The End of Putinomics

Vladimir Putin
Vladimir Putin is seen during a dinner at his suburban residence in Novo-Ogarevo, outside Moscow, Russia, March 1, 2012. Davide Monteleone / VII

The world is changing. Russia is not. And Vladimir Putin would like things to stay that way. Stability has been his No. 1 selling point ever since he came to power 12 years ago. Even prosperous Muscovites—people who don't much care for their president's brand of Soviet nostalgia, his macho nationalism, or his KGB-style crackdowns on dissent—mutter among themselves that for all his regime's flaws, its predictability is still preferable to the wild upheavals of the 1990s.

And who can blame them? Over the past century, Russians have seen their full share of excitable demagogues, from Bolsheviks to capitalist shock therapists, all of them promising big changes for the better, and most of them dismally failing to deliver. If graphic designer Shepard Fairey were to make the equivalent of his Obama "HOPE" election poster for Vladimir Putin, it undoubtedly would say "NO CHANGE." Th at reassuringly solid sense of permanence is why more than 60 percent of Russians say they still love Putin after all these years.

Unfortunately for the Russian president, however, change is imminent—and in a form utterly beyond his control. Two words have already begun rocking Putin's world: shale gas. The new technology, which allows natural gas to be extracted cheaply and in previously untapped places, is about to upend not only global energy prices but also the geopolitical status quo—with Russia as the prime loser.

For more than a decade, rising oil and gas prices have kept Putin's Russia aloft. The entire unwieldy apparatus, from massive military spending to the magical thinking of Putin's lowtax, high-spend policies, is based on petro-wealth. When Putin was anointed as Boris Yeltsin's successor in 1999, oil stood at $17 a barrel. Today it's bumping along at roughly $110. Th at windfall is the secret of Putin's economic miracle, of his popularity, and of his arrogance.

But 2013 is shaping up to be the year when the magic stops. Putinomics is in many ways like a gigantic Ponzi scheme. Free money comes bubbling out of the ground; the government and its cronies skim off a sizable chunk, and then spend the balance on keeping the people happy—subsidizing a vast and antiquated military-industrial complex, for example, thereby ensuring plenty of steady jobs for defense workers. But just like a Ponzi scheme, it works only as long as supplies of new cash keep growing.

And Russia's fountain of loot is beginning to dry up. Although crude-oil prices have stayed pretty firm, propped up by rising Chinese demand and continued unrest in the Middle East, world natural-gas prices have fallen through the floor. In the past five years the United States has overtaken Russia as the world's largest natural-gas producer, and U.S. domestic prices are a quarter of what Russia's gas giant, Gazprom, has been trying to charge in Europe. Liquefi ed natural gas (LNG), another growing piece of the global energy market, is trading at half the Russians' price, which is indexed to crude oil.

The impact is already apparent at Gazprom. The state-owned company employs nearly half a million people and accounts for 8 percent of Russia's GDP; its taxes constitute roughly 20 percent of the state budget. And according to preliminary figures, its profits fell by half in the last quarter of 2012. Its total stock value has plunged from $365 billion in May 2008 to $120 billion as of this writing.

The road ahead looks no less grim. Although Gazprom remains the supplier for a quarter of Europe's gas, customers slashed orders and negotiated price discounts worth $4 billion in 2012 alone. Worse, the European Union is investigating Gazprom for allegedly "preventing the diversification of supply of gas" and "imposing unfair prices on its customers by linking the price of gas to oil prices." A $20 billion exploration project under the Arctic Sea was supposed to open Russia's first new gasfields since the 1960s, but it has been shelved after foreign partners dropped out, citing lack of demand. For the foreseeable future, natural-gas prices are headed only one way: down.

Putin likes to think of his country as an energy superpower , and it's true that Russia remains the world's biggest energy exporter. But shale gas and LNG have broken Gazprom's stranglehold on Europe's energy supply. Th at in turn is leading to a profound shift in the relationship between Russia and Europe. A decade ago, Putin counted then German Chancellor Gerhard Schroeder among his closest friends and shared traditional Russian saunas with him (not to mention signing him up for a cushy job at Gazprom when Schroeder retired in 2005 ). But Schroeder's successor, Angela Merkel, is not so shy about taking Putin to task for human-rights abuses.

The contrast was unmistakable when Merkel traveled Moscow in late 2012. In the wake of a German parliamentary resolution condemning the Kremlin for locking up opponents, the rapport between Merkel and Putin was chillier than the November weather in Red Square. The air grew still more frigid when Putin attacked Merkel for being soft on the jailed punk rockers Pussy Riot, whom he falsely accused of anti-Semitism. (The activists were filmed at an antifascist rally carrying ironic anti-gay, anti-Semitic and racist slogans—but Putin, who boasts that he doesn't use a computer, couldn't check the clip on YouTube.)

Putin's falling out with Germany is likely to portend frostier relations with Europe in general. For years the European Union has been split over its ties with Russia. Countries like Poland and Estonia have favored a tough line against the Kremlin's human-rights violations, while like Germany and Italy have urged leniency rather than risk their privileged access to Russian energy and Russian trade. Now the continent has a chance to pull together at last, and Russian bureaucrats are threatened not only with sanctions to punish their mistreatment of political dissenters but also with Europe-wide action to freeze ill-gotten money and deny visas to corrupt officials.

Still, it's ordinary Russians who are likely to feel the most severe impact from the shale-gas revolution. The country's 2013 state budget is predicated on oil selling at $117 a barrel. According to Citibank's forecasts, however, the actual price will average around $80. With energy accounting for more than half of Russia's state revenue, the country is facing a massive deficit. Until 2010, Russia's petrocash windfall was relatively well managed, parked in a stabilization fund to cushion against future oil shocks. But that protection went away when the government dumped the fund's founder, Finance Minister Alexei Kudrin, and Putin raided the stabilization kitty for a socialspending splurge and a massive $770 billion, 10-year rearmament program, including Cold War hardware like nuclear submarines and main battle tanks.

In other words, this year Putin should expect to run out of money. And if recent events in Athens, Lisbon, and Madrid are any indication, the Russian people will respond with something less than utter equanimity to cutbacks in government spending. Putin may remember the winter of 2011—12, when 100,000 Russians defied the arctic weather, filling the streets of Moscow to protest against rigged elections and rampant corruption. "The driving force behind democratic change in Russia is young, educated, and politically savvy middle-class Russians who grew up during the past 20 years of market reforms," says opposition leader Vladimir Ryzhkov. And that's why the Kremlin, initially rattled, finally shrugged off the anti-Putin demonstrations. Russia's middle class may be angry, but it's still only a tiny fraction of the population. Until now, at least, the bulk of the Russian heartland has remained firmly behind their president.

As a result, Putin's continued popularity depends on supporters like Svetlana Kuritsyna. The young seamstress was given hero status on state-run television after she was bussed to Moscow by a pro-Kremlin youth group during the 2011 protests and publicly extolled the country's progress under Putin in ungrammatical Russian. "We have started to dress more better," she said. "And there are no problems with housing." But what will ordinary Russians say when the Kremlin's housing money evaporates and the people are living more worse?

The authorities made short work of its middle-class critics. Tall poppies like Pussy Riot received brutal two-year labor-camp sentences. Dozens of others have been detained on trumped-up charges. Opposition activist Leonid Razvozzhayev is charging that he was kidnapped in Kiev, Ukraine, drugged, and spirited across the border, KGB-style, to face charges of allegedly having stolen 500 fur hats 15 years ago. (Prosecutors straightfacedly claim that Razvozzhayev came home on his own and turned himself in.) To Western observers, the absurdity of accusations like those faced by Razvozzhayev only undermines the credibility of the government that makes them. But to Russians—especially those in the line of fire—it's precisely the absurdity that conveys the real threat: we can convict you for anything, and you have no chance of defending yourself. It's a modern-day version of the old Stalin-era dictum, "Show me the man, and I will show you the offense." Small wonder that so many young Russian professionals are planning to emigrate, adding brains to Russia's other two main exports: hydrocarbons and stolen money.

As always, Russia's leaders and its government-run media persist in blaming the country's troubles on conspiracies and spy plots. U.S. Ambassador Michael McFaul has been accused of being a paymaster for the protesters, and a new law has massively expanded the definition of treason. Now nongovernmental organizations that receive funding from abroad are being required to register officially as "foreign agents." Some have refused, like the venerable Memorial group, which documents the victims of political repression from Stalin's era to the present. Vandals responded by smearing the group's offices with graffiti and anti-U.S. slogans.

Meanwhile the country's bureaucrats continue to bleed the state's coffers and the national economy for a total of $300 billion a year, according to the Moscowbased think tank Idem. The years of oil wealth have only worsened the range and scale of corruption. Rapacious officeholders have reinforced the country's dependence on the oil industry by strangling independent enterprise. Small businesses employing fewer than 100 people make up just 7 percent of Russia's economy, as compared with Poland, for example, where they make up fully 50 percent.

Russians see nowhere to turn for help in curing the pervasive rot. State employees are universally despised and distrusted. Putin seems never to stop announcing anticorruption drives, but everyone knows that graft has become the government's lifeblood. "Putin's system is dependent on corruption—on corruption as a form of management and a guarantee of loyalty from officials," says blogger and opposition leader Alexei Navalny. "They will not kick out from under themselves the stool that they are standing on."

While the oil money kept flowing, ordinary people laughed at corruption—at least a bit. One of the regular characters on the satirical television show Nasha Rasha is Nikolai Laptev, the honest traffi c cop. His kids wear clothes made of sacking and his apartment is bare of furniture, but crazy, dumb Nikolai keeps on congratulating himself for never having taken a bribe. Cue hysterical audience laughter. Soon, however, that routine may not seem so comical. During the winter protests of 2011—12, there was one issue on which the metropolitan revolutionaries connected with grassroots support across Russia: everyone was fed up with the country's thieving bureaucrats. As the tide of money recedes, that resentment will only grow.

High-ranking heads will likely roll. Putin's longtime defense minister, Anatoly Serdyukov, has already been axed over a murky property deal. But going after scapegoats in the government's senior levels will be a dangerous game. Infighting among Putin's former KGB associates has occasionally broken the surface over the past few years, and the struggles have been ugly affairs involving cops raiding other cops, accusations leaked to the press, and flurries of prosecutions and counterprosecutions by rival clans. Expect much more of that as internecine conflicts break out over dwindling wealth—and over which former partners will be sacrificed in order to appease an angry public.

The big question is whether Putin will be able to stay above the fray, or whether he'll get pulled down into it. For 12 years he has systematically dismantled the country's legitimate safety valves, like independent media and organized political opposition, all in the name of stability. Now there aren't many ways left for frustrated Russians to vent their anger short of aiming it directly at the leadership.

In the past, the Kremlin's political strategists have set up bogus opposition parties to channel popular protest safely away from Putin. They're sure to try that ploy again, but it may be useless against unrest like what Yeltsin faced during the 1998 economic crisis: nationwide strikes, railroad and highway blockages, and mass protests in downtown Moscow. Putin had a tacit agreement with the Russian people: he gave them stability and prosperity, and they gave free rein to him and his associates. Now he's losing the wherewithal to keep his end of the bargain. Russians can count on one thing: he won't give up quietly.