Streetwise Professor

June 2, 2010

Vladimir Putin, Transaction Cost Economist

Filed under: Commodities,Economics,Politics,Russia — The Professor @ 8:28 pm

I find the whole upstream-downstream dispute in the metals markets in Russia very fascinating.  To watch the operation of a slice of the natural state is to understand the whole.  Putin’s role in these events is particularly illuminating.

Putin held a meeting with the head of Russia’s Federal Antimonopoly Service, Igor Artemyev, at which he gave a soliloquy telling how it was going to be.  Most notably, Putin advocated the return to a system of long term contracts with fixed prices (or prices based on a formula—press accounts vary):

The largest producers and consumers of metal could return to the practice of long-term contracts with a fixed price formula, which would rule out the possibility of price hikes. He said that the government believes that the supplies of metal, iron ore and coke to the domestic market should be viewed as a priority.

But as some bank analysts point out, this doesn’t solve the problem.  Fixed prices  are almost always wrong, out of alignment with current market conditions.  Sometimes they are too low, other times they are too high.  One party of the other has a reason to squawk that current prices are out of line.  And with commodities (the role of which in the Russian economy Putin’s soliloquy emphasizes with pride, in a very revealing counterpoint to Medvedev’s embarrassment at Russia’s commodity-centric economy), since prices are very volatile, misalignments are frequently large.

The key thing is that as any good transactions cost economist knows, contracts are first and foremost a part of a mechanism to govern the relationship between the contracting parties.  They provide some structure to the relationship between the parties.  But these contracts are necessarily incomplete, and need a mechanism to respond to developments not anticipated in the contract

Putin gets this, sort of, in an intuitive way:

Disagreements over prices should not lead to the unilateral termination of deliveries or failure to pay, and commercial dispute over contracts must be resolved through talks or arbitration tribunals, without driving partners into a corner.

But crucially, Putin also outlined a state-directed governance mechanism.  As described by John Helmer:

Putin’s fourth point in the pricing formula is a vague undertaking to a new form of state supervision of input costs and state planned price benchmarks, enabling the FAS and the Ministry of the Industry to deter or control sharp price deviations.  “The relevant federal agencies will be instructed, said Putin, “to calculate the economic benchmarks for metals prices and prices for other basic goods and services.”

In brief, Putin is advocating a system in which the state plays an important role in setting and administering prices, and governing contractual relationships between big firms.

This is part of the logic of the natural state.  Competition and conflict over rents is highly destabilizing to such a state.  The state has to limit access, dampen competition, and intervene in the interactions between nominally independent firms in order to maintain stability.

The fact that the most powerful man in the country is involved in these matters intimately, and on a daily basis, also reveals the fundamental political character of these ostensibly economic issues.  The most powerful politician must use his power primarily to maintain the delicate balance between vying factions identified first and foremost by their commercial interests.  Failure to do so–the deluge.

Calvin Coolidge once said “the business of America is business.”  Things are a bit different in Russia.  Of it, it can be said that the politics of Russia is business.

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  5. During my time there (15 years) we used to refer to this as Kanutian economics. Albeit Kanute was trying to demonstrate that he was not all powerful whereas Putin believes that he is.

    The tide will destroy this sandcastle as effectively as it has all the others

    Comment by Alistair Stobie — June 3, 2010 @ 7:01 am

  6. [...] Professor reflects upon the ongoing discussion in Russia about regulating the metals' market by price fixing, and Prime [...]

    Pingback by Global Voices in English » Russia: State regulation of metals market — June 4, 2010 @ 7:32 am

  7. “The tide will destroy this sandcastle as effectively as it has all the others.”

    Like the USSR and Tsarist Russia, just for instance.

    Comment by La Russophobe — June 6, 2010 @ 7:50 pm

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