Joera Mulders
July 6, 2011
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The new political buzzword in Moscow and Russia’s other 82 regions is decentralization. At the St. Petersburg International Economic Forum, president Medvedev announced the creation of  two working groups to come up with ideas to decentralize the country’s political power, an idea which we saw yesterday is supported by 56% of the population.

Medvedev’s announcement brings the issue into the limelight, but the need for decentralization is not his invention. The idea has been growing ever since Putin’s vector of centralization fulfilled most of its purposes and ran out of steam. Below you may read a translation of a Vedomosti editorial based on conclusions reached by working groups at the Perm Economic Forum with the more than interesting title ‘the new social contract: Decentralization in exchange for loyalty.‘ If you wish to understand what will happen in Russia in the years to come, this is the article you should read. Before we turn to the editorial a few more words about the recent buzz about decentralisation. It is important to realize that its rationale isn’t as much political, as it is economic. The return of direct elections for governors could become the crown on the process of decentralization, it is however not its aim.  The working groups have been ordered to focus on the ‘inter-budgetary relations’ between the federation and its subjects as well as the system of tax distribution.

When also during SPIEF business union OPORA published its annual report, much of the discussion focused on the lack of incentives for regions to create better conditions for small and mid sized businesses. Taxes paid by these companies are currently sent to and distributed by Moscow. Allowing the regions independent control over part of these tax revenues would create competition between regions for small and mid-sized businesses.

This sounds great, but it also implicates that there will be significant resistance to decentralization. An Ekspert article notes that Many of the receiving regions, whom are in the majority, will fear a net loss of budget revenues. In 2006 five regions produced more than half of the countries value added tax. What complicates the matter further are persistent rumors that the current value added tax will be replaced with a sales tax. I haven’t seen a convincing explanation of the implications yet, which leads me to think Russian entrepreneurs or even regional officials don’t know either. What is for certain is that there are concerns that a sales tax would place the tax burden on the retail sector, whom are often small and mid sized businesses. All in all, the idea of decentralization by means of a redistribution of taxes will unleash a considerable amount of fear for the unknown.

Last week vice premier Kudrin said that in the spirit of decentralization, his ministry of finance would start distributing funds to the regions at the start of the year rather than at the end. It would take his ministry until 2014 to accomplish this. Afterwards in his opinion ‘it will be necessary to simply pass taxes to the regions and make less use of federal targeted programs to plan for the regions, and let the regions do that themselves.’ According to Kommersant Kudrin warns for the complexity of this ‘phase’. ‘It will be become difficult when we move from principal decisions to action, to ‘scratch out’ powers of each ministry and transfer them downwards.’ In other words, he doesn’t expect the federal bureaucracy to give in easily.

In general, as the conservative negotiator a good minister of finance is, Kudrin recognizes the idea of decentralization as an inevitable direction, while cautioning expectations of swift changes.

What follows below is a direct translation of a Vedemosti editorial written by Aleksander Auzan (economist, twice voted most authoritative expert of the year on political debate show ‘the people would like to know.’ ), Bulat Stolyarov (consultant and former advisor to Khloponin in Krasnoyarsk), Sergei Aleksashenko (former deputy minister of finance and the director of Macroeconomic Studies at Moscow’s Higher School of Economics), Nikolai Kovarsky (Expert Council Member at the Government Commission for Increasing Development Stability in the Russian Economy ) and Svetlana Makovetskaya (Head of the research project The Future of Human Rights in Russia).

The new social contract: Decentralization in exchange for loyalty

The room for the majority of economic decisions that Russia needs to make is confined by an ‘institutional ceiling’. That’s why all key economical discussions (about the crisis, modernization and the strategy up to 2020) boil down to the necessity for serious institutional-political changes, including a principal balance shift in the relations between society, business, the regions and the federal authorities.

The results of the ‘troubled’ 90s and the ‘fat’ 2000s clearly demonstrate the pendular nature of Russia’s institutional development. The political and economic decentralization of the early 90s and the launch of market mechanisms –  both in a situation of unprepared legislation, infrastructure and institutions – resulted in a clear and evident collapse of the decentralized model. As a consequence the public demanded a strong hand and a new period of political and economic centralization in the 2000s.

The social contract of the 90s (expressed by Yeltsin in the formula ‘all the sovereignty you can take’) made place for the social contract of the Putin period (‘loyalty in exchange for stability). Russia is not unique. In the majority of transition economies  a collapse of the first surge of reforms have lead to a period of reaction.

By the end of the first decade of the new century the contract of the Putin period has evidently become outdated. The catalyst of its collapse was the economic crisis of the years 2008 and 2009, during and after which the levels of prosperity of business, of the regions and of the population declined significantly. And this – inherent to the formula of the contract itself – signals the necessity of a principal shift of balance:  the loyalty of the main groups to the authorities has notably diminished. An escape from this situation demands a new period of development and for this development to start a wide range of institutional changes needs to be completed. And these institutional changes can only be based on the replacement of the current social contract.

Our discussions at the Perm Economic Forum have shown the potential for a new contract. Not only did the various parties to the contract voice clear demands for a new model of interaction and clearly articulated their claims to one another, but they also showed the preparedness to somehow – with money, power, time or corrections in behavioral patterns – to reach for an acceptable compromise.

The preconditions of formation

The working group, representing all four parties to the contract (society, business, the regions and the federal authorities) came up with answers to three questions in relation to 1/ the aims of the parties, 2/  their claims and 3/ the resources they are prepared to contribute. The principal outline of the positions of these parties was plotted in a diagram. 
Most criticism was directed at the federal authorities, whose policies markedly interfere with the aims of the other groups. It is important to note that the second place as to the amount of claims directed against it was occupied by society, which according to the other parties with its passivity and immaturity legitimates the formation of an excessive level of centralization. The regions and business ascertain that without active support from society it will be impossible to end the federal monopoly on decision making and to increase its efficiency.

The main demand from private companies is the maximal exit of the state from business and a complete ban on the use of administrative resources in business as a factor dramatically distorting competition.
Business has no need for the state as a player and competitor. It needs a predictable regulator. 88% of the participants of the Perm forum agree that the growth of the state sector in the economy did not live up to its goals and that the state has proved that it is an inefficient owner. Notable interest was also expressed for transparent mechanisms for the formation of tariffs and the independence of the judicial system. Entrepreneurs are prepared to pay for these changes with their behavior: social investments, observance of business standards and civic ethics, as well as participation in the social process and planning the future of their families and children in Russia.Ten years ago business wasn’t ready to make such sacrifices.

The working group of regions fixed their attention on the crisis in the model of ‘competitive federalism’, dominant during the 2000s (the centralization of resources at the federal level in exchange for the generous distribution of development budgets to the ‘active’ and the ‘loyal’). Now being deprived of the resources to finance their activities, the regions will welcome the mandates and tax resources to unlock their potential for self development. In return the regions are prepared to take responsibility for the development of contacts with the institutions of civil society and also provide a certain amount of independence to the municipalities and in particular the larger cities, whose development is of upmost important for the regions. The participants of the Perm forum supported request of the regions for decentralization, including political. 66% of the plenary audience thinks that the abolition of direct election of governors did not live up to its expectations, but on the contrary, that the quality of regional government declined. Another 26% is of the opinion that nothing has changed and only 8% is convinced that centralization lead to an increase of quality in regional management.

Society is dissatisfied with the current situation in which its opinion isn’t ‘wanted’ in the decision making process. The system of redistribution of budgetary resources on the federal level arouses strong discontent. Society demonstrated considerably more forbearance in its relation to the regional and municipal authorities, whom they wish to support in their demands for decentralization. The resources (or anti-resources) that society is prepared to invest into the new contract are very weighty: from self-regulation as well as investment of time and money in socially significant projects to voting with their feet, emigration that is.

In this situation in which the majority of demands are directed from three parties in the contract to one, the representatives of the federal authorities at the forum showed their principal willingness to reach for a compromise. Their obvious aim, preservation of the status quo, for which sake ‘the Federation’ will be ready for some concessions.

Sensing the discomfort unleashed by the crisis of the social contract of the 2000s caused by the financial crisis, ‘the Federation’ is prepared to take steps towards decentralization. Such steps could entail amongst others the return of part of the resources and mandates to the regional level, the partial exit of the state from the economy and the introduction of institutes of public control over the decision making process. These concessions would be granted in exchange for the preservation of loyalty to ‘the federation’ and its immunity throughout the period of the new contract.

The new formula

These results of the working groups allowed the consolidated group to write a formula for a new potential social contract: ‘the increase of autonomy in exchange for the preservation of loyalty’. The formula is based on two principal assumptions: a/ it takes into account the basic demands of all of the four groups and b/ it leads to a relatively smooth and conflict free transition from the deprecated model to the new. This is important because the principal unwillingness of one of the groups could lead to a revolutionary scenario.

This article is based on discussions in which participated close to 1500 experts gathered at the Perm economic forum 2011. More materials will be published in a series called Perm contract, which we hope will contribute to the most accurate model for a new social contract in Russia. You are invited to the discussion.