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. Last Updated: 07/27/2016

Raising New Doubts About State Capitalism

Last week, we were once again warned about the possible perils of state control in Russia -- this time by no less than President Vladimir Putin's top economic adviser, Arkady Dvorkovich. In a speech to a conference, he cautioned that further expansion of state control to other specific sectors of the economy could hurt economic growth.

Except for a self-interested group of economically illiterate people who are unfortunately well connected to the power vertical, Dvorkovich's observation is obvious and noncontroversial. Is there a cause for concern? How likely is the extension of state control over the economy? And can Russia's economic steamroller be stopped as a result?

To begin with, there is no simple concept of state control. It has many meanings in global practice, a number of which could apply to the country, going well beyond government ownership of companies.

For instance, it can describe a partnership of government and big business, where the state is intervening on behalf of large companies, in contrast to laissez-faire capitalism, where big business isn't protected from market forces. Alternatively, it can describe a close relationship between the government and private sector, with private companies producing for a guaranteed market. An example of this would be a military-industrial complex in which companies producing under government contracts aren't subject to the discipline of competitive markets. Another example: exporters that benefit from cheap state credit or guarantees.

The idea of state control has strong historical roots that vary from country to country and over time. State control has suggested itself as a reaction to economic collapse and sector decline or to ensure operation of a natural monopoly. Imitating the "infant industry" argument as a development model, some were inspired by the examples of earlier Japanese or Korean economic miracles.

A variant on this theme used by supporters of state control is the need to create national champions in response to globalization, already a supposedly worn-out idea borrowed from West European experience. Socialist ideology, of course, has also been a key factor behind nationalization in postwar Britain and Francois Mitterrand's France.

Clearly, state control exists to some extent in all countries. So, it is understandable that there is support in the country for some major role for the state. And those who favor greater state control, whatever their real motives, are not shy in using the above arguments. In fact, Russia has belatedly joined a crowded field where state ownership of the so-called "commanding heights"-- to use Lenin's phrase to describe strategic sectors -- is common.

State control, as a policy, is subject to fashion. Since Milton Friedman's influence on the Reagan-Thatcher era and the fall of the Berlin Wall, much of the world has moved away from direct state ownership to a more regulatory or partnership mode with the private sector. So Russia seems to be bucking the global trend toward privatization. But this should not hide the fact that there has been a rampant increase in government interference in the form of regulation in various guises. Public-private partnerships have become the new flavor of the day.

Before jumping to conclusions, it should be noted that, according to the European Bank of Reconstruction and Development, about 35 percent of gross domestic product is from the public sector, well below West European averages and only slightly higher than in the United States.

So, going beyond the rhetoric, is there a problem with state control in Russia? In some sectors, such as energy, the state role is understandable even if the costs of extensive state ownership are high. The state also dominates in banking, aircraft, shipbuilding and now nanotechnology. The latest on the list is Russian Technologies, which plans to develop heavy industry. And Dvorkovich referred to proposals from government ministries in recent months that called for state companies to run the fishing industry, build roads and produce pharmaceuticals.

The concerns expressed by Dvorkovich are warranted. Even while appealing in theory, the practical experience of state control is not inspiring. With few exceptions, in most countries state-controlled enterprises are associated with waste, corruption, overstaffing and underperformance -- all of which constitute a huge burden on the economy. And in a country like Russia, where the principal challenge is to develop trained, competent and honest managers -- especially in the public sector -- the last thing the country needs is to bring more of its economy under the control of state managers. This has to be a sure recipe for more rent-seeking behavior by bureaucrats and state managers and for more corruption.

Before condemning this apparent trend in Russia, however, we have to acknowledge that the experience in every country is different. Although a few years ago the International Monetary Fund was somewhat sceptical about the prospects for Moscow's stabilization fund, few now doubt that the fund has had unprecedented success in preventing Russia's economy from being infected by the Dutch disease, which is caused by rapid and extensive currency appreciation. By analogy, it is not a given that state control will fail, although it is quite likely.

And it is hard to argue with Russia's success so far, even if energy prices played an important role. The economy has been growing an at average rate of almost 7 percent for eight years in a row.

Moreover, there is a real difference between the modern Russian experience and international precedents. State control is not driven by ideology but by raw greed disguised as patriotic necessity -- or worse, as economic rationale. This is by no means a return to a Soviet model.

Since the people who support the extension of state control are driven by their own self-interest, we can expect that they will go to great lengths to preserve the gains of their asset grab. In this sense, the country's experiment with an expanded state sector could be short-lived. The newly installed state-appointed managers and directors of these enterprises will want to ensure that they and their progeny continue to enjoy the lifestyles created by their control over state assets. The only way to do this is to privatize a certain percentage of the companies over time with big chunks of shares going to those currently in control. The recent flurry of initial public offerings is likely to continue and perhaps intensify in the year ahead, financial market conditions permitting. Deplorable as it may be, this scramble for assets cannot come as a big surprise.

Dvorkovich is absolutely right -- particularly so at a time when the formula for success of the past eight years is unraveling. For instance, the country's external current account balance will be in deficit by next year, and the days of easy productivity gains through the better use of installed capital will give way to an era when new capital investment is crucial. Without a significant contribution by the private sector, including foreign direct investment, the country could face real medium-term risks. Already, Russia pays a price in terms of foregone growth, jobs that are not created, new skills that are not developed and competitiveness that is lost.

Putin understands this, even if all of his entourage does not. We can only hope that during this period of political transition, he will be able to keep the greed of his acolytes in check.

Martin Gilman, a former senior representative of the IMF in Russia, is a professor at the Higher School of Economics in Moscow.