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Putin Fouls his Own Nest

In the early nineties, in the wake of the collapse of the Soviet Union, there was a sense in the American business community that the new Russia would be a land of opportunity. Pepsi and McDonald’s famously set up shop in Moscow, and many other iconic western companies lined up to get in on the action.

There were, it seemed, 140 million people emerging from many decades of economic stagnation, eager to consume the fruits of western capitalism. And consume they did, ravenously.

But by 2001, when Vladimir Putin first emerged on the world stage, the results for American and other western companies were largely disappointing. Progress was absurdly slow, mostly because the Russians themselves made nothing easy.

Graft has always been baked into the Russian business culture. Bribery, extortion, protection rackets, government kickbacks, property seizures, and a robust organized crime community, all do their part in keeping the playing field permanently askew. For those intrepid American companies looking for a foothold in Russian markets, corruption became a cost of doing business — a line item in the budget — and a huge drag on the balance sheet.

And this was just as the U.S. Justice Department was cracking down on that sort of thing. The Foreign Corrupt Practices Act (FCPA) — enacted in 1977, but previously under-enforced — made those bribes and kickbacks illegal under American law. So Americans in Russia — and in other notoriously corrupt countries — couldn’t just pay the bribes and hide them under miscellaneous expenses.

It's hard to stay within those rules and still turn a profit, and a lot of American companies left Russia in frustration. A lot hung in there too. Some doubled down on their investment. Some rolled with the system and achieved real success.

But it was never easy or straightforward, and as Putin amassed more and more power, it became clear that he was putting a much more cynical — and sinister — system in place.

Bill Browder saw this first-hand. He was once the largest foreign portfolio investor in Russia, until his private equity fund, Hermitage Capital, was literally stolen out from under him. An entire billion-dollar company and all its assets were simply confiscated by the government, on the flimsiest of pretexts, forcing Browder himself to flee Russia, one step ahead of the posse. 

Browder’s Russian lawyer, Sergei Magnitsky, was subsequently arrested, beaten, tortured, and denied medical care. He died in prison of untreated pancreatitis.

But unlike others who had similar stories, Browder had the political juice to bring this sordid episode to the attention of the U.S. Congress. This ultimately resulted in the Magnitsky Act, which allows the U.S. government to sanction any foreign actor implicated in human rights abuses, anywhere in the world.

The Magnitsky Act and its associated sanctions hit Putin and his oligarchs where it hurt, and they’re still angry about it. So angry, they went out of their way to subvert an American election and get a Russia-friendly puppet elected president.

One of the most important tasks assigned to Donald Trump by Putin was the swift repeal of the Magnitsky Act. Trump, not surprisingly, failed to do that. Trump’s incompetence was the best thing about him.

But even with all the obstacles thrown in the path of western companies, Russian consumers remained interested in buying their products. A vibrant but fragile consumer culture now exists in Russia, and Russians will dearly miss it when it’s gone. Which will probably be soon.

Russia pays for its consumer goods largely with exports of oil and natural gas. To this day, the exploitation of natural resources remains roughly 60 percent of Russian exports.

They can’t export much else because they don’t make much else that the world wants. The corruption embedded in the system stifles innovation, balloons development costs, and strangles in its infancy any product that might compete in global markets. Russian consumerism depends heavily on foreign goods and services, which makes it more vulnerable to the outside world than most Russians are comfortable with.

This is not the best platform from which to wage war on a neighbor, especially one as resourceful and determined as Ukraine. You can’t help but feel that Putin has fouled his own nest.

Because beyond his warped strategy, beyond his warped vision of a warped Russia that exists only in his warped imagination, he has convinced western companies to do what they might have eventually done anyway — take their business elsewhere.

The invasion of Ukraine has been the last straw for a lot of companies, and they’re pulling out of Russia in droves. They’re cancelling orders, voiding contracts, halting deliveries, leaving behind assets they may never be able to reclaim, and generally making expensive corporate decisions that will not easily be reversed. It’s like they’re imposing sanctions on themselves.

In other words, they’ve chosen to take their losses now. In the case of, say, BP, that’s a write-off of $15 billion, not exactly small change. In effect, BP is making a major investment in getting the hell out of there.

The thinking seems to be that Russia will be excluded from the global business community for as long as Putin stays in power, and probably a good while after that. Yes, Russia will continue to sell gas to the world, but the world is already feverishly pursuing workarounds for all things Russian, especially gas.

With so many companies closing shop, massive unemployment will surely follow. A broad cross-section of the Russian workforce will be losing their jobs just as the ruble tanks, the stock market shuts down, and western sanctions start to really kick in. The business climate has turned ominously cloudy, but most Russians don’t even know it. Yet.

Russia is now an information vacuum, as sealed off from the outside world as it ever was in Soviet times. Everyday Russians have no visibility into the bleak realities of the Ukraine invasion. Using the word “war” in public now carries a fifteen-year prison term.

For many, the first inkling that there actually is a war will come when their Visa card is declined or their ATM runs out of cash. Even then, they won’t believe it, at least not immediately. But it could happen to a lot of Russians this week.

It's hardly fair to compare the looming depression in Russia with the cataclysmic devastation Putin has inflicted on Ukraine. But there is no question that all strata of Russian society will soon feel it.

Will it make a difference? Hard to say. Putin is a stubborn thug, and Russians are a stoic people. As I’ve written previously, privation is a constant theme in their history. In just the last century, they’ve survived multiple catastrophes and homicidal leaders, and they’ve brushed off western-imposed sanctions before. They don’t hunger for democracy, which they’ve never really experienced. And they have a soft spot for tough guys.

Even so, we wonder about a breaking point, and how much pressure it would take for the Russian people to reach one. Or what reaching one would even mean.

It seems we’re about find out.

 

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