Monday, February 26, 2007

Russia's Nationalisation Trap

Which are the common assets of a nation and who should be allowed to utilise them? This is a question of heated debate for current Russia, as the vital energy sector is gradually being nationalised. It is privatisation in reverse - for everyone to see - no matter what the Kremlin might claim. The question is: Is it good for Russia?

In terms of economics, monopolisation - in this case nationalisation - may be motivated if the sector in question constitutes a natural monopoly. This may mean one out of two things: Either the social costs of monopoly production are lower than under competitive circumstances, or if the fixed costs of entry into a sector are so high as to be predatory, it allows but one viable and effective producer. Areas associated with natural monopolies are e.g. water services, postal services, telecommunications, and so on. However, as examples in global economy show, natural monopolies are not a sine qua non. Private companies may offer such production and services, as are associated with natural monopolies, more efficiently and at a lower price, than a state monopolist may. This is not always the case, and monopoly may in some instances be preferrable to competition. However, one should not automatically rule out competition only on the basis of existing economies of scale appearing to naturally favour a monopoly situation.

So, in view of current nationalisation of the Russian energy sector, could it be argued that it constitutes a natural monopoly? Most probably not. Instead nationalisation may threaten the industry as a whole.

What an industry such as the energy sector needs is long-term engagement and development. It needs large-scale investments over a long period of time in construction and maintenance. It also needs technical skills and know-how along the entire scale from prospecting to sales. Finally, it needs means of development - the capacity to expand and extract new resources and deliver them to costumers under efficient and competitive circumstances. These are qualities that a state actor does not necessarily posses.

So, does the Russian state have the financial resources and the commitment to maintain and develop the energy sector? For obvious reasons, it is a question still to be determined. However, judging from the current situation and the way the Russian state acts, perspectives are bleak for efficient state-owned energy production in Russia. First, Russian state-owned energy companies do not fit the profile depicted above. The situation clearly needs the dynamics only attainable under competive conditions. Secondly, Russian state interests tend to come in conflict with the rational needs of the energy sector.

The 2003 Yukos scandal and its aftermath clearly indicates a conflict of interests between the state and private enterprise in the energy sector. It is often argued that Yukos founder, Mikhail Khodorkovsky, had become too mighty and did not know his place, by meddling into politics. He was considered a political threat to power. However, reviewing the case from an economic perspective is even more disastrous. What really was at stake, were the large investments into energy infrastructure that Yukos planned to make - the various pipelines the company wanted to build. If these plans had been realised, they would have made Khodorkovsky more or less politically independent from Russian state leverage. Still, economically, such investments would potentially have brought profits and prosperity to Russia's economy and, indirectly, to its people. Furthermore, they were exactly the kind of investments that were economically sound and would have developed the energy sector in a positive direction. Thus, by victimising Yukos for political reasons, Russia was rendered an economic loss that the state was unable to compensate for. Consequently, as Khodorkovsky's 2005 nine-year jail sentence serves to show, the interests of the state and private business are far from always compatible.

Since then, the tendency arising from the Yukos scandal has strengthened. Private companies in the energy sector meet with state or pseudo-state opposition. Deals once made are put into question. Pressure is brought to bear on outside actors, such as when Gazprom recently seized control over the Sakhalin offshore project, ousting a foreign consortium led by Shell. Environmental motives are given for action against foreign investors, whereas Russian companies would never meet with such demands. Also, as the Yukos case shows, expropriation has become a new method for the state to forward its own and associate interests.

The perspective becomes even more horrendous when reviewing the issue from a security point of view. In Putin's opinion, it seems that not having full control over Russia's energy resources would pose a threat to the country. Accordingly, Russia cannot depend on private, and often foreign, companies for its energy production. Furthermore, the country cannot depend on transit of oil and gas by pipelines running through foreign states. Consequently, new state-controlled pipelines are built bypassing intermediate countries, such as the Nordstream pipeline projected to run through the Baltic Sea. From an economic point of view, it is highly questionable whether this and similar pipeline projects are financially viable, especially as the costs for developing and expanding already existing pipelines over foreign territory would be much lower, as would even be the case of building new ones. Therefore, it is obvious that Putin's obsession with control is detrimental to almost any economic rationale.

So, who stands to gain from nationalisation of the Russian energy sector? Who is allowed to utilise the common assets and to what end? The obvious answer would, of course, be the Russian state. However, with lacking long-term commitment to maintenance and development, the overall GDP stands to lose from state ownership. The state will be forced to either carry the burden of investments or see energy incomes dwindle due to neglect and inefficiency. Consequential interruptions of delivery to costumers would not vouch for Russia's role as a reliable producer. So, why should Russia voluntarily assume these great costs, when private companies could freely do it with greater professionalism than the state would ever be able to do?

The other obvious answer would be that the Russian people would gain from nationalisation. However, to what extent are the energy incomes redistributed to the people, and if so, would it be in the true interest of the people? First, the Russians receive little of the energy profits. It is true, there have been some attempts at state social reform and economic support lately, but it is questionable whether this is motivated out of real concern for the people. An example is Russia's population decline, where Putin seems more worried about the decrease in the future number of conscripts for the military and similar issues, than the social malaise of the people itself. Also, if too great a proportion of the incomes would actually be distributed to the people, it might cause economic crisis due to consequential hyperinflation. Finally, a state-run energy sector would probably be less efficient than a private alternative, creating comparatively lower profits. The effect would be an overall lower GDP, negatively affecting the Russian people. Thus, it seems that the Russians have little to gain from nationalisation of the energy sector.

Then, does nationalisation of the state sector strenghten Russia in its foreign relations? Initially, it might seem that control of the energy - as a strategic resource - would strengthen Russia's international power. The threat of "turning the tap" would seem to be a constant leverage for Moscow towards foreign states, mainly the EU, dependent upon Russian energy. However, this is countered by an equal risk that foreign states would turn to other producers or seek alternative energy solutions, such as e.g. nuclear power. Still, as the example of the European Union shows, Russia is more dependent on the EU than the EU is of Russia. Also, the EU is becoming increasingly weary of Russian ambitions and the country's reliability as an energy deliverer. Moscow has declined to ratify the European Energy Charter Treaty. European initiatives to develop the energy contents in a renewed Partnership and Cooperation Agreement (PCA) have met with outright opposition from Russia. Thus, Moscow is sending an increasingly clear message to Bruxelles about its intentions: Russia is not to be trusted as a reliable partner to the European Union. Regretfully, these are exactly the sentiments beginning to grow in Bruxelles and European capitals.

Today, it is obvious that Putinist ideology is the foundation of the current nationalisation of the Russian energy sector. It is the sort of étatism that belongs to the 19th century. It is a statist view that emphasizes control over rationality. It is an antiquated geopolitical outlook that puts the map before the realities of modern society. It is a perspective where the power of a state is measured by the quantity of its population, not of its output. It is a perspective that sees foreign relations as a zero-sum game. That president Putin wants the state to assume control of Russia's energy resources is but another factor in this overall scheme. For him, that the state owns a country's resources is only the natural state of things - how it should be. Reviewing this perspective, the conclusion is apparent: Putinist ideology simply is a notion that lacks understanding of the modern world.

Still, what the modern world is about is cooperation to the common good of those who participate in it. Thus, what Putinist ideology disregards is a fact so obvious that it needs neither stating nor reiterating: Modern power derives from the relative gains of cooperation - not from conflict or absolute capabilities. Making it alone is simply not an option in the modern world, and still this is the absolutist approach that Putinist Russia is opting for. That it is no viable long-term option for any state, seems of no concern to the country's leadership. Sooner or later, Putin's path will, regretfully, come back with a vengeance to Russia and its people.

In the meantime, the common assets of Russia are utilised to the detriment of the country and its people. Nationalisation is not good for Russia, and thus the Russian people may gradually come to understand that Putinism is simply not good enough for them. Until then, Russia is caught in a nationalisation trap.


Sergej Varsjinskij said...

Dear Vilhelm,

In my humble opinion you missed three important aspects necessary to answer the question, 'why' Russia nationalizes the oil-sector, extensively .

1) the way how the privatisation took place in the Yeltsin era.

2) the criminal background of oligarchs like Mikhail Khorkovsky

3) the predatory of the 'transit countries'.


Vilhelm Konnander said...

Dear Sergej,

Your "humble opinion" is quite correct, in pointing out to me that I left these factors out.

Also, in two out of three cases I agree with you that they are relevant, that is if writing about privatisation. However, my piece is about nationalisation - its opposite.

As for your third comment, I simply do not agree with you that Moscow could not get along with its neighbours if one really wanted to. That would be economically sound and probably not that difficult as all states concerned are largely driven by economic motives.

That privatisation deprived the people of common assets is quite true. However, were they during soviet reign allowed to utilise them and draw the benefits of Russian resources? Will the people get this from current nationalisation?

That the oligarchs are crooks is quite evident. I wonder, though, why so many of them - loyal to the Kremlin - are allowed to continue their activities. Is there some sort of double standards? From a moral point of view, criminal oligarchs could well be put on trial, provided that equality before the law and rule of law is applied, giving them all the legal security established by the constitution.

So, why did I leave out the three factors you mention? The reason is that they today are not sufficiently relevant when reviewing the issue of current nationalisation. Nationalisation is essentially an economic issue, and from an economic point of view, nationalisation may become disastrous for the Russian people.

So, when addressing the issue, I am looking to the future, not the history.

As for the political side of it, one could argue, as I do, that nationalisation is mainly an economic issue, when looking at its consequences. However, one cannot really leave out its driving-force in Putinist ideology. That would be like leaving out Hugo Chavez when speaking about nationalisation in Venezuela.

Let me point out, I do not disagree with you, but raising these issues, one should also address other questions that they imply. This was something I wanted to avoid in this context, as it would be beyond the point of the subject of nationalisation. A blog is simply not an encyclopaedia, and it has to focus on the issues at hand.



Sergej Varsjinskij said...

Comrade Vilhelm,

I will not waste the precious space in your comment section to address this topic. I will rather dedicate an entry on my blog to our fruitful and friendly 'debate' on this topic. This, and I hope you will understand, makes it a little easier for me. I enjoy our conversation and am delighted to see two 'professionals' engage in an exchange of views. I respect Scandinavians in general, and Swedes in particular, so I particularly enjoy our dialogue.

I kindly ask you to excuse my horrible English.


james24 said...

Thanks for this insightful post, Vilhelm. Bob Amsterdam has just posted his perspective about this article here:

Vilhelm Konnander said...

Dear James,

I am glad you liked it. Thanks also for pointing out the piece covering it on Robert's blog. I have actually already posted a comment to his piece there, so hopefully the discussion will continue.



Sergej Varsjinskij said...

Dear Vilhelm,

you will find my comment on your work at

I hope you will still talk to me after having read it.