YUKOS Affair: After the Scandals

Attentive readers of Russian newspapers might be forgiven for being confused. Does the World Bank these days advise unraveling the privatization process? Certainly not. But behind entertaining headlines hides an important discussion. Slowly, the debate of the "Yukos affair" has moved onto a more serious plane. Beyond summer readings of a colorful cast of heroes and villains and a lot of guesswork about their motives, deeper structural issues have emerged, issues that are likely to resurface after this affair has been forgotten. The first of these concerns the economic consequences, the price for entangling economic life with politics. The second concerns the security of property rights established through privatization.

To gauge the economic effects of the current affair, a logical distinction must be made between how it affects businessmen already operating in Russia and how it affects those who are thinking about coming here. With respect to the former, there has -- so far -- been notably little impact. The numbers show no capital flight: Reserves declined by $1.1 billion last month (Platon Lebedev was arrested on July 2), but $970 million of this was spent on debt repayments. High demand for hard currency before the August holidays and uncertainty at the beginning of July about exchange rate policies and the euro/dollar rates are likely to have contributed toward more rather than less hard-currency holdings. The stock market went down, but not anywhere near crisis mode. Importantly, Yukos went down while other stocks did not -- signaling that the markets were well able to discriminate. They perceived a particular stock under threat, but not the system as a whole (as some observers have claimed). Russian eurobond yields went up, but this started before the Yukos affair broke and it affected all emerging markets. These observations do add up: Investors already operating in Russia have priced in a certain amount of political risk.

Of course, this should not be taken as a denial of the negative real effects of the affair. In particular, Russia's image abroad will be tarnished. And in general, the longer any kind of political interference into the economic process is perceived to exist, the more difficult it will be to attract capital into Russia, be it foreign or domestic.

This leads to the next question, namely what underlies the current situation. Fr om the economic point of view, the key difficulty here seems to be how to find closure to the privatization results of the 1990s.

Here two principles conflict. Both are important, and no one has yet found a way out of this dilemma. The first principle is the obvious economic one, namely that anyone tampering in an arbitrary way with an existing distribution of property rights plays with fire. It is logical and easy to understand that no one will invest in a place where investors feel that the government or other agencies can violate their property rights in an arbitrary manner. It is this fear that spooked investors in the wake of the Yukos scandal.

On the other hand, there is a widespread perception that the results of privatization were partially obtained in an illegal or "unfair" fashion. Because of this and the enormous gaps in wealth and income that have emerged, the existing distribution of property rights is rejected by a majority of the population. Consequently, some argue, an amnesty should be out of the question. It would only reward those who violated whatever rules were in place at the time, thus undermining the rule of law rather than securing it.

There are very few historical precedents that might be instructive as to how such a dilemma can be solved. None of them lends itself easily to the Russian situation, but perhaps they are able to provide some cues. One is East Germany, wh ere the legal right of the old owners to the physical restitution of property (expropriated either by the Nazis or the Communists) deterred new investors to such an extent that this right eventually had to be replaced with monetary restitution. Even those who had a justified claim could no longer claim physical property back (such as land or houses) but had to take monetary compensation instead. The simple lesson is that a modern state has more means at its disposal to work around economic constraints than redistributing physical property, monetary settlements being one of them. (Interestingly, and unrelated to this example, Boris Nemtsov recently advocated a similar mechanism based on tax transfers.) Another episode that comes to mind, this one admittedly from an entirely different context, is South Africa's Truth and Reconciliation Commission. When trying to put closure on a historical period it may be necessary, we learned, to do so in an inclusive manner.

But in the end, Russia's dilemma persists. On the one hand, the economic argument is correct. The system needs closure. Property redistribution is not an option, as otherwise not only the productivity of existing assets but new investment itself is bound to suffer. On the other hand, one needs to be careful when discussing an amnesty. The legal system is weak, and an amnesty per se does not lend more credence to it. What is to be addressed by it? Who makes the distinction between "serious" crimes and the violations of procedural rules everyone engaged in? Is there a way of paying for past mistakes without redistributing property? And most importantly, can closure really be obtained if the overwhelming majority of the population is convinced it has been cheated?

These are serious questions that have not been addressed sufficiently. And yet, it is precisely the resentment of large parts of the population that plays into the hands of the few who are currently abusing Russia's turbulent economic history to foster their own purposes.

There is no obvious solution to this dilemma, or at least there is none yet. But it seems evident that such a solution can only be found if a debate on these issues ensues -- a debate, not the kind of sensationalism currently dominating most of the discussion -- that will bring about a broader consensus rather than yet another truce between a small group of particular oligarchs and politicians.