Putin and the Oligarchs

Marshall I. Goldman

From Foreign Affairs, November/December 2004

Summary:  The jailing of Russian oil tycoon Mikhail Khodorkovsky has revealed the fault lines running through the post-Soviet political economy. The reforms and privatization of the 1990s were so flawed and unfair as to make them unstable. A backlash was inevitable. Given Vladimir Putin's authoritarian tendencies, that backlash has proved equally flawed and unfair-and perhaps equally unstable.

Marshall I. Goldman is Kathryn W. Davis Professor of Russian Economics, Emeritus, at Wellesley College, Associate Director of the Davis Center for Russian and Eurasian Studies at Harvard University, and the author of The Piratization of Russia: Russian Reform Goes Awry.

When it came to dealing with the oligarchs, the government was generally unable to exercise much control. Since the state was very weak, these "new Russians" paid little or no taxes on their purchases. And if most American robber barons had at least created something out of nothing, the Russian oligarchs added nothing to what already was something. Virtually all their wealth came from the seizure of Russia's raw material assets, which until 1992 had been owned and managed by the state. An oligarch's success, in other words, almost always depended on his connections to the government officials in charge of privatizing the country's rich energy and mineral deposits, as well as on his ability to outmaneuver or intimidate rivals. (Two senior Yukos executives have been charged with murder and attempted murder, and the mayor of Nefteyugansk, where Yukos' major producing unit is headquartered, was murdered after criticizing the firm's failure to pay taxes.)

By the time Putin succeeded Yeltsin in 2000, there was much to remedy. One of Putin's first steps was to declare a change in the rules of the game. As he put it in a meeting with the oligarchs in February 2000, "It is asked, what then should be the relationship with the so-called oligarchs? The same as with anyone else. The same as with the owner of a small bakery or a shoe repair shop." That Putin said this at a special meeting with the oligarchs and not with a group of bakers or cobblers is beside the point; the statement was taken as a signal that the tycoons would no longer be able to flout government regulations and count on special access to the Kremlin. In July of that year, Putin told the oligarchs that he would not interfere with their businesses or renationalize state resources as long as they stayed out of politics-that is, as long as they did not challenge or criticize the president. Although the promise provided some reassurance, it also displayed a warped concept of how markets, businesses, and the state are supposed to function in a democracy.

Limiting the oligarchs' political involvement proved difficult. As more people grew richer, some were inevitably tempted to expand their activities beyond business. Several, including Vladimir Gusinsky and Berezovsky, created media empires of television stations, newspapers, and magazines and used these outlets to attack not only each other, but also Putin, particularly for his policies in Chechnya and his inept response to the 2000 sinking of a nuclear-powered submarine in the Barents Sea.

As Putin started to feel betrayed by the oligarchs politically, others found themselves victimized economically. Investors in Khodorkovsky's projects regularly found that they had acquired worthless pieces of paper. The American investor Kenneth Dart had to write off an estimated $1 billion. The oil company then known as Amoco (and later as BP Amoco) had a similar experience. Both had put money into an oil-producing subsidiary that Khodorkovsky seized and stripped of its assets. Similarly, when the Russian company Tyumen Oil stripped the assets of a Sidanko Oil subsidiary, BP Amoco had to write off, at least temporarily, $200 million of its $500 million investment in Sidanko Oil.

After the Russian government declared a moratorium on the repayment of its debt on August 17, 1998, most Russian banks, including Khodorkovsky's Menatep, simply closed their doors, depriving hundreds of thousands of ordinary Russians of their savings. Rather than try to help depositors and other lenders, Khodorkovsky took whatever sound assets he could salvage and diverted them to a subsidiary in St. Petersburg, beyond the reach of his creditors. After lengthy and often halfhearted intervention by the government, Menatep eventually agreed to provide token compensation; so did Yukos, to those who had taken its stock as collateral for loans to the company. But by the time Khodorkovsky was through issuing new shares and watering down the old stock, few of the banks' depositors or lenders had much to show for their efforts.

Still, it was less Khodorkovsky's financial skullduggery than it was his interference in political matters that upset Putin. Khodorkovsky was reported to have offered Russia's two liberal parties, Yabloko and SPS (the Party of Right Forces), $100 million to unite and campaign together in opposition to Putin and his United Russia Party. And he broadly hinted that he would run for president in 2008, when Putin's term is due to expire.

Khodorkovsky also actively promoted legislation that would benefit Yukos. It was said that, to ensure such support, he bought control of as many as 100 seats in the Duma (the lower house of the Russian parliament), including several held by members of the Communist Party. Whether the rumors were true or not, he was able to head off attempts by the Duma to increase taxes on petroleum producers in 2001 and 2002.

Such heavy-handed lobbying is hardly unknown in the U.S. Congress, especially on energy matters, but to Putin it represented a violation of the deal he had offered the oligarchs. The siloviki, the law-and-order types from the KGB, the police, and the army that Putin had been bringing into the government, felt the same way. Khodorkovsky's methods were a fundamental challenge to their control of the country-or, as one noted, "a danger and threat to the Russian state."

FLEECING THE BEAR