Corruption and Abuse of Power Are Threatening Russia's Economic Gains

Photograph by Alexander Gronsky / Agency.Photographer.ru for TIME
Economic twilight? The Kremlin promises change, but so far it's more talk than action

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The Politics of Pillage
what's gone wrong? the problems are rooted in the structure of Russia's economic model. After a tumultuous decade in the wake of the Soviet demise, which featured an embarrassing 1998 government default, Putin took over in 2000 and re-established the state's dominance in the economy. He wrested control of large swaths of Russian industry from the handful of oligarchs who had taken advantage of the disintegration of the Soviet command economy to build massive business empires. Lubricated by oil revenue, Putin lavished spending on state welfare programs, sparking a consumer boom. Russia was even lauded by some economists for its model of state capitalism, which has at times appeared superior to the more laissez-faire systems of the West, particularly in the immediate aftermath of the financial crisis.

Now, however, state capitalism is strangling Russia. Government-owned companies, shielded from competition, are crowding out private enterprise. Over the past seven years, the government has gobbled up private players in the crucial energy sector, with Rosneft, the state-controlled oil giant, and Gazprom, the natural gas monopoly, becoming two of the largest energy companies in the world. The government owns about half of all shares in companies listed on the Moscow stock exchange, up from 30% eight years ago. As a result, says Arkady Dvorkovich, an economic adviser to the somewhat more reform-minded President, Dmitri Medvedev, the performance of the entire economy has suffered. "With state control, state companies enjoy a better position in the market," he says. "They don't have motivation to improve efficiency and the quality of goods and services, and this affects the whole market." The number of public-sector employees exploded under Putin, growing by nearly 80% to more than 868,000 in 2009, without much improvement in services. With more bureaucrats, there are more sticky fingers grabbing at entrepreneurs like Shifrin. In its 2010 corruption-perception index, Transparency International ranked Russia well below the other BRICs and behind even Zimbabwe, Haiti and Pakistan. "Russia has 140 million hardworking people and 1 million people who want to steal from them," says William Browder, CEO of Hermitage Capital Management, a London-based investment fund.

Browder should know. The American-born financier has been at the center of one of several high-profile controversies that have exposed parts of the Russian bureaucracy as something akin to an organized-crime family. Once the largest foreign portfolio investor in Russia, he created a stir by confronting corporate managers over shady dealings. That led to his banishment from the country and a scam in which, Browder claims, government officials used his corporate documents to steal $230 million in tax revenue. One of his lawyers died suspiciously while in pretrial detention. (The Russian government is investigating the death, as well as a tax-evasion case against Browder.)

Billionaire Alexander Lebedev, who controls the National Reserve Bank and the country's most popular opposition newspaper, has publicly accused a cabal of police and secret-service agents of seeking to seize his assets through an intricate conspiracy, which he has linked to recent police raids at his offices, intimidation of his staff and alleged demands for multimillion-dollar bribes. Earlier this year, he wrote an open letter to Putin appealing for an investigation of these "werewolves in epaulets." Without curtailing corruption and strengthening the legal system, Lebedev says, Russia can't compete with China or India. "The political system here is an impediment to economic growth," he says. "You can hardly find an aspect of life that cannot be explained by the huge dominance of corruption at the highest echelons. It has come to the point that it couldn't get worse."

Actually, it could. The corrupt and intrusive state is scaring off what the Russian economy needs most: investment. Over the past six quarters, a net $65 billion of private capital flowed out of the country. Without that cash, Russia can't spur growth, rebuild decrepit infrastructure, upgrade its industrial base or create jobs for college graduates. In a March speech, Medvedev admitted that the investment climate "is very bad, very bad" and corruption had "a stranglehold" on the economy. "We cannot let this situation continue," he warned.

The Market Fights Back
that pledge has led to a rethink of Russia's economic model at the highest levels of policymaking. Those who admire state capitalism "don't know what they're saying," says Dvorkovich. "This way of doing things has exhausted all its potential, so we need to change policies." A flood of market reforms has rushed from the Kremlin, including proposals to eliminate regulations, reduce controls on foreign investment, shrink the bureaucracy and improve the transparency of state companies. In early August the government announced it would sell off majority stakes in a wide range of state-owned enterprises by 2017. "I want to state loud and clear here that we are not building state capitalism," Medvedev said in June.

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State-Run Shakedown