “Lukavaya Tsifra” (“Deceiving Statistics”), which caused a sensation back in perestroika times. The objections of doubters like Khanin, however, did not in the least hinder the campaign to promote the book in the public space as a “fundamental scientific monograph” showing how to effect a “Russian economic miracle.”
How the campaign was carried out led to the impression that very influential people were behind it, using the ideas of the book’s authors to justify the transition to a mobilization model for the economy. For example, in May 2023, during a speech at the St Petersburg International Legal Forum, Investigative Committee Chair Alexander Bastrykin explicitly stated that the main sectors of the economy should be nationalized to ensure “economic security in times of war.” Recall that before his appointment to the post of prosecutor general, Krasnov had worked for 13 years under Bastrykin.
If we proceed from this interpretation, then the claims of the Prosecutor General could be considered a trial balloon. Since the cases caused a nervous reaction from big business and gave rise to a series of public statements, the initiative was slowed down – so as not to create unnecessary tension, especially since the presidential election is coming up in March 2024. However, after the election, given the huge increase in spending on the army and other security forces penciled in to the budget, as well as Putin’s statements that the special operation will go on until victory is achieved, we should expect a new escalation in the war with Ukraine. And this, in turn, could become grounds for a full-fledged pivot to a mobilization economy.
The problem is that in the mobilization model that the authors of Growth Crystal put forward, there is simply no room for big private business. All the “strategic heights” in such an economy are controlled by the state. Anyone who disagrees with this approach will “fall out of windows” (as has already happened with a number of top managers from major Russian companies in the last year and a half – here and here), while the remaining businesspeople are destined to become at best new “red directors,” appointed and removed by Kremlin fiat. Meanwhile, the declared relocation of the parent holdings of the biggest companies to Russian jurisdiction will certainly make their business more controlled by the authorities.
A more general view
A preliminary discussion for this commentary with a number of experts (including those still in Moscow) does not suggest that any one of the three abovementioned motives is clearly the main one – neither the seizing of property by private players close to the Kremlin, nor general pressure on big business with the aim of having headquarters moved to Russian jurisdiction, nor moving toward a mobilization model for the economy. One of the experts said that it is impossible to deny the trend; the only question is where (at what level) it will end. Still, there is no fatal predetermination yet that everything will be sucked up by the state – after all, in the end it was private business that showed a very high degree of flexibility and pulled the economy back from the brink in the spring of 2022.
Another expert believes that the system still operates on a model in which the key factor is not certain ideas or interests but physical access to Putin. The state apparatus (including security services) will implement all decisions that have a green light from Putin – no matter how contradictory they may be. In addition, these decisions could well be implemented alongside the realization of certain private or corporate interests.
And yet it seems to me that
A convincing critique of the arguments regarding the effectiveness of the Soviet “mobilization economy” is given in a comprehensive review of Galushka’s book, “What the History of the Stalinist Economy Teaches,” by Professor Girsh Khanin, coauthor of the famous article “Lukavaya Tsifra” (“Deceiving Statistics”), which caused a sensation back in perestroika times. The objections of doubters like Khanin, however, did not in the least hinder the campaign to promote the book in the public space as a “fundamental scientific monograph” showing how to effect a “Russian economic miracle.”
How the campaign was carried out led to the impression that very influential people were behind it, using the ideas of the book’s authors to justify the transition to a mobilization model for the economy. For example, in May 2023, during a speech at the St Petersburg International Legal Forum, Investigative Committee Chair Alexander Bastrykin explicitly stated that the main sectors of the economy should be nationalized to ensure “economic security in times of war.” Recall that before his appointment to the post of prosecutor general, Krasnov had worked for 13 years under Bastrykin.
If we proceed from this interpretation, then the claims of the Prosecutor General could be considered a trial balloon. Since the cases caused a nervous reaction from big business and gave rise to a series of public statements, the initiative was slowed down – so as not to create unnecessary tension, especially since the presidential election is coming up in March 2024. However, after the election, given the huge increase in spending on the army and other security forces penciled in to the budget, as well as Putin’s statements that the special operation will go on until victory is achieved, we should expect a new escalation in the war with Ukraine. And this, in turn, could become grounds for a full-fledged pivot to a mobilization economy.
The problem is that in the mobilization model that the authors of Growth Crystal put forward, there is simply no room for big private business. All the “strategic heights” in such an economy are controlled by the state. Anyone who disagrees with this approach will “fall out of windows” (as has already happened with a number of top managers from major Russian companies in the last year and a half – here and here), while the remaining businesspeople are destined to become at best new “red directors,” appointed and removed by Kremlin fiat. Meanwhile, the declared relocation of the parent holdings of the biggest companies to Russian jurisdiction will certainly make their business more controlled by the authorities.
A more general view
A preliminary discussion for this commentary with a number of experts (including those still in Moscow) does not suggest that any one of the three abovementioned motives is clearly the main one – neither the seizing of property by private players close to the Kremlin, nor general pressure on big business with the aim of having headquarters moved to Russian jurisdiction, nor moving toward a mobilization model for the economy. One of the experts said that it is impossible to deny the trend; the only question is where (at what level) it will end. Still, there is no fatal predetermination yet that everything will be sucked up by the state – after all, in the end it was private business that showed a very high degree of flexibility and pulled the economy back from the brink in the spring of 2022.
Another expert believes that the system still operates on a model in which the key factor is not certain ideas or interests but physical access to Putin. The state apparatus (including security services) will implement all decisions that have a green light from Putin – no matter how contradictory they may be. In addition, these decisions could well be implemented alongside the realization of certain private or corporate interests.
And yet it seems to me that
“The political-economic system that has taken shape under Putin is objectively at an important fork in the road.”
Mikhail Abyzov, formerly minister for open government affairs, was arrested in 2019 and sentenced to 12 years in prison in December 2023. Source: VK
For a long time (in fact, starting from the Yukos case), the system was based on good opportunities for business to make profits in exchange for a fundamental renunciation of all political activity that is not sanctioned by the Kremlin. The key actor in this model was the state apparatus. This meant a big role for the top bureaucratic elite, which had relative autonomy, controlled significant resources and generally pursued a liberal economic policy. It was this policy that built the foundation for the market economy that turned out to be robust to major external shocks.
However, against the backdrop of the political protests in 2011-12, the balance of power in the elite changed: the Kremlin opted for the outright priority of security and militarization, and the top bureaucracy began to lose its influence as a result. Its autonomy turned out to be illusory in the absence of political competition. Top officials are appointed by the Kremlin, can be removed just as easily and, if needed, can also be sent to prison on charges of “corruption” – as happened with Nikita Belykh, Alexei Ulyukaev and Mikhail Abyzov.
After the Yukos case, big business lost the status of a full-fledged partner in the ruling coalition, though business as a whole played an important role in the current economic model all these years, ensuring its stability. That is why, in dealing with business, the Kremlin has tried to keep to the same “social contract,” maintaining the same terms.
One of the products of this contract in the 2010s was regular pressure on the bureaucracy through the National Entrepreneurial Initiative to improve technical conditions for doing business (reflected in Russia’s noticeable progress in the World Bank’s Doing Business ranking). Another product: the authorities’ deliberate suppression of collective actions by workers (through the exceptional weakness of official trade unions) and, as a result, maintenance of low labor costs for businesses.
Business is by definition a more autonomous actor than bureaucracy. Officials have only the powers granted to them by the state. And with the loss of these powers, they lose access to resources. On the contrary, businesspeople have at their disposal significant financial resources that belong to them, as well as enterprises with thousands of employees. In addition, unlike officials, businesspeople still have the opportunity to travel abroad and, in most cases, have foreign assets.
Also important is the continuing diverseness of Russian business: along with a number of large companies whose business was built on political connections and access to sources of rent, there are tens of thousands of firms did everything themselves. This became possible thanks to the previous liberal economic policy, and it was these firms that allowed the Russian economy to withstand the pressure of major international sanctions. However, because they rely on the market, such businesses might demand liberal policies, especially when markets are shrinking and profits declining.
However, against the backdrop of the political protests in 2011-12, the balance of power in the elite changed: the Kremlin opted for the outright priority of security and militarization, and the top bureaucracy began to lose its influence as a result. Its autonomy turned out to be illusory in the absence of political competition. Top officials are appointed by the Kremlin, can be removed just as easily and, if needed, can also be sent to prison on charges of “corruption” – as happened with Nikita Belykh, Alexei Ulyukaev and Mikhail Abyzov.
After the Yukos case, big business lost the status of a full-fledged partner in the ruling coalition, though business as a whole played an important role in the current economic model all these years, ensuring its stability. That is why, in dealing with business, the Kremlin has tried to keep to the same “social contract,” maintaining the same terms.
One of the products of this contract in the 2010s was regular pressure on the bureaucracy through the National Entrepreneurial Initiative to improve technical conditions for doing business (reflected in Russia’s noticeable progress in the World Bank’s Doing Business ranking). Another product: the authorities’ deliberate suppression of collective actions by workers (through the exceptional weakness of official trade unions) and, as a result, maintenance of low labor costs for businesses.
Business is by definition a more autonomous actor than bureaucracy. Officials have only the powers granted to them by the state. And with the loss of these powers, they lose access to resources. On the contrary, businesspeople have at their disposal significant financial resources that belong to them, as well as enterprises with thousands of employees. In addition, unlike officials, businesspeople still have the opportunity to travel abroad and, in most cases, have foreign assets.
Also important is the continuing diverseness of Russian business: along with a number of large companies whose business was built on political connections and access to sources of rent, there are tens of thousands of firms did everything themselves. This became possible thanks to the previous liberal economic policy, and it was these firms that allowed the Russian economy to withstand the pressure of major international sanctions. However, because they rely on the market, such businesses might demand liberal policies, especially when markets are shrinking and profits declining.
“In this sense, business poses a more serious threat to the Kremlin than the bureaucracy.”
Until now, the Kremlin could count on the loyalty of business because of the windfall profits of 2022 and (in part) 2023, which businesspeople reaped due to the contradictory design of the international sanctions. “Personal sanctions” also worked in favor of the Kremlin, essentially pushing major businesspeople into Putin’s arms. Finally, as an additional “loyalty bonus” there was the possibility of purchasing the assets of foreign companies leaving Russia.
However, as macroeconomic destabilization begins and the economic situation inevitably worsens, it will become increasingly difficult for the Kremlin to maintain the loyalty of business. For this reason, it is business (primarily big business) that is very likely to suffer the greatest losses in 2024 – not so much due to the rising labor costs caused by an acute shortage of workers amid mobilization and recruitment into the army, but more owing to direct expropriation of property. In the logic of populist politics, the most likely candidates for such expropriation would be the “oligarchs” of the Yeltsin period.
Such a threat could theoretically create incentives for big business to take collective action – as happened in 1996 amid fears of a Communist victory in the presidential election. But the 2003 scenario seems more likely at this point. At that time, during the turmoil caused by the Yukos case, big business turned out incapable of collectively defending its interests. The difference with the current situation is that instead of the carrot of high earnings as compensation for “political loyalty” (as was the case in the 2000s and 2010s), the likely outlook for Russian business will be the stick – the best-case scenario is today’s Belarus with its nationalized economy, and the worst something along the lines of North Korea. Meanwhile, this will imply dismantling the economic base on which the Putin regime has relied for two decades in its foreign and domestic policy.
However, as macroeconomic destabilization begins and the economic situation inevitably worsens, it will become increasingly difficult for the Kremlin to maintain the loyalty of business. For this reason, it is business (primarily big business) that is very likely to suffer the greatest losses in 2024 – not so much due to the rising labor costs caused by an acute shortage of workers amid mobilization and recruitment into the army, but more owing to direct expropriation of property. In the logic of populist politics, the most likely candidates for such expropriation would be the “oligarchs” of the Yeltsin period.
Such a threat could theoretically create incentives for big business to take collective action – as happened in 1996 amid fears of a Communist victory in the presidential election. But the 2003 scenario seems more likely at this point. At that time, during the turmoil caused by the Yukos case, big business turned out incapable of collectively defending its interests. The difference with the current situation is that instead of the carrot of high earnings as compensation for “political loyalty” (as was the case in the 2000s and 2010s), the likely outlook for Russian business will be the stick – the best-case scenario is today’s Belarus with its nationalized economy, and the worst something along the lines of North Korea. Meanwhile, this will imply dismantling the economic base on which the Putin regime has relied for two decades in its foreign and domestic policy.
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