Thursday, August 28, 2008

Russia’s Georgian Adventure: Whither an Economic Cold War?

I remember the arcane science of ‘Kremlinology’; sifting through the tea leaves in an attempt to understand the USSR’s objectives and motivations. An East – West studies major at the end of the Cold War at Georgetown’s School of Foreign Service, we were still very much focused on such matters. Within a year of graduating, the paradigm had begun to drastically change with the break-up of the Soviet Union and Warsaw Pact. Within four years, Your Genteel Moderator was writing speeches for pro-market economy politicians in formerly Communist controlled countries and working to acquire privatized companies in Poland, Hungary, [then] Czechoslovakia, the Ukraine, and Russia. The latter was open for business and despite the enormous difficulties of doing business there, from legislative uncertainty to serious issues with currency, foreign direct investment was flooding in at the multi-billion dollar level. One theory, much touted by the Clinton Administration and one of my former professors of “Kremlinology”, Secretary of State Madeleine Albright, was that such investment would so entwine Russia in the global economy as to ensure its commitment to the principles of free-market democracy. I must say, I was dubious after spending time in Russia (including a forced stay in Moscow during the aborted Coup d’Etat in the summer of 1991) and dealing with the Russian government.

Fast forward through the chaos of the Yeltsin years when “bizness” generally meant the expropriation of any state assets one could lay hands on and the swelling of numerous Swiss bank accounts. Pass more slowly through the pendulum reaction of the Putin Presidency when the supremacy of the State, and the Head of State, were reestablished creating an “etatist” economy that closely entwined government, political cronies, and economic strategy, fueled (literally) by ever increasing oil and gas revenues. Arrive at the farce of “President” Dimitry Medvedev’s election and subsequent appointment of Vlaidmir Putin as “Prime Minister” with a substantially increased portfolio of overt powers to bolster his continued de facto control of the State. Russia is a powerful, re-armed, aggressive regional power with substantial wealth, and major leverage (in the form of natural gas sales) over Germany and other Western European nations. Rightly or wrongly perceiving NATO expansion into Central Europe and potentially further east (Georgia’s abortive candidacy was ill-advised to say the least), Russia is using US preoccupation with Iraq (and irony of ironies) Afghanistan to reassert its political and military hegemony over the former USSR states. It certainly doesn’t appear that investment by US and Western European companies has entangled Russia in the global economy to the extent necessary to force more responsible and less hostile activity. The question one has to ask is whether substantial investment in Russia and its littoral states has in fact diminished the US and Western European appetite for confronting such aggression and reverting to a traditional policy of containment?

Despite protestations from both Russia and the West that we are not seeing a return to the Cold War, it is very hard to view this in any other light. Reemerging from a period of military and political weakness Russia perceives the West (and particularly the US) pursuing a policy of encirclement. Its old nemesis NATO is on its western and southern borders with a vastly diminished ring of “buffer states”, the US military is conducting extensive operations along its soft southern underbelly, and a US anti-ballistic missile system threatens to neutralize its strategic nuclear threat. The West is no better. Viewing the inevitable return of authoritarian government in Russia (who could imagine anything else?) as necessarily a threat to security and stability in Europe and Central Asia (granted, with good reason), it has put the boot in with abandon wherever it could from the Ukraine, to former client states like Tajikistan, Turkmenistan, and Kazakhstan, and finally to its courtship of Georgia, all the while decrying the conduct of the Russian government domestically. For Russia, expansion and the creation of buffer states has been an historic imperative from a security standpoint. For the West, containing that expansion and mitigating Russia’s (in whatever guise) influence and power farther afield has been a basic policy since the mid 19th century. Re-emergent Russia means resuscitation of containment in one form or another.

There is however a major twist in this emerging Cold War: a global economy. In the old Cold War, the economic doctrines of Marxist/Leninist Communism in Russia meant that the USSR and its Warsaw Pact satellites were not integrated into an economy that had become increasingly global in scope in the forty some years after the close of WWII. While East – West Trade existed, it was almost always subservient to the political strategies and interests of either party. After 1990, the growth of trade, the substantial inflow of foreign direct investment to Russia, and the substantial capital flight from Russia to investment opportunities around the world contributed the rapid acceleration of Russia’s involvement and participation in the global marketplace. Rising fuel costs in the middle of this decade (driven in part by Russia’s partial success in developing its own economy and, to some extent, by the large expansion in disposable income for a segment of Russian society) have given the country economic muscle and the wherewithal to rebuild its military. Not only has Russia’s emergence as a player in the global economy been one of the forces driving current pressures on commodity and fuel prices, but its control over substantial volumes of commodities as well as its own oil and gas reserves have provided it with leverage over the likes of Germany that even batteries of medium range nuclear missiles couldn’t deliver in the 1980s.

What does this mean for “Western” companies with investments, affiliates, joint ventures, etc., in a Russia that appears set on a course for confrontation with the West? Risk. And risk management. The first thing that any high profile companies with transparent investments in Russia and listings on Wall Street needs to do is take stock of its political entanglements in Russia. Despite the Foreign Corrupt Practices Act (FCPA) and the best of intentions in adhering to it, nobody has been doing large-scale business successfully I Russia without some sort of political entanglement. If confrontation escalates or, perhaps, as conflict escalates between the West and Russia, those entanglements – silent partners, minority JV partners, counselors, “friends”, whatever one is calling them these days – will be the cause of pressure. Whether that pressure is from the West over revelations of such entanglements or through them from the Russian government, now is the time to be cutting them loose or distancing the company from that exposure. As time goes by, this will get harder and the cost of doing so will be higher.
Next, take the “New York Times test”. What will the nature of any transactions, investments, or entanglements look like printed on the front page of the New York Times or Wall Street Journal when the next act of Russian aggression or Western provocation results in something more serious than the annexation of unpronounceable territories at the back end of nowhere? Develop scenarios. Will there be a share-price impact? Will such revelations negatively impact business development efforts elsewhere? Finally, develop contingencies and exit strategies starting now – quietly. Better to run the risk of unnecessary planning now than face the Board’s question as to why you weren’t prepared for this later.

The Bleeding Heart does not share Your Genteel Moderator’s gloomy forecast. Over the phone from Denver, sounding like a teenager on ecstasy at a rave, he assured me that all would be well come November. “When Obama is elected, this gloom and doom atmosphere is going to rapidly change. There will be a new optimism in this country and a new respect for America abroad. He’s going to be able to work with the Russians and others because he believes that talking and negotiating are the way to get things done, not unilateralism and provocation. Investment in Russia has been a good thing and has helped to tame Putin’s more aggressive tendencies.” The Bloated Plutocrat was somewhat less optimistic. “The only thing worse than Godless Communism is Russian Capitalism. My family lost a lot when Russia went Red in 1917 and while I have made a good deal of money through investments and transactions in Russia over the last 15 years, I am divesting rapidly. Whether this President or the next does something stupid to set them off is irrelevant. The rules have never been fair and the market has never been free in Russia, but with the return of increasing political and security tension on the geo-political level as well as the significant economic risks, the costs of doing business there are simply going to be too great in the not so distant future”.

To be sure, in any time of political uncertainty there is money to be made. That will be true in Russia for the foreseeable future. What many need concern themselves with is that there is also a great deal to be lost, and it will be the re-emergence of the dialectic between Russia’s urge to expand and the West’s perceived need to contain, with a new global economic twist, that will govern the risk/return ratio in Russia and Central Asia for some time to come.

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