Streetwise Professor

January 29, 2013

Medvedev Speaks the Truth About Gazprom: Money Comes First

Filed under: Energy,Politics,Russia — The Professor @ 8:41 pm

FWIW, there’s been something of a kerfuffle over Medvedev’s statement Davos that Gazprom’s export monopoly may end.  And WIW? Not much: remember, it’s Medvedev.  In Davos.

Let’s go back to basics.  The creation of a state-owned export monopoly (or any monopoly, for that matter) is fundamentally the result of the lack of a state’s fiscal capacity and ability to raise revenue through the tax system.  If a state could collect taxes costlessly, the best way to exploit a resource like natural gas would be to encourage ruthless competition in exports: the competition would minimize costs and maximize the surplus to be created.  A state that can collect taxes costlessly could then maximize its take by charging a tax on exports.

However, an inefficient or corrupt tax service means that the state would never realize much of this revenue.  Firms would conceal sales or income, or bribe the tax authorities, and most of the tax revenue would just vanish, to Cyprus, etc.

An export monopoly can achieve the same revenue outcome.  If it’s easier and cheaper for the state to audit and monitor the state export monopoly than a bevy of exporting firms that are supposed to pay tax, the state will prefer such a monopoly even if it is less efficient.  There is less leakage.  Not no leakage, but less leakage.

Moreover, powerful people in the state can often control and tap into the rent stream of the state firm more easily than a bunch of competing firms, some of which might just be fly-by-night shells of trading firms.

State grants of monopoly privileges are common in polities with relatively undeveloped fiscal and tax systems.

There is a political economy angle too.  Look at oil export taxes in Russia.  Oil companies exert political pressure on the state to reduce export taxes because a ruble not collected by the government goes into the pockets of the owners of the oil companies.  State ownership reduces the power of incentives to lobby for tax reductions.

What this all means is that the elimination, or not, of Gazprom’s export monopoly will be driven by fiscal, taxation, and corruption considerations.  If Putin and the siloviki (Medvedev?-please) deem that  the Russian state has developed sufficient fiscal capacity and capacity to tax, they will substitute a combination of free export and taxation (similar to what is observed in the oil business) for Gazprom’s export monopoly.  Relatedly, if they deem that they can siphon off the tax revenue more effectively than Gazprom’s cash flows, they will treat Gazprom like they are beginning to treat Assad: “Do I know you?”

This is the natural state in action.  The natural state imposes restrictions in order to create a stream of rents that can be distributed to the elite, or to buy political support for the elite.  There are different kinds of restrictions.  Taxes-including export taxes.  Monopoly licenses-including export monopolies.  In a world with no transactions costs, there are a variety of alternative means of generating the maximum stream of rents: setting price or output are perfect substitutes.

Things are different in a world with positive transactions costs, in particular, when monitoring and measuring output/revenue/profit and/or collecting taxes are costly.  With transactions costs, measurement, monitoring, and collection technologies are crucial in determining the best way of creating a stream of rents.  “Best” from the perspective of the elite, and where the stream of rents reflects the cost of monitoring, measuring, enforcement and collection.

These considerations will drive Gazprom’s fate.

Medvedev did say one sensible (though obvious) thing. “But we mustn’t lose money, that’s the important thing.  Money comes first.”

The crucial thing is who is this “we”, kimosabe? It is the elite, notably Putin and the siloviki.  The technology of transforming natural resource rents into income/wealth for the elite.  Sometimes a grant of monopoly privilege is the most efficient way of making that transformation.  That is often true in relatively crude polities with underdeveloped or corrupt taxing capacity.  That has been a fair characterization of Russia for a very long time.  That is what drove collectivization under Stalin.  That was the rationale for the commune system in tsarist times.  That has been the case with Gazprom since the fall of the USSR.  Gazprom will continue to exist as as long as the taxation capacity of the Russian state is relatively weak, and it is easier to direct Gazprom’s cash flows to elite pockets than it is to direct state tax revenues to that destination.

So don’t expect Gazprom’s monopoly privilege to disappear any time soon.  It is an inefficient monstrosity in some ways: it wastes land, labor, and capital in prodigious amounts. But it is the most efficient way to achieve the rent seeking objectives of the Russian elite.  It is their money that comes first.  They are willing to live with a wretchedly wasteful monopoly that dramatically shrinks the size of the pie, if it allows them to get a bigger piece.

Update: There’s another reason to doubt Gazprom’s monopoly privilege is going to end anytime soon.  The Russian oil industry was originally highly fragmented.  There is no export monopoly (though Transneft does have a monopoly: Gazprom is different because it is integrated upstream and downstream) and the industry was largely privatized starting with the collapse of the USSR.  Instead, Russia has collected taxes (export taxes and income taxes) from oil companies-and often had a difficult time doing that.  Moreover, as mentioned in the post, there has been a good deal of conflict over oil export taxes.  But in recent years, the industry is becoming increasingly consolidated under state-owned Rosneft, with the acquisition of TNK-BP making Rosneft by far the dominant company in the industry.  There has been talk of partially privatizing Rosneft, but Sechin has succeeded in preventing this and Putin has been unenthusiastic.  The main supporters have been in Medvedev’s circle.   Thus, the oil industry is moving towards the state-owned model, with Rosneft paying large dividends to the state.  There is thus something of a convergence of the gas and oil models: it would be passing strange if the state company became increasingly dominant in the oil industry and less dominant in gas.

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  1. Let me try to paste a relevant video:

    Comment by Vlad R — January 31, 2013 @ 4:58 am

  2. Interesting analysis. Presumably some of the energy revenue gets plowed back into the minimal expenditures needed to maintain overall state stability, e.g. pensions and defense, but the basic point is unchanged: State-owned monopolies and tax systems are substitute methods of gathering revenue for the ruling regime.

    I guess IRS effectiveness is an under-appreciated guarantor of US economic liberty.

    Comment by srp — January 31, 2013 @ 9:02 pm

  3. As once a freind of mine said, “there is nothing state-owned in Russia…” 😉

    Comment by MJ — January 31, 2013 @ 9:28 pm

  4. @srp. Thanks. Yes, they do plough some back to the state. A lot goes . . . who knows where? It is in some ways like the Credit Mobilier. Gazprom overpays for supplies (esp. steel pipe, including to companies that are very tight with Putin-one owned by a judo buddy in particular). I think part of the preference for state-owned firms is not just that they are a substitute for (ineffectual and/or corrupt) tax authorities, but that it is easier to steal from them than from the state directly. Harder to challenge capex (a good fraction of which is actually overcharges for materials) than it is to identify and challenge direct theft from the treasury. This is especially true when the bidding process is cartelized, and there is not a lot of competition generally.

    Yes, since everything is relative, an efficient tax authority is to be preferred.

    The ProfessorComment by The Professor — January 31, 2013 @ 9:33 pm

  5. @MJ. True, true. Except, in the sense of “l’etat c’est moi” or “l’etat c’est nous.” The natural state is highly personalized, and the line between the individuals in the elite and the state is extremely blurred. Russia was historically a “patrimonial state” where the line between the state and the individual ruler has always been indistinct, if it exists at all. Gazprom-and increasingly, Rosneft-are just the new patrimonial state. What is old is new again. The Russian hamster wheel.

    The ProfessorComment by The Professor — January 31, 2013 @ 9:48 pm

  6. @Professor. I would not be surprised if Gazprom and oil-industry part ways, since the people with stake in them belong to different (maybe opposing) camps and at some point we will see «каждый за себя.” The power industry, for one, has been pushing for further liberalization, though I doubt that Chubais will ever accomplish it as most of the Russian power plants supply also steam for centralized heat.

    Comment by MJ — January 31, 2013 @ 10:39 pm

  7. > Let’s go back to basics.


    > the best way to exploit a resource like natural gas would be to encourage ruthless competition in exports: the competition would minimize costs and maximize the surplus to be created.

    Why? Do you really think that the rulers/owners of Gazprom don’t want to minimize their costs and maximize their profits? As I recall from my Econ 1 class, a monopoly is good for the producer but bad for the consumer. But what incentive does Putin have in helping the foreign consumers at the expense of his own profits?

    > The creation of a state-owned export monopoly (or any monopoly, for that matter) is fundamentally the result of the lack of a state’s fiscal capacity and ability to raise revenue through the tax system.

    Well, tax collection in Russia is enforced only against political opponents (just as in the USA in the 1920s it was used against Al Capone). Plus Russia’s individual tax is maxed at the measly 13% (making it a haven for Depardieu and other tax minimizers). Certainly uniform tax enforcement, combined with the existing Gazprom profits, could increase the government budget and help Russia keep its defenses from falling further behind the warmongering country that spends close to $1 trillion (stolen from its own taxpayers) per year on the military and chooses to make Russia its enemy. But then again, most of this extra budget money would end up in the pockets of Russian politicians and bureaucrats.

    Comment by Vlad R — February 1, 2013 @ 2:04 am

  8. @Vlad R. It is an illusion to think that the Gazprom monopoly benefits the local consumers. If one goes away from Moscow and St. Petersburg, as far as Ivanovo, it is not even clear what is being supplied to the gas-stoves of the population – frequently you cannot light the stove. So, to think that the situation benefits the local population and takes advantage of the foreigners does not correspond to the reality.
    I also think that your insinuation of a “known warmongering country” making Russia its enemy is totally off base. It is Russia that has decided to be on the wrong side of history constantly choosing losing foreign policy priorities. There is a well-known saying, “tell me who your friends are, and I will tell you who you are.” Now, you tell me please who Russia’s friends are by her own choice are … let me start the list: Iraq (used to be), Syria, Venezuela, Cuba, Iran (double-edged friendship)… I am trying hard to find one more…
    There is not a single country in this list from the composition of the Soviet Union. Even Ukraine and Belorussia, who share the same cultural and ethnic heritage with Russia, are not friends. None of the above is perhaps enemy of Russia, but friends? I don’t think so. And that lose of friendship is attributable to just one person’s very peculiar complex which I would qualify as short man’s syndrome (with all due respect to all short men) tempting him to look taller.

    Comment by MJ — February 1, 2013 @ 2:46 am

  9. @MJ > It is an illusion to think that the Gazprom monopoly benefits the local consumers.

    Dear MJ, where did I talk about “local consumers”?

    > It is Russia that has decided to be on the wrong side of history constantly choosing losing foreign policy priorities.

    Back in 1996 I personally warned the American public in my Usenet posts that NATO’s eastward expansion was designed to provoke Russians into electing an anti-Western demagogue. So did the Cato Institute and many other sane people. The US military-industrial-congressional complex needs a scarecrow to scare the American public into giving up their hard-earned money to the military companies, their lobbyists and their congressmen. Then in 1999 we all warned against the Kosovo war. The public didn’t listen. In 1999-2000 Putin came to power, just as we had warned, and the US taxpayers are now willingly paying $1 trillion per year in various military expenses.

    Putin and the American hawks are the yin and yang of modern politics: they need each other to suck the blood and money out of their citizens.

    My guess is that you live in Poland or some other like place and don’t give a damn about the economic crisis and the budget crisis here in the US. All you want is to leech off of the American taxpayers. But I am an American and I do care about America. If you hate Russia so much – spend your own EU money on the NATO and on all other projects. Or better yet – go help your Turkish friends install the Sunni extremists in Syria and exterminate the Shiites and the Christians.

    Comment by Vlad R — February 1, 2013 @ 6:04 am

  10. @Vlad R. I have very low appetite for polemics. I can just state that your premise and guess are wrong on multiple levels. But I refuse wrapping myself by the American flag and waiving in the air my America loving credentials.

    I apologize for using a departing point of one of my arguments that you insinuated that Gazprom’s policies have a goal of benefiting the local population. It was a misunderstanding of what you were saying on my side.

    On a factual level, I can agree on one thing, though. American policy makers do not understand the psychee of this region as a result of absence of history of calonization contrary to the Europeans.

    Comment by MJ — February 1, 2013 @ 6:57 am

  11. @Vlad R-interesting video-just pieces on a chessboard.

    Comment by pahoben — February 1, 2013 @ 7:08 am

  12. @MJ,

    I am glad that you love America. But what amazes me is that so few people understand the universal truth that politicians and “policy makers” all over the world, including here in the US, act not out of the best interest of their voters/taxpayers, but out of their own best interest, usually that of preserving their power/getting re-elected. And the role of the mass media everywhere is that of brainwashing the average people into tolerating/re-electing these politicians. Every analysis of a political situation has to start with that understanding.

    Comment by Vlad R — February 1, 2013 @ 7:12 am

  13. There was a Yeltsin line before he rose up Putin that I always wondered about. As I remember it was in relation to Chechnya and it was something like-Mr Clinton shouldn’t forget that we have nuclear weapons. I always wondered if Clinton or NATO had some idiot plan to support the Chechens.

    Comment by pahoben — February 1, 2013 @ 7:13 am

  14. @Vlad R. Somehow, though, I don’t think the situation is that canister. While the U.S. is lead by the most cynical and voulgar politician I have ever witnessed in my lifetime, I find that incompetence is a more prevalent factor than cynicism.

    Comment by MJ — February 1, 2013 @ 8:22 am

  15. Sorry, I meant to say sinister.

    Comment by MJ — February 1, 2013 @ 10:26 am

  16. @MJ,

    Your Freudian slip “canister” was even funnier than “history of calonization” and “wrapping myself by the American flag”. You must be really looking forward to tomorrow. 🙂

    It came as no surprise that a Democrat president scares you. As far as explanation of the role of the lobbyists in the US policy-making goes, I stand by my claim that this is a fundamental mathematical law of nature like the suppply-and-demand curve intersection. I assure you that most US policy fiascoes are due not to stupidity of our politicians but to the special needs of the special interest groups that contribute money to their re-election campaigns and employ them after retirement.

    Comment by Vlad R — February 1, 2013 @ 6:48 pm

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