The Institute of Modern Russia continues the work on developing a reform program for post-Putin Russia—an initiative that we launched in 2016. As part of this initiative, today we are presenting a new report titled “Demonopolization of the Economy as an Axis of Russia’s Future Reforms” that focuses on the fundamental problems in the Russian economy and offers a blueprint of potential reforms. The report has been prepared by a research group headed by economist Vladimir Milov.

 

A drilling rig at the Southern Priobskoye oil field of the Gazprom Neft. Photo: Vladimir Smirnov / TASS.

 

  

According to Mikhail Krutikhin, a well-known Russian energy expert and partner at RusEnergy consulting firm, who penned an introduction to the report, “Russian-style monopolism, particularly in the form of monopolies headed by government officials, is inevitably underpinned by corruption schemes and kickbacks, inflicting huge damage not only on the companies themselves, but also the state budget.”

“At the same time, questions arise about the primacy of economic monopolism in relation to its political cousin, and hence about the priority of improving the economy and the socio-political situation in Russia. There is reason to believe that the modern structure of the Russian economy, strangled by inefficient corporations ruled by officials, took shape as a result of the purposeful actions of the political establishment. It would be a mistake to presuppose that such economic forms gave rise to the political monopoly of power, and not the other way round.”

 

EXECUTIVE SUMMARY

Demonopolization of the Russian economy is more than just a new economic policy tool to reverse the country’s headlong fall into economic crisis. Demonopolization is a global idea and something of a new philosophy in the field of economic thinking that can—and must—fundamentally alter the fabric of Russian social life.

There is every reason to link the degradation of Russian socio-political institutions from 2000-2015 directly to the monopolization of the Russian economy, with economic power concentrated in the hands of a narrow circle of corporations close to the state and affiliated entities and individuals. It was oversized state monopolies that created the demand for “bad institutions” by restricting competition, using the state to extract preferences, increasing profits at the expense of taxpayers and consumers, and eliminating competitors through unlawful interference in the courts and law enforcement agencies. In Russia, political and economic over-centralization are inextricably intertwined.

Without wholesale economic decentralization in Russia, its political counterpart (i.e., transfer of powers to parliament, development of free media, independent courts and local self-government, etc.) is sure to fail. If the narrow cartel of state-linked monopolies controlling key sectors of the Russian economy remains in place, these monopolies/oligopolies will quickly corrupt any new elite and slow down vital reforms, prompting a new wave of centralization of power for personal gain.

The experiences of other post-Soviet countries, including those that have been through inherently anti-bureaucratic and anti-corruption revolutions, fully corroborate this conclusion. In Russia, state companies account for more than 50 percent of the revenue of the 100 largest firms, and this figure nudges up to 60 percent if “shadow (latent) state companies,” i.e., officially private corporations closely affiliated with the state (e.g., Surgutneftegaz, Sibur, Stroygazmontazh, Stroytransgaz, etc.) are factored in. As for the top 30 firms, the figures are 65 and 70 percent, respectively. That is the extent of state control over key sectors of the economy. 

The importance of demonopolization is not limited to its influence on politics. There is a purely economic dimension, too.

  • Over the past 25 years of reform, Russia has failed to achieve low inflation. Experience shows that inflation drops by 2-3 percentage points without regular increases in monopoly prices. By eliminating this factor, annual inflation in Russia could be lowered to 3-4 percent, stimulating growth in investments, real incomes, and pensions.
  • Excessively high monopoly prices in various sectors (energy, transport, bank loans) and monopoly barriers to market entry reduce the national economy’s competitiveness internationally and make other countries with no such monopoly barriers more attractive to investors.
  • The public sector’s labor productivity is low. Freeing up internal reserves could be a powerful source of modernization and a means to increase the efficiency and international competitiveness of the Russian economy.
  • Monopolies’ investment performance is poor. In 2013, the combined annual investment programs of the 10 largest state companies in Russia came to almost 3 trillion rubles; at the same time, economic growth flatlined, even before sanctions and falling oil prices.

 

Compare: private oil companies from 2000-2004 managed to increase oil production by 50 percent, investing only 100-200 billion rubles a year. It is no secret why state monopolies do not invest effectively: they enrich contractors, the state underwrites their losses, and their market share is not threatened by competition. But the economy can no longer afford to invest trillions of rubles in unwanted gas pipelines, stadiums, dams, and power stations. The private sector would invest the cash far more efficiently.

Many of the failures of the Russian market reforms in the 1990s—hyperinflation, sluggish efficiency improvement, low labor productivity—are directly attributable to the lack of attention paid to demonopolizing the post-Soviet economy. This is exemplified by the fact that by the late 1990s, some at least partially demonopolized branches of the economy were already on a growth trajectory, unlike the stagnant “primitive” monopoly industries still in existence (e.g., the oil and coal industries versus the monopoly Gazprom).

This suggests that 1990s Russia could have climbed out of the post-Soviet hole much faster if a decisive demonopolization program had been implemented. 

Despite its overarching importance, demonopolization of the economy needs to be broken down by sector (banking, energy, etc.). The nature of the task in each case is defined by what is objectively taking shape in these sectors.

 

Demonopolization of the banking sector

Russia has a huge number of private banks, yet more than half of all banking assets and two-thirds of the corporate loan portfolio are presently controlled by six major state-owned banks. Studies show that the margins and operating expenses of Russian banks are overstated compared to their European counterparts, which adds 4-6 percentage points to the interest rate on loans even after deducting the difference between the respective inflation rates. Sovereign risk is not the only factor. The Russian banking sector is clearly hampered by the oligopoly of the major banks, which must be eliminated.

 

Demonopolization of the energy sector

The state and its affiliated structures control about half of oil production, two-thirds of gas production (plus the entire gas transportation system), more than half of electric power capacity, and (together with three large private financial-industrial groups) almost three-fourths of Russia’s generating capacity. At the same time, in 2013 domestic wholesale prices in the electric power and gas industries in dollar terms exceeded average wholesale prices in the U.S., where the market share of the largest oil and gas producers is no more than 4-5 percent, and the five largest electric power companies control only a fifth of generating capacity. In Russia, these sectors are seeing endless price rises against a backdrop of industrial stagnation and declining labor productivity.

 

Demonopolization of the transport sector

The importance of demonopolizing the Russian transport industry cannot be overstated, since inflated prices here are a key obstacle to economic development given the country’s vast territory. The two sectors where the problems are most obvious are railways (where a competitive transport market has not been created) and aviation (where Aeroflot’s takeover of Transaero has given it two-thirds of the domestic passenger market, while the rest of the market is occupied mainly by uncompetitive regional carriers).

Pipeline transportation can also be mentioned in the context of demonopolization, given the drive to diversify oil and gas transportation routes. Transneft and the future Transgaz (hived off from Gazprom) could readily be split up into several competing companies that will then be forced to cut costs and reduce tariffs in a competitive environment caused by surplus pipeline capacity.

 

Demonopolization of the utilities sector

In recent years, the utilities sector has seen the active displacement of independent players coupled with monopolization—from heat supply to housing maintenance. This directly contributes to an inflated rise in consumer costs for utilities and, as a result, a decline in people’s purchasing power.

The nationwide utilities sector must:

  • Eliminate monopolies artificially created by government in potentially competitive areas, based on the results of monitoring carried out by independent NGOs;
  • Create an effective system of public audit and regulation of grid monopolies with a detailed analysis of individual performance indicators and the establishment of tariffs based solely on public audit results.

 

Demonopolization of government procurement and land distribution

More than 92 percent of Russia’s land fund remains in state and municipal ownership, with only 0.5 percent owned by legal entities. The system of government procurement and land distribution in Russia serves only the vested interests of the bureaucracy and associated business structures. A Forbes report entitled “Kings of the State Order” alleges that businesses close to Putin receive more than a trillion rubles of government procurement funds a year. This phenomenon permeates both the regional and local levels. 

The distribution of government procurement funds and land should be placed under the legislative control of independent NGOs. With respect to the land fund, quick and decisive action is needed to create a transparent and liquid market for land transactions, denationalize the land fund to the greatest extent possible, and strip officials of land disposal rights.

 

Demonopolization of agriculture 

In the agricultural sector, there are two main problems: 1) creeping monopolization of the industry by large agroholdings with the displacement of small private entrepreneurs; 2) traditional monopoly/oligopoly in the wholesale procurement chain.

Barriers, preferential state support for large agricultural enterprises, and low purchase prices set by the oligopoly in the wholesale chain hinder the development of agricultural output in Russia, creating nothing but monopolistic structures that feed off state support and increase profits by squeezing small players out of the market.

The system of state support for the agro-industrial sector should be thoroughly revised with a view to creating a highly competitive environment and eliminating monopolies in the wholesale procurement chain through antitrust measures. Independent non-governmental structures should help identify barriers to independent agricultural producers for the purpose of removing them.

 

Demonopolization of defense and machine-building

Over the past 15 years, the defense industry has been overcentralized within the framework of sector-based verticals (United Aircraft Corporation, United Shipbuilding Corporation, Rostec), which has seriously impacted performance and led chiefly to price rises. Even the initiator of the process, Vladimir Putin, has complained about this. Rearming and modernizing the army is a core priority, but one that requires a drastic reworking of Putin’s policy of “verticalization” of the defense industry; demonopolization is also necessary.

Likewise, the past 15 years have seen attempts to overcentralize the machine-building industry, with no tangible or justifiable results. The most striking example is Rostec, with its financial problems, bankrupt plants, etc. This sphere, too, needs denationalization, demonopolization, and road maps to develop competition.

 

Demonopolization of the retail sector

From 2011-2016, according to Rosstat, retail chains’ share of retail trade turnover rose from 18 to 27 percent. There is nothing wrong with the development of retail chains per se, but in Russia it often takes place in collusion with officials and the creation of artificial barriers to small merchants. A national inventory of such artificially created barriers (broken down by region and city) is required, along with the abolition of all unjustified discriminatory restrictions on small trade.

 

Demonopolization of media and advertising

Robust media freedom in Russia is unattainable without comprehensive demonopolization. It is not even a matter of who controls the major TV stations. The problem is that the public has access to just a tiny number of channels, which leads to informational asymmetry. Advertising needs to be demonopolized: the market is populated by Kremlin-linked monopolists, e.g., Video International, which controls more than a third of TV advertising (according to the Panama Papers, associates of Putin own shares in the company).

The main idea is to create an infrastructure for mass access to a large number of competing electronic media that belong to different owners, and to ensure that the state withdraws entirely from the media landscape.

 

  

The Institute of Modern Russia wishes a happy birthday to Lyudmila Alekseyeva, who celebrated her 90th anniversary on July 20.

Lyudmila Alexeeva occupies a unique place in the history of human rights, being one of the most outspoken and respected rights advocates in Russia and beyond. Due to her dedicated efforts, resilience, strong morale, and ever dignified stance, thousands of people have more freedom in Russia today.

We are grateful to Lyudmila Alexeyeva for her support, her invaluable, selfless and incredibly long service, for her ability to speak truth to the authorities, for her adherence to high ideals and beliefs. Lyudmila Mikhailovna, you are an example to all of us. Thank you.

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