The role of the state in the economy has been a topic of great interest. Some follow the Hobbesian view and trust the responsibility of the state to play an active part, creating supporting institutions and providing effective regulation. Others adopt Locke's approach and consider government interference to be harmful in that it reduces economic efficiency achieved by private players, who call for a natural evolution of property rights. In this paper, I argue that the function of the state is highly dependent on the country's entrenched customs and traditions, political rule, and subsequently, its legal developments.

For instance, one of the most widely accepted arguments against state's involvement in economic affairs is that delegation of power to the government is often not matched by its credible commitments to other players. In their famous work, North and Weingast (1989) provide an example of 17^th century England, where the revenue-seeking Crown continually dishonored its contractual conformities, and was subsequently stripped of its monopoly decision-making power to allocate funds. The ruling power of the Crown was replaced by political institutions, which enforced ex post contractual agreements. The new redistribution of control resulted in the emergence of greater political and civil freedom, as well as the ability of the sovereign to credibly commit to protecting private property rights. The success of these new institutions is linked to England's economic development.

Yet, at the same time, the authors point out that the reforms did not arise naturally — it is unlikely that the present governing institutions in England would exist had the Crown had an army to suppress the opposition. More importantly, the new hierarchies (the Parliament, the Whigs, etc.) did not operate in a country without a — although somewhat weak — legal system. Magna Carta, an English legal charter, which was originally issued in 1215, revealed certain individual rights which were bounded by law.No Freeman shall be taken or imprisoned, or be disseised of his Freehold, or Liberties, or the free Customs, or be outlawed, or exiled, or any other wise destroyed… We will sell to no man, we will not deny or defer to any man either Justice or Right.(Clause 29, Magna Carta 1215)

In other words, the concept of private property rights was not unfamiliar to England before the Glorious Revolution. Economic agents identified substantial gains to be made from long-term commitment, and wealth expropriation by the Crown was seen as a hindrance to achieving economic prosperity.

Similarly, Weingast (1995) attributed the success of the US common market, characterized by strong protection of property rights, to the federalism system, which allowed the states to have the power to supply their citizens with public goods, but limiting these powers to a particular region. However, the author states that such restrictions were made credible by a combination of formal institutions and informal norms that regulated the behavior of economic agents.Market-preserving federalism was the product of a historical process resulting in a strong consensus supporting these limits…and rested on the fact that the vast majority of the population consistently favored policies and parties limiting the federal government and protecting economic rights.(Weingast, 1995, p. 26)

By examining the innovations that focused on lowering transaction costs in mercantile early modern Europe, North (1991) drew attention to the evolution of capital markets, an important component of which was well-defined property rights, facilitating trade and investment. North believed that the increasing enforceability of contracts, a process which was aided by an improving legal system, was the product of “the long evolution of merchant law from its voluntary beginnings and the differences in resolutions that it had with both the common and the Roman law are a part of the story” (North, 1991, p. 107).

However, not all countries followed institutional development course of England, the US and Europe. Russia's political and institutional evolution can be contrasted to that of the above. In Russia, traditional authoritarian rule continuously impeded the development of a strong legal system.Lawyers! What is the use of so many? I have only two in my whole empire, and I mean to hang one of them as soon as I return.(Peter the Great on his travels to London in 1698. Quoted in: Smith, 1996, p. 1)

Ill-defined property rights hampered the formation of business strata in Russia, reducing the necessity for appropriate market infrastructure. The persistent absence of the necessary prerequisites for a market economy also implied that if Russia's political and economic system had more than one competing hierarchy, such as truculent members of the lower classes of bureaucracy, the objective of the elites would not have entailed long-term economic growth, for the gains from short-term wealth siphoning would have been much larger. Indeed, for early as the mid-16^th century, the ruling dynasty believed that the oligarchy was undermining Russia's economic progress, subsequently implementing an extremely autocratic regime (Yanov, 1981). Later, under the “enlightened” Peter the Great, the centralized authoritarianism directed Russian industry to “westernize” (Pipes, 2004). One of Peter's rationales for centrally directing his “modernization” was his need to overcome the truculence of many members of the lower state bureaucracy, many of whom were known as boyars (Raeff, 1962). The latter remained locked in protecting their feudal privileges, and therefore opposed the introduction of western-style, commercially dominated cities, while suspecting that new economic reforms were incompatible with the survival of the old empire. The tradition of centrally imposing commercial revolutions was reaffirmed during the reign of Nicholas II at the end of the nineteenth century, when the Stolypin and Witte reforms served to spark Russia's incipient industrialization. Once again, modernizing reforms were rigorously opposed by the overwhelming mass of the conservative bureaucracy of the period (Holzer and Illiash, 2009).

Similarly, Russian privatization process can be described as a recent example of several competing hierarchies operating in an environment without clearly-defined property rights, where private economic agents became free to acquire state's assets without any regulatory framework (Stiglitz, 2002). As previously mentioned, several elite groups, such as new “businessmen,” or oligarchs, and regional government officials were formed, and they did not find it profitable to make long-term commitments and invest into their corporations. In the absence of supporting institutions, it was far more lucrative to engage in asset-stripping (Black et al., 2000; Sonin, 2000). Each of the hierarchies, having attained considerable political and economic power, competed rigorously with each other for resources, eroding the nation's wealth at an even faster rate (for example, Ponzi schemes carried out by the newly formed Russian banks, see Pistor and Spicer, 1997; Laeven, 2001). It is therefore unsurprising that the Putin administration reverted back to the traditional “top-down” control strategy and forced oligarch quasi-owners and regional bureaucrats to give up their power (Goldman, 2003; Tompson, 2005).

With Vladimir Putin coming to power, the central government focused on taking control of the commanding heights. The “day of the oligarchs” was truly over, and regional officials no longer controlled parts of Russia's economy. Any remaining 1990s business elites were expected to fully cooperate with the state's economic objectives and assist in Kremlin's domestic and foreign policy initiatives (Aris and Marshall, 2004). At that time, many scholars drew attention to the rise of the new elite. Siloviki, who were seen as Putin's trusted men and represented security service and law enforcement veterans, became the pillar of the new administration. They were placed on company boards, particularly in industries of national importance, in order to enforce the regime's policies and to safeguard company assets. In contrast to the oligarchs, siloviki exercised their power through managerial positions rather than ownership. They saw their role as to reverse problems created by the oligarchs, reintroduce hierarchical loyalty, and, above all, protect national interests (Treisman, 2007). Similarly, trusted government officers were put in charge of the seven “super-regions,” which were created to reverse the leakage of power to regional bureaucrats (Rutland, 2000; Orttung, 2001; Hashim, 2005).

This paper adopts the view that siloviki did not represent a separate elite — they merely served as a conduit for the central government, through which the new policies were channelled. In addition, I highlight the fact that although after a brief experiment with laissez-faire policies Russia was once again drawn to its long-standing tradition of authoritarian rule, the new regime did not revert back to state-controlled economy; instead, the government aspired to become an effective partner with private investors. It aimed to promote long-run economic growth, which was to be financed through a mixture of state subsidies and private investment funds. The government recognized that in the absence of efficient Western-type institutions, investors faced significant transaction costs that would result in underinvestment, if the state did not introduce some effective substitute.

The next section introduces two related hypotheses. First, it is proposed that given a persistently weak legal environment, the central state did not allow competing hierarchies to exert influence on the economy and it implemented its strategy by positioning itself as the leader in a Stackelberg game, whereby it promoted corporate growth by encouraging private agents’ operations through a combination of free-market and state-mandated policies, but also induced severe punishment for contractual non-compliance. The Stackelberg model shows that the incoming regime did not aim to rebuild old Soviet institutions, but focused on restoring order and protecting national economy from the elites’ concentrated economic and political power.

Second, as such games were more costly across industries with large sunk costs and high asset specificity, where firms were not only characterized by high hold-up costs, but also bigger international scandals, the state chose to form state-private co-partnership systems with private investors. In this partnership, the state played a major role in firm corporate governance and could therefore avert rent-seeking behavior from the outset, thus minimizing misappropriation of both government and private investors” funds in the absence of well-defined property rights.

This section outlines a model adopted by the central state in order to enforce contractual compliance of private decision-makers. The model can discourage short-term rent-seeking behavior by allowing the state to execute punishment if a decision-maker chooses to pursue wealth tunneling objectives. It is argued that the model was developed in response to the legacy of previous regime's reforms, which empowered the rising elite to take advantage of an open but weak political system and use their ill-gotten wealth to buy media coverage, as well as state officials, in order to further their interests and to strip the nation's assets.

The state, which acts as the Stackelberg leader, passes laws that address protection of investment funds. It knows that, due to a poor legal system, the laws may not be effectively enforced. The government also acknowledges that a private decision-maker (for example, firm manager) can be non-cooperative and ignore the law if the expected return from short-term wealth tunneling is higher than that from a long-term investment commitment strategy. Therefore, the state develops a punishment strategy, which it imposes on private decision-makers if they do not conform to the implemented policy. If the penalty is severe, it is in the best interests of a private decision-maker to conform.

Fig. 1 shows the state acting as the Stackelberg leader. The maximum payoff the state can achieve is represented by π, while the corresponding payoff to a private decision-maker is (1– s)π /n. However, π is also unattainable, as it can only be accomplished by not inducing a punishment mechanism, with private agents still credibly committing to honor their contractual obligations and not adopting short-term investor expropriation strategy. However, one can see that given the no-penalty option, agents can obtain a larger profit of m ((1– s)π /n), where m corresponds to a positive coefficient obtained by not conforming to the state's policy and cheating, leaving the state with a smaller profit of απ. The state anticipates such opportunistic behavior, and introduces a punishment strategy at cost c in the initial period. The cost of punishment leaves the state with a reduced profit of π – c, yet one can see that the outcome π – c, ((1– s)(π – c)) /n is the only equilibrium in this game, because by choosing the “not to conform” option with a punishment strategy already in place, private agents will create an even smaller profit for themselves, as well as the state.

Fig. 1

The state acts as the Stackelberg leader in a two-player game between the state and a private decision-maker.

Perhaps the most apparent example of this game was the prosecution of the head of Yukos oil company, Mikhail Khodorkovsky. In 2003, the richest oligarch was accused of engaging in extensive asset-stripping, as well as using his position to bribe local bureaucrats. The federal government placed Khodorkovsky under arrest for tax evasion and Yukos assets were subsequently sold to the state-owned company Rosneft. By executing such punishment the state sent a clear message that Kremlin will not be challenged by the elite, who became accustomed to fusing their political and economic power (practice that western institutions vetoed since the 1920s). Other oligarchs, who were subjected to similar fate included Boris Berezovsky, who initially made gains from channelling money from a motor company Logovaz in the 1990s and later set his interests on Aeroflot, Sibneft and Russian Public Television. In an attempt to cement his power over the Russian economy, Berezovsky also expressed keen interest in politics, which resulted in his exile to London in 2000. Vladimir Gusinsky, who successfully created a media empire and used his position to influence politics in order to usurp further wealth, also found himself in exile (Sakwa, 2008). The punishment strategy signalled that the only way for the oligarchs to participate in economic transactions was to accept the government as the Stackelberg leader, who inevitably dictated the rules of the game. Evidence suggests that Kremlin allowed several oligarchs to maintain their empires as long as their behavior did not disrupt the state's strategy (Goldman, 2003). For example, Oleg Deripaska, Vladimir Potanin and Roman Abramovich still controlled metal mining empires, but they had to adhere to certain conditions imposed by the state (such as Abramovich selling his major ownership stake of oil company Sibneft to the government). In sum, the oligarchs had to become servants, as opposed to competitors, or opponents of the regime (Lavelle, 2004).

Now consider what happens when private decision-makers become leaders in the Stackelberg game (Fig. 2). By gaining the first-mover advantage, private agents can attain their maximum payoff of m ((1– s)π /n) by choosing the “not conform” option, knowing that if the state punishes them in this period, it receives the smallest profit generated by the game. This strategy leaves the state with a much reduced payoff of απ, and represents a weakened government, which is frequently vulnerable to oligarch power wars (for example, the notorious “loans for shares” scheme of the mid 1990s).

Fig. 2

A private decision-maker acts as the Stackelberg leader in a two-player game between the state and a private decision-maker.

From the outcomes produced above, one can see that in the absence of strong property rights, it is socially optimal to re-establish the state as the market leader, because such organizational structure can better secure long-term investment funds. The government is able to place constraints on private decision-makers and thereby limit their abilities to engage in short-term predatory behavior by forcing them to conform to state's anti-expropriation policies. This approach enables the state to obtain its maximum attainable payoff (which also corresponds to the social optimum), and it also enables private agents to make a profit.

While the Stackelberg game strategy between the state and private decisionmakers ameliorates rent-seeking, one must also draw attention to c, or cost of implementing punishment. The government has to spend substantial resources to monitor the behavior of private decision-makers, as well as absorb the cost of investment scandals. For instance, there were numerous reports referring to continuous government interference in the operations of private companies (Buck, 2003), especially if these companies belonged to industries of national interest, such as the oil sector (Finon and Locatelli, 2008). Such practices culminated in internationally-condemned business environment, which deterred global investors from entering the Russian market (Hanson, 2007). McFaul and Stoner-Weiss (2008) argued that the regime focused on “rolling back democratic gains” in exchange for stability and growth.

Therefore, as the punishment strategy may not always be the most efficient policy, I argue that the central state often opted to create a direct partnership with private investors. By acquiring a large proportion of capital in many enterprises, the government became a major partner in firm decision-making process and had the authority to block predatory behavior (Nikonov, 2005; Tompson, 2008).

From the theoretical perspective, Russia's choice of economic organization is a response to the existence of severe transaction costs and to subsequent mitigation of contractual incompleteness in the absence of a strong property rights system. In the Russian economy, many large fixed investment projects, which have significant sunk costs and can be defined as long-term to maturity, are undertaken. In the absence of a well-defined legal code or some effective substitute, one ex ante expects high hold-up costs, and high hold-up costs lead to a high level of underinvestment, particularly in strategic economic sectors, which are also characterized by high asset specificity (Klein et al., 1978; Williamson, 1979). While it is believed that Russian firms have benefited from stringent corporate governance reforms (Yakovlev, 2003; Lazareva et al., 2007), one cannot expect a rapid emergence of an appropriate legal system, which can assure private investors of their expected returns. Subsequently, in more vulnerable industries a second-best corporate governance mechanism has arisen in the form of the state–private co-ownership system, which can act to monitor the behavior of corporate insiders and constrain their wealth tunneling objectives until Russia develops a secure property rights system.

Grozovskiy (2007) and Hanson (2009) showed that the political regime of the 2000s eschewed renationalization of enterprises and instead increased its stake in corporate equity from 20 percent to just under 40 percent between 2003 and 2007. Sprenger (2010) also drew attention to significantly increased government control over the country's largest enterprises. Above all, the state targeted energy sector firms, as Russia's economic revival depended on the ability of the state to collect energy sector rents, while offering investors their expected rate of return (Butt et al., 2008). Foreign investors were also encouraged to form partnerships with the state (Erochkine and Erochkine, 2006; Hanson, 2009). It is reported that over 40 percent of the 500 points Russian stock market growth during the 2000–2006 period was attributed to two major energy companies, namely Gazprom and Rosneft, which introduced partnerships between the state and private investors (Harris, 2009). However, Tompson (2008) and Vanteeva and Hickson (2016) went a little further by showing that state participation also increased in industries such as utility, metallurgy and mining, transport and manufacturing (see Table 2 for number of co-partnerships among RTS-listed firms). These industries are associated with large sunk costs and high asset specificity and in the absence of a well-defined property rights system, are subject to significant hold-up costs. Vanteeva and Hickson (2016) also reported that the implemented state-private co-partnership had a positive effect on company long-term performance, indicating that this strategy may have been less costly and more effective than simply monitoring and punishing private decision-makers. Chernykh (2005) demonstrated similar results and argued that the state's key objective was to regain control over strategic enterprises in order to minimize wealth tunneling, and not, according to a popular belief, to “cherry pick” most profitable firms (Chernykh, 2011). In other words, under the new regime, a partnership between investors and Kremlin was successful in increasing private investment from $11 billion in 2000 to $54 billion in 2005 (Treisman, 2006), while capital inflow comprised seven percent of GDP in 2007 (Kudrin and Gurvich, 2015).

Table 2Download as CSV 

State-private co-ownership across eight industrial sectors during 1998–2006 and the percentage of state-private owned enterprises relative to the overall number of firms in this industry (based on RTS-listed firms).

	1998	1999	2000	2001	2002	2003	2004	2005	2006
Utility	1	1	4	5	5	12	10	10	19
	(2%)	(2%)	(7%)	(9%)	(9%)	(21%)	(16%)	(10%)	(18%)
Energy	1	0	1	2	2	3	2	3	3
	(6%)	(0%)	(5%)	(11%)	(11%)	(16%)	(11%)	(16%)	(16%)
Metallurgy & Mining	0	1	1	2	2	2	3	3	5
	(0%)	(5%)	(5%)	(10%)	(10%)	(9%)	(17%)	(13%)	(21%)
Transport	2	2	1	1	1	1	0	0	1
	(29%)	(29%)	(14%)	(14%)	(14%)	(14%)	(0%)	(0%)	(14%)
Manufacturing	0	3	7	7	7	8	7	7	14
	(0%)	(8%)	(17%)	(17%)	(17%)	(19%)	(16%)	(15%)	(30%)
Communications	1	1	1	1	1	1	1	1	1
	(8%)	(7%)	(7%)	(7%)	(7%)	(7%)	(7%)	(7%)	(7%)
Banking & Services	0	0	1	1	1	1	0	1	1
	(0%)	(0%)	(11%)	(7%)	(6%)	(6%)	(0%)	(4%)	(4%)
Food & Retail	1	1	1	1	1	1	2	1	1
	(20%)	(17%)	(14%)	(11%)	(10%)	(8%)	(15%)	(7%)	(7%)
Total	6	9	17	20	20	29	25	26	45

Source: Vanteeva (2012).