Streetwise Professor

December 16, 2006

Remember the Trust

Filed under: Russia — The Professor @ 11:13 pm

As I wrote earlier, trying to figure out whodunit in the Litvinenko affair is a futile exercise. There are two main theories: (a) that Litvinenko’s murder was a security force operation (perhaps with state sanction), and (b) that it was somehow related to a nuclear smuggling operation directed against Russia.

I would merely note that these are not mutually exclusive alternatives. In the murky world of espionage, opposition groups can be infiltrated by, and manipulated by, the intelligence operations of the state they are acting against. Indeed, in some cases, these groups can be the creation of the intelligence forces.

A classic Russian example is the The Trust , a Soviet secret police (OGPU/ОГПУ) operation that established a fake anti-Bolshevik operation to smoke out and eliminate opponents of the regime.

I have no clue one way or the other whether a similar organization is involved in the Litvinenko affair. In my opinion, this case will never be solved. Even if the actual perpetrator is identified, his/her motives and connections will never be established definitively.

I only bring up The Trust to illustrate that in this amoral and murky milieu, the apparent puppeteer may be in fact somebody else’s puppet. Obsessive theorizing is ultimately purposeless, as these theories are not testable. The main thing here is not the identity of the actual poisoner, but the light it sheds on the poisonous politics of Putin’s Russia.

Further My Last

Filed under: Russia — The Professor @ 10:49 pm

This article by Oleg Gordievsky suggests that the analogy between the modern FSB and the oprichniki is apt:

But under Vladimir Putin, the militant element of the KGB (now known as the FSB) slowly began working to persuade the leadership to carry out such killings, according to my sources. “Too many enemies,” they said.

Those members of the FSB have a different style than in the past, however. The Communist Party was cruel, but it had its rules. The current people are like bandits — no code, no rules, hard to distinguish from the Mafia. The gangster mentality started to spread after 2000; there were assassinations inside the country, of enemies of the regime. But there were so many contract killings at the time under Putin that it was difficult to tell which were the work of the FSB and which were not. In that atmosphere, it was easy to disguise an assassination.

The FSB has also become a protection racket. Some of those in business who are willing to go along with the FSB report everything to its operatives and also give 10 percent of their profits to the KGB’s successor agency. And everyone is happy.

So in a way it’s a big criminal state. The FSB has become like the Mafia in its methods and goals.

The combination of political power, the elimination of political opponents (in the name of eliminating “enemies” or “traitors”), and mercenary motives is shared by the oprichniki and today’s FSB (and the siloviki with FSB connections) of Gordievsky’s description.

Coincidentally, it is commonly estimated that there were about 6000 oprichniki. Evgenia Albats, an expert on the FSB, estimates that some 6,000 former or current intelligence officers are in the executive [branch] and legislature. Fun(?) facts to know and tell.

December 14, 2006

новый Опричнина? (The New Oprichnina?)

Filed under: Russia — The Professor @ 11:11 am

One must be careful with historical analogies. They are never exact, and can mislead as well as inform. Nevertheless, reading this Washington Post article on the pervasive and growing influence of the FSB in Russia immediately brought to mind a historical antecedent–the Oprichnina (and Oprichniki) of Ivan IV (you know, the Terrible one). There are enough parallels to make the example an illuminating one.

The history of the Oprichnina is shrouded in mystery. According to Richard Pipes, after its abolition in 1572 it was forbidden even to mention the word again, and very little documentary evidence from the period survives. Its basic contours are known, however. The Oprichnina was Ivan’s personal domain, a state within a state that seized control of the most valuable properties in Russia. These properties were managed by the brutal oprichniki, the Tsar’s personal security force. Support of the oprichniki consumed substantial sums of wealth. The oprichniki carried brooms on their saddles, and deemed it their duty to “sweep out” treason against the Tsar. According to Pipes, they were allowed to “abuse or kill” those under their control with impunity. The boyars (noblemen), who Ivan considered a threat, were singled out for special attention by these thugs.

Reading the WaPo article, and other recent news from Russia, it is not a stretch to view the FSB as the modern equivalent of the oprichniki, with a writ to kill traitors; Russian natural resources (oil, gas, minerals) as the valuable property ceded to the Oprichnina; and the oligarchs as the latter-day boyars. As yet there have been no pogroms (as in Novgorod in 1569–although residents of Grozny may disagree), but the neo-oprichniki have pillaged the properties of those deemed to be enemies of the state, using taxes, extortion, and abrogation of contracts rather than fire and sword.

There is one bright spot in the Oprichnina story. (“Bright spot” is often a very relative term in history.) The Oprichnina was an abject failure. A rule of thugs run riot devastated the Russian economy. The oprichniki were too busy pursuing vendettas and enjoying their ill-gotten gains to defend the realm against a Tatar incursion. After a mere 7 years, the Oprichnina was dissolved, and consigned to the 16th century equivalent of the memory hole. But as Pipes says, by this time, “the job was done.” Opposition to the autocracy had been fatally weakened.

It would be unwise to expect that the rule of the FSB will lead to such a sudden and spectacular economic collpase. However, people whose comparative advantage is espionage and extortion are not well suited to building productive enterprises and institutions. The rule of the FSB will not build a wealthy Russia–though many in the FSB will become wealthy.

The WaPo article evokes other interesting historical comparisons. In particular, historically most dictatorial and autocratic states have had multiple security organs, each of which spends disproportionate time and effort watching after the others. Dictators and autocrats usually don’t want any single entity to become dominant, lest it threaten their rule. In essence, dictators exploit the prisoners’ dilemma to keep the security forces in control–if any one tries to take power, it is the dominant strategy of the others to oppose it. Russia and Putin are therefore adopting a non-traditional strategy when they allow the FSB to expand to assume the responsibilities heretofore exercised by other state organs. This is a very dangerous game, and anyone in power in Russia must rest very uneasily knowing that there is a security monoculture that has few scruples about wielding its powers. Perhaps the Kremlin is trying to play off factions within the FSB against one another, but this is probably a less reliable approach than pitting formally separate forces like scorpions in a bottle.

December 12, 2006

Sakhalin Shell Game

Filed under: Commodities,Energy,Russia — The Professor @ 6:26 am

I flew over Sakhalin Island on my way back to the US from Beijing this summer. During the trip I thought about the Soviet shootdown of KAL 007 over Sakhalin in 1983.

Sakhalin is back in the news for a completely different reason today. Under intense pressure from the Russian government, Shell has agreed to give a controlling stake in a gas production and liquified natural gas processing venture located in Sakhalin to Gazprom. The Financial Times’ coverage of the issue is outstanding; in addition to the linked article, there are several others. Robert Amsterdam has released a critical assessment of the deal.

Shell did itself no favors with the $10 billion cost overrun. This would have upset any residual claimaint–and under the terms of the original contract, the Russian government was a residual claimant, receiving payment only after the project’s revenues were sufficient to cover the original investment outlay. This does not mean that handing control to Gazprom is the best way for Shell to compensate the Russian Federation for any mis-management that contributed to the overrun. Gazprom has no expertise in such large and technically complex offshore projects. It can contribute nothing in terms of management or technical expertise. It can barely manage its sprawling–and somewhat decrepit and declining–existing collection of upstream and midstream assets. It has already announced that it would develop the Shtokman field in the Barents Sea–another project which it probably has no business doing by itself. If the economics of the Sakhalin project were already dicey (as the FT article suggests), Gazprom’s “contribution” will be to make them even dicier.

Some adjustment of the contract, such as requiring Shell and its Japanese partners to eat some of the overrun, would have been a more efficient way to handle the situation. But that wouldn’t have suited Putin and Gazprom. That would have resulted in money received down the road. They want control–now.

Moreover, the means by which the RF and Gazprom muscled their way into control is predictably shameful. Trumped up environmental problems–which again should have been dealt with and compensated for in other, more efficient ways–were the knout that Putin/Medvedev wielded this time to bludgeon Shell into submission. One day it’s taxes, the next day it’s environmental laws. As Roseanne Roseannadana used to say, it’s always something–and something always results in Gazprom walking away with the marbles.

This rent seeking makes some people wealthy, and some governments more powerful, but in the end is wealth destroying. It discourages investment, especially in “strategic sectors” that are most likely to be the next target of Putin’s predation. Moreover, it will result in the inefficient exploitation of Russia’s natural resources. Gazprom’s involvement can only cock up the already cocked-up operation of Sakhalin even more. And it is highly unlikely that Gazprom’s magic touch will enhance Shtokman’s productivity (sarcasm alert!). Russia’s taxation through expropriation creates enormous deadweight losses, but advances the interests of state power and the interests of the connected, who care more about the distribution of rents than the maximization of value.

December 11, 2006

So right, but so wrong

Filed under: Russia — The Professor @ 9:58 am

Russian scholar Aleksandr Khromchikhin of the Institute of Political and Military Analysis, participating in an Radio Ekho Moskvy program monitored by the BBC:

Khromchikhin said that Russia lacks a proper “national authority”. “In my opinion, the Russian state lacks a proper sense of national identity. We simply have Gazprom, the veto at the UN Security Council and a strategic nuclear potential,” he observed.

That is a fair summary of Russia’s geopolitical strategic assets, its (few) advantages in the “correlation of forces,” as the Soviets phrased it. However, it ignores Russia’s primary asset–its human capital–its engineers, scientists, mathematicians, musicians, writers, and artists. Indeed, contrary to Khromchikhin’s lament, Russia’s main tragedy may well be that its government’s monomaniacal efforts to create a “national authority” and a “national identity” (defined primarily negatively by opposition to the West in general and the US in particular) are making it impossible for this human resource to reach its full potential. The neo-mercantilist drive to create “national champion” companies to compete globally deprives talented individuals of the space and freedom they need to flourish. The Ozymandius-like obsession with power and national prestige is undermining the civil society that would permit Russia’s human capital to thrive.

In brief, a little less national authority, and a national identity built on something other than great power status, would be good things. Unfortunately, inasmuch as a good fraction of the Russian populace has bought into this mindset, this is unlikely to happen any time soon.

Technology and Exchange Competition

Filed under: Exchanges — The Professor @ 9:36 am

As I have mentioned in several earlier SWP posts, and in my academic writing, competition in financial exchange markets is likely quite imperfect. Dominant financial exchanges have a considerable competitive advantage due to the nature of liquidity. When those who want to trade have to decide where to submit their order based on the expected cost of execution, they have a compelling reason to submit their order to the exchange to which they expect most other traders to direct theirs. This creates a network effect that induces tipping to a single exchange. Any competing venue faces daunting obstacles to overcome this positive feedback mechanism.

Things would be different if traders could condition where they submit their order on the actual terms of trade offered at competing exchanges, rather than on the expected terms of trade. In this case, a smaller exchange might be quoting a better price than the larger exchange, and could attract some orders.

This pre-trade transparency is difficult to create in some trading technologies. For instance, in an open outcry futures market, current trading opportunities are expressed in the bids and offers of floor participants, and are said to be “good only as long as the breath is warm.” Much of the liquidity is latent–represented by the limit orders held in brokers’ decks, and known only to them. Although one can call to get the current bid and ask prevailing on the floor, this takes time, and frequently prices change before an order is submitted and a trade can be executed. The better-safe-than-sorry strategy is to submit the order to the bigger exchange where good execution is more likely.

Electronic trading tends to improve pre-trade transparency. In many trading systems, one can observe the current bid and offer in real time, and often a good portion of the entire order book is displayed. Theoretically, it is possible to monitor multiple markets simultaneously on the computer, and submit the order to the market displaying the best price.

There are still difficulties, however. It is not a trivial task for a human being to monitor multiple markets on a computer screen, identify which offers the best trading opportunity, and pull the trigger. The markets move quickly, prices jump around on the screen, and sometimes the human is too slow to identify and exploit the best trading opportunity.

How can this problem be mitigated, thereby weakening the order flow network effect, undermining the tendency of markets to tip, and reducing barriers to entry?

One way is to socialize liquidity pools by creation of a central limit order book, or “CLOB.” That is, a single open entry execution facility where all orders from multiple exchanges or trading systems are directed.

Proposals to create a CLOB have been around in securities markets since the 1970s. They have never gone very far, despite receiving some potent political support from Morgan Stanley, Goldman Sachs, and Merrill Lynch (the “MGM” group). As I noted in my 2002 JLEO piece, a CLOB raises thorny issues relating to pricing of access, organization, and governance. Moreover, CLOB proposals engendered vociferous opposition from the incumbent exchanges–primarily the NYSE.

In securities markets, the SEC has taken a different approach. Since 1975, it has advocated what I have termed (in my 2005 Regulation Mag article) the “information and linkages” approach. This approach mandates display of quote information, and attempts to forge linakges between exchanges that facilitate the flow of orders from the exchange to which they are submitted to other exchanges offering better prices.

The first attempts to implement this approach (in 1975) did not change substantially the competitive playing field. The impending RegNMS has the potential to have a much bigger impact. By mandating the rapid and automatic direction of orders to the exchange offering the best price RegNMS will facilitate the direction of orders to the venue offering the best current terms of trade, rather than the venue that offers the best expected terms of trade.

In essence, RegNMS requires the individual exchanges to monitor trading opportunities in other markets, and redirect orders they receive to other exchanges offering better current trading opportunities. RegNMS is having a major impact even before it is in effect. It has motivated the NYSE to expedite its movement to electronic trading. It has led to the entry of new securities exchanges, such as the ISE’s stock trading service. It has revitalized previously moribund regional exchanges, attracting investments to these entities from major brokerage firms that anticipate that the regulation will loosen the NYSE’s stranglehold on order flow.

Is something like RegNMS essential? Maybe not. Rather than forcing exchanges to monitor trading opportunities at competing exchanges, and directing orders to the venue offering the best prices, it may be possible to rely on customers to do this monitoring themselves. In particular, institutional customers (who account for progressively larger shares of equity and futures trading) can utilize computer technology and algorithmic trading tools to monitor trading opportunities on myriad markets, and direct their orders to the exchange offering the best terms. Although humans have difficulties in monitoring many markets simultaneously, this is easy for computers.

That is, rather than having centralized intelligence in the system (in the extreme form in a CLOB, or to a lesser degree via RegNMS) it may be possible to rely on distributed intelligence to monitor diverse markets and direct orders accordingly.

This would work best in electronic markets where exchanges display extensive order book information, allowing large traders to determine the optimal way to trade orders bigger than the best bid or offer displayed at any single exchange. This raises the possibility, though, that exchanges may reduce the information that they display in order to influence trading strategies and the competitive environment. This is an interesting subject for future research.

Distributed intelligence holds open the possibility of weakening the positive feedback mechanism that gives the biggest trading venue a strong competitive advantage. That is, it might weaken the strong centripetal force of liquidity.

One should not get carried away at the prospect, however. The high valuations of futures, options, and equity exchanges suggest that the equity market believes that these institutions will continue to earn substantial rents now and in the foreseeable future. If incumbent exchanges’ competitive advantages were widely believed to be under threat, we would not observe these rich stock prices.

Nonetheless, this discussion suggests that it may be possible to increase inter-exchange competition without heavy handed regulation Encouraging and facilitating distributed intelligence would be one way of doing so.

Apropos my earlier posts on clearing, in the event that distributed intelligence and algorithmic trading effectively opens the liquidity network, clearing will be the main monopoly bottleneck in the trading system.

There are other interesting competitive issues in markets. In particular, the growth of “dark liquidity” is intriguing. Large brokerage firms that receive substantial order flows are matching some customer orders internally (customer v. customer) rather than directing them to exchanges. Some are also internalizing orders and serving as the principal in the transaction. These intra-broker order flows are called “dark liquidity pools.”

These are understandable reactions to the pricing power of for-profit exchanges. Why pay super-competitive fees to exchanges if they can be avoided? From a price efficiency perspective, if one believes that a Kyle model is a reasonable characterization of price determination, the matching of offsetting customer orders has no impact on the efficiency of market prices; order imbalance is what matters in this setting, and customer v. customer matches don’t affect the order imbalance at the locus of price discovery.

Internalization is somewhat different. It is likely that internalized orders are the result of cream skimming, i.e., the market maker/broker identifying orders that are unlikely to be informed, and taking the other side. This exacerbates the adverse selection problem that market makers in the price discovery market(s) face, widening spreads and reducing depth.

Cream skimming is often criticized, but these criticisms frequently assume (incorrectly) that there is perfect competition in the exchanges where price discovery occurs. In this case, exacerbating adverse selection is inefficient.

However, in reality exchanges exercise considerable market power. In the old days of non-profit exchanges, they exercised market power by limiting entry to the exchange. Nowadays, for-profit exchanges charge supercompetitive trading fees.

In this environment, cream skimming can be a second best response to exchange market power. As I show in my paper “Third Markets and the Second Best,” cream skimming can increase total surplus, even though it makes some traders (those who are uninformed but cannot prove it) worse off.

Thus, dark liquidity and cream skimming internalization are market responses to exchange market power, and likely improve welfare (though they are not Pareto improving). They represent competition for exchanges, and increase the elasticity of demand for exchange services, thereby making it less profitable for exchanges to jack up fees. These are likely to be the main forms of competition unless and until distributed intelligence and algorithmic trading make exchange v. exchange competition more viable.

Is Bigger Better?

Filed under: Climate Change — The Professor @ 5:44 am

No, it’s not what you’re thinking. And it’s not about the CME-CBOT merger either. It’s about models–climate models, in fact.

I have been reading a lot about these models in recent months. They embody a convergence of academic interests–in energy (because global warming and the possible policy responses thereto will have a major impact on energy markets, and are leading to the creation of new commodity markets for carbon), and in numerical methods (I research and teach on numerical methods in finance).

I must say that the models are incredible achievements. They are extremely complex. Indeed, they are far more complex than even the most advanced derivatives pricing models. The typical derivatives valuation model is a 1 dimensional or 2 dimenional single-equation linear PDE. Climate models involve systems of non-linear PDEs. Moreover, climate models must characterize the behavior of complex weather phenomena (such as clouds and precipitation) that cannot be resolved due to their small scale (relative to the scale of the discretized grid on which the equations are solved). Due to their complexity, and the numerical constraints that must be satisfied to ensure stability of the solution, these models must be solved on state-of-the-art supercomputers (whereas even fairly sophisticated derivatives models can be solved on desktop machines.)

That said, there is room for skepticism about these models. The characterizations of small scale phenomena–the “parameterizations”–are often problematic. Important forcings (e.g., solar forcings not related to the intensity of the sun, aerosols) are poorly understood, or missing altogether. Similarly, important feedbacks may be missing or mischaracterized. If there are non-linearities in climate processes (a proposition for which there is considerable theoretical support) observational errors in initial conditions can lead to forecasting errors. Coupled ocean and atmospheric models require computational “fudges” to permit solution, and to give even passably realistic results.

These problems manifest themselves in some serious, but too seldom acknowledged, problems. These models have very little skill in predicting regional climate variations. Their predictions about tropical climate are particularly bad. Moreover, their predictions about tropospheric and surface warming differ substantially from observed data (which either indicates a problem in the models, or in the surface observations, or both). Predictions about precipitation and soil moisture are especially dubious. These empirical rejections of the models’ predictions should give everyone pause when interpreting the dire model-based forecasts of impending climate doom–but this is too seldom the case. Day after day I read in the press of studies predicting dire changes in regional climate–notably regional precipitation–based on models alone. The models’ poor track record in predicting regional climate variations and precipitation is seldom noted in these reports. The modelers have become like the Wizard of Oz–imposing, disembodied authorities speaking down to the little people, shrouded in smoke, illuminated by flashing lights, raging at those who dare question them. Pay no attention to the little man behind the curtain.

The analogy is not exact, but the situation reminds me of macroeconomics in the 1970s. That was the era of the big model with hundreds of equations. Those models were also tours de force, but it eventually became evident that bigger wasn’t better. The big models did not perform well. The real economy was too complex. The Lucas critique also showed that these models could not capture important feedback effects–notably, the maximizing responses of economic agents. The models became progressively more complex, but their performance did not improve dramatically, and as Lucas noted, they faced inherent limitations; you could make them bigger and bigger, but that didn’t mean they got that much better. There are still big models around, but their day has passed.

I wonder if the same might not happen in climate science.

One alternative to these structural models is reduced form time series models, like those described in Dobrovolski’s book on stochastic climate models. These models clearly have their own deficiencies. Notably, they do not specify the causal relations and feedback mechanisms in the way that structural climate models do. However, they do allow parsimonious characterizations of the data. Moreover, they exhibit different behaviors at different levels of temporal and spatial aggregation. These can provide benchmarks against which the structural models can be tested: can these models generate the same time series patterns as observed in the data, and the diversity of behaviors at different levels of aggregation? Through use of Kalman filtering and MCMC methods, these time series models can also handle the observational errors that are inherent in climate data. Thus, although the structural and time series approaches have largely evolved along separate paths, there seems to be considerable benefit to integrating them in some fashion.

December 10, 2006

Beryl Sprinkel, Call Your Office

Filed under: Politics — The Professor @ 4:41 am

James Baker has been mentioned in this blog once before, as the target of Beryl Sprinkel’s priceless remark about flying monkeys and a certain body orifice. Baker is an extremely unlikable figure. Some of the adjectives that come to mind: arrogant; smug; cynical; amoral; fixer. Nor would I consider him a great thinker. He seems to spout conventional wisdom–when he hasn’t lapsed into banality. His policies as Secretary of State and Reagan staffer–notably his support for keeping together the USSR (he was the architect of the “chicken Kiev” speech and fought against Reagan’s call to Gorbachev to “tear down this wall”) and for letting Saddam survive after Gulf War I–and as Secretary of the Treasury–especially his desire to close the markets during the 87 crash–suggest a fetish for stasis and a dislike of spontaneous change.

The Iraq Study Group that Baker chaired only reinforces my disdain for Baker as a person, and as an intellect. I hope that when Baker next meets Bush, some brave soul will reprise Beryl Sprinkel’s role and say: “We’ll negotiate with Iran and Syria and sell out Israel when monkeys fly out of my ass.” And while I’m fantasizing, Bush will channel Alan Greenspan, and reply: “I go with the monkeys.”

December 8, 2006

Several Perceptive Articles on Russia

Filed under: Russia — The Professor @ 11:32 am

I read several perceptive articles on Russia today.

From the Carnegie Endowment’s Nikolay Petrov:

In Russia, a strong, semi-military, mobilization state has traditionally dominated over a much weaker and barely consolidated society. The policy of state strengthening that has been undertaken during Putin’s presidency has largely brought back the familiar Russian pattern: the state is ubiquitous and encroaches upon public territory, pushing out the genuine public initiatives that are not controlled by the state. Having “streamlined” media, business, political parties, and other institutions, the state now attempts to expand its control over civil society.

Yes. Historically, Russian political philosophy has been diametrically opposed to the concept of government of, by, and for the people. Instead, it has been the people of and for the government. Indeed, government probably is not the right word. The ruler or the state would be more appropriate. I have seen people talk about the “rule of law” in Russia. Putin has touted the restoration of the rule of law in Russia after the lawless 90s. In a Russian sense, he is probably right. He is moving toward the restoration of the traditional absolutist concept of law, which is contrary to the classical liberal conception thereof.

Next, Anders Aslund:

At present, the oil surplus is driving economic growth, which is being generated mainly by the consumer sector, retail trade and housing construction, while industrial output has increased by just 4 percent per year over the last two years. That these are the conditions underlying growth does not bode well.

Ironically, Russia’s least dynamic sector is energy production. In 2003, oil production skyrocketed by 11 percent, thanks largely to private ownership and investment. But the confiscation of assets from Yukos led to the renationalization and disorganization of almost half the oil industry. The new state owners are less effective as managers and direct more of their efforts to purchasing further assets than developing those they already control. The remaining private oil companies are rightly afraid of investing or boosting production too much. As a consequence, oil production may rise by only 2 percent this year and stagnate in the future.

Some people do not handle luck well and end up succumbing to hubris, as is the case with Russia’s current leaders. By and large structural reforms ended in 2003, even if continued restructuring of some enterprises is driving some isolated reform, as is the case in the electricity sector. Despite declining official enthusiasm, Russia is approaching WTO accession. Yet, beside what has been responsible macroeconomic policy, the overarching actual economic policy today is that of renationalization.

The evident cause of this economic policy is the oil bonanza. Former Prime Minister Yegor Gaidar and the economists Clifford Gaddy and Barry Ickes have all discussed Russian economic policy as a product of the oil curse. They compare current policy to that of Soviet times. The oil riches of the 1970s led to the Brezhnev petrification, and even contributed to the foolhardy war in Afghanistan, while economic growth was closely correlated with international oil prices. Economics was ignored to the point that investment in the vital oil and gas sector was badly neglected in just the same way that it is today. When the oil prices finally fell in the 1980s, the Soviet economy collapsed.

The situation is much better today. The leadership has learned the importance of macroeconomic stability and is focused on growth. Fortunately, private enterprise dominates, but wherever the public sector prevails problems amass — in gas and oil production, banking, the aircraft and automotive industries and a large part of public transportation, health care, education and law enforcement. The longer oil prices remain high, the worse economic policy will become. The medium-term economic cost might not be high, but the long-term cost will be. Booms breed complacency and corruption.

Oil does not have to be such a curse. Kazakhstan’s economy is even more dominated by oil but, unlike Russia, Kazakhstan steadily increases its oil production by developing new fields. It does so successfully because a multitude of foreign and private oil companies operate there. Kazakhstan is ahead of Russia in banking, labor market, pension and government reform, as well as scholarships abroad. And its growth rate has been at almost 10 percent per year for the last seven years.

Read that last paragraph again. When Kazakhstan is a more reliable protector of property rights, and therefore attracts more foreign investment, and when a country which I am sure most Russians look down upon is ahead of Russia in economic structural reform, one cannot rate Putin’s performance that highly. (Not that Kazakhstan is a classical liberal’s idea of Nirvana.)

This paragraph is of particular interest:

From this perspective, Russia’s real average economic growth of 6.8 percent per year since 1999 does not look as impressive. Russia has also underperformed in relation to the other former Soviet republics, which have grown by an (unweighted) average of nearly 9 percent per year over the last three years. The stars have been the Baltic states, Armenia, Azerbaijan and Kazakhstan. All of these, with the exception of Azerbaijan, have undertaken more extensive structural reforms than Russia.

Putin’s popularity no doubt is largely a result of the marked improvement in the economic circumstances of most Russians. One of my Russian colleagues says that the improvement is noticeable each time he returns home. When the benchmark is absolute disaster, anything is pretty good by comparison. But the fact that other countries that have fewer inherent advantages (poorer infrastructure, less human capital, and in the case of Armenia and the Baltics, a far poorer natural resource–especially energy–endowment) are growing faster should lead to a more critical appraisal of Russian performance.

I also like Anders’ line that “some people do not handle luck well” and his warning about hubris. This echoes a point made in some of my earlier posts.

All in all, these articles–and many more like them–indicate that there is widespread recognition that (a) the current Russian government is reverting to a well-established historical type, and (b) the centralization of political and economic power is simultaneously dangerous geopolitically, but ultimately damaging to the Russian economy. Perhaps Milton Friedman’s old adage about government will be our salvation: the only thing that protects us from government is its inefficiency. The inefficiency of the Soviet economy ultimately undermined its geopolitical ambitions. Although the current Russian economic system is far less dysfunctional than its Soviet predecessor, the common tendency to overcentralization will ultimately constrain Russia’s power potential.

December 7, 2006

Gates & Gazprom

Filed under: Energy,Russia — The Professor @ 9:48 am

I am keeping an open mind on Robert Gates. Score one in his favor today: he emphasized Europe’s vulnerability to energy blackmail, and noted that (ahem) Reagan had warned the Europeans about relying on Russian gas oh so many years ago (a point I made in my July World Energy piece on Gazprom.) Pace one of my earlier Russia posts, he averred that the Russians (I would say the Russian government) were humiliated by the loss of their empire, and are thirsting to matter as a world power again. Like I said before, with all of Russia’s other pressing problems, this is so sad.

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