Streetwise Professor

February 19, 2009

A Natural Experiment on the Theory of the Natural State

Filed under: Economics,Energy,Politics,Russia — The Professor @ 11:51 pm

Well before the financial crisis, back in fact when Russia was back!  off its knees! I wrote several extended posts identifying what I believed to be a key vulnerability of the country’s political system.  Applying the theory  advanced by North, Wallis, and Weingast (their book is forthcoming next month), I argued that Russia is a “natural state.”  Relatedly, I analogized the Russian state to a cartel of violence specialists.  Both approaches emphasize the vital role of rents in maintaining the stability of the system.  Competing cliques (or clans) of violence specialists maintain an uneasy peace only because this allows them to divide rents, rents that in Russia derive primarily from natural resources, especially oil and gas.  I noted that both theories predict that the stability of this type of system is quite precarious.  More specifically, declines in rents eliminate the “glue” that holds the system together.  Thus, even when oil was going from $80 to $100 to $140, I made the conditional predictions that when prices fall, the system would be subject to stress; that the stress would be greater, the greater the fall in resource rents; and that there was inherently a large probability that the system would collapse in a flurry of infighting in the event of a large decline of rents.  

At the time I made the predictions, the conditions under which its predictions would be testable seemed remote, so I cannot be accused of designing my theory to fit contemporary facts.  The conditions are remote no longer.  They have arrived, and in a more severe form than I would have thought reasonably likely.  

So, now Russia presents a natural experiment to test my theoretical predictions.  Of course the system has not collapsed, and ardent Russophiles (you know who you are!) derisively dismiss even the possibility.  We’ll see.  I have noticed in the past several days, however, an accelerating stream of stories that suggest that inter-clan conflict is heating up in Russia.  

In past days I linked to, and wrote about, stories regarding Kudrin’s increasingly tenuous position.  Today’s FT has another article that suggests that the heat on him is increasing dramatically.  Both Moscow mayor Luzhkov and Russian Railways head (and silovik)  Vladimir Yakunin have publicly and viciously excoriated Kudrin.  (Interestingly, Yakunin openly called for currency controls, something that I opined might be in prospect, but which had not received widespread attention.)  According to the FT:

A senior Russian official on Tuesday called for the immediate imposition of exchange controls to ensure the foreign currency spent supporting the rouble was not taken out of the country.

The remarks from Vladimir Yakunin, the head of state-run Russian Railways and a close associate of Vladimir Putin, the prime minister, were seen as a thinly veiled attack on Alexei Kudrin, the liberal finance minister and the man behind recent efforts to defend the rouble by drawing $200bn (€159bn, £141bn) from the country’s currency reserves.

Mr Yakunin said “temporary” restrictions should have been introduced when the central bank started defending the currency last year. Having failed to act then, the authorities should act now, he said in an interview with the Financial Times. “It’s never too late, and better late than never.”

While Mr Yakunin did not name names, he pointed the finger at Mr Kudrin saying such measures were the “responsibility of the fiscal authorities”.

Mr Yakunin’s comments come amid a growing dispute in Moscow about the huge sums lost slowing the decline in the rouble. With foreign exchange reserves plummeting from an August peak of $597bn to $383bn this month, there is spreading unease among officials about who might be held responsible for the losses.

There are also fierce arguments between liberals and conservatives over policy, with conservatives wanting more public spending in the economy and complaining that funds have been wasted on ill-judged currency interventions.

Luzhkov blamed Kudrin for amassing large reserve funds, rather than spending money on infrastructure.  

Relatedly, commentor Michel pointed me to this Forbes article:

The growing queue for state bailouts among businessmen and the resultant political infighting are the key reason why Russia has no new budget for 2009 almost two months into the year.

When the country’s main financial document is finally ready in two or three weeks, as the Finance Ministry pledges, Kremlin watchers will have a rare chance to identify favourites by looking for cash winners in often opaque budget books.

Should there be too many lucky cash recipients, the government will be left hoping the oil price does not come down further, pushing the deficit out of control and resulting in a further devaluation of the rouble and a spike in inflation.

‘The budget will give us an idea of who managed to win the race,’ said Audit Chamber member and former parliamentarian Vladimir Semago, who saw Russia cut budget spending many times in the 1990s.

‘And besides the wide road and front staircase (for money) to Prime Minister Vladimir Putin, we will see a narrow path, a small door and a short flight of stairs with no handrail yet to President Dmitry Medvedev,’ said Semago.

. . . .

Russian firms, which borrowed heavily to fuel growth and must redeem over $100 billion in foreign debt in 2009, were shocked when the government this month halted its $50 billion direct refinancing programme after disbursing only $11 billion.

They must go now to commercial banks. As some of the biggest lenders will enjoy support from the anti-crisis budget, the struggling empires of the likes of aluminium tycoon  Oleg Deripaska  still bear hopes they won’t be allowed to go under.

‘There is a lot of noise, but all the money that is being disbursed to fight the crisis ends up in 10-15 resource companies anyway,’ said Alexander Lebedev, a businessman rare in his willingness to criticise the Kremlin.

This suggests to me (and to Michel) that the Kremlin and the RF White House recognize that there isn’t enough money to go around.  The impending social demands arising from rising unemployment and the shrinking pool of rents to spread around to the violence specialists and favored oligarchs means that Putin et al have to make choices, to cut some people and companies loose.

Put differently, Russia’s governing elite is facing a classic lifeboat problem.  There’s not enough food and water for everybody.  For some to survive, others are going to have to perish.  But who?  And who decides?  

This is the situation in which cooperation turns to conflict and competition.  Nobody wants to go over the side willingly.  What is there to lose by fighting?  Passivity leads to certain doom.  Sure, conflict is costly, and dissipates rents, but its better to survive and get a piece of a smaller pool than perish and get nothing.  So, it becomes every man for himself, and devil take the hindmost.

In the past I likened Kudrin to Horatius at the Gate, and said that if he went, there would be a free-for-all among the siloviki to grab the monies he husbanded in the seven fat years.  That would represent the watershed, the event that would accelerate the slide into conflict and chaos, as silovik battles silovik, clan battles clan to grab as much as possible as quickly as possible.  

The very public attacks on Kudrin, heretofore considered a close ally of Putin suggest that day is approaching.  Now three major public attacks have been mounted against him, by the special investigator, by Yakunin, and by Luzhkov.  These people would feel bold enough to make these attacks against Kudrin unless they already sensed that he was extremely vulnerable, perhaps having lost Putin’s confidence.  For Putin, not one to take responsibility, a scapegoat is a necessity.  And Finance Minister Kudrin is a tailor made patsy for an economic and financial crisis that is swallowing Russia whole.  (The only other alternative explanation is that these are attacks on Putin himself.  The implications of that would be even more dire.)    

In sum, this is playing out pretty much as the natural state/cartel theory predicts.  Moreover, the attacks on Kudrin suggest that the climax is approaching.  Rapidly.

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  1. “Every men from himself”

    I hope they fight it out because it is the only hope to see this regime falter..

    I have long lost any confidence the Russian people would raise up on an orange styled revolution.

    Comment by Blaze — February 20, 2009 @ 5:05 am

  2. Paul Goble has a interesting piece detailing how the Russian State seems to be preparing itself for large-scale civil unrest:

    His conclusion sums it up nicely:

    And third, as various writers have pointed out, Moscow faces so many problems that it is ignoring some like nationality ( and the situation in the regions ( in hopes that the current crisis will end before the government’s money runs out.
    But what is perhaps most striking about today’s announcement about increases in the size and armament of internal forces is not how worried the regime is about its fate but rather its self-confident assumption that force alone will be enough to keep it in power, a decision, like one to fight a grease fire with only water, that could prove a grave miscalculation.

    Comment by Michel — February 20, 2009 @ 6:40 pm

  3. Is sounds like the line from the movie “Blood Diamonds” – “This is Africa” (TIA)

    Comment by elmer — February 22, 2009 @ 12:05 am

  4. Well, IMHO, social revolutions can happen pretty quickly. Who would have expected the Berlin Wall to fall so quickly? Who would have expected the Soviet Empire to break up so quickly? Who living in France in the 18th century would have expected the French Monarch and the Old Regime to be overthrown? My reading is as follows: societies will appear stable, unchanging, even as pressures build up. Much like blowing up a balloon. It looks nice, it looks stable, but as soon as you have a needle that creates the tiniest hole when enough pressure has been built up inside the balloon, it will rapidly blow up even with the most insignificant pin prick. The question in any such society/balloon is what will be the prick that eventually leads to the explosion?

    Comment by Michel — February 22, 2009 @ 2:19 am

  5. Michel–

    Exactly. Don’t know if you saw the post I did about a month ago on the article by Vladimir Shlapentokh that compared today’s Russia with that of the late-Tsarist period and the USSR. He similarly argued that both of these systems collapsed very quickly and unexpectedly, and that the objective conditions in Russia today are quite similar, and conducive to a similar collapse.

    When thinking about social revolution from an economics/game theoretic perspective, the key issue is that there is a coordination game aspect that tends to reinforce stability/passivity, but if this equilibrium is perturbed by exogenous factors (e.g., a severe economic crisis that dramatically reduces what people have to lose by protest) it can be replaced quickly by one in which resistance becomes pandemic. If most people believe that no one else will protest, it is individually rational to remain passive. This can be the equilibrium even if the vast majority of people want a change in regime. If exogenous factors spark a critical mass of protest, however, this equilibrium can collapse, and be replaced by most everybody joining the protest. This tendency to black/white equilibrium pair (with nothing in between) is reinforced by the fact that whereas the government can concentrate its repressive resources on a small number of dissidents thereby making it very costly for any individual to go into active opposition, widespread protest diffuses those resources, thereby reducing the cost that any individual expects to incur by joining the protest. It also affects the calculations of those in the repressive services. They are of course concerned about their fates in the event that the regime falls, and a substantial increase in the probability that the regime will fall (as indicated by swelling protest) makes many of them less likely to repress intensively.

    In sum, there are a variety of positive feedback mechanisms that (a) make the status quo stable, but (b) lead to rapid shift to a protest equilibrium if the conditions are right.

    A short time back, I was reading some of the literature on speculative attacks on currency. I think some of those models could be readily adapted to formalize what I characterize informally here.

    In my view, this is why the Russian government was so intent on ramping up its repressive resources, attacking civil society, and attacking even the most quixotic–pathetic, even–opposition figures even when the government’s popularity was evidently quite high (e.g., August 08 and before). It wants to atomize society completely, to raise the cost of assembling the critical mass of opposition that could lead to the jump to the mass protest equilibrium.

    The ProfessorComment by The Professor — February 22, 2009 @ 9:02 am

  6. That said, I think that the biggest threat to the government is internal,i.e., battles among factions over $ and power. Such battles could, of course, also affect the odds of popular unrest.

    The ProfessorComment by The Professor — February 22, 2009 @ 11:16 am

  7. Craig,

    Though I am not a big fan of game theory, here I believe it might be relevant. I agree with your analysis. You would have to calculate social costs and benefits. How much are people willing to lose and how do they evaluate their rewards?

    Before the crisis, you would have protesters who risked physical assault, jail time, loss of jobs, etc… Given the protests were small (often with more MVD and OMON than protesters), I agree with your analysis that the rewards were more symbolic than tangible. As such, you would have potentially high social costs and low (if any) social rewards. This is certainly not a recipe for a social revolution. Also, when times were good, people were not highly motivated to risk losing their tangible, though some would say small, gains (and this includes competing clans within the power structure who certainly gained and shared billions of dollars) for future theoretical increased gains (whether in terms of a better economy or great political freedoms).

    This can change is social costs go down. How can they go down? They go down if you get mass protests. If you had 100,000 or 1,000,000 taking to the streets of Moscow, people would know that the odds of any one individual being arrested would be small. Likewise, if people feel they have nothing to lose, then they may evaluate the potential gains much higher the potential social losses.

    The question is where will the tipping point be located? By tipping point, I would mean the point whereby there will be mass protests as the potential gains surpass social costs for a large portion of the population. Like the popping balloon, it is when you have passed this tipping point that you will have an exponential growth in the number of protesters in the streets and other forms of social protests and potential civil war in the power structures.


    Comment by Michel — February 22, 2009 @ 2:25 pm

  8. Michel–we’re on the same page.

    Funny what you say about game theory. I’m not a huge fan either. It’s one of those things were you can construct a model that generates almost any kind of behavior you want. Which means, that it’s not really scientific.

    I have found, however, that coordination game concepts can be very illuminating. I’ve used them in some of my academic work, and it seems useful in explaining discontinuous shifts/”punctuated equilibria”/hysterisis/path dependence. A shift from apathy to protest would involve such a discontinuous shirt. And, I think that Putin et al are in fact believers in it, as their entire M.O. seems to be to raise coordination costs/atomize society in order to reduce the likelihood of a shift to the protest equilibrium.

    The ProfessorComment by The Professor — February 22, 2009 @ 2:42 pm

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