Enigmavariations

A special report on RussiaNovember 29th 2008

RussiaCOV.indd 1RussiaCOV.indd 1 18/11/08 15:48:4418/11/08 15:48:44

The Economist November 29th 2008 A special report on Russia 1

Russia is not the Soviet Union, but what is it? A recovering worldpower�or a corrupt oligopoly with a market economy of sorts? Arkady Ostrovsky explains why it is both

lapse, crossed an internationally recog­nised border and fought a short, victoriouswar: with Georgia. Russia’s leaders saidthey were defending two breakaway terri­tories, Abkhazia and South Ossetia, fromGeorgia’s aggression. But at home theyalso hinted that this was a proxy war withAmerica which had tried to muscle its wayinto what Russia calls �the region of privi­leged interest�. It was a de�ning momentfor Vladimir Putin, Russia’s president untilthe election in March this year of DmitryMedvedev and still the man who, from hisnew job as prime minister, holds the reinsof power.

To many, the con�ict brought backmemories of the cold war and portrayedRussia as a Soviet Union mark two, tryingto regain its former territories. All the signsappear to be in place: Russia is ruled by for­mer KGB men like Mr Putin who see ene­mies everywhere; its political opposition iscrushed; independent journalists occa­sionally get killed; and the state mediapump out anti­American propaganda.Once again military parades are being heldin Red Square. And in his belligerent state­of­the­nation address on November 5thMr Medvedev threatened to station short­

Enigma variations

ON DECEMBER 25th 1991 the Soviet �agabove the Kremlin was lowered for

the last time and the last president of theSoviet Union, Mikhail Gorbachev, madehis resignation speech. �The totalitariansystem has been eliminatedðfree elec­tionsðfree press, freedom of worship, rep­resentative legislatures and a multi­partysystem have all become reality.�

A few hours later, America’s then presi­dent, George Bush senior, declared victoryin the cold war. �For over 40 years the Un­ited States led the West in the struggleagainst communism and the threat itposed to our most precious valuesðThatconfrontation is now over. The UnitedStates recognises and welcomes the emer­gence of a free, independent and demo­cratic Russia.�

The collapse of the Soviet empire wasinevitable, rapid and largely bloodless. Inits aftermath the world watched, with amixture of hope and despair, the emer­gence of a new country that turned out alot less free and democratic than adver­tised. Confrontation with America did notdisappear but took on a new meaning.

In early August this year the Russianarmy, for the �rst time since the Soviet col­

An audio interview with the author is at

www.economist.com/audiovideo

A list of sources is at

www.economist.com/specialreports

The long arm of the stateThe �nancial crisis may lead to renational­isation by stealth. Page 3

Grease my palmBribery and corruption have becomeendemic. Page 6

A matter of judgmentRussia’s legal system is deeply �awed.Page 7

The incredible shrinking peopleRussians are dying out, with dire consequences. Page 8

The wild southRussia’s treatment of its republics in theCaucasus has turned them intotinderboxes. Page 10

Handle with careA cornered Russia could pose greater risks.Page 13

Also in this section

AcknowledgmentsThe author would like to thank all those quoted in thisreport, and also the many others who gave generously oftheir time and knowledge; in particular, NataliaAbbakumova; Peter Aven of Alfa Bank; Magomed Bakarov;Milly Bell; Zeljko Bogetic of the World Bank; LarisaBurakova; Larisa Dorogova; Mikhail Fridman of the AlfaGroup; Murray Feshbach of the Woodrow Wilson Center;Yevsey Gurvich of the Economic Expert Group; RebeccaHewitt; Valery Khatazhukov; Mark Kirsh of Linklaters;John Lloyd of the Reuters Institute of Journalism; RoryMacFarquhar of Goldman Sachs; Michael McFaul ofStanford University; Natalia Orlova of Alfa Bank; InnaSolovyova of the Moscow Art Theatre School; Angela Stentof Georgetown University; Alexei Venediktov of EkhoMoskvy; Chris Weafer of Uralsib; Yevgeny Yasin of theHigher School of Economics; Tatyana Yembulgayeva of theEBRD; Nazim Efendiev of Uralmash; Yahia Yevloyev; PavelZolotarev of the Institute of the USA and Canada; andAndrei Zorin of Oxford University.

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A country brie�ng on Russia is at

www.economist.com/russia

2 A special report on Russia The Economist November 29th 2008

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range missiles in the Kaliningrad region,aiming them at Europe, unless Americabacked o� from its plan to put a missile­de­fence system into eastern Europe.

But the parallels with the cold war aremisleading. Russia is not the Soviet Union.It does not have a communist (or any oth­er) ideology, nor does it have much faith incentral planning. It has private businesses,a free market of sorts and a great taste forconsumption. Russian �rms are listed onforeign stock exchanges. Their managers�y business class to factories in the Urals,read �nancial newspapers and labourover spreadsheets on their laptops.

Members of the country’s elite havemany personal ties with the West: theyown property in London, send their chil­dren to British and American universitiesand hold foreign bank accounts. But noneof this stops the Kremlin from being anti­American and autocratic.

So far the state has not interfered in peo­ple’s personal lives. It gives them freedomto make money, consume, travel abroad,drive foreign cars and listen to any musicthey like. They are even free to criticise theKremlin on radio, in print and on the inter­net, though not on television. And al­though Russia’s elections are stage­man­aged, the support for Mr Putin is genuine.During the war in Georgia it hit almost 90%in opinion polls. The biased television cov­erage plays its part, but unlike Soviet pro­pagandists, who told people what to think,Russian propagandists tell people whatthey want to hear, says Georgy Satarov,who used to be an aide to a former presi­dent, Boris Yeltsin, and now runs INDEM, athink­tank. What people want to hear, es­pecially as they are getting richer, is thattheir country is �rising from its knees�,sticking its �ag in the Arctic Circle, winningfootball games and chasing the Americansout of Georgia.

Mr Putin has positioned himself as thesymbol of a resurgent nation recoveringfrom years of humiliation and weakness.In fact, few Russians in the 1990s broodedon such feelings; most were too busy get­ting on with their lives. But there was onegroup that had good reason to be ag­grieved: members of the former KGB.When Mr Putin came to power in 2000,they projected their views onto the wholecountry. America’s hawkishness towardsRussia made their job easier.

Mr Putin also accurately sensed andcleverly exploited nostalgia for Soviet cul­tural symbols. One of the �rst decrees ofhis presidency in 2000 was to restore theSoviet national anthem. Soviet icons wererevived not because of their connectionwith communism but as symbols of stabil­ity, continuity and power. A TV show, �TheName of Russia�, based on a British pro­gramme, �100 Great Britons�, lists JosephStalin as one of the country’s �ve all­timegreats. Most Russians associate him notwith repression and terror but with thepower and respect which their countryonce commanded.

�Our foreign policy is clear. It is a policyof preserving peace and strengtheningtrade relations with all countriesðThosewho want peace and seek a business rela­tionship with us will always �nd our sup­port. And those who try to attack our coun­try will be dealt a deadly blow, to deterthem from sticking their snouts into ourSoviet backyard.� Stalin made this speechin 1934, re�ecting on a recent world eco­nomic crisis which, as he explained,�spread to credits and liquidity, turning up­side down �nancial and credit relation­ships between countriesðAmidst thisstormðthe Soviet Union stands separate­

ly, like a rock.� Similarly, in reaction to the current eco­

nomic turmoil, Mr Putin declared the Rus­sian economy to be a �safe haven� for for­eign capital. On the other hand, �the trustin America as the leader of the free worldand free economy is blown for ever.�

A love­hate relationshipThe paradox of Russia’s nationalism is thatits patriotic zeal closely follows the Ameri­can model. One of the biggest pop hits inRussia a few years ago was a song called �IWas Made in the USSR�, �rst performed in2005 in the Kremlin, in front of Mr Putin.�Ukraine and Crimea, Belarus and Moldo­va�it is my countryðKazakhstan and theCaucasus as well as the Baltics�it is mycountryðI was born in the Soviet Union;made in the USSR,� its lyrics go. As the au­dience rose to applaud, it was perhaps un­aware that the tune was the same as BruceSpringsteen’s �Born in the USA�.

Konstantin Ernst, the boss of Russia’smain TV channel, which churns out na­tionalistic, anti­American propaganda,worshipped Francis Ford Coppola, anAmerican �lm­maker. These days he pro­duces American­style blockbusters on aRussian theme and sells distribution rightsin Hollywood.

The loudest anti­Americans in Russiaare not the unreformed communists butthe well­dressed, English­speaking speech­writers from the perestroika era. The Krem­lin’s confrontation with the West is basednot on di�erences of ideology or economicsystems but on the conviction that Russiais no di�erent from America and that theWest’s values are no stronger or better thanRussia’s. Any public criticism by Westernleaders of Russia’s behaviour is therefore

1Pride before the fall

Source: IMF *Estimate

Russia’s GDP, % change on year earlier

1997 99 2001 03 05 07 08*6

4

2

0

2

4

6

8

10

12

+

–

The Economist November 29th 2008 A special report on Russia 3

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seen as deeply hypocritical.America looms much larger in Russia’s

mind than Russia ever did in America’s. Tocompete with America, Mr Medvedeveven scheduled his recent state­of­the­na­tion address to coincide with the Ameri­can election. Russia wants to be like Ameri­ca and follows in its footsteps. Unfortun­ately, says one American former o�cial,�they followed our mistakes and not oursystem of governance.�

Russia’s war in Georgia and its unilater­al recognition of South Ossetia and Abkha­zia copied the West’s recognition of Kos­ovo in the Balkans, even though only a fewmonths earlier Mr Putin had said that uni­lateral recognition of Kosovo was �immor­al and illegitimate�. Conversations withRussian o�cials often end with the plain­tive question: �What have we done thatyou haven’t done?�

Igor Shuvalov, the �rst deputy primeminister and Mr Putin’s right­hand man,was in London (where his son studies)when Georgia erupted. The war showedthat Russia and the West are now cement­ed together, he argues. �It showed that allour values are exactly the same. Russia is acivilised country, we all want to live well,like ordinary Americans, we want to pro­tect ourselves from external threats likeyou doðPerhaps we do not have such asophisticated democratic infrastructure,but in essence American presidential elec­tions are no di�erent from ours.�

The confrontation between Russia andthe West is not about di�erent values, hesays, but about di�erent interests, �nancialand geopolitical. �Friends are only friends

until you start splitting the money. These[Western] countries need to have access tooil and gas, and to get it they are preparedto use any means, including accusationsthat Russia has a di�erent system of valuesAllðRussia is doing is defending its inter­ests. We want to live peacefully, but theWest cannot tolerate the idea that we arean equal partner, that we are the same.Now there is no more time for niceties.�

Yet although the Russian elite hasadopted a Western lifestyle, it rejects keyprinciples of Western governance. LiliaShevtsova of the Carnegie Moscow Cen­tre, a think­tank, argues that �hostility to­wards America and the West sustains theauthoritarian and corrupt rule of the rent­seeking elite which portrays its narrowcorporate interests as the interests of thenation.� In Georgia, Russia was defendingnot so much the separatists but its own rul­ing class and its value system. By imitatingand repelling America at the same time,Russia tries to ward o� a hostile value sys­tem that includes democracy and the ruleof law. The Kremlin sees its relationshipwith the West as a zero­sum game: if it re­surges, America will decline.

A long way to goA few years ago Mr Putin said Russia’s na­tional idea was to be competitive. TheKremlin asserts that Russia has regained itsstatus of �a mighty economic power�. Itsgoal is to achieve economic and social de­velopment which be�ts �a leading worldpower of the 21st century� by 2020.

This special report will draw attentionto the many things that stand in its way.

The country is beset by chronic and dan­gerous weaknesses. Its economy dependson natural resources and cheap credit, andits private business, which pulled thecountry out of the 1998 crisis, is constantlybeing harassed by the state. Corruption isso pervasive that it has become the rule.Russia’s population is shrinking by700,000 a year. And its neocolonial meth­ods of governance in the north Caucasushave created a tinderbox.

The gap between rich and poor is grow­ing. Moscow’s exclusive outskirts look likeAmerican suburban shopping malls writlarge, yet villages not far away lie aban­doned. The rich and powerful are steepedin luxury, yet the average Russian earns amere $700 a month. Russia is buildingpipelines to Europe but much of its owncountry has no gas or even plumbing. Rus­sia’s �great leaps forward� have rarely ben­e�ted its own people, who have tradition­ally been seen as a resource. Most Russiansgrumble about their lives, but see �interna­tional prestige� as a consolation prize.

Russia has the potential to develop intoa strong and prosperous nation, but theKremlin’s nationalism, hostility towardsthe West and authoritarianism make thetask more di�cult. A two­minute videomade by a Russian soldier captured inGeorgia (now on YouTube) illustrates thepoint. As they smash up neat Georgianbarracks, the Russians curse their ownpoverty and hail their victory in the samebreath. �They [the Georgians] had every­thing,� one Russian soldier says. �They hadnice barracks, good furniture, and we livelike tramps. But they got screwed.� 7

EVEN to someone who has never been toYekaterinburg, a large industrial city in

the Urals, the changes are obvious. Shinytowers of metal and glass have shot upeverywhere without order or design,pushing aside historic buildings and mak­ing the Soviet­era apartment blocks lookeven grimmer. At night cranes are lit up likeChristmas trees. At eight in the morningheavy tra�c, mostly of foreign­made cars,chokes streets that still bear Soviet names.The city’s ultra­modern airport makesMoscow’s look shabby.

Yekaterinburg, traditionally the centre

of the mining and metal­bashing industry,is a microcosm of Russia’s economy. Untilrecently it has been �ush with money,mostly from natural resources and cheapcredit, spent in sprawling supermarkets,restaurants and car dealerships. Oil, gasand metals make up around 80% of Rus­sia’s exports, and until recently their priceswere rising fast. For the past �ve years theeconomy has been growing at about 7% ayear. Measured in dollars the rise has beenmuch faster. Some of this money has beenstashed away into a stabilisation fund, buta large portion has been fuelling an un­

precedented consumer boom. Real in­comes have more than doubled since 1999and the growth in retailing has averaged12% a year.

In a country so long starved of good res­taurants, hotels and shops, it was naturalthat consumers should take a lead role,says Andrei Illarionov, a former economicadviser to Vladimir Putin and now one ofhis �ercest critics. Besides, there is so muchuncertainty around that most peoplewould rather spend than save.

But there has been plenty of capital in­vestment too, though mostly in extractive

The long arm of the state

The �nancial crisis may lead to renationalisation by stealth

4 A special report on Russia The Economist November 29th 2008

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industries. Fixed investment last year roseby a record 21% on the year before, al­though it remains relatively low.

Private initiative, freed up by the marketreforms of the 1990s, became the mainforce behind Russia’s economic recoveryafter the 1998 crisis. Growth was particular­ly strong in sectors that were not weigheddown by any Soviet legacy, such as mobiletelecoms. But private ownership was alsotransforming Soviet­era behemoths.

Proud to be privateOne example is Uralelektromed, a largecopper producer in the Urals, which ispartly owned by Andrei Kozitsyn. In thepast �ve years the company’s revenueshave tripled. It has used the money to in­stall a new production line, along with thelatest American equipment. To add value,it has begun to produce high­quality wire,which it exports to Europe. �We had to becompetitive, otherwise we were meaning­less,� says Mr Kozitsyn. Having started as aworker in the factory, he rose to the top be­cause he wanted to be in business. Butthese days, he says, young people preferbureaucratic careers.

Tax revenues from his industry provideabout 40% of the Ural region’s budget. Butthe government has used the money topay higher salaries to its employees, recruitmore of them and renovate o�ces ratherthan build new roads and railway lines,which companies like Uralelektromedbadly need.

Crucially, the government failed to usethe good times to diversify the economy,clean up its banking system, reform capitalmarkets, strengthen property rights and es­tablish the rule of law. As long as the oilprice was going up, nothing that Russiadid�from the overt expropriation of Yu­kos, a giant Russian oil company, to forcingforeign oil companies out of production­sharing agreements�seemed to stop the�ow of money into the Russian stockmark­et. The job of raising capital was out­sourced to foreign banks and capital mar­

kets. They lent money to state companiessuch as Gazprom and Rosneft whose debtswere implicitly backed by the government.

This uncontrolled corporate borrowingundid the government’s success at repay­ing state debt, building up foreign­ex­change reserves and setting up a stabilisa­tion fund in which to accumulate some ofthe oil revenues. At the end of June Russia’stotal external debt was $527 billion. Its totalreserves in November were $475 billion.

Mr Putin boasted that the net in�ow ofcapital had reached $80 billion last yearand total foreign investment had risen to9% of Russia’s GDP. But only a quarter ofthis was foreign direct investment; the restcame in the form of loans and portfolio in­vestments. As Kirill Rogov of the Instituteof Economy in Transition, a think­tank, ex­plains, this re�ected the strength of Rus­sia’s reserves and the weakness of its in­vestment climate. Whereas otheremerging economies were �ghting toothand nail for direct investment, Russia wasborrowing cheaply instead, he says.

When the world economy started towobble, the government increased itsspending by 40% to boost consumption,says Evgeny Gavrilenkov, chief economistat Troika Dialog, an investment bank. Withdemand outpacing supply, the Russianeconomy started to overheat. In�ation

topped 15% during the summer. Held backby red tape, the strong rouble and weakproperty rights, Russian industrial produc­tion grew by 5.4% in the �rst nine monthsof this year and imports in the same periodshot up by 42%. Yekaterinburg is full of de­partment stores, but hardly anything thatis sold in them is produced around there.What is made locally is tanks, exports ofwhich did go up last year.

Even as the Russian stockmarket wentinto a nosedive, Mr Putin insisted that Rus­sia had escaped the �nancial crisis. OnSeptember 13th, in an interview withFrance’s Le Figaro, he gloated: �We did nothave a crisis of liquidity; we did not have amortgage crisis [like America or Europe].We did not have it, we escaped it.�

When the music stoppedBut when the oil price started to fall, for­eign banks stopped lending and moneybegan to �ow out of Russia, it became clearthat the economy was more vulnerableand more highly leveraged than many in­vestors had wanted to believe. The cranesin Yekaterinburg, and in many other Rus­sian cities, are now standing idle. Produc­tion lines have ground to a halt and metalcompanies and carmakers have begun tosack workers.

The fall in the stockmarket mattered be­cause Russian �rms had borrowed heavilyagainst their shares and faced margin callsfrom their foreign creditors. Mr Illarionovsays this is a �standard� credit and liquid­ity crisis rather than a budget crisis. Com­pared with many other countries Russiastill has plenty of cash, even if its reservesare dwindling at a worrying rate. Leavingaside the recent spending spree, the coun­try’s overall macroeconomic policy hasbeen sensible. For the past eight years thegovernment has been running budget andcurrent­account surpluses. If growth wereto slow down to 3% next year, as some an­alysts predict, that would still be more thanin most countries.

Igor Shuvalov, the �rst deputy primeminister, puts a brave face on it: �High oilprices corrupted us, in�ated our expendi­ture and distorted our economy. If this cri­sis had not happened now, by 2011 thequality of credit portfolios would havebeen much worse. So it is a blessing. Nowwe can start the real project, to develop do­mestic industry and the �nancial sector.�

In essence Russia’s problems are politi­cal, not economic. �We have come to thiscrisis well prepared,� says Yegor Gaidar, aformer prime minister and architect ofRussia’s post­Soviet economy. �But now

2What everyone wants

Source: IEA *Estimate

Russia’s production of:

1998 2000 02 04 06 07*

20

21

22

23

24

25

250

300

350

400

450

500

Natural gas,terajoules, gross, m

Crude oil,kilotonnes, m

All quiet now in Yekaterinburg

The Economist November 29th 2008 A special report on Russia 5

2 we need to stop nationalising companies and cut down on populism. You can make any argument for nationalisation, but when Russia started to nationalise its oil industry production stopped growing.�

Russia may also need to devalue the rouble. The central bank recently allowed it to depreciate slightly against a basket of currencies, but it still intervenes in the market to defend it. Politically a strong rouble has become a proxy for a resurging Russia and devaluing it or letting it �oat would hurt Mr Putin’s reputation.

As Mr Rogov explains, it would do no harm if Russia’s highly leveraged oligarchs were to hand over their stakes to foreign creditors, but the Kremlin would not allow this. The risk is that instead of clearing the system and promoting the most e�cient �rms, the crisis is helping the least e�cient. The government is already introducing protectionist measures.

�The crisis itself is less grave than the potential consequences of the govern­ment’s actions in solving it,� says Andrei Sharonov, a former deputy economics minister who now works in the private sector. The government has earmarked a total of more than $200 billion for various rescue measures, which as a proportion of GDP is almost three times what the Ameri­cans are spending. But in contrast to America, there is little public scrutiny of what the money goes on. The �rst victims to be rescued by the government were two banks said to be closely linked to senior government o�cials.

To unblock the banking system, the government deposited $50 billion in three banks, two of which are state­linked. The third used to be controlled by Gazprom and is now owned mostly by private individuals. The idea was that the banks would inject liquidity into the system, but in the event they did not lend the money on to other banks, so now the government decides whom they should lend to.

Another $50 billion of the rescue money was earmarked for bailing out �strategic� companies. At the front of the queue were Russia’s largest oil and gas companies, in­cluding the state­controlled Gaz­prom and Rosneft. Igor Sechin, the powerful deputy prime minister in charge of energy, seems to have promised $9 billion of government money to energy companies. Half of it will go to Rosneft, which has a debt of $20 billion that goes back to its controversial takeover of the Yukos oil company. Mr Sechin is also the chairman of Rosneft and, says Mikhail Khodorkov­sky, the former boss of Yukos (and now in

jail), the man who destroyed his company. Next came electricity companies, car­

makers and anyone else who could think of a good reason to ask for help. As one Russian oligarch observed, a lot of people in the Kremlin would like to take back the companies that were privatised in the 1990s. Back then the oligarchs lent money to the cash­strapped state and got assets at knock­down prices in return. Now it is the companies that are in debt, whereas the state is cash­rich and can buy the assets back cheaply. To make them even cheaper, government o�cials publicly threaten companies or dig out old charges against them, as Mr Sechin has recently done with one of Russia’s largest fertiliser producers.

The crisis has also changed the behav­iour of private �rms. In the past the market pushed them to improve their governance, but now they are encouraged to look to­wards the state, says Roland Nash of Re­naissance Capital.

Mr Shuvalov admits that some private assets might end up in state hands, but he insists that the government does not in­tend to keep them. The question is how, and to whom, these assets will be sold. Na­tionalising businesses is risky in any coun­try, but in Russia, with its weak institutions and powerful Kremlin clans, it is almost certain to lead to a redistribution of proper­ty to the ruling elite, mainly past and pre­sent members of the security services, col­lectively known as siloviki, or hard men.

Neither one thing nor the otherThe new entities that could emerge from the crisis may be neither state nor private, says Mr Rogov, but the worst of both worlds: opaque, quasi­state �rms run by people a�liated with the Kremlin. One model for this form of ownership is a pri­vately controlled subsidiary of a state­con­trolled company. Another is something

called a �state corporation�. One example is Russian Technologies,

run by Sergei Chemezov, a former KGB o�­cer and a friend of Mr Putin’s from the 1980s when the two served together in East Germany. Until last year Mr Chemezov was in charge of a state arms­trading mo­nopoly, which did not stop him from tak­ing over a successful private titanium busi­ness and a car factory. This year his empire, now under the umbrella of Russian Tech­nologies, has grown even further. State cor­porations’ assets, Mr Chemezov once said, �are neither state not private�; they are �state commerce�.

He has successfully lobbied for the in­clusion in Russian Technologies of some 420 mostly state­controlled companies, some of which�such as airlines or proper­ty�seem to have little to do with the corpo­ration’s declared aim of promoting tech­nology. Alexei Kudrin, Russia’s �nance minister, noted that giving Russian Tech­nologies all these assets would amount to �a covert privatisation and the loss of con­trol over how the proceeds are spent�. But his words fell on deaf ears.

Another state corporation is based on Vneshekonombank (VEB), which is meant to be bailing out Russian �rms that need to re�nance their foreign debt. The commit­tee that decides on the bail­outs is chaired by Mr Putin himself. VEB has recently lent $4.5 billion, well above its supposed limit, to Rusal, a company controlled by Oleg De­ripaska, a Russian aluminium tycoon, so he could repay a foreign loan backed by 25% of Norilsk Nickel, the world’s largest nickel producer. In return VEB will include government o�cials in the company’s management and board. But even before the crisis Norilsk Nickel’s controlling shareholder, Vladimir Potanin, one of the most politically savvy oligarchs, had put a former KGB o�cer in charge of the com­pany�to be on the safe side.

The projection of KGB power in Rus­sia’s politics and economy has been a guid­ing principle of Mr Putin’s period in o�ce. In the past the siloviki often had to rely on tax inspectors or the Federal Security Ser­vice (FSB) to get hold of assets. Now the cri­sis is creating new opportunities for what Mr Illarionov calls the �KGB­isation of the economy�. The result, he explains, could be a new, highly monopolistic system, based on a peculiar state­private partner­ship in which the pro�ts are privatised by Kremlin friends and debts are national­ised. This will not take Russia back to a state­run economy, but it is likely to shift it further towards a corporatist state. 7

?To come

Source: IMF *May

Russian trade, $bn

1997 99 2001 03 05 07 08*0

50

100

150

200

250

300

350 Exports

Imports

3Full of energy

Source: IMF

Russian trade, $bn

1997 99 2001 03 05 070

50

100

150

200

250

300

350 Exports

Imports

6 A special report on Russia The Economist November 29th 2008

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RUSSIA may not have democratic elec­tions or the rule of law, but it does have

one long­standing institution that works:corruption. This has penetrated the politi­cal, economic, judicial and social systemsso thoroughly that is has ceased to be a de­viation from the norm and become thenorm itself. A corruption index compiledby Transparency International gives Rus­sia 2.1 points out of ten, its worst perfor­mance for eight years and on a par withKenya and Bangladesh. Ordinary Russiansare well aware of this, with three­quartersof them describing the level of corruptionin their country as �high� or �very high�.

The size of the corruption market is esti­mated to be close to $300 billion, equiva­lent to 20% of Russia’s GDP. INDEM, athink­tank that monitors and analyses cor­ruption, says 80% of all Russian businessespay bribes. In the past eight years the sizeof the average business bribe has gone upfrom $10,000 to $130,000, which is enoughto buy a small �at in Moscow.

A businessman who was stopped bythe tra�c police in Moscow recently wasshown a piece of paper with �30,000 rou­bles� written on it. He refused to pay andasked the policeman why he was beingasked so much for a minor o�ence. �Theanswer was that the policeman hadbought a �at for his mother in Bulgaria andhe now needed money to do it up,� thebusinessmen said. Far from being a taboosubject, corruption is discussed openly bypoliticians, people and even the media�but it makes no di�erence.

Corruption has become so endemicthat it is perceived as normal. Opinionpolls show that the majority of Russians,particularly the young, do not considerbribery a crime. The Russian language dis­tinguishes between �o�ering a reward� toa bureaucrat for making life easier for you,and the brazen (and sometimes violent)extraction of a bribe by a bureaucrat.

Small and medium­sized businessessu�er the most. Dmitry Golovin, whoowns a tool­leasing company in Yekaterin­burg, explains: �You go to the local admin­istration to get permission for somethingand they send you to a private �rm thatwill sort out the paperwork for you, whichhappens to be owned by their relatives.�

The reason for the persistent corruptionis not that the Russian people are genetical­ly programmed to pay bribes, but that thestate still sees them as its vassals ratherthan its masters. The job of Russian law en­forcers is to protect the interests of the state,personi�ed by their particular boss,against the people. This psychology is par­ticularly developed among former (andnot so former) KGB members who havegained huge political and economic powerin the country since Mr Putin came to of­�ce. Indeed, the top ranks in the Federal Se­curity Service (FSB) describe themselves asthe country’s new nobility�a class of peo­ple personally loyal to the monarch andentitled to an estate with people to servethem. As Russia’s former prosecutor­gen­eral, who is now the Kremlin’s representa­tive in the north Caucasus, said in front ofMr Putin: �We are the people of the sover­eign.� Thus they do not see a redistributionof property from private hands into theirown as theft but as their right.

The precedent was set by the destruc­tion of the Yukos oil company in 2003­04.Mr Khodorkovsky, its then owner, was ar­rested at gunpoint in Siberia and after a

sham trial sent to jail where he has spentthe past �ve years. Yukos was broken intobits and, after an opaque auction, passedto Rosneft, a state oil company chaired byIgor Sechin, the ideologue of the siloviki.

Tricks of the tradeMr Khodorkovsky was accused, amongother things, of selling Yukos’s oil througho�shore trading companies to minimisetaxation. So now Rosneft sells the bulk ofits oil through a Dutch­registered trading�rm, Gunvor, whose ownership structurelooks like a Chinese puzzle. The rise inGunvor’s fortunes coincided with the fallof Yukos. A little­known company before2003, Gunvor has grown into the world’sthird­largest oil trader, which ships a thirdof Russia’s seaborne oil exports and has es­timated revenues of $70 billion a year.

One of Gunvor’s founders is GennadyTimchenko, who sponsored a judo club ofwhich Mr Putin was honorary presidentand worked in an oil company that wasgiven a large export quota as part of a con­troversial oil­for­food scheme set up by MrPutin during his time in St Petersburg. MrTimchenko says he was not involved in thedeal and his success is not built on favours.

The Yukos case changed the logic ofcorruption. As INDEM’s Mr Satarov ex­plains, before 2003 o�cials simply took acut of businesses’ pro�ts. After Yukos theystarted to take the businesses themselves.These days businessmen pay bribes asmuch to be left alone as to get somethingdone. They call it a �bribe of survival�.

This new form of corruption is chang­ing the structure of the Russian economy.�Yeltsin­era corruption ended in a privati­sation auction, even if it was a fake one.The new corruption ends in the national­isation of business,� says Yulia Latynina, awriter. Nationalisation is not quite theright word, however, because sometimesstate property is quietly transferred intoprivate bank accounts. And even where abusiness is formally controlled by the state,the pro�ts or proceeds from share salesmay never reach its co�ers.

When Mr Medvedev was chairman ofGazprom, a state­controlled gas giant, oneof his �rst jobs was to oversee the return ofassets which had been siphoned o� under

Grease my palm

Bribery and corruption have become endemic

What are we going to do about this?

The Economist November 29th 2008 A special report on Russia 7

2 the previous management. But as BorisNemtsov and Vladimir Milov, two opposi­tion politicians, explain in a recent book,�Putin and Gazprom�, in the past few yearsGazprom’s control over its multi­billion­dollar insurance company and part of itspension funds has passed to a private bankcalled Rossiya, controlled by Yury Koval­chuk, who is thought to be a friend of MrPutin’s. The bank advertises itself as �Ros­siya: the country of opportunities�.

A necessary evil?Both Mr Medvedev and Mr Putin con­demn corruption in public. In a recentspeech Mr Putin grumbled: �Anywhereyou go, you have to go with a bribe: �re in­spection, ecologists, gynaecologists�everywhere. What a horror!� Mr Medve­dev’s �rst presidential promise was to �ghtcorruption for the Russian public, and re­cently he thundered: �We have to do some­thing. Enough of waiting! Corruption hasbecome a systemic problem and we haveto give it a systemic answer.� Soon after­wards he appointed himself head of a newanti­corruption committee.

Mr Satarov says this may be more thanjust populism. �They feel that the systemhas become unmanageable. They alsoneed to protect and legalise the wealth

they have accumulated in the previous �veyears�hence all this talk about building alegal system.�

As a former lawyer, Mr Medvedev hasstarted with legislation. A new draft law re­quires bureaucrats to declare their ownand their family’s income and assets. Butthere are a couple of loopholes. First, theinformation about their income is con�­dential and available only to other bureau­crats. Second, the family is de�ned as

spouse and under­age children�but notsiblings, parents or grown­up children. �Itis as if the government is telling everyonewhich accounts they should transfer themoney into,� says Elena Pan�lova, head ofTransparency International Russia.

The trouble is that corruption in Russiahas become a system of management rath­er than an ailment that can be treated, ex­plains Ms Latynina. Central to this systemis the notion of kompromat, or compromis­ing material. �It is easier to control some­one if you have kompromat on them, sothat is how a boss often chooses his subor­dinates,� she says.

The only way to �ght corruption, ex­plains Ms Pan�lova, is through politicalcompetition, independent courts, free me­dia and a strong civil society. Those thingsmay not get rid of it, but at least they wouldestablish uncorrupt norms. Yet �ghtingcorruption from within the Kremlin wouldrequire the skills of a Baron Münchhausen,who famously escaped from a swamp bypulling himself up by his own hair. As MrKhodorkovsky said in a recent interview:�The �ght against corruption is a �ght fordemocracy.� The interview cost Mr Kho­dorkovsky 12 days in solitary con�nement.But the cost to Russia of allowing corrup­tion to �ourish is a lot higher. 7

4Reliably awful

Source: Transparency International

Corruption-perception index, 2008Least corrupt=10

0 2 4 6 8

Germany

Japan

United States

France

Turkey

China

Brazil

India

Russia

Somalia

Rank

14

18

18

23

58

72

80

85

147

180

DESPITE Mr Putin’s promise to estab­lish a �dictatorship of the law�, the ju­

diciary in Russia is far from just. At leastthat is the view of Sergei Pashin, a formerjudge and now a law professor. He shouldknow: in 2000 he was dismissed aftersupporting a young man who had politi­cal objections to serving in the army. MrPashin was later restored to o�ce, but theyoung man he helped to free died in mys­terious circumstances.

The trouble starts with the selection ofjudges, says Mr Pashin. The process looksreasonable on paper, but it leaves scopefor interference. Judges are appointed ei­ther directly by the president or on his rec­ommendation by the upper chamber ofparliament. But most of them are �rstscreened by a Kremlin commission whichincludes the deputy heads of the securityservices and the interior ministry. And al­

though judges are appointed for life, theircareers (and perks) are in the hands of thechairman of their particular court, who isappointed for a six­year term, renewableonce. To get that second term he has toprove his loyalty, Mr Pashin explains.

The criteria for assessing a court’swork are the number of cases it processesand the number of successful appealsagainst its decisions. To avoid too manyappeals, a trial judge often seeks informaladvice from a judge in a higher court. As­tonishingly, fewer than 1% of criminalcases tried by a judge end in acquittals. Butin jury trials, which were introduced in allRussian regions except Chechnya in 2002,the acquittal rate is about 20%.

However, prosecutors quickly found away round the new system. For a start,most cases coming before a jury involve aconfession, often obtained under duress.

Yet when evidence of torture is presented,juries have to leave the room. Second, ajury can be dismissed if it includes some­one linked to the police or security ser­vices, so prosecutors often plant such peo­ple in juries so that the verdict can beoverturned if it is inconvenient.

Things are not much better in cor­porate disputes. Large companies rarelytrust in a judge’s unprompted decision. Incommercial courts a judge often takes abribe for reaching a speedy conclusion.All this helps to explain why the EuropeanCourt of Human Rights is overwhelmedwith Russian cases, and why large Russiancompanies seek justice in London. The Yu­kos case showed that the courts have be­come part of the Kremlin machinery. Theproblem, says one Moscow lawyer, is that�the law in Russia is often trumped bymoney and always by high­level power.�

Russia’s legal system is deeply �awedA matter of judgment

8 A special report on Russia The Economist November 29th 2008

1

YOU do not need to travel far to �nd evi­dence of Russia’s demographic pro­

blems. Just 250km west of Moscow, in theSmolensk region, it is glaringly obvious.Turn o� the main road in the village ofSemlevo and you will see rusting gates andderelict buildings. Continue for a short dis­tance on what just about resembles a roadand you will see a new cowshed.

A third of the people working here arefrom Tajikistan. Marina, a 38­year old Rus­sian milkmaid, is married to one of them.Talib, she says, may be strict, but he doesnot drink or beat her up. She prefers him toher �rst, Russian, husband who drank him­self to death at the age of 47, leaving herwith three children. Her 19­year old son isunemployed and drinks heavily.

Talib came to Russia so that he can feedhis other family in Tajikistan, and Marinadoes not mind Talib having another wife.But local residents resent the Tajik and Uz­bek migrants because �they are preparedto work for a pittance and take our jobs.�Yet �nding sober local working men in thevillage is di�cult, says Sergei Pertsev, thefarm manager. �Here, everyone has fallenill with alcohol.� To make sure the farmfunctions properly Mr Pertsev keeps peo­ple in reserve, to �ll in for those who go ona binge. It used to be mainly men whodrank, but now women do too.

Semlevo’s collective farm was built in1962. Since then the village’s populationhas dropped to a third of its former level.Thirty years ago the village school had 500pupils. This year only one girl entered the�rst grade. Some people have left the vil­lage, others have died of drink. Those whoremain drink heavily. Still, by local stan­dards, Semlevo, with its 900 residents, is athriving metropolis. Some nearby villageshave just two or three people left.

Tatyana Nefedova, a geographer andspecialist on Russian agriculture, callsthese deserted areas �Russia’s black hole�.In the European part of the country alonethey account for one­third of the landmass. Urbanisation has drawn peoplefrom villages into larger cities and to thevast industrial building sites in the east andnorth of the country. Active life is concen­trated in a radius of 35­40km from the cen­tre of these large cities. Russia has only 168

cities with a population over 100,000 andtheir number is dropping. The average dis­tance between large cities is 185km. Accord­ing to Ms Nefedova, this means that astretch of 100km between them is a socialand economic desert. In villages closer tolarge cities, especially Moscow and St Pet­ersburg, or in the south of the country,things are better.

But for Mr Pertsev, the idea that Russia is�rising from its knees� seems like a badjoke. Two years ago he lost his son, whowas in the army. The young man was killedby a drunk driver who crashed into a col­umn of soldiers in the dark. �The only peo­ple who live well in this country are thosewho make decisions, sit on an [oil] pipe orthose who guard it,� says Mr Pertsev.

The sorry state of villages like Semlevois the result of �negative social selection�,says Ms Nefedova: the most active andable people have migrated to large towns.Few people have stayed behind, and mostof those are unable to work. In Semlevothere is only one farmer who keeps hisown sheep and chickens. Most housesthere have no running water, plumbing orgas heating. Still, Semlevo’s old collectivefarm is considered lucky: it was recently

bought by a businesswoman from Mos­cow. Most other collective farms in this dis­trict are dead.

Russia’s demography be�ts a country atwar. The population of 142m is shrinkingby 700,000 people a year. By 2050 it couldbe down to 100m. The death rate is doublethe average for developed countries. Thelife expectancy of Russian males, at just 60years, is one of the lowest in the world.Only half of Russian boys now aged 16 canexpect to live to 60, much the same as atthe end of the 19th century.

No babies to kiss�If this trend continues, the survival of thenation will be under threat,� Mr Putin saidin his �rst state­of­the­nation address in2000. Six years later he o�ered an increasein child support and a bonus for second ba­bies. Since then the birth rate has started toclimb, the number of deaths has declinedand life expectancy has edged up a little(see chart 5, next page). Mr Putin rejoiced:�We have overcome the trend of risingdeaths and falling birthsðIn the next threeto four years we can stabilise the popula­tion �gures.�

But demographers say there are few

The incredible shrinking people

Russians are dying out, with dire consequences

Rare and precious

The Economist November 29th 2008 A special report on Russia 9

2

1

grounds for optimism, and Russia’s goal ofincreasing the population to 145m is unat­tainable. Anatoly Vishnevsky, Russia’sleading demographer, says an increase inthe number of births in a single year doesnot reverse a trend. People may respond to�nancial incentives by changing their tim­ing rather than having more babies overall.An extra $100 a month is helpful to peoplewith low incomes and rural or Muslimfamilies, who have more children anyway,but is unlikely to persuade middle­classfamilies to produce more babies.

The main reason for the recent rise isthat there was an uptick in the birth rate inthe 1980s and the people born during thatperiod are now having children them­selves. But the next generation to reachchild­bearing age is much smaller. �Whatwe are going to see over the next few yearsis a rapid decline in the number of births,�says Mr Vishnevsky. At the same time thedeath rate is likely to go up, not becausepeople will die any earlier but because thegeneration which is getting to the end of itslife now is larger than the one born duringthe war.

Russia’s demographic crisis is one ofthe main constraints on the country’seconomy. Although Russia’s populationhas been ageing, over the past decade thecountry has enjoyed a �demographic divi­dend� because the age structure was in itsfavour. This dividend has now been ex­hausted and the population of workingage will decline by about 1m a year, in­creasing the social burden on those that re­main. Over the next seven years Russia’slabour force will shrink by 8m, and by 2025it may be 18m­19m down on the present �g­ure of 90m.

What makes a shrinking populationdangerous for a country that has alwaysde�ned itself by its external borders is theloss of energy it entails, Mr Vishnevsky ar­gues. The Soviet Union did not just try toexploit the resources of its vast and inhos­pitable land, it tried to populate it. Nowlarge swathes of land in Siberia and the fareast are emptying out as people move tocentral Russia. The population density inthe country’s far east is 1.1 people persquare kilometre. On the other side of theborder with China it is nearly 140 timesthat �gure.

The decline in Russia’s population is of­ten linked to the collapse of the Soviet Un­ion. In fact, the pattern was set back in themid­1960s when the number of births fellbelow replacement level and life expectan­cy started to shrink. In 1964, after severalyears of post­Stalin thaw, life expectancy

for men was 65.1 years, only slightly lowerthan in the West. But by 1980 the gap withthe West had widened to more than eightyears and is now 15 years.

Russia’s health problems, says Mr Vish­nevsky, were partly a legacy of the coldwar. By the middle of the 20th century thedeveloped world had learnt to control in­fections that killed large numbers of peo­ple. The next targets were illnesses causedby lifestyle, such as heart attacks, pollutionand respiratory diseases. But whereas theWest invested heavily in health­care sys­tems and better lifestyles, Russia was put­ting its �nancial and human capital intothe arms race and industrialisation.

If life expectancy in Russia had im­proved at the same pace as in the West, thecountry would have had an extra 14.2mpeople between 1966 and 2000, adding10% to the population. The Soviet Union’sspending on health care was less than aquarter of the American �gure. The Com­munist Party elite was well looked after,but ordinary people were less fortunate.

Crucially, the paternalistic Soviet sys­tem, which survives in today’s Russia, wasgeared towards �ghting epidemics and in­fections rather than to empowering peopleto look after their own health. Even nowRussian doctors treat patients and their rel­atives like imbeciles. O�cially the stateguarantees free care for all, but half the pa­tients o�er gifts and money to doctors and

the other half often have to forgo neces­sary treatment.

Boosting the country’s health­carespending was one of the �national pro­jects� Mr Medvedev was in charge of be­fore becoming president. Last year its fund­ing doubled to 143 billion roubles ($5.8billion). That is still below Western stan­dards, but the main problem is that it is notwell spent. For example, the governmentmore than doubled general practitioners’pay. But as Sergei Shishkin of the Indepen­dent Institute for Social Policy argues, thepay increase was not linked to perfor­mance and created a sense of injusticeamong specialists.

The curse of the bottleRussian history, particularly in the 20thcentury, has encouraged the view that lifeis cheap. But there is also a strong self­de­structive streak in the national character.Drinking yourself to death is one of themost widely used methods of suicide.

Alexander Nemtsov, a senior research­er at the Institute of Psychiatry, points to aclear correlation between the death rateand the consumption of alcohol in Russia.A short anti­alcohol campaign conductedby Mikhail Gorbachev in the late 1980s ex­tended life expectancy by three years. MrNemtsov estimates that nearly 30% of allmale deaths and 17% of female deaths aredirectly or indirectly caused by excess alco­hol consumption and that over 400,000people a year die needlessly from drink­re­lated causes, ranging from heart disease toaccidents, suicides and murders.

The average Russian gets through 15.2 li­tres of pure alcohol a year, twice as muchas is thought to be compatible with goodhealth. The problem lies not just with howmuch but also with what is drunk: moon­shine and �dual­purpose� liquids, such asperfume and windscreen wash, make up asigni�cant proportion of alcohol con­sumption, according to Russia’s chief phys­ician, Gennady Onishchenko. Tens ofthousands a year die of alcohol poisoning,against a few hundred in America. In largecities the fear of losing a job, and growingcar ownership, is keeping people soberer.

The most obvious reason why Russiansdrink so much is the low price and easyavailability of alcohol. Consumption in­creased dramatically in the 1960s when thestate hugely boosted production. Peoplestarted drinking not just on special occa­sions but during the week and at work too.

Vodka is one of a very few Russian pro­ducts that seem relatively immune to in�a­tion. Between 1990 and 2005, for example,

5Drooping

Source: United Nations

Population, m

1960 70 80 90 2000 08

120

130

140

150

Life expectancy and birth rate

1962 70 80 90 2000 08

5

10

15

20

25

62

64

66

68

70

Births per1,000 population

Life expectancyat birth, years

10 A special report on Russia The Economist November 29th 2008

2

1

the food­price index increased almost fourtimes faster than the alcohol­price index. Acheap bottle of vodka in Russia costs thesame as two cans of beer or two litres ofmilk. The easiest way to curb consumptionwould be to make hard spirits much moreexpensive and less accessible, as manyNordic countries have done. But as withmany other things in Russia, corruptiongets in the way: two­thirds of hard liquor isproduced illegally and sold untaxed.

Occasionally the government raises thealarm about alcohol poisoning, but it doeslittle to curb drinking. Instead it has de­clared war on Georgian wine and mineralwater, which it claims is not �t for con­sumption. But life expectancy in Georgiaremains 12 years higher than in Russia.

Unlike drinking, AIDS is a relativelynew problem for Russia. The �rst case ofHIV was recorded in 1987, but it took a longtime for the country to take notice. By 1997the number of cases had grown to 7,000.Now the o�cial �gure is over 430,000, thelargest in Europe. The real number couldbe double that, according to the WorldHealth Organisation. Most victims are un­der the age of 30. Some two­thirds aredrug­takers, but the epidemic is nowspreading to the general public.

The government seems to have wokenup to the danger and has increased spend­ing. But Vadim Pokrovsky, head of the fed­eral AIDS centre, says Russia still lacks ade­quate prevention measures.

About 28,000 people have already diedof AIDS­related illnesses, but the real num­ber could be masked by a co­infection ofHIV and tuberculosis which kills peopleafter two or three months. The incidenceof TB is the highest in Europe. Last year

24,000 people died of the disease, almost40 times as many as in America, not leastbecause most TB hospitals are crumblingand some lack sewerage or running water.

The only solution to Russia’s demo­graphic problems appears to be immigra­tion, as in the village of Semlevo, but theRussian public is hostile to it.

Wanted but not welcomedMost low­skilled migrant workers in Rus­sia come from Central Asia. In the east ofthe country they are mainly Chinese. Theprecise �gures are impossible to pin downbecause the vast majority of immigrantsover the past decade have been illegal. Un­til recently they were treated much likeserfs. They could not apply for work per­mits but had to rely on their employers,who would often impound their passportsand refuse to pay them for their work.Thousands of corrupt police o�cers grewfat on the proceeds.

In the past couple of years the ruleshave become more accommodating andmigrant workers can now apply for theirown work permits and sign contracts withtheir employers. But for tax reasons only aquarter of immigrants do so. The new lawhas increased the number of legal mi­grants to more than 2m, but the real �gureis thought to be �ve times that.

Many migrants are scared to ventureoutside on their own for fear of runninginto police or skinheads. Employers muchprefer illegal immigrants to local workersbecause they are cheaper and will put upwith worse conditions. But a xenophobicpublic habitually vents its anger on the im­migrants, even though they are estimatedto generate 8% of Russia’s GDP.

Support for extremist organisationssuch as the Movement Against Illegal Im­migration has risen sharply in the past fewyears. More than half the population sup­ports the slogan �Russia for the Russians�and almost 40% feel �irritation, discomfortor fear� towards migrants from CentralAsia and Azerbaijan. Hate crimes are onthe rise. SOVA, a body that monitors rac­ism, last year counted 667 racists attacks,including 86 racially motivated murders.

At a recent pep talk with the editors ofRussia’s leading media, Mr Putin urgedthem to guard against xenophobia. Rus­sia’s new day of unity is traditionallymarked by ultra­nationalist marches, andthe youth wing of Mr Putin’s own UnitedRussia party campaigns against immi­grants. Dmitry Rogozin, a nationalist politi­cian who built his campaign for parlia­ment in 2003 on anti­immigrant rhetoric, isnow Russia’s ambassador to NATO. On hiso�ce wall hangs a portrait of Stalin. 7

A cheap way to oblivion

�I DESIRE that the terror of my nameshould guard our frontiers more po­

tently than chains or fortresses, that myword should be for the natives a law moreinevitable than death,� wrote Alexei Yer­molov, Russia’s legendary general whowaged total war during his conquest of thenorth Caucasus in the early 19th century. Ahero of the Napoleonic wars revered byRussian romantics, Yermolov is still uni­versally hated by �the natives� who thinkof him as brutal, contemptuous and geno­

cidal. In the late Soviet period his statue inChechnya was regularly blown up until itwas eventually thrown into the river.

On October 4th a new, giant statue ofYermolov on a red granite pedestal was un­veiled in the ethnically Russian region ofStavropol that faces the north Caucasus,marking an unseen line of separation be­tween Russia and the �ve Muslim repub­lics on its southern border.

When the Soviet Union collapsed,Chechnya, the most rebellious of the �ve,

demanded complete independence fromRussia. Boris Yeltsin waged brutal war withit in 1994­96, with disastrous results. Vladi­mir Putin, trying to bring Chechnya to heelonce and for all, resumed hostilities in aneven more brutal form in 1999, withknock­on e�ects in the entire region. Nineyears later the Caucasus still feels like a tin­derbox. The Georgian war and Russia’sunilateral recognition of South Ossetiaand Abkhazia have added even more com­bustible material.

The wild south

Russia’s treatment of its republics in the Caucasus has turned them into tinderboxes

The Economist November 29th 2008 A special report on Russia 11

2

1

But the main cause of instability is Rus­sia’s colonial methods in the Caucasus,which have altered little since Yermolov’stime. The di�erence is that he was con­quering new territory, whereas Russia isdealing with people who are, at least onpaper, its own citizens.

A peace of sortsChechnya is now relatively quiet underthe thumb of a former rebel, Ramzan Ka­dyrov, who was installed as president byMr Putin last year. Grozny, its capital,which was razed to the ground by the Rus­sians, has been rebuilt. On October 5th MrKadyrov reopened the city’s main thor­oughfare, now lined with trees. It used tobe called Victory Prospect, but Mr Kadyrovhas renamed it Putin Avenue.

In recent local elections Mr Kadyrov,who is �ercely loyal to Mr Putin, promisedthat the turnout of voters for his hero’s Un­ited Russia party would be �100% or evenmore�. But it is not clear that his loyalty ex­tends to Russia as a whole. As he himselfhas said: �I am not anyone’s president, I amnot a man of the FSB or GRU [Russian secu­rity services]. I am Putin’s manðPutin isGod’s gift, he gave us freedom.�

And Chechnya is indeed much freer ofRussian control than it was eight years ago.Mr Kadyrov has his own armed forces,makes women wear headscarves, levieshis own tax on businesses and sets hisown rules. The day after the unveiling ofthe new­look Putin Avenue the occupantsof the ground­�oor o�ces, cafés and shopsfound their premises sealed o�. Beforethey could start trading again they had topay a �fee� of 200,000­500,000 roubles tosome agency.

Recently Mr Kadyrov asked for Groznyairport, which is federal property, to bemade over to Chechnya and given interna­tional status. It would also be nice forChechnya to have its own customs service,he said. As for the Russian troops still sta­tioned in his republic, he thinks their mainjob should be to guard Russia’s interna­tional borders, not to meddle in Chech­nya’s a�airs.

Yulia Latynina, a Russian journalist andwriter, says that �the war between Russiaand Chechnya was won by Mr Kadyrov.�But although military resistance in Chech­nya itself has subsided, violence hasspread to neighbouring republics, notablyIngushetia and Dagestan. It is transmittedby state­sponsored repression, corruptionand lawlessness that alienates and radical­ises the population and drives young meninto the hands of Islamist militants.

Ingushetia, a Muslim republic with apopulation of just 500,000, has turnedinto the region’s new �ashpoint. Reportsof killings, explosions and kidnappingshave been coming in daily. In the past yearthe number of attacks on police by Islamistmilitants, both Chechen and Ingush, hasalmost doubled. In return, the Russian se­curity and military services have terror­ised the local population, using much thesame methods as the militants.

Sliding into anarchyOn a recent visit, cars with tinted windowsand no licence plates raced around Nazran,Ingushetia’s grim capital. Tra�c policemenleft their posts as soon as the sun set, in fearfor their lives. �We don’t know who is�ghting with whom, but every day moth­ers cry over their children,� said Zarema,who was selling Chinese clothes in a mar­ket. �If I am a Russian citizen, why are theynot protecting me?� The word most oftenheard in Nazran is bespredel, or anarchy.

Almost everyone curses Murat Zyazi­kov, an ine�ectual former KGB general in­stalled by Vladimir Putin as the republic’spresident in 2002. Under his watch 600people died and 150 disappeared without atrace, says Bamatgiri Mankiev, a formermember of parliament and now one of theopposition leaders. Yet Mr Zyazikov couldnot be voted out because in 2004 Mr Putinabolished regional elections across Russia.Only when the situation came to resemblea civil war did the Russian government re­move Mr Zyazikov on October 30th and

appoint a tough military commando in­stead. As the Ingush celebrated Mr Zyazi­kov’s departure, his o�cials were clearinganything of value from the administrativebuildings.

At a recent protest rally demonstratorsthreatened to call a referendum on inde­pendence for Ingushetia unless the gov­ernment in Moscow treated them as Rus­sian citizens. The cause of the rally (andprobably of Mr Zyazikov’s removal) wasthe brazen murder of Magomed Yevloyev,the editor of an opposition website thatpublicised human­rights abuses. He hadirritated Mr Zyazikov by running an �I didnot vote� campaign, collecting 90,000 sig­natures to counter the o�cial claim that98% of Ingushetia’s 164,000 voters casttheir ballot for the Kremlin’s party in lastyear’s parliamentary election.

On August 31st Mr Yevloyev arrived inNazran on the same �ight as Mr Zyazikov.When they landed, Mr Zyazikov waswhisked o� in a limousine and Mr Yev­loyev was arrested and driven away in anarmoured car. Minutes later he was dead,�accidentally� shot in the temple by one ofthe guards in the car. His body wasdumped in front of a hospital. When MrYunus­Bek Yevkurov took over from MrZyazikov, he immediately o�ered his con­dolences to Mr Yevloyev’s family.

Over the past 60 years Ingushetia hasseen little kindness from Russia. In 1944Stalin deported the entire Ingush and Che­chen populations in cattle trains to Kaz­akhstan. When the survivors returned in1957 they found their houses occupied bythe mainly Christian North Ossetians. In1991Boris Yeltsin signed a law restoring theterritorial rights of the Ingush. But themechanism for this �territorial rehabilita­tion� was never established and soon a bit­ter con�ict broke out between the Ingushand the North Ossetians.

Russia took the Ossetians’ side, allow­ing them to push 60,000 Ingush out of thePrigorodny district. Some 18,000 refugeesare still unable to return home. The o�cialexplanation is that �their neighbours arenot prepared to live next to them.�

Russia’s war in Georgia and its backingof the South Ossetians in�amed feelingsof injustice and anger in Ingushetia. ManyIngush identify with Georgia more thanwith Russia. And Russia’s recognition ofSouth Ossetia and Abkhazia has creatednew precedents for the North Caucasus.

Ruslan Aushev, Ingushetia’s �rst post­Soviet president, feels strongly about theissue: �Russia fought two wars in Chech­nya, which cost a lot of lives, blood, sweat Kadyrov is Putin’s man

12 A special report on Russia The Economist November 29th 2008

2 and money, defending the principle of itsown territorial integrity. Now it has recog­nised two small republics and added twonew hotspots to its existing problems. Thisdoes not bode well for Russia.� The biggestmistake the Kremlin made in the Cauca­sus, he says, was to use force.

The irony is that despite the many his­toric injustices it su�ered, Ingushetia hastraditionally been loyal to Moscow. Theproblems in Ingushetia, says Ekaterina So­kiryanskaya of Memorial, a human­rightsgroup, are of Russia’s own making. Most ofthem stem from indiscriminate violence inthe second Chechen war which spilt overinto Ingushetia.

Until 2001 Mr Aushev, a charismaticmilitary commander who had served inAfghanistan, managed to keep Ingushetiarelatively stable. He resisted attempts bythe government in Moscow to drag the re­public into the Chechen war and did notallow it to be used as a military base for theRussian army. Keeping Ingushetia neutralwas no mean achievement, given its closeethnic ties with Chechnya. When Russianforces carpet­bombed the Chechen capital,Mr Aushev ignored Russian orders to cuto� all escape routes from Chechnya andallowed 300,000 Chechen refugees intoIngushetia.

But in 2002 Mr Aushev was replaced bythe much more co­operative Mr Zyazikov.The �rst bout of violence in Ingushetia wasdirected at Chechen refugees. Alleged re­bels and their sympathisers were kid­napped and often tortured, both by Mr Ka­dyrov’s forces and by their Russianbackers. An Ingush o�cial who tried to in­vestigate the Russian security services’ be­haviour was himself kidnapped by theFSB. Mr Zyazikov did nothing.

Tit for tatThe violence soon engulfed the republicand in 2004 Nazran was attacked byarmed rebels. �At the time�, says Ms Soki­ryanskaya, who spent �ve years in Ingush­etia, �everyone was shocked by how manyIngush took part in the attack. Today noone is surprised that Ingushetia has itsown armed underground.� According to asurvey carried out by Ms Sokiryanskayawith a North Ossetian think­tank, themain reason young people join the armedrebels are personal revenge, the violenceof the security services, unemploymentand propaganda by religious extremists.

Timur Akiev, who heads the Nazran of­�ce of Memorial, says the tactics of theRussian security services changed after2005. Until then suspects were taken to

North Ossetia, where they were torturedand made to confess. They were thenbrought back to Ingushetia for trial andsent to jail. However, jury trials in Ingushe­tia stopped relying on such �confessions�and started to acquit suspects. Mr Akievsays that from then on people started todisappear or were shot during arrest evenif they showed no resistance. Sometimesthe dead bodies were �tted up with weap­ons or grenades.

What eventually sparked public prot­ests in Ingushetia was the killing of a six­year­old boy. Early in the morning of No­vember 9th 2007 three armoured person­nel carriers, several minivans and amilitary truck, all without number plates,drove into a small Ingush village as part ofa �special operation� to capture an alleged

terrorist. After throwing a smoke bombthrough the window of a house, a group ofarmed men burst in and opened �re. Butall they found was a family of �ve. One ofthe bullets had killed the youngest child.

When the soldiers realised what theyhad done, they made it look as though theyhad been attacked, throwing grenades atthe empty house, moving the child’s bodyand putting a machine gun next to it. TheIngush authorities took three days to reactto the murder. Mr Zyazikov promised per­sonally to supervise the investigation. Sofar no one has been arrested.

When people took to the streets, theywere dispersed by the police in brutal fash­ion. A group of TV journalists who had ar­rived from Moscow to cover the murderand the protest were kidnapped from theirhotel, beaten and �deported� from Ingush­etia as if it were a separate state.

Two months later people came out inprotest again, carrying pro­Putin bannersand pleading with him to protect themfrom state lawlessness. Mr Putin dismissedthe protests with the words: �Someonehad decided that Ingushetia is a weak link

in the Caucasus and we see attempts todestabilise the situation there.� MaksharipAushev, an opposition leader in Ingushetia(no relation to the former president), spokefor many when he said: �Until then I couldhave bet that Putin did not know what wasgoing on here, that the money is stolen,that unemployment is almost 80%, thatpeople get abducted. But it is now clearthat we have to do something ourselves.�

Until last year Mr Aushev ran a success­ful marble­trading business and had littleinterest in politics. But in September lastyear his son and his nephew were abduct­ed by the security services. He launchedhis own search and forced the local prose­cutors to investigate what turned out to bea secret prison in Chechnya where Ingushresidents were being taken for torture andexecution. Mr Aushev later learnt that hisson and nephew were taken to the moun­tains to be executed with snickers (explo­sives tied to their bodies) but at the last mi­nute they were let go.

Unable to convey their anger throughthe ballot box and unwilling to take uparms, Mr Aushev and several others haveset up an alternative parliament elected byfamily clans. They have agreed to co­oper­ate with Yunus­Bek Yevkurov, Mr Zyazi­kov’s replacement, who had previouslycommanded Russian troops in Kosovo andtaken part in special operations in Chech­nya. His �rst steps were encouraging, but tostop the violence he will have to �ght boththe militants and the federal forces whohave got out of control. Unless Russia stopstreating this region as enemy territory andbegins to observe its own laws here, vio­lence will escalate.

More devolution pleaseWhat happens in the Caucasus will de�nethe future of federalism and of territorialintegrity in the whole of Russia. The cen­tral government’s policy failures in theCaucasus are particularly clear when com­pared with the far more successful policybeing pursued in Tatarstan, the largestMuslim republic, which was integratedinto the Russian empire in the 16th centuryand has been at peace ever since. In the ear­ly 1990s oil­rich Tatarstan became a sym­bol of decentralisation in Russia. It washere that Yeltsin famously said: �Take asmuch sovereignty as you can swallow.�Under Mr Putin this phrase came to sym­bolise the weakness of Mr Yeltsin’s regime.In fact it was its strength. It is the centralisa­tion of power and the colonial methods ofsuppression of dissent that are the biggestthreat to that territorial integrity. 7

The Economist November 29th 2008 A special report on Russia 13

1

THE magic word during Vladimir Pu­tin’s eight years as president was �sta­

bility�. The social contract between theKremlin and the people was based on ris­ing incomes and private freedoms. Mostpeople happily signed up to this. Accord­ing to Boris Dubin, a leading sociologist,three­quarters of the Russian people feelthey have no in�uence on political andeconomic life in their country, and the vastmajority of them show little interest in pol­itics anyway.

It was this contract, backed by high oilprices and cheap credits, that kept Mr Pu­tin’s ratings up and allowed him to hold onto power as prime minister after his pro­tégé, Dmitry Medvedev, was installed aspresident in March this year. When a for­eign journalist asked Mr Putin shortly be­fore the election why Mr Medvedev wasnot campaigning, the answer was candid:�Salaries in Russia are growing by 16% ayearðpeople want this trend to continueand they see Dmitry Medvedev as a guar­antor of this trend.�

The rise in earnings, albeit from a lowbase, has also masked discontent aboutthe appalling state of the health systemand the corrupt and ine�ective police.Most people say both have been gettingworse in recent years, but they generallydeal with them by making private arrange­ments with their local doctor and �ndingfriends among the police. Seventy years ofliving in the Soviet Union have made theminventive and adaptable.

The lives of ordinary Russians have gotbetter, but not that much better. Half ofthem say they have enough money forfood and clothes but struggle to buy dura­ble goods. Most simply hoped thingswould not get worse. Now, with an eco­nomic downturn under way, things aregetting worse, especially in big citieswhere the improvements had been mostnoticeable. Private �rms are starting to layo� sta� and cut pay. For now the govern­ment is trying to soothe people’s fears.Journalists have been told not to link thewords �crisis� and �Russia�, so the statemedia consistently talk only about a worldcrisis and Russia’s �anti­crisis� measures.

Yet if the economy deteriorates, thatwill no longer be enough. A recent survey

of successful young urban people showedthat many of them contemplate emigrat­ing. For now, most people have even lessappetite for protests than they did in 1998,when rouble devaluation and debt defaultcaused millions to lose their savings.

Most Russians are deeply cynical abouttheir government: 60% say its members are�only concerned with their own wealthand careers� and just 9% say they are hon­est. After the 1998 crisis businessmen whohad lost everything picked themselves o�the �oor and started again, and the samething may happen this time, although stateinterference in business has increased. Butthe popularity of Mr Putin and Mr Medve­dev, who are seen as promoting stability, islikely to su�er. After the 1998 crisis Yeltsin’sapproval ratings, already in the dumps,plummeted from 15% to 1%.

Yet there are important di�erences be­tween then and now. First, people havemore to lose. Over the past decade GDP perperson has almost doubled, to almost$12,000 at purchasing­power parity. Sec­ond, Russia’s rigid political system no lon­ger allows much room for manoeuvre.When the 1998 crisis struck, Mr Yeltsin de­fused the situation by sacking the primeminister and the entire government. Untillast year Mr Putin too had this option.When things went wrong people blamedthe government, not the president. Butnow that Mr Putin himself is in the primeministerial seat it may be harder for him to�nd scapegoats.

Third, in 1998 the government was

bankrupt and weak, so businesses wereleft to deal with the crisis in their own way.Now the government is sitting on massivecash reserves which have already becomethe object of factional �ghting. The Krem­lin is by no means a homogenous entity.Indeed, the main reason for making MrMedvedev president under Mr Putin’s su­pervision was that it would preserve thestatus quo. But now there may not beenough money to keep the large band ofKremlin friends happy.

Russian experts, whatever their di�er­ences, all agree on one thing: these are un­stable, unpredictable and dangeroustimes. As Mr Satarov of the INDEM think­tank observes, the biggest advantage of de­mocracy is that it allows political systemsto adapt to changing economic and politi­cal circumstances. That luxury is not avail­able to Russia. Instead, Mr Medvedev hasproposed extending the presidential termfrom four to six years. This was Mr Putin’sidea, and he may be the one to bene�t fromit. The change, which has been rushedthrough parliament, would give him theprospect of 12 years as president when MrMedvedev’s term expires in 2012. Some sayMr Putin might return earlier.

Whatever next?The most optimistic (but unfortunatelyleast likely) scenario is that the crisis willconcentrate minds in the Kremlin andmake it improve the country’s investmentclimate, build proper institutions and tameanti­American rhetoric. Mr Gavrilenkov ofTroika Dialog argues that Russia’s attitudeto America is closely correlated with itsbalance of payments. When that is strong,Russia turns anti­American; when it isweak, Russia becomes a friendlier place.

There are some signs that the crisis hasstrengthened the hand of economic ex­perts in the Kremlin, such as the �nanceminister, Alexei Kudrin. One of Mr Ku­drin’s deputies, Sergei Storchak, who wasarrested a year ago in a power struggle be­tween di�erent factions, has suddenlybeen allowed out of prison. But as long asthe oil price remains relatively high andeconomic growth in the rest of the world isweak, businesses will rely more on thegovernment than on foreign investors.

Handle with care

A cornered Russia could pose greater risks

6So-so

Source: Levada Centre/RussiaVotes.org

How would you assess your family’s present

material condition?, % of respondents

1998 2000 02 04 06 08

0

20

40

60

80

100

Good

In-between

Bad

14 A special report on Russia The Economist November 29th 2008

2

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Business, �nance, economics and ideas The sea January 3rd 2009The future of �nance Jan 31st 2009Growth in emerging markets February 14th 2009Waste February 28th 2009Entrepreneurship March 14th 2009

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Still, a recent survey of various Russianelites, including business and media peo­ple, lawyers and doctors, showed thatsome 45% disagree with the current au­thoritarian system. Worryingly, the samesurvey found that the group which feelsmost alienated and unhappy about the sta­tus quo is the armed forces.

The chances that Russia will indeedturn more liberal are minimal. The mood isagainst it, and liberal parties cannot evenmuster the support of the signi�cant liber­al minority that does exist. The Kremlinhas launched its own �democratic� cloneparties to gather up these votes. Accordingto one modern Russian writer, Zakhar Pri­lepin, ideological opposition to the Krem­lin is impossible because the elite has noideology: it is capable of agreeing withboth the extreme right and the extreme leftof the political spectrum. Its only ideologyis to stay in power.

A more likely�and alarming�scenariois that the current regime will harden itsstance and tighten the screws or be re­placed by an even more nationalistic andmilitant one. That is the direction in whichRussia has been moving for the past eightyears. In his book, �The Death of the Em­pire�, Mr Gaidar, the former prime minis­ter, points to the dangers of post­imperialnostalgia in Russia and draws parallelswith the dying days of Germany’s WeimarRepublic. The war in Georgia made thoseparallels more obvious. It has movednationalist ideologues from the margins ofpolitical discourse to the centre.

According to Andrei Zorin, a culturalhistorian and professor of Russian at Ox­ford University, periods of restoration thatfollow revolutions do not bring back theold order but often introduce new threatsand instability. �Russia may yet emerge asa nation state, but in the process it couldalso turn ugly and nationalistic,� he says.In such a multi­ethnic country that wouldbe a recipe for further disintegration.

Many Russian liberals argue that West­ern policy towards Russia has helped tomake the country more nationalistic.America’s triumphalism after the cold warcaused the same sort of resentment in Rus­sia as the settlement of the �rst world wardid in Germany. America’s unilateral with­drawal from the Anti­Ballistic MissileTreaty in 2001, its plan to put a missile­de­fence system close to the Russian borderand NATO’s expansion played into thehands of Russian hardliners, as did theWest’s recognition of Kosovo. �You canonly imagine how much champagne wasdrunk in Russia’s hardline circles after the

recognition of Kosovo,� says Mr Gaidar. Yet America acted as a catalyst, not the

primary cause. The process that led to thewar in Georgia had its own domestic logicinseparable from Mr Putin’s authoritariansystem. That system, says Lilia Shevtsovaof the Carnegie Moscow Centre, relies onimages of Russia as a �besieged fortress�.

More dangerous than the cold warThe Russian leadership can, and does,blame the current �nancial crisis on Amer­ica. It is doing its best to mobilise Russiansagainst the West and the Westernisers andis becoming more confrontational. Thatmight conceivably lead to another war inthe Caucasus or to an attack on Ukraine,vulnerable because of the ethnically Rus­sian Crimea. Georgia remains a particular­ly explosive place. Russia’s recognition of

South Ossetia and Abkhazia has madethings worse. Pavel Felgenhauer, a Russianmilitary analyst who accurately predictedthe Georgian war in August, says a newand possibly bigger military con�ict is onlytoo likely.

Since Russia’s nationalism de�nes itselfin relation to America and the West, muchwill depend on American diplomacy. MrGaidar argues that o�ering NATO mem­bership to Ukraine or Georgia would be agift to Russian nationalists. �This is not a re­turn to the cold war. It is much more dan­gerous. With the Soviet Union everythingwas more or less clear and predictable.Both sides got used to each other andfound a way of talking to each other. Bothsides won in the second world war andwere con�dent and not hysterical. Nowwe are dealing with a country that has suf­fered a collapse of empire. And a signi�­cant part of the Russian elite feels the timehas come to �ght back.�

The biggest challenge for the West willbe to �nd a policy that neither appeasesRussia nor ignores it. Given the country’snuclear potential, its nationalism and itshigh levels of corruption, the risks are high.In the past Russia kept its nuclear technol­ogy out of reach of America’s sworn ene­mies, but a power shift inside the countrycould change that.

Historically, Russia has often demon­strated an ability to take unexpected turns,whether for good or ill. Few people fore­saw the collapse of the Soviet empire. Rus­sia today has a glass­like quality to it: rigidand fragile at the same time, and liable todevelop cracks in unforeseen places. Thedanger lies in its unpredictability. Yet thatmay also be a reason for hope. 7

Some things have got better