Can Oligarchs Be Good for the Economy?

It is impossible to discuss economics in Russia, or in many other countries formerly known as the Soviet Union, without reference to oligarchs. Ever since the Iron Curtain was officially drawn back in 1991, this new class of powerful businessmen, with personalities as big as their checkbooks, has stood out as an omnipresent symbol of Russian capitalism. It is generally assumed that the effects oligarchs have on the companies they control, and on the economy in general, are categorically negative. As is often the case, however, the reality can be much more complex.

What is an oligarch?

The term ‘oligarchy’ literally means ‘a few who rule/govern’, a system of power where a small select group of individuals exert vastly inordinate influence. In Plato’s Republic, the term oligarchy is used to refer to an undemocratic form of governance in which a few people rule over the rest of the population. More than simply referring to wealth, the notion of an ‘oligarchy’ is crucially related to power, and the control that certain individuals exert over a country’s resources. An oligarch is not only someone who simplycommands greater material wealth but someone who is able to use this wealth to influence the political system.

In Russia, a mere 110 individuals own 35% of household wealth – the highest level of inequality in the world outside several small Caribbean islands, according to Credit Suisse’s 2013 Global Wealth Report. Russia has one billionaire for every $11 billion in wealth whereas the average for the rest of the world is one for every $170 billion. Moreover, the Putin regime is notorious for its ability to get the country’s oligarchs to tow the party line. Though many of Russia’s original oligarchs owe their wealth to Boris Yeltsin and his liberalization of the Soviet economy, the rules of the game changed when Putin came to power. He made it clear that only the oligarchs that supported his administration would maintain their fortune; one only has to look to the recently freed Mikhail Khodorkovsky to understand what this entailed.

Oligarchs and the economy

So, what effects do these oligarchs have on the companies they control? Going against the grain, two researchers at UBS Warburg suggest that Russia’s oligarchs possibly improve firm performance since they have broken the traditional barrier between ownership and control. An oligarch who owns and controls a large company should have strong incentives for restructuring and building up the value of his asset and little incentive to strip the company of its assets and/or divert cash flows. Furthermore, the business empires of Russian oligarchs are often vertically integrated, with companies controlling every stage in the production process. Oil companies, for example, will own their own reserves, their own ports, and their own banks, thus eliminating ‘hold-up problems’, where each party involved in the production process will attempt to renegotiate a greater share of the collective surplus. It is in part this vertical integration that has allowed Russian companies like Lukoil, presided by the oligarch Vagit Alekperov, to compete globally.

Furthermore, the Turkish-born American economist Daren Acemoglu has argued that, because democracies often have higher rates of redistributive taxation, which distort the market, oligarchical societies can achieve much greater efficiency. This is, in part because those that end up becoming oligarchs are often “selected” to that position because they enjoy a comparative advantage in that sector. Before Khodorkovsky made his billions, he had climbed the ranks of the communist and Yeltsin administrations, becoming Deputy Minister of Fuel and Energy in 1993. It was this position that allowed him to gain control of Yukos, the major Russian oil producer, in 1995. These positions of comparative advantage, combining vertical integration and close relationships with public officials, allow oligarchs to mold policy environments in their favor and, consequently, maximize efficiency.

Nevertheless, while oligarchical leadership may be beneficial for their individual firms in some cases, there is no question that the close relationship between these elite businessmen and state officials hinders the emergence of a competitive environment. Indeed, Acemoglu writes that, while the political power that oligarchs enjoy can help them protect their property rights, this power can also be used to “erect entry barriers that protect […] their incumbency advantage.

At the end of the day, an oligarchy, like the fabled ‘benevolent dictatorship’, can have its benefits. What may be gained in effectiveness, however, comes at the price of a loss of economic freedom, the real motor of a prosperous nation.

One Response to "Can Oligarchs Be Good for the Economy?"

  1. john1025   February 3, 2014 at 12:22 pm

    Surprised you didn't mention our oligarch and plutocrat rulers in the United States.