Q&A: Putin's Critical Adviser

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"When I took the job, we spoke about pursuing a liberal economic policy. Now, the state has evolved in quite the opposite direction," explained economist Andrei Illarionov during a news conference where he announced his resignation as a key economic adviser to President Putin. Within hours of Illarionov's public decision, Putin's press service said the President had accepted the resignation.

Illarionovs decision to resign comes at a moment when the Kremlin is escalating its intention to dramatically hike gas prices in Ukraine by as much as a fourfold increase. On Saturday (December 31), Putin made Ukrainians another offer: Sign on the new price now, start paying three months later. Unless they accept the offer, which they hardly can, Putin ordered Gazprom to turn off the tap at 10 a.m. on January 1. On Saturday (December 31), Illarionov told TIME: Over the last 48 hours things between Russia and Ukraine have been developing under the worst possible scenario on the gas issue—and not just the gas issue. This (gas) war was the last drop in my decision to resign. I was offered to take part in it as a propagandist who would explain why the price hike and everything else that is being done in our bilateral relations are liberal economic policies. However, the factors that led to this decision have nothing in common with liberal economic policies.

Illarionov, 44, started in the Russian government at the heyday of the nascent and short-lived Russian democracy back in the 1990s as a member of young Turks economists headed by Yegor Gaidar, Yeltsin's Acting Premier. In 1994, Illarionov quit the cabinet in the wake of his conflict with Premier Victor Chernomyrdin, whom he accused of stifling liberal reforms and staging an economic coup detat.

Always a maverick, he had called for a sharp devaluation of the Russian ruble before the August 1998 financial meltdown. Illarionov is also credited with playing an important role in making the 13 percent flat income tax a reality. From the outset of Putins presidency, Illarionov struggled to curb state interference in the economy and oppose the monopolist economic policies of natural gas, electricity and railway corporations.

Illarionovs recent criticism of Putin had put him in the cross hairs, and he was being eased out of office. He was stripped of his crucial job as Russia's envoy to the G-8, and his Kremlin staff had been gradually reduced. But it was Illarionov who took the final step to resign this week. In a lengthy interview with TIME, Illarionov sat down to discuss his decision to leave office, the tense situation in Ukraine and his harsh criticism of the current administration.

TIME: You said that you stayed on the job while there was an opportunity for you to speak out, but now that opportunity is gone. When did it go? What served as the watershed?

Illarionov: The process of this state evolving into a new corporativist (sic) model reached its completion in 2005. Quantitative changes have evolved into qualitative ones. The Freedom House best summed it up six months ago, when it downgraded Russia to "completely unfree" from "partially unfree." My job assumed the ability to hold free public discussions of ongoing processes. My willing suspension of this ability would have been a gross dereliction of official and professional duties on my part. I chose to resign instead.

TIME: Did you discuss the reasons for your resignation with President Putin? When did you see him last?

Illarionov: We talked one day before I resigned. However, I have never commented on my relationship with the President while I worked for him, nor do I intend to do so now.

TIME: What is the real picture in the economy?

Illarionov: The economy is doing fine—if you gauge it in traditional ways. The growth of GDP is 6.2%, which is good. The market is growing. Russia's state foreign debt has been brought down to $86 billion. This is 11% to 12% of the GDP versus 96% six years ago. But do we compare Russia to developed countries or to a country like China that has the GDP growth of 9%—or oil producers like Azerbaijan with 12%, or Kazakhstan with 19%. This way, we see that Russia's achievement is more than modest. Under oil windfall profits, Russia's GDP should have grown by 15% to 16% in 2005. Once you dismiss the windfall profits, you see a poor quality of the economic policy that has proven negative to the tune of losing some 9% to 10% of the GDP growth.

TIME: Still, Russia is awash in cash?

Illarionov: Our Stabilization Fund is $40 billion now. This is 6% of the annual GDP. But Norway's Stabilization Fund makes 70% of the GDP. China imports oil, but its hard currency reserves have grown by 22%. Russia's GDP is worth $200 billion. Some $100 to 110 of it comes from the oil windfall profit. According to Russia's Central Bank, the export of capital this year has reached some $40 billion.

TIME: Where did it go wrong?

Illarionov: The strengthening of the corporativist state model and setting up favorable conditions for quasi-state monopolies by the state itself hurt the economy. Like Gazprom purchasing Sibneft, and another state monopoly purchasing other private company. The state generated some $30 billion in debt to do just that. Or take the case of RAO UES (the electricity monopoly) buying a sizable part of the Power Machines Plant. When the state unraveled Yukos, officials insisted it was a single such case rather than a trend. But it soon became obvious that Yukos was not a single case, that this concerns the entire economy. Just this month, officials of the state-owned Rosoboronexport (the weapons trade monopoly) has taken over the privatized AVTOVAZ (a major automotive plant).These and other such cases show that Yukos was a campaign, which is intensifying weekly.

TIME: So what kind of an economy is Russia ending up with?

Illarionov: One can assume that it'll be an economy, controlled by quasi-state corporations in energy, infrastructure, in all the cash flow realms.

TIME: You emphasize the word "quasi".

Illarionov: Thank you for having noticed this. Indeed, this is important. What we witness is a case of corporations that have the status of state-owned, and indeed their stock belong to the state. But the way they operate has quite little in common with the state interests. Quite to the contrary, they do act against the state interests. Take the case of Rosneft (the state-owned oil company). Now, Rosneft is preparing its IPO, which is advertised as a major event for the Russian economy. Rosneft will issue dozens millions worth shares to cover its assets—with not a single dollar earmarked for the state budget. It's not privatization; it's IPO by a state-owned company. In this context, the action does look like stealing state funds on a multi-billion scale. This is just one example of many. Cabinet members or key Presidential Staff executives chairing corporation boards or serving on those boards are the order of the day in Russia. In what Western country—except in the corporativist state that lasted for 20 years in Italy—is such a phenomenon possible? Which, actually, proves that the term "corporativist" properly applies to Russia today. We are witnessing aggression on the part of quasi-state run corporations against whatever private businesses capable of generating cash flows. In fact, this aggression spreads outside Russia as well.

TIME: How so?

Illarionov: By using economic weapons—particularly, energy as a weapon—RAO UES bought a power station in the Transdniester Republic (a breakaway Moldova province, very much under Moscow's influence), and then cut off Moldova from this key power supplier, until Moldova met its terms. Transneft (Russia's state-owned oil pipe monopoly), blocked oil flowing from Kazakhstann to Lithuania, because Russia coveted Lithuania's oil refinery. The latest such case is abruptly raising natural gas prices fourfold for Ukraine.

TIME: The Kremlin says it just charges market prices.

Illarionov: There is no such thing as a gas market prices, because there is no such thing as gas market. What they are doing to Ukraine is obvious price discrimination. Because Russia offers quite different terms for analogical (i.e., former republics that surround Russia) countries, while nobody has even suggested that the fuel basket price be calculated for Ukraine, the way they do for Germany, say. When watching all this, one can't avoid the impression that this price escalation during the negotiating process aims at NOT reaching the agreement rather than at reaching one. One feels that the main objective is having the negotiating partner sufficiently insulted in order to make reaching the agreement impossible. One feels that Russia seeks frustrating the deal for some duration. Actually, Konstantin Kosachev, Chair of the Duma's Foreign Relations Committee, put it succinctly when he said the other day that no deal would be reached before Ukraine has its parliamentary election in March. I guess Mr. Kosachev knows what he is talking about. Hence, all the hysteria that Russia is whipping up, making the talks so public. Even with Georgia, with which the relations are way more strained, the gas talks have been held quietly—and the price is two times less.

Another thing, Russia has made it plain it wants Ukraine's gas transporting system. Then, Gazprom says, the prices will go down. This is the same usage of an energy weapon, as OPEC did in November 1973, when they placed the U.S. and Holland under oil embargo for siding with Israel. Prices skyrocketed; Saudi Arabia enjoyed a couple of years of fat profits. Then, the U.S. and other Western countries improved their economies, and adjusted to new prices, while per capita income in Saudi Arabia has sharply dropped since. A country that is prepared to wield energy weapons must know that it is going to lose in the long run. History gives an unequivocal answer to where Russia will slide, should it embark on this road.

TIME: What is your view of Russia's political scene today? How meaningful or symbolic is the new legislation restricting NGOs?

Illarionov: I see the reduction of the volume of political freedom, more restrictions clamped on political parties, the media, public expression—all this is obvious. The trends that have been long accumulating, found their completion and finally shaped up in 2005. That Freedom House report I mentioned came six months ago—nobody in Russia has even tried to deny it officially. Now that Russia has passed this new law restricting NGOs, I think it will push Russia's next year rating even lower.

TIME: You were Russia's envoy to the G-8. You worked hard to secure Russia's membership in G-8. Do you think now that Russia really belongs there?

Illarionov: I wish Russia would be a G-8 member as a developed, free and democratic country. I worked to that end. At the time when Russia was invited to the political part of G-8, nobody suspected such changes in political trends. But they would have hardly accepted Russia, if the Yukos affair and all other things that started in 2003 were happening even then.