During Putin’s first two terms as president (2000-2008), Russia was neither a market-led nor a state-controlled economy. Rather, it took the form of a more complex hybrid of political economy that balanced the various needs of different segments of the economy.
Within this system, freedom and competition coexisted. At the same time, the large rivers of the economy continued to remain under state control. While the economy of Russia is highly complex, it is nevertheless possible to attempt to present a simplified model of the system that emerged under Putin during his early years.
The First Sector – Profit
The first sector largely consists of enterprises in the oil, gas and mining sectors. In addition, it also includes large agricultural enterprises and businesses involved in the construction of armaments and machinery for the purposes of generating nuclear energy.
Firms in this sector naturally need to remain globally competitive as they sell their goods and services on the world stage as well as in the domestic market. They do not rely on or require state subsidies to survive.
The stats is said to remain dominant in this sector either through direct ownership or via strong influence that is exercised over privately-owned firms.
The State’s ownership stakes are in the oil, gas, nuclear and defence sectors while the ‘influential’ role is in the mining and agriculture sectors.
The Second Sector – Redistribution
The second sector consists of industries that are not globally competitive as they do not sell their goods and services globally. Instead, their focus is on the domestic Russian market.
Unlike the first sector, the second sector relies on subsidies and other forms of support from the State, which either transfers resources to them or shields them from global competition.
Despite receiving this support from the state, firms in the second sector can struggle to make ends meet. This sector may not generate profits. In Russia, these industries include: parts of the defence industry, the automobile industry and the shipbuilding sector.
The second sector also comprises social groups that are dependent on the state for their income, for instance: civil servants and pensioners.
The link between these two sectors–the first and the second–explain much regarding how the Russian political economy worked during Putin’s first two terms as president. The profit of the first sector is taken by the state and redistributed to the second sector.
The impetus behind this flow is done for a number of reasons. The State’s role is crucial in managing this flow and a number of methods are used to put it into practise. The most obvious mechanism is to tax the profits in the first sector and spend it in the second sector.
At the same time, the state exercises informal power over privately-owned firms in order to encourage them to perform social and even political functions that would not be expected of a firm in a market-led economy.
When initiated together, these methods enable the state to support production and employment in the noncompetitive sectors of the Russian economy.
This, in turn, creates jobs and boosts income.
The State-Owned Enterprise
One important feature of this system is the use of state-owned enterprises as an instrument of governance. The SOEs, as they are known in short, pursue objectives beyond that of profit.
These firms are required to perform functions that promote social and regional development. They are even sometimes used to advance the foreign policy objectives of the Kremlin.
In this system, the strength of property rights is conditional upon close relations to the government. This is especially the case in the lucrative and strategically important natural resources sector.
Competition in both sectors is repressed by the state. This can take the form of legal barriers to effectively disallow for the emergence of new firms as well as financial support for the incumbents.
Economic efficiency–that firms are and continue to remain profitable–is not required to guarantee a firm’s survival within this sector. Instead, in a homage to the days of the USSR, budget constraints for these firms tended to be soft. What became more important to a firm’s survival is whether or not it was able to produce goods and services that are of importance to the state.
This might take the shape of providing incomes to single-industry towns or when a firm enhances Russia’s national security and international standing.
The first two sectors account for the vast majority of economic activity in Russia. Estimates are said to be around 60-70 percent. It is, therefore, clear that despite the large number of market reforms of the 1990s, the Russian state remains the single most important actor in the economy.
The consequence of this outcome is that innovation and productivity have suffered. Due to the state suppression of competition, the state has reduced the incentive for the creative management of these firms to boost efficiency.
Without the threat of immediate competition, the need to invest in entrepreneurship to restructure and boost productivity has been severely dampened.
If those that manage or run the enterprises know–for a fact–that they cannot go bust, there is absolutely no need to change the trajectory or to find a new way.
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