Putin's third way.

• Author: Gaddy, Clifford G.
• Position: Vladimir Putin

Speaking to a group of foreign investors on October 20, 2008, Russias prime minister, Vladimir Putin, boasted that in contrast to policy makers around the world, including those in the leading international financial institutions, he had not been caught unawares by the present financial crisis. While "all of them" were unprepared, he said, "we did not allow ourselves to be caught by surprise. When we formulated our long-term economic and financial policy, we took into account potential risks and threats." Alluding to his insistence on building up huge financial reserves, Putin noted, "We were sometimes even criticized for being too conservative. Well, I think that conservatism proved justified."

Was Putin really so prescient? The simple answer is no, Putin anticipated neither the exact timing nor the nature of this crisis. But in a more important sense, he did prepare. For eight years Putin pursued two main economic-policy priorities. One was to set up a system that could maximally exploit the advantages of the market economy while ensuring that the interests of private business owners would always remain subordinate to the strategic interests of the state. The second priority was to make the Russian economy robust to crisis. The dual policy objectives of optimal efficiency and maximum robustness to short-term shocks are inherently in tension. They cannot be permanently reconciled. Rather, they require continual balance. Until now, the balance has been struck such that there is a firm commitment to market methods and an openness to the global economy. But whether this can continue in the face of a much deeper and prolonged crisis has implications not only for Russia's short- and long-term economic development--especially in the critical oil sector--but also for the country's geopolitical behavior.

As Russia's leader for the past nine years--in the posts of prime minister, president and then again prime minister--Putin has presided over one of the fastest-growing economies in the world. Until very recently everything seemed to go his way. When he began his tenure, the economy was on the rebound from the 1998 financial collapse. That crisis had briefly paralyzed the economy, but because it also resulted in a fourfold devaluation of the currency, it gave a boost to domestic goods-producing sectors, like the food, auto and consumer-appliance industries, that had previously been swamped by foreign imports. By the time Putin took over, the recovery was already under way. Later, as it slowed, the oil boom took off. The rise in the world oil price from its 1998 low of under $10 a barrel to over $140 in 2008 transferred a vast amount of extra wealth to Russia. During Putin's eight years as president, Russian oil and gas companies earned over $650 billion more from their exports than in the previous eight years under Boris Yeltsin.

The oil and gas wealth was leveraged to other sectors, mainly through the channel of consumer spending. Strong growth in personal incomes boosted the retail, construction and real-estate sectors. The stock market's rise reached bubble proportions. In the spring of 2005, the market value of the companies on the country's benchmark stock exchange, the Russian Trading System (RTS), was around $300 billion. A little more than three years later, the figure was nearly $1.4 trillion. Predictably, the global crisis--and especially the oil-price collapse--hit the stock market with a vengeance. As the price of oil has fallen back to its early 2005 level of under $50 a barrel, so too the RTS capitalization is rapidly falling down to the value it had previously.

As in the rest of the world, the severity of the current global crisis and especially its effects at home were slow to be acknowledged in Russia. Most of that complacency is gone now. Across the economy, from the federal and local governments to companies and households, Russians are scaling back on expectations they held only weeks earlier. Politicians in Moscow and in regional centers do not hesitate to refer to the situation of the past three or four years as a bubble, and warn that budgets will have to be revised and personal incomes will not grow.

It is impossible to predict whether there will be serious long-term ill effects. As in any bubble, economic agents at all levels made mistakes; that is, they made consumption and investment decisions that would not have been justified in nonboom conditions. But the bubble period was relatively brief at only three years. Whatever mistakes were made in that time pale in comparison with the misallocation of resources that took place during seven decades of Soviet management of the economy. Overcoming the structural legacy of communism remains the long-term problem. Here, far too little has been accomplished under Putin. This is the other side of the "conservatism" in economic policy of which Putin boasted. While Putin and his associates regularly devote much rhetoric to the need to address the deep-seated problems of the Russian economy--the inadequate and deteriorating infrastructure, outmoded physical capital, and the demographic and health...