Putin's Regional Policy and its Impact on the Political Economy of Partial Economic Reform in Russia's Regions

Abstract

This paper aims to analyze the political economy of economic reform in post-Soviet Russia’s regions under Yeltsin and Putin, to identify reasons why and how reforms became stalled during the 1990s and how the state of partial reform has been broken up under Putin by federal policy towards the regions. The research is based on a review of the relevant scholarly literature, analytical reports, articles from newspapers and newsletters, and e-mail conversations with specialist on particular aspects of the research topic. The major findings of the paper are as follows: Russia’s transition towards the market in the 1990s was stalled by regional governments and business elites, which, in the absence of a strong federal government, forged strong distributional coalitions. The incentive structure responsible for this halt of the reforms has not substantially been changed by Putin’s federal reforms which merely established an additional administrative layer between the federal and the regional level. Instead, the state of partial economic reform has been broken up by structural reforms (reform and re-centralization of the fiscal system, reform of electricity and debureaucratization), together with a recentralization of law enforcement structures and rising investment into regional assets by Russian big business.

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Table of Contents

Introduction   4

Chapter 1  Governance and Economic Change in Russia’s Regions under Yeltsin  8

1.1  The Rise of the Regional Elites and Fall of the Federal Center  8

1.2  Privatization of large-scale Companies  10

1.3  The Federal Tax System and its Impact on Economic Change  11

1.4  Regional Governments and Economic Policy  13

1.4.1  Protecting Large Regional Enterprises  14

1.4.2  Price Liberalization  15

1.4.3  Small-scale Business  16

1.4.4  Land Ownership  17

1.5  Conclusion  17

Chapter 2  Putin’s Federal Reforms  19

2.1  The Establishment of Seven Federal Districts  19

2.1.1  Harmonizing Regional Laws with Federal Legislation  20

2.1.2  Coordinating the Federals  21

2.1.3  Intervening in Regional Elections  23

2.1.4  The Envoys’ Relations with the Governors  24

2.1.5  The Envoys’ Engagement in Economic Policy Issues  26

2.2  The Reform of the Federation Council  28

2.3  Firing Governors and Disbanding Regional Legislatures  30

2.4  Governors to be appointed by the President since 2005  31

2.5  Summary  33

Chapter 3  Federal Policy Initiatives  36

3.1  Recentralization of Law Enforcement  36

3.2  Fiscal Recentralization  38

3.2.1  Expenditure Assignments and Budgetary Responsibilities  39

3.2.2  Revenue Assignments and Tax Reform  40

3.2.3  Changes in Intergovernmental Transfers  42

3.2.4  Federal Control over Subnational Budgets  43

3.2.5.  The Impact of Fiscal Recentralization  43

3.3  Reform of the Electricity Sector  44

3.4  Legislation on Debureaucratization  47

Chapter 4  Rising Investment in Regional Assets  50

  by Russian Big Business  50

4.1  Breaking Up the Fraternity of Governors and Regional Economic Elites  51

4.2  Strategies of the Regional Elite  52

4.3  Political Strategies of Big Business  54

4.4  En Lieu of a Conclusion: Scenarios of the Regional Political Economy  55

  Conclusion  58

  Bibliography  60

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INTRODUCTION

Post-Soviet Russia’s economic transformation from a planned economy to a proper market economy is arduous and not yet completed. Although reform policies were launched by the federal centre (price and trade liberalization, monetary stabilization, privatization), these policies could only incompletely be implemented, due to resistance from stakeholders who benefited from the state of partial reform. Such stakeholders are, for example, insider owners of former state enterprises who stripped assets rather than invested in the enterprises, the commercial bankers who obstructed macroeconomic stabilization in order to benefit from arbitrage in distorted financial markets, but also state officials who prevented the creation of a functioning state administration in order to keep opportunities of rents from corruption and embezzlement. Joel Hellman was one of the first political scientists who shed light on the role of these early winners of partial economic transition in blocking further reforms. ¹ A special characteristic of post-Soviet transition in Russia is the process of regionalization. Beginning during Perestroika and continuing after the break-up of the Soviet Union, political and economic power and competencies shifted de facto from the state centre to Russia’s 89 regions. Regional elites increasingly became self-confident and pursued their own interests against the centre. In most regions these elites were a close fraternity of local political, industrial and financial leaders organized in informal networks inherited from Soviet times. During the privatization process, they gained control over property in the regions. Symptomatically, the interests of regional elites frequently obstruct economic reforms on the ground. ² Thus, according to Hellman’s theoretical concept, regional elites can be included in the category of early winners of transition blocking further reforms. Although economic reformers in the Yeltsin era eventually achieved macro-economic financial stabilization, the important micro-economic structural reforms largely failed either to

¹ Hellman, Joel S. “Winners take all. The Politics of Partial Reform in Postcommunist Transitions.” World Politics 50, 1 (January 1998): 203-34.

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be brought onto the reform agenda or to be implemented. Russia’s financial crash in August 1998 was partly the result of neglecting structural reforms, as well as of the still-incomplete macro-stabilization which was completed only when the budget was brought under control in 1999.

Again, regional governments were one of the main political stakeholders opposing the implementation of necessary structural reforms. Therefore, it can be argued that progress in Russia’s economic transformation towards a market economy depends inter alia on a weakening of the economic and political power of regional elites. Or more moderately, at least it is necessary to change the incentives for regional elites that in the past caused them to obstruct economic reforms.

The regional reforms launched by President Putin in May 2000 can be understood as an attempt to weaken the power of the governors. The predominance of regional executives over political and economic life in the regions was to be broken up by re-establishing a “power-vertical”. First, seven federal districts have been created each headed by a presidential representative. Secondly, a new recruitment system for the members of the Federation Council has been introduced. Thirdly, the President has the right to fire governors and disband regional parliaments that repeatedly (seriously) violate federal laws or refuse to adapt regional laws to federal legislation. Most recently, since January 2005, the governors are no longer elected by the people, but instead they will now be appointed by the President and confirmed by the regional assemblies.

Besides the regional reforms, other policy initiatives have also been launched by the federal centre that could have a real effect on the economic power base of the regional executives. The federal centre is trying to regain control over law enforcement organs in the regions. The fiscal relations between the centre and the regions have been altered in favor of increased central control and larger centre-regions transfers.

² Nicholson, Martin. Towards a Russia of Regions. London: RIIA, 1999. p. 29.

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The pursuit of liberal reforms by the centre generally has consequences for the political economy in the regions. Legislation on de-bureaucratization has been adopted in order to make life easier for small firms suffering from the harassment and bribe-taking of regional bureaucracy. A reform of the electricity monopoly is envisaged that could diminish governors’ opportunities to conduct independent economic policy by subsidizing inefficient regional enterprises with low electricity prices. Housing reform has been undertaken that deprives regional officials of some other rent-seeking opportunities. Meanwhile, another development is occurring, not as a result of government policy, which may be changing the economic order in the regions. Large, national-scale Russian firms are buying regional assets. This is having an impact on the relationship between regional firms and regional politicians, and subjecting those regional firms to more efficient management.

In the light of these changes in the relations between the federal centre and the regions, this paper shall investigate how the capabilities of regional executives to obstruct economic reform are weakened and how incentives to do so have changed under the Presidency of Vladimir Putin. I argue that, in contrast to Putin’s initial ambition, the federal reforms as such (recreating the power-vertical) are relatively ineffective in breaking the preponderance of the governors and overcoming the state of partial reforms in Russia’s regions. Instead, it is the structural reforms (reform and recentralization of the fiscal system, reform of electricity and debureaucratization), together with a recentralization of law enforcement structures and rising investment into regional assets by Russian big business, which are weakening the capacities of the governors to obstruct further economic reforms.

The paper is structured as follows: in chapter one, it will be analyzed how regional governments got control of regional economies and how they obstructed economic reform and transition to the market during the 1990s. In chapter two, the impact of Putin’s federal reforms on subnational governance will be explored. In particular, the institution of the seven federal

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representatives and its impact on the power of the regional executives will be investigated. The third chapter turns to other political initiatives launched under Putin, which have an impact on the power of the governors: law enforcement, fiscal recentralization, reform of the electricity sector, and legislation on debureaucratization. Chapter four examines how the acquisition of regional assets by national-scale firms changes the political economy in the regions. The conclusion sums up the findings and assesses the prospects of economic reforms in Russia’s regions.

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CHAPTER 1 - GOVERNANCE AND ECONOMIC CHANGE IN RUSSIA’S REGIONS

UNDER YELTSIN

This chapter deals with the regionalization of political power and its consequences for economic change in Russia’s regions in the 1990s. The mechanisms by which regional elites gained power and pursued their own economic policies in the regions will be explored. A brief overview on the characteristics of centre-regions relations will be given and the outcomes of the privatization process in regions and the impact of Russia’s peculiar fiscal federalism on the political economy in the regions shown. The question of how the governors used their leeway on the regional economy to conduct their own economic policies will be explored. The main findings circle around how and why regional political and economic elites forged coalitions to distribute the few economic fruits instead of daring further liberal and structural reforms which would have threatened their control over the regional economy.

1.1 The Rise of the Regional Elites and Fall of the Federal Center A retrospective view of the late Soviet period is necessary to understand why regional administrations and the local business elite have a close relationship. Regional officials had close ties with local enterprise directors and used their influence to exercise discretionary power to organize the economic and social functioning of their region. Enterprises that were situated in the region, even if they were not officially subordinated to the local party commission, provided important resources such as funds, material, labor, socio-cultural institutions, social welfare facilities (support for clinics and schools) and housing. ³ The enterprise managers, though not necessarily part of the regional party Nomenklatura, were effectively brought into the regional elite. After the collapse of Communism, in the regions,

³ Slider, Darrell. “Regional Aspects of Privatization in Russia.” In Beyond the monolith: The emergence of Regionalism in Post-Soviet Russia. eds. Peter J. Stavrakis, Joan DeBardeleben, Larry Black, Jodi Koehn. Baltimore and London: The Johns Hopkins University Press, 1997, p. 106.

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even more than on the federal level, a significant change of elite did not occur. ⁴ The regional

elite maintained its cohesion and continued to use the informal networks.

The regionalization of power was also supported by the weakness of the federal centre.

The break-up of the Soviet Union was accompanied by a breakdown of hierarchies within the

state bureaucracy ⁵ resulting in a general weakness of the state. ⁶ The centre was exposed to

political and bureaucratic fragmentation and was unable to pursue a coherent policy towards

the regions. ⁷ In consequence, the federal government’s policies towards the regions were

mainly characterized by the predominance of informal relations, a tendency to bilateral

bargaining (most prominent were the bilateral treaties between the centre and individual

regions), lobbyism, a constant rearrangement of the administrative bodies in charge of centre-regions relations, a policy of favoring some regions and punishing others. ⁸ Moreover, federal

ministries barely coordinated their policies that had an impact on the regions.

The regional branches of federal agencies, including law enforcement, failed to

implement policies that had been adopted by the federal government and were often de facto

dependent on the governors who provided housing and other resources. The most obvious

example of the weakness of the federal centre was certainly the institution of the presidential

representatives for each region. ⁹ The representative was to supervise the implementation of

⁴ Approximately 80% of the former party elite hold important posts in the regional administration and economy.

For a detailed analysis, see Kryshtanovskaya, Olga and Stephen White. “From Soviet Nomenklatura to Russian Elite” Europe-Asia Studies 48, 5 (May 1996).

⁵ Solnick, Steven L. Stealing the State. Cambridge: Harvard University Press, 1999.

⁶ McFaul, Michael. “When Capitalism and Democracy Collide in Transition.” Center for Strategic and

International Studies, Washington, D.C.: Program on New Approaches to Russian Security, Working Paper Series, No. 1, 1997. Michael McFaul defines three criteria for state strength: internal cohesiveness, both ideological and institutional, of the state; the relative autonomy of the state from society (i.e. the degree to which state structures are or are not captive to particular interests); and the ability to implement policy effectively. McFaul comes to the conclusion that the post-Soviet Russian state on all three criteria is remarkably weak.

⁷ As the French political scientist Marie Mendras puts it, “[m]ost of the process of regionalization since the early

1990s has derived from Moscow’s lack of strategy and her failure to devise constructive policies.” Mendras, Marie. “How Regional Elites Preserve Their Power.” Post-Soviet Affairs 15, 4, (April: 1999): 295-311, p. 300.

⁸ Heinemann-Grüder, Andreas. “Putins Reform der föderalen Strukturen: Vom Nachtwächterstaat zum Etatismus

(Putin’s Reforms of the Federal Structures. From Nachtwächterstaat to etatisme).” Osteuropa. Zeitschrift für Gegenwartsfragen des Ostens 50, 9, (September 2000): 979-990, p. 980.

⁹ To be more precise, usually a representative was appointed for one region. In few cases the representative

monitored two smaller regions.

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federal law and provide information on the things going on in the regions. ¹⁰ However, the

presidential representatives largely failed to increase the leverage of the centre on the regions. In comparison to their duties on paper they clearly lacked the administrative resources and were easily co-opted by the governors. ¹¹ Despite all informal cooptation, the federal centre, at

least legally, continued to be responsible for channeling financial funds to the regions, thus retaining a bargaining lever on the regions. ¹² To sum up, a weak federal state was apparent

everywhere in post-Soviet Russia. However, the regions, as states en miniature, managed to perform at least some of the state functions the federal centre was not able to fulfill. 13

1.2 Privatization of large-scale Companies

During the privatization of state enterprises, the regional elite managed to keep control of most large enterprises in the regions. ¹⁴ Regional leaders resisted the privatization scheme

suggested by the reformers within the centre and could force the federal government to make concessions that allowed them to “adapt” the reform in their own favor. Often, the old Soviet directors turned out to be the new de jure owners of the enterprises. Those enterprises that were transformed into joint-stock companies largely remained under control of the regional leadership, which retained a controlling interest in large local enterprises. Usually, regional officials sat on the boards of these enterprises and exerted significant discretionary power over their business. The result was, as Darrell Slider puts it, “formal privatization with little real change in the operating principles of enterprises. Few have attempted to alter the

¹⁰ Stoner-Weiss, Kathryn. “Central Weakness and Provincial Autonomy: Observations on the Devolution Process in Russia.” Post-Soviet Affairs 15, 1 (January 1999): 87-106, p. 101.

¹¹ Stoner-Weiss, Ibidem, p. 102.

¹² Nicholson, op. cited, p. 42.

¹³ Simone Schwanitz argues that “within the Russian Federation regions developed strong states en miniature, being able to fulfill many of the necessary functions demanded by McFaul.” Schwanitz, Simone. “The Influence of Regional and Central Governmental Decision-Makers on Institutional Change in Russia.” Paper presented at the International Conference on Communist and Post-Communist Societies, Melbourne, Australia, 7-10 July

1998, p. 28.

¹⁴ For a detailed analysis of the privatization process in Russia’s regions, see Slider, Darrell. “Regional Aspects of Privatization in Russia.” In Beyond the monolith: The emergence of Regionalism in Post-Soviet Russia. eds.

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managerial or corporate-governance practices that would be necessary for success in a market economy.” 15

In some cases regional leaders tried to consolidate control over regional economies by setting up huge holding companies that comprised a number of important local enterprises. 16

Prominent examples are the Sistema group founded by Yuri Luzhkov, the mayor of Moscow, and the joint-stock company PAKT created by Yevgenii Nazdratenko, the then governor of Primorskii Krai. These arrangements were to prevent outsiders from buying into regional assets and thus threatening the regional elite’s control over local business.

1.3 The Federal Tax System and its Impact on Economic Change

One of the main obstacles to economic reform in Russia throughout the 1990s had been the incentives provided to economic and political actors by the tax system. ¹⁷ Tax

collection was a matter for federal bodies, though regional and local governments (like the federal centre) were and are entitled to adopt independent budgets. All levels of government (whether local, regional or federal) mainly depend on shared taxes for the majority of their tax revenues. The share each level obtained was normally fixed by annual tax laws; in reality, however, it differed from region to region. Furthermore, in the single region the regional government had broad discretion over how large the share is that the localities in their jurisdiction obtain, thus exerting significant power over the municipal issues. Between December 1993 and 1997, regional and local governments were legally entitled to introduce their own taxes within their jurisdiction with rates at their discretion.

Peter J. Stavrakis, Joan DeBardeleben, Larry Black, Jodi Koehn. Baltimore and London: The Johns Hopkins University Press, 1997.

¹⁵ Slider, Darrell. “Russia’s Market-Distorting Federalism.” Post-Soviet Geography and Economics 38, 8 (August 1997): 445-460, p. 450.

¹⁶ Nicholson, op. cit., pp. 28-9.

^{17 For a detailed description of Russia’s tax system in the 1990’s, see Shleifer, Andrei, and Daniel Treisman.} Without A Map. Political Tactics and Economic Reform in Russia. Cambridge: MIT Press, 2000, pp. 113-9.

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After this the ability to do this sustained in practice. ¹⁸ The State Tax Service (STS) - a federal

agency with branches in the regions - was in charge of collecting all taxes, with the exception of custom duties, which were collected by the State Customs Committee. The regional branches of the STS, as with many federal agencies in the regions, in practice had become dependent materially on the support of the regional governments. ¹⁹ What were the various

incentives this kind of tax system gave to political and economic actors? Taxation in Russia created an oppressive burden for business, because of the fact that three levels were trying to receive as much tax as possible and did not coordinate the burden of taxation. Under high formal tax strains, small firms in particular preferred to go into the shadow economy. Although tax sharing is a feature of some other federal states too, in a weak state such as Russia, it gives strong incentives to enterprises to cheat one level of government with the help of the other level. Thus, tax revenues were retained at the regional level by collusion chiefly between regional governments and local large enterprises for taxes to be paid in kind. ²⁰ The

advantage for the regions was that more money remained in the region, which would otherwise have gone to the centre. Another point of criticism concerns the role of the regional branches of the tax collecting agency, STS. Due to the fact that STS is in charge of collecting taxes for three levels of government, local STS officials face an intra-role conflict. They are pressed by all three levels to primarily collect the few taxes that are 100% for the respective levels of government. Thus, the collection of shared taxes is neglected and overall revenues fall. ²¹ In general, the de facto dependence of the regional branches of the STS on regional or

local governments hampers the enforcement of nationwide taxation principles. The amount of tax revenues varies from region to region. In order to prevent too strong regional divergences, a Federal Fund for Regional Support was set up in 1994. The

¹⁸ E-mail conversion with Philip Hanson, 26 August 2002.

¹⁹ Shleifer, Treisman, op. cit., pp. 118-9.

²⁰ Hanson, Philip. “Administrative Regions and the Economy.” Paper presented at the conference Ten Years since the Soviet Union, SSEES, London, 9-10 November 2001, revised draft, 20 December 2001, p. 11.

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majority of recipient regions (subdivided into the categories “needy” and “very needy”) received funds, whereas a minority of so-called donor regions did not receive any transfers. In fact, the system rewarded regions that tried to minimize their official tax revenues. As a Russian observer put it: “Under the current tax system it is beneficial to be subsidized; the worse you work now, the larger the transfer payments you can expect next year.” ²² In the 1990s the federal centre, lacking funds, delegated a number of responsibilities to the regions without giving them the legal power to establish their own base of revenues, such as the right to collect their own taxes. Thus, in many cases regional and local government coopted federal officials in the regional STS branches and, together with local enterprises, circumvented federal tax collection by manipulating enterprises’ official balances. Moreover, enterprises in the regions had to make informal contributions to regional extra-budgetary funds, in order to finance social welfare, subsidies on food products, housing, agriculture and infrastructure in the region. 23

1.4 Regional Governments and Economic Policy

Regional governments used their grip on the local economy in order to conduct their own economic policy. These policies differed from the economic reform policy envisaged by the federal centre and impeded the transition towards a market economy. Of course, economic policy was dependent on special conditions (political regime, economic structure, etc.) in the respective region. However, some general patterns can be outlined here. 24

²¹ Treisman, Daniel. “Russia’s tax crisis: Explaining Falling Revenues in a Transitional Economy.” Economics and Politics (July 1999).

^{22 A.G. Voronin, former deputy minister in the Ministry of Nationality Affairs and Federal Relations, in:} Pskovskaya Pravda, quoted as in Slider, Darrell. “Russia’s Market-Distorting Federalism.” Post-Soviet Geography and Economics 38, 8 (August 1997): 445-460, p. 456.

²³ Heinemann-Grüder, Andreas. Der heterogene Staat. Föderalismus und regionale Vielfalt in Rußland (The heterogeous state. Federalism and regional diversity in Russia). Berlin Verlag Arno Spitz: Berlin, 2000, p. 372.

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