Putin's Tall Order

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One curious feature of Russia's bureaucracy is that the more incompetent an official is, the more likely he is to be rewarded and promoted. This rule has endured under various regimes, from the 19th century to the Soviet period and on to present-day Russia. It provided fodder for generations of Russian satirists, from Gogol to Saltykov-Shchedrin and from Ilf and Petrov to Vladimir Voinovich.

It was no different during Vladimir Putin's two terms as president. Mind-boggling incompetence and grotesque blunders were never a cause for dismissal. Take, for example, the Beslan tragedy; no top officials in the security agencies ever lost their jobs as a result of their negligence.

But in September, there was something of a departure from the usual modus operandi. A modest Cabinet reshuffle resulted in the elevation of Finance Minster Alexei Kudrin to the rank of deputy prime minister. Putin seemed to be rewarding one of the most competent ministers in recent governments. Since being appointed in 2000, Kudrin had earned the trust of financial markets, foreign investors and Russia's own business establishment by maintaining financial stability. Deliberately apolitical, he was able to keep inflation under control by resisting populist calls to hike public spending and counteracting the effects of rising oil prices and inflows of dollar liquidity with tight monetary policy. At the same time, he performed a difficult balancing act on the ruble, allowing it to appreciate gradually in response to upward market pressures but keeping it from becoming dangerously overvalued.

Now, with Putin as prime minister, Kudrin will give up some responsibilities outside his immediate Finance Ministry mandate. They will be assumed by Igor Shuvalov, the new first deputy prime minister, who will nominally be Kudrin's senior in the new Cabinet. But it is probably not a demotion in the end.

Kudrin's success in curtailing inflationary pressures has been all the more impressive since Russia is not, strictly speaking, a free-market economy. It has a market where prices are set more or less freely. But its market is overlaid with leftover government regulations and an extensive and inefficient social-services network. More important, it is larded with layers of bureaucracy that boost prices and restrict competition.

As a result, even when inflation reached its lowest point last year, it was still among the highest in major emerging economies, on par with Argentina and Venezuela. In recent months, domestic inflation rose as global food prices increased. Russia's economy is simply not flexible enough to absorb external price increases.

Under Putin's second term, financial regulations were loosened and currency controls removed, but the stranglehold of the bureaucracy on the country's society and economy has, if anything, tightened further.

Dmitry Medvedev has been talking the liberal talk since emerging as Putin's potential successor last year, but this is no choreographed good-cop bad-cop routine. Medvedev probably is more pro-Western and more pro-market than his mentor -- if only because he comes from a different generation. Just as the Soviet Union collapsed only after the Stalinist gerontocracy died out, so the remaining Soviet mentality will be wrung out of Russian society only when the last former Soviet citizens leave the stage. Medvedev was about 20 years old when Mikhail Gorbachev initiated his perestroika. He is the first Russian leader of the post-Soviet generation.

Putin seems to be going along with Medvedev's desire for reforms because he dreams of making Russia great again before he permanently leaves the political stage. He genuinely believes that the country could become a global center of science and technology once again, while also emerging as a European financial capital on the par with Frankfurt, if not London. All this will remain a pipedream without in-depth political and economic reforms.

Even more important, the siloviki have grown increasingly confident now that Putin has engineered a smooth transfer of political power. They want to make sure that the economic system in which they have come out on top remains viable.

This is similar to what happened to 1990s-era oligarchs like former Yukos CEO Mikhail Khodorkovsky. Initially, when they first acquired their oil companies, they had a take-the-money-and-run mentality. As time passed, they realized that they could become much more wealthy if they invested into their companies and made them more investor-friendly.

The oligarchs' wealth was largely expropriated by ex-KGB men and others in Putin's entourage who now run state-controlled companies and are the main beneficiaries of Russia's natural-resources wealth. They want to preserve this situation, but to do so they need Russia to remain stable. In other words, they want to make sure that the population stays contented and that the economy provides goods and services at moderate prices.

Shuvalov has worked on priority national projects in the Kremlin, and his new job in Putin's government will likely be creating a viable, thriving small and medium-size business sector that would offset the unwieldy, inflexible state monopolies in the "strategically important sectors," such as oil and gas. If he succeeds, he will make Kudrin's job of maintaining monetary stability easier.

But in order to do so he will have to take on the country's rapacious, corrupt bureaucracy, which has been growing steadily bigger, richer and more powerful. It is an extremely tall order.

Alexei Bayer, a native Muscovite, is a New York-based economist.