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. Last Updated: 07/27/2016

State Capitalism as a Model for Development

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In the last five years, the weight of state-owned firms in the Russian economy has expanded dramatically, leading some observers to speak of a reversal of market reforms. Such concerns are overstated, however. Neither the behavior of the state-owned enterprises nor the environment in which they operate recall the pre-reform era. Indeed, much of the state-owned enterprises' expansion reflects the commercial, profit-driven ambitions of their leaders rather than a coherent policy rationale. The government's main challenge is not to ensure the microeconomic efficiency of state-owned enterprises, but to make sure that the their expansion does not threaten its other priorities.

According to researchers at Alfa Bank, in the middle of 2003, state-owned stock was worth about 20 percent of the capitalization of Russia's stock market. By early 2007, the state's share had topped 35 percent. Much of the growth represented a buying spree by state-owned enterprises, especially Rosneft and Gazprom. Among the largest acquisitions were major assets confiscated from the private oil company Yukos in lieu of tax debts; Rosneft purchased these debts and thus became the country's largest producer of crude oil. Gazprom, for its part, purchased the private oil company Sibneft for $13 billion in 2005. It agreed to spend more than $7 billion in 2006 to buy a share of the Sakhalin-2 oil project from Royal Dutch Shell.

Hydrocarbons are not the only industry to witness the trend. In the banking sector, state-owned VTB has acquired private rivals. Defense firms in aviation and shipbuilding are consolidating into large conglomerates under state control. The state's arms export firm, Rosoboronexport, has taken control of assets in metallurgy and carmaking.

Because privatization is so closely identified with economic reform, some observers have seen growing state ownership as evidence of a reversal of reform. Such judgments, however, obscure the shifts under way by implicitly associating contemporary state-owned enterprises with the rickety enterprises of Soviet-era ministerial bureaucracies that Moscow privatized in the 1990s. State-owned enterprises operate on international capital markets in ways that radically differ from practices in the pre-privatization era. They have borrowed huge sums on international markets to fund their acquisitions. Rosneft took on $22 billion of debt in early 2007 for the purchase of Yukos assets, and Gazprom is seeking $12 billion in new financing for its entry into Sakahlin-2 and other purchases.

Even though the majority of their shares are held by the state, all major state-owned enterprises view stock market capitalization as a crucial measure of their performance. Gazprom has liberalized circulation of its stock, unifying long-segregated foreign and domestic markets; with a capitalization of more than $220 billion, it is now one of the world's most valuable firms. Rosneft, VTB, and Sberbank have held initial public offerings for a portion of their shares.

Beyond raising general concerns about the microeconomic efficiency of state-owned enterprises, some observers have suggested that the slowing growth in domestic oil production since 2004 underscores the negative side of state expansion. But rapid oil production gains in the prior years were largely a one-off, short-term opportunity to use new technology to improve yields from mature fields discovered in the Soviet era. Gazprom and Rosneft seem to be managing their newly acquired oil fields no worse than Sibneft and Yukos did before them.

Ironically, the expansion of state-owned enterprises is creating the greatest challenges in areas where one might expect state ownership to confer an advantage -- fostering a coherent set of priorities and a long-term focus. Their massive foreign borrowing is a primary example. When these loans are converted into rubles, the money supply expands, contributing to Russia's core macroeconomic dilemmas of inflation and real exchange rate appreciation. Borrowing has been especially intense recently. In the final quarter of 2006, foreign indebtedness of state-owned banks and other firms grew by $13.9 billion, nearly 19 percent. Capital inflows for 2006 reached a record $40 billion, a figure that was nearly equaled in the first five months of 2007 alone.

Finance Minister Alexei Kudrin and other government officials have called for a slowdown in foreign borrowing, and they have pushed state firms embarking on IPOs to seek capital from the ruble-holding public instead of relying solely on new funds from abroad. Macroeconomic factors limit how much incoming investment Moscow can effectively absorb. The state must thus regard international financing as a scarce resource and take steps to ensure that it is directed in line with long-term development priorities. At the moment, however, state-owned enterprises are directing these scarce resources not to production projects, but to empire-building acquisitions, saddling themselves with large debt burdens that could be a barrier to their subsequent development.

Gazprom is the most important example. As gas consumption rises with economic growth and as deposits in developed fields dwindle, the company will need to make large investments in new fields to meet demand. But Gazprom has not made these investments a priority. Instead, it has raised capital to bring more assets under its control. The oil and gas giant is presently poised to significantly widen its presence in the power generation sector, where assets are now being sold off as part of efforts to promote competition and attract investment. Despite objections from the state's anti-monopoly agency, Gazprom is also likely to win approval for the purchase of coal producer SUEK, which would leave it controlling nearly 40 percent of the country's coal output. Thus, Gazprom's acquisitions threaten to undermine the competitive logic of the intricately crafted electricity sector reform.

In other sectors, however, state-owned enterprises do not threaten to reduce competition (to the extent that it exists to begin with). Banking has been dominated by state-owned entities since the 1998 financial crisis, and acquisitions by state banks do not significantly change the competitive balance in the sector. In carmaking, foreign companies are building significant new capacity. Private companies will likely continue to play a central role in the production and refining of oil.

In assessing the growth in state ownership of the economy, the key issue is not the precise percentage of assets owned by the state. Indeed, this is likely to shrink in the medium term. Even though many energy system assets will wind up under the control of Gazprom, others will pass to the private sector. Heavily leveraged state-owned enterprises are also likely to engage in additional share offerings to pay down their debts. This reversal, should it occur, would not resolve the major difficulties revealed in the their acquisition boom. Russia's macroeconomic situation limits the volume of foreign investment it can accept without severe inflationary consequences. It needs to take steps to insure these funds are directed not to reshuffling ownership, but to productive investments for the long term.

So far, expanded state ownership has failed to accomplish this urgent goal. This may cast a long shadow over prospects for converting Russia's current economic boom into sustainable development, the benefits of which are broadly distributed across different regions and social groups.

David M. Woodruff, lecturer in comparative politics at the London School of Economics, published this comment in Development and Transition Newsletter, produced by the United Nations Development Program and the London School of Economics.