Yegor Gaidar

Anyone who worries about the direction Russia has taken under Putin will find this post from Leon Aron, director of Russia studies at the American Enterprise Institute, on Yegor Gaidar's death heartbreaking.

The positive aspects of any man's life tend to be accentuated in death, and many of the tributes to Gaidar, like this one, have taken a decidedly rosy perspective on the shock therapy he administered to the Russian economy. The reality is far more complicated and much less positive.

But however flawed that project would ultimately be, imagine the alternative. The historical revisionism of the Putin years, under which the names Gorbachev, Gaidar and Yakovlev became synonymous with humiliation and suffering, must have slowly killed a man like Gaidar, a man whose work was to literally save the Russian people from famine and collapse.

Modernize or Die

Russian President Dmitry Medvedev used his state of the state address to call for a sweeping modernization of the Russian economy, rejection of the corrupt oligarchy and diversification away from the nationalized oil and gas sector. Speaking to an audience that included Prime Minister Vladimir Putin, chief architect of the system Medvedev wishes to reform, the president rhetorically stepped outside of his mentor's shadow and set a vision for his legacy.

He might also have just ruled himself out of a reelection bid.

A liberal by nature, Medvedev has failed to deliver the economic and institutional reform many hoped for. This is unsurprising as real power has been consolidated firmly in the PM's office, and the silvoki now pervade Russian society from the commanding heights to regional governorships. These vested interests are backed by the PM himself, and therefore unlikely to encounter any serious challenge their grip on Russian power and wealth. Nonetheless, Medvedev's rhetorical liberalism, often in direct contrast to Putin on economic matters and the glorification of the Soviet past, has sustained a slimmer of hope that after building his own power center he would set out on a reform agenda and confront the rotting Russian core. Few doubt his sincerity.

But confidence in the president to deliver on this vision cannot be high within Russia. Medvedev has thus far been long on words and short on actions, and opposition to any liberalization of strategic sectors, either through ownership or management, will undoubtedly be fierce. One can easily foresee a scenario where Putin simply brushes Medvedev aside in 2012 to return to the Kremlin. But if he can begin to produce tangible reforms, such as electoral reform in the regions, and achieve some high-profile break-ups of state-owned companies, he just might build some momentum among a population clearly dissatisfied with Russia's ability to cope with the financial crisis. At the very least, this could stimulate a fundamental debate within Russian society as to the direction of the country and the best mechanisms to get it there. That would be downright revolutionary in the Putin era.

Medvedev has it right: Russia must modernize or die. Its massive FX reserves carried it through the worst of the global financial crisis, but exposed the economy's vulnerability to oil and gas price volatility. The lack of alternate sources of revenue is a serious crutch to the country's future prospects. With its oil and gas sector declining at an alarming rate, and woefully mismanaged by firms like Gazprom, Russia's FX reserves could increasingly be needed to finance the budget and subsidize state-owned behemoths in sectors from aviation to agriculture. The planned return to international debt markets shows the government is aware of impending, possibly chronic, shortfalls. The writing is on the wall, but can the PM read it?

Medvedev could yet convince Putin of the future's peril, but this seems unlikely. A confrontation seems more probable, and unfortunately for the Russian people, Putin is a strong favorite to emerge victorious. I mean, have you seen them guns?

That Was The Week That Was

Politique
-G20 leaders arrived in Washington for a summit that had been hailed Bretton Woods II. With President-elect Obama avoiding the summit, and sharp differences between world leaders on the reforms needed to repair the international financial and economic systems, the summit ends like so many before it- with a consensus on principles, little coordinated action, and an agreement to meet again. Declaration text here.

-A regional war looms as the situation in the DRC deteriorates. African peacekeepers are impotent and declared targets by Nkunda, the number of foreign troops/mercenaries in the country grows by the day, and southern African leaders are threatening full-scale military involvement. The NYT looks at the role of minerals in the DRC's history of conflict.

-The EU agreed to restart talks on a strategic partnership agreement with Russia following an EU/Russian summit at Nice. Russia hasn't met the EU conditions set out as a prerequisite to talks following the conflict in Georgia, and it seems only Lithuania has the spine to say so.

-Iraq's cabinet approves new security pact with the US. The agreement extends US troop mandate through 2011.

Economia
-Paulson shocks congress with plan to spend remaining TARP money on capital injections into troubled institutions and companies and consumer spending. The Treasury will no longer purchase illiquid assets, and congressmen/women of both parties are screaming "bait and switch". Paulson deputy Kashkari testified before an angry House, with Rep. Elijah Cummings asking him, "Is Kashkari a Chump?"

-Treasury v. FDIC. FDIC's Bair wants to directly assist 1.5 million homeowners in the US, while Paulson resists a (*cough-cough*) "government spending program"- Paulson believes that his actions are "investments".

-Is a sterling run imminent? That's what George Osborne, Tory shadow chancellor, implied this week in criticizing Gordon Brown's fiscal plans. Osborne's political career is likely done. Sterling has hit a 6-year low against the dollar at $1.49, and Simon Derrick at BoNY Mellon believes sterling's position is now worse than Sept. 1992.

-Eurozone enters its first official recession.

The Rest
-India celebrates first lunar landing.

-This week in Japanese innovation: a robot that feeds you, and bionic legs.

-Arsenal's Prem title run is dead in the water.

-Gordon Brown: control freak.

The Morning FT Round-up

The Financial Times is easily one of the best English-language newspapers out there. I used to consider the pink paper the symbol of snotty, umbrella-toting bankers in the Square Mile, but it's a reliable source of quality material on all things international political economy. Here's a selection from today:

Asia's Revenge - Martin Wolf points to the depressing similarities between this crisis and the various other financial crises of the past three decades. Wolf moves away from the specific day-to-day details to provide a broader historical perspective on the trends that led to our current situation. He then draws conclusions about the relationship between liberal capital markets and the global economy. This is a must-read.

Banks Face a Regulatory Revolution - although talking specifically about banks in the UK, this applies to both sides of the Atlantic and the English Channel. The article does a better job of arguing what I was getting at below: namely, that more regulation is required, but "cowing the financial sector utterly and turning its members into mere regulated utilities... would extinguish one future motor of national economic growth at a stroke."

India Cannot Afford To Delay Banking Reform - In the reverse of the situation in the UK and US, reform in India has come to a screeching halt as the anti-reform members of the ruling coalition have been strengthened by the apparent implosion of Anglo-Saxon capitalism (the Anglo-Saxon model forms the basis of many of the banking sectors' "best practices.")

The broader Indian population is right to be more cautious about opening up its banking sector to global markets before it is strong enough - East Asia learned that lesson already. But if the author is correct, and large areas of India are starved of capital, then the further growth of the Indian economy is being held back. And although the debate over how to properly sequence banking reforms is ongoing, this is not likely a step in the right direction.

Subprime Mortgages & Risk Sensitivity Explained

"It is sad how little we have learned about the market’s frequent insensitivity to risk."

That's the concluding sentence of a short essay by Avinash Persaud that helps to explain why sub-prime mortgages, which account for less than 1% of the world's debt, caused this whole mess:

The pursuit of “risk sensitivity” led to a re-organisation of bank assets away from lending on the basis of the banker’s private views about the borrower - regulators considered this hard to quantify and a little suspect – towards lending on the basis of an external credit rating. The higher the rating, the lower the capital banks had to set aside against the loan. Regulators saw this as not only risk-sensitive but transparent and quantifiable. Banking by numbers was oh so modern.

Regulators always seem to be pushing towards greater transparency in all things. Transparency is, in itself, a good thing - no question. But I find the total and complete focus on transparency to place too much faith in the ability and/or willingness of market actors to understand what these indicators reveal (or don't) and to alter their behaviour accordingly. In this case, the article concludes that the push for quantifiable risk actually obscured the nature of the risk within debt instruments.

For the policy discussion at hand, this is part of a larger point on regulation. Last night we heard Senator Obama blaming "deregulation" for the current crisis, and it's reasonable to expect the regulatory hand to come down a lot more heavily in the months to come. So be it. But preventing future bubbles in non-mortgage-related markets will require better regulation, not simply more of it. This is, of course, easier said than done - but I think it's time to take a good hard look at the market's historical record in sensitivity to risk.

Why the AKP Matters

On July 31, Turkey’s constitutional court narrowly rejected the top prosecutor's request to ban the Justice and Development party (AKP) from politics for five years, and its Prime Minister, Recep Tayyip Erdogan, for life. This in spite of a guilty verdict on the charge of being a “centre of anti-secular activity”.

The ruling is a victory for both the AKP and Turkish democracy. The prosecutor alleged that the AKP had undermined the secular state and sought to impose Sharia law. The charges were the culmination of a deep struggle for the political future of the country. The secular establishment (led by the military) has reacted to the AKP's rise with fear and aggression. The military's political intervention last year led the AKP to call a snap election, in which it affirmed its mandate with nearly 50% of the popular vote. This support is particularly strong among the rural poor.

The party has also been one of the emerging market darlings of foreign investors- according to the Financial Times, it has tamed hyperinflation, produced average GDP growth of 6.9%, and slashed gross government debt in half. Approximately 70% of the Istanbul stock exchange is held by foreign investors.

But the AKP has misplayed its political mandate since reelection, taking actions that threaten the delicate cohabitation that has existed with the military. The AKP's constitutional amendment to remove the ban on headscarves in universities was seen by hardline secularists as a dangerous affront to Turkey's Kemalist tradition. Despite the merits of opening higher education to universal access, the headscarf issue was a political powder keg, and one the AKP should not have pursued under such heightened tensions. The backlash has led Turkey into political chaos, and threatened the economic reforms so impressively achieved over the past 5 years.

However, political miscalculation is not Islamic revolution. The constitutional court's ruling is a welcome and important decision, as the AKP matters both within and beyond Turkey's borders. It's structural and market reforms have rescued Turkey from repeated financial and economic crises, an agenda it has recently strayed from amidst the political turmoil. It stands as an important example of how moderate political parties can develop out of political Islam. It is a bridge between West and East, one that should be more fully supported by Europe in particular.

The removal of the external incentive of European Union accession has undermined the reform agenda and external "check" on military intervention. A clearer commitment to integrating Turkey into Europe would be a powerful response to the constitutional court's ruling, and once again provide the incentives for moderating the internal tensions undermining Turkey's economic and political progress.