December 3, 2018

Towards a New Social Contract in Putin’s Russia

Russia's President Vladimir Putin
Russia's President Vladimir Putin

The Russian political economy is on the move.

Since the 2018 presidential elections and the beginning of Vladimir Putin’s fourth term, the social contract between the state and the rest of Russian society has started to take a different shape. Ongoing economic initiatives include an increase in value added tax from 18% to 20%, the introduction of new property taxes and a wholesale reform of pensions aiming to significantly raise the retirement age, leading to reduced financial commitments to future pensioners for the National Pension Fund. Although various attempts to ameliorate the federal budget often occurred in the past, the scale of the most recent economic decisions exceeds expectations. The unpopular measures were explicitly announced only after Putin’s re-election, despite at least two years of intra- and inter-institutional battles. In this way, Russia’s political elites seem to have secured the status quo prior to launching a large-scale reassessment of the economic ideology.

Most strikingly, changes in Russia’s political economy have triggered a shift in the collection of oil revenues by the Russian government. In contrast to previous initiatives related to oil taxation, the Ministry of Finance assumed the pivotal role in formulating the new initiatives, while the traditional channel for oil lobbyists, the Ministry of Energy, was mostly removed from the decision-making process. As a result, the oil industry has lost “the Game of Thrones” and will consequently bear an increasing tax burden on domestic expenditure and operations. Even though duties on oil exports are expected to be gradually phased out over the next five years, taxation will be substantially higher for the industry as a whole.

The outcome may look as if Moscow is ready to sacrifice its “sacred cow” for the sake of higher inflows to the national budget. However, the international expert community still operates with outdated notions of Russia’s oil lobby triumph, Putin’s unwillingness to conduct structural reforms and Russia’s persistent status as an energy superpower. In this context, a fresher perspective on power relations in Russia becomes crucial.

What’s New?

From Putin’s first presidency, Russia’s resource regime was based on duties collected from oil and gas exports, which provided significant windfall profits for the budget, especially during hikes in the world oil price. The Russian state provided a certain level of welfare support and assured relatively low taxation for its citizens. In turn, the resource regime implicitly requested little involvement of society and business in domestic political affairs. After the noted Yukos case of 2003–4, Russian oil companies enjoyed a rather generous degree of economic autonomy in exchange for keeping out of domestic politics. Russia’s social contract assumed an apparent political stability in exchange for economic benefits distributed by the resource regime.

Today, the Russian state takes a different approach to budget revenues by focusing on domestic income from non-hydrocarbon sectors of the economy and from society at large. Since the main revenue burden will now be shifted from exports to domestic activities (upstream development, refineries, domestic sales), the state will exert unprecedented pressure on its core economic sector, which already provides up to 60% of national income. Experts on the Russian economy have already been warning that the new system might have detrimental effects on the domestic refining and processing segments of the industry. Whilst the Russian state exempted the most innovative refineries from the new taxation regime, up to 75% of the refining and processing sector has remained outside any eligible exemption. In the context of low competition in domestic oil product markets, an additional tax burden may drive prices for gasoline and heating fuel up across Russia’s regions. The effects on society might become unpredictable since the ex-Homo Sovieticus still considers low fuel prices a core social right.

Concerns over the detrimental effects on oil refining even provoked tensions between the authors of the reform and Rosneft, the largest state-owned oil company. Contrary to widespread assumptions, Rosneft’s CEO, Igor Sechin, was rather unsuccessful in securing the driving seat in conducting the so-called tax manoeuvre. Temporary exemptions on a case-by-case basis may be the only major gain he managed to secure during negotiations. Quintessentially, these exemptions look like a consolation prize for the loss of control over the whole system of oil governance in Russia.

In this context, the export tax exemption seems to be a fair counter-offer to large oil firms in exchange for higher domestic taxation. Paradoxically enough, the previous attempt to exempt the industry from export duties occurred in 1996, during the Yeltsin years of domination by oligarchs and oil tycoons. Whilst the Yeltsin era is now widely criticised by the current political elites in Moscow, the relationship between the state and the powerful oil businesses seems to be returning to demands for tax relief, as raised during periods of economic hardship. Exemptions favouring the wealthy may generate further domestic discontent already fuelled by the aforementioned unpopular measures.

Ultimately, even the very concept of “energy power” (energeticheskaya sverkhderzhava) elaborated by Russia since the G8 Summit in 2006 is now being challenged. This political concept marked an explicit difference from a traditional petrostate, implying a higher level of modernisation in the domestic energy sector. However, the ongoing transformation of the resource regime may create serious difficulties for the modernisation of hydrocarbon processing industries and may have a detrimental effect on small and medium-sized private oil producers. Moreover, earlier promises to stimulate exports of refined fuels have suddenly been overshadowed by gloomy prospects for national oil products. Consequently, the new resource regime risks diluting the previously carefully elaborated Russian “energy power”.

Domestic affairs prioritised. Based on the changes briefly sketched out above, one might argue that Russia’s concept of “energy power” has now altered due to the change in the social contract that was the cornerstone of the regime for almost two decades. EU and US sanctions have undoubtedly contributed to triggering the change, even though the Russian state had already been facing economic inefficiency since 2009, way before Moscow’s tensions with the West. The project’s hypothesis focuses, rather, on understanding the short- and long-term implications of the ongoing changes in the social contract. The project will assess possible effects on domestic power relations between the oil industry and the Russian state, as well as between the state and society.

Implications for international expert communities and decision-makers. The shift in Russia’s resource regime will soon constitute an interesting puzzle for Kremlinologists across the world. Western sanctions might have generated an expected effect in weakening Russia’s economy, while the desired outcome remains unattained because the Russian state seems to be heading towards even deeper isolation. In fact, the change in the resource regime will decrease Russia’s reliance on international oil markets and will therefore leave room for tensions with the West despite the sanctions. In addition, oil firms targeted by Western sanctions may become more resilient to economic restrictions, thanks mostly to generous exemptions from export duties.

Literature on resource regimes may also expect that increased budget dependence on domestic revenues would highlight a greater reliance on Russia’s society. A general theory of resource regimes presumes that a non-inclusive resource regime does not need heavy domestic taxation and allows such regimes to exert autocratic governance (e.g. the UAE and Saudi Arabia, which have almost no domestic taxation). Instead, an inclusive resource regime depends on civil society and is therefore combined with a solid taxation system (Canada and Norway being the most notable examples). Based on this theoretical premise, one may even expect political change stemming from society’s increasing dependence on the state. Nevertheless, in Russia’s case, a change in the social contract towards a higher reliance on domestic revenues is unlikely to lead to an inclusive resource regime. Instead, the Russian government will probably attempt to direct the population’s discontent towards scapegoats—“evil oil tycoons”—in order to portray itself as the most equitable Hobbesian balance of power.


Dr. Andrei V. Belyi is Adjunct Professor at the University of Eastern Finland and Founder of Balesene OÜ, a consulting firm based in Tallinn, Estonia. The views expressed in this article are his own.*