Crisis of Command
America’s Broken Civil-Military Relationship Imperils National Security
Over the last two years, there has been no shortage of predictions that the regime of Russian President Vladimir Putin would soon collapse under the crushing weight of falling oil prices and Western sanctions. After all, Russia’s economy was weak even before the start of the pro-democracy demonstrations in Ukraine in 2013. The annexation of Crimea in early 2014 and the conflict with the West that followed might have boosted Putin’s popularity at home, but as the argument goes, it dug the country into an even deeper financial hole. Without sound structural reforms to promote investment and growth, the roof would simply cave in under widespread protests, and soon.
But this reading is fundamentally flawed. The real threat to Putin’s hold on power does not arise from societal discontent, whether it’s from Moscow’s and St. Petersburg’s so-called creative class or the lower class, which has been further impoverished by the economic downturn. Instead, the current Russian government survives because it has successfully placated the elites who have become fabulously rich and powerful thanks to Putin’s crony capitalism. This group of insiders either knew Putin during his early political career in St. Petersburg or worked in the “force structures” (known as the siloviki) within the army, police, or Federal Security Service, the successor to the KGB. Over the last decade, they have amassed incredible fortunes, benefiting from the nationalization of oil and gas companies such as Yukos in 2004 as well as insider deals, such as providing banking and other services to the government.
This transfer of wealth into the hands of such a small group of elites has created a system of mutual dependence with Putin: he orchestrated their rise but cannot rule the country or sustain economic growth without their backing. The drying up of oil revenue and restricted access to the West threatened to upend this relationship and shake these elites’ support for the current government. In 2015, the crisis turned nearly two dozen billionaires into millionaires, over one-fifth of the 111 at the beginning of the year. (As a comparison, many billionaires around the world were fairly insulated from the 2009 financial crisis and even saw their wealth increase.) And yet Putin is still in power.
The reason this group of elites has continued to back Putin is that he was able to redistribute wealth to this inner circle, an exploit he orchestrated during this latest financial crisis. True, the hard-line stance toward the West and military intervention in Syria helped elevate Putin’s political stature, but more important, his adept manipulation of national-level economic policies has staved off potential defections. For one, the government passed laws and regulations designed not to kick-start Russia’s economy, but to partially compensate insiders for their losses due to the crisis.
Take, for example, the use of state procurement contracts, which help funnel enormous sums of money to politically connected companies. Despite the passage of a new federal law in 2014 designed to promote transparency and an increase in investigations by various anticorruption organizations, little has changed with regard to how the procurement process operates. Large-scale tenders are written explicitly so that only preferred suppliers are eligible to participate. In 2015, Putin awarded his judo partner Arkady Rotenberg with a $4 billion deal to build the long-awaited dual-use rail bridge across the Kerch Strait. He also put his cronies in charge of several liquefied natural gas projects and of building oil pipelines to China. Often, infrastructure jobs are handed to family members of high-level officials. Moreover, state-owned companies have lobbied successfully to be excluded from these reforms and continue to abide by a separate, and much less stringent, federal law.
Putin also caters to these elites through import substitution, a policy that favors replacing foreign products with domestic ones. It is intended to stimulate the economy, but since the policy was ramped up in mid-2014, it has done more to shore up the finances of large agribusiness interests than boost domestic production by small and medium enterprises. In fact, agriculture is now a hot sector for billionaires in Russia, given that Western sanctions have increased the demand for domestically grown food. One primary beneficiary, Ros Agro, is raising $250 million to fund new investments for this new endeavor. Overall, agricultural output is rising steadily as Russia imports less and exports more thanks also to a weak ruble. But the result is that connected conglomerates snap up wealth while consumers pay ever-higher prices for basic necessities. Pharmaceuticals, another industry that benefited from import substitution policies, had a record year of mergers and acquisitions in 2015. Regulations encouraging decentralization also gave larger companies an advantage to seize opportunities across Russia’s many regions, which inevitably reward the political and economic elites who control them.
The Kremlin has proposed privatizing key state-owned assets for some time now, and it raised the idea yet again in February of this year. Economists consider this public-to-private transfer as a way of turning bulky state enterprises into more efficient businesses. But in reality, this policy will continue the trend of prioritizing elite interests over the public good. In fact, Putin has made it clear that only “strategic investors” (those directly invited by Russian privatization officials) will be allowed to participate in the selloffs and that the state will still retain control of these companies. This will likely scare off foreign investors, and thus, it seems likely that a transfer of ownership will take place through backroom deals to insiders.
Although Western sanctions have served as an effective deterrent to further escalation in Ukraine, they have not helped break up this elite circle. In fact, the sanctions have drawn them closer together. Gas giants Gazprom and Rosneft, which are historical rivals, have even attempted to work together to reduce the sting of reduced oil exports. Although there has been concern that Russian elites are becoming unhappy about being cut off from the perks of leading a double life in the West, they remained united during the removal of key ally Vladimir Yakunin in August 2015 from his post as the head of the mammoth Russian Railways, as well as the arrest of billionaire Vladimir Yevtushenkov. Neither action provoked a widespread outcry in top circles. This is partly because other insiders have been allowed to take over valuable assets and powerful positions created by these individuals’ exits. But perhaps more important, Putin has ensured that those falling out of direct favor still receive sinecures and retain access to government spoils, even when convicted of corruption, as with the case of former Minister of Defense Anatoly Serdyukov.
Of course, this short-term strategy of placating elites could backfire if the money runs out before oil prices rebound. It does not appear that Putin has any long-term strategy except to buy enough time for the markets to return Russia to the glorious days of $100 per barrel of oil, as it was during the mid-2000s. With oil prices slated to recover slightly, Putin will be here to stay for a while longer.