Russia’s Godfather Saga

“Keep your friends close, but your enemies closer,” was the lesson taught to Michael Corleone by his father Vito in the Godfather movies. It’s something Russian President Vladimir Putin apparently also took to heart when he chose to keep the increasingly outspoken Andrei Illarionov on the job as economic advisor until the latter’s resignation in late December.<?xml:namespace prefix = o ns = “urn:schemas-microsoft-com:office:office” />


Illarionov, a strong advocate of free markets and fan of Ayn Rand who once had Putin’s ear, saw his influence diminish over the past two years. (For a profile of Illarionov from that more optimistic time, see here.) Holding on to his diminishing position, he said, “I considered it important to remain here at this post as long as I had the possibility to do something, including speaking out.” But he finally resigned in frustration at the Putin administration’s increasingly authoritarian direction, which included a sharp turn away from economic liberalization. Free marketers saw Illarionov’s influence as a beacon of hope for <?xml:namespace prefix = st1 ns = “urn:schemas-microsoft-com:office:smarttags” />Russia’s future. His departure may indicate that things in Russia have gotten worse—but some good may yet come from it.


The 1998 ruble collapse brought Illarionov notoriety as the first analyst to sound the alarm. He argued unsuccessfully for the government to undertake a controlled devaluation of the currency to avert a crash and warned against policy advice from the International Monetary Fund, which, he argued, set “unrealistic targets” regarding inflation, GDP growth, and trade balance. Further, “unearned financial assistance” in the form of IMF loans, he argued, created an environment of moral hazard which led the Russian government to spend and borrow excessively.


In 1999, Illarionov joined the Center for Strategic Planning, an economic policy think tank set up by Putin. In December of that year, the Center released its Strategy of Development for the Russian Federation to the Year 2010, co-authored by Illarionov. The document endorsed wide-ranging market reform, including deregulation of the economy and strengthening of property rights. In April 2000, Putin named Illarionov as his top economic adviser and endorsed Illarionov’s proposal for a 13 percent flat tax—which was enacted—and his goal of doubling the size of Russia’s economy in 10 years.


To achieve the latter, Illarionov argued, Russia would need to reject the Kyoto Protocol, which would stifle Russia’s economic growth by limiting the country’s use of energy. Illarionov had reason to be optimistic. In December 2003, he announced that Russia would not ratify Kyoto; President Putin did not contradict this public statement. And why tamper with success, especially if economic reform’s results were starting to show—with Russian GDP growth of 9 percent in 2000, 5 percent in 2001, and 4 percent in 2002? But in November 2004, Russia ratified Kyoto in exchange for European Union support of its entry into the World Trade Organization. For Andrei Illarionov, it was a major defeat.


And then came the Yukos affair. In October 2003, members of the FSB security force—the successor to the KGB—stormed the private jet of Mikhail Khodorkovsky, at the time head of oil giant Yukos and Russia’s richest man. He was arrested and later charged with fraud and tax evasion. Found guilty, he was sentenced last May and is currently serving a nine-year sentence in a Siberian prison.


Critics of Putin saw Khodorkovsky’s arrest and prosecution as punishment for his financial support of opposition parties. Moreover, the arrest came shortly after he acquired the publishing rights to the prestigious Miskovskiye Novosti newspaper and hired an investigative journalist critical of Putin, reports the BBC.


Assessing the merits of the case would require another article, and Khodorkovksy, as a well-connected oligarch, hardly made for a sympathetic dissident figure. But it would be difficult for any disinterested observer to consider the Russian government’s handling of the case anything but heavy handed.


In August 2004, the state seized Yukos’s biggest asset, its Yuganskneftegaz oil production unit—which at the time accounted for 60 percent of Yukos’s daily production of 1.7 million barrels—under the justification of settling exorbitant back-tax claims which came to total over $27 billion. In December of that year, Yukos was forced to sell Yuganskneftegaz to state-owned oil company Rosneft for $9.4 billion.


The assault on Yukos became part of a larger trend of greater state involvement in the economy, especially in the energy sector, as state-owned companies moved to acquire more assets. The Russian state now controls around 30 percent of the nation’s oil industry.


Economically, the Yukos takeover gained the government little. Growth in oil production has slowed from an average of 9 percent during the early years of Putin’s government to around 3 percent this year, Valery Nesterov, an energy expert with the Russian investment bank Troika Dialogue, told The Christian Science Monitor. And Illarionov notes that Yuganskneftegaz, which once pumped 1 million barrels a day, saw its production drop by at least 15 percent between 2000 and 2003, observing that this “staggering drop in proceeds…merits being entered in the book of anti-records.”


Yet for the Kremlin, there may be significant political gains form its energy sector meddling. First, the Khodorkovsky prosecution rid Putin of a powerful opponent.


In addition, Illarionov has decried what he calls the “selective use of energy as a weapon outside Russia.” Russia has used its dominance of the former Soviet energy infrastructure, such as pipelines and pumping stations, as leverage over its neighbors. Recently, state energy giant Gazprom said that it will raise prices substantially for its once-surrogate neighbors, including former Soviet republics Ukraine and Georgia, which today have pro-Western governments. (On New Year’s Day it briefly shut off gas to Ukraine after the latter balked at a massive price hike.)


Illarionov’s public reaction to these developments was unlikely to raise his status inside the Kremlin. He was openly critical of the Khodorkovsky trial. In December 2004, he called the government’s intervention into the energy sector—including the forced sale of Yganskneftgaz and state-owned energy giant Gazprom’s $13.1 billion acquisition of the then-independent oil company Sibneft—the “scam of the year.” Days after making these remarks, Putin stripped Illarionov of his duties as Russian representative to the G8. And over the past year Illarionov found himself less listened to by Putin as the latter went in a more authoritarian direction.


“It is one thing to work in a country that is partly free,” said Illarionov on the day of his resignation. “It is another thing when the political system has changed, and the country has stopped being free and democratic. I did not sign a contract with such a state, and therefore it is absolutely impossible to remain in this post.” Economic freedoms may not be the only ones threatened. On December 27, Russia’s upper house approved new controls on non-governmental organizations (NGOs), including human rights groups.


So is Russia crawling back to its Soviet past? Not really. Illarionov recently said that Russia is descending into a “corporate model ruled by state corporations,” in which some private firms continue to thrive, but where the state controls the economy’s commanding heights. Recognizing the importance of energy to a country’s future led Illarionov to oppose the Kyoto Protocol. Unfortunately, the Putin government also recognizes energy’s importance, and is now seeking to utilize it for illiberal ends—and that is bad enough.


For Putin, it may have been better politically to keep Andrei Illarionov within the tent in the hope that he would not take sides, in Michael Corleone’s words, “against the family.” Yet Illarionov was never afraid to criticize the president he served. It will be interesting to see how his criticisms of the Putin government shape up now that he is outside of it. Let’s hope he turns up the heat.