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The Dangers Of Doing Business With Putin’s Russia

I spent the 1990s teaching economics at a business school in Moscow. Our students were graduates of FizTech, Mekh-Mat, MIFI—the whole alphabet soup of science and technology schools that had fed the Soviet military-industrial establishment. These young men and women had degrees in things like “laser weapons platform design” that weren’t in much demand in Boris Yeltsin’s new Russia. Now they wanted to become financial analysts, accountants, and business IT specialists.

The students were incredibly bright and had great quantitative skills, but there were ideas in our American-style MBA curriculum that many of them found hard to grasp. Not my subject, economics. None of them had ever had an econ course before, but they ate up equations and models like breakfast cereal. Instead, the hardest thing for some of them to grasp was the idea that business could be something other than a zero-sum game.

The zero-sum mentality

Our Russian students had been brought up in a system where the central question, at least in dealing with strangers, was the quintessentially Russian “???-?????” Who is going to get the best of whom? The question reflects a belief that every human interaction with outsiders necessarily has a winner and a loser. The idea that arms-length business dealings with people to whom you owe no prior duty of loyalty could have mutual benefits was new. Some students caught on, some did not.

Attempts at trade in which one party has a ???-???? mentality and the other is looking for mutual gains are fraught with risk. For the party with the zero-sum mindset, the risk is that of missing out on genuine opportunities for mutual gain. For the party looking for mutual gain, the risk is that the benefits promised in return may not materialize, for one of three reasons:

•    Fraud. You hand over your money for a bottle of Armenian brandy, but when you get home and open it, you find it is cheap vodka colored with tea.
•    Non-fulfillment. You deliver a manuscript to a publisher in return for promised royalties; the book is published and appears in every bookstore, but the royalties are never paid. Go to court? You’re joking, of course.
•    Hold-up. You enter into a contract that involves an investment in sunk costs on your part. After you have made the investment, your contract partner demands a renegotiation of terms, knowing that your commitment of sunk costs has weakened your bargaining position. (For example, you lease an office, and after you have redecorated it and advertised the address, the landlord demands an increase in the rent.)

When these risks are present, the only trades into which you, as an individual, can safely enter are ones that involve the simultaneous exchange of cash for goods or services whose quality you can verify on the spot. If you look at trade from a national rather than an individual perspective, the risks are even greater.

Traders vs. Guardians

Just who are the people with whom it is dangerous to trade? Certainly, I do not mean to put all Russians in that category, any more than I would say all Americans are reliable trading partners. Instead, I would point to a distinction that Jane Jacobs makes, in her book Systems of Survival, between two mindsets or “ethical syndromes” that she calls the guardian mentality and the commercial mentality.

The guardians, who get their name from Plato’s ideal rulers, include government leaders, soldiers, and police, although their way of thinking also extends to criminal gangs, hunter-gatherers, and some other groups. Of the fifteen virtues Jacobs lists as characteristic for guardians, five are especially relevant for our discussion: First, guardians value and receive respect for exerting prowess. Second, they consider it important to take vengeance, in some cases even when doing so is costly to them. Third, they admire skill in deceit as a means of achieving an end. Fourth, they treasure honor. Fifth, although they are willing to trade when necessary, they do not view trade as an especially virtuous activity. They are suspicious of trade, in part, because it easily leads to corruption, treachery, or other conflicts between group and personal interests.

Commercial types, or traders, have a different set of virtues. They value efficiency, novelty, industriousness, and thrift. They seek voluntary agreements as the preferred means of attaining an end. Accordingly, they place a high value on respect for contracts and on honesty. They are not completely unwilling to use force, but they tend to shun it as regrettable necessity and to use it only as a last resort.

Honor is a particularly tricky concept. As Jacobs uses the term, it appears to mean the respect and esteem earned by admirably fulfilling one’s moral obligations. The puzzle is why she lists it as a guardian virtue but not a commercial one. Yes, clearly, a guardian can earn respect and esteem by exhibiting courage, loyalty, prowess on the battlefield, and so on, but can’t a trader equally earn respect and esteem by building a successful enterprise through thrift and innovation, by keeping promises, and paying debts?

I think the key to the puzzle is that honor is elevated to a distinct, separate virtue among guardians because that moral system creates a more frequent tensions between moral obligation and self-interest. It is not in your immediate self-interest to be the brave soldier who rallies retreating comrades and leads them back for one last, long-shot attack, but it is honorable to do so. Also, guardian societies are hierarchical, so unless you stand at the very top, honorable conduct requires loyalty and obedience even when they go against your immediate self-interest.

In contrast, a society of traders operates under the principle of Adam Smith’s invisible hand or what Friedrich Hayek called spontaneous order. In such a society, the pursuit of self-interest by each member is supposed to be consistent with the interests of the community as a whole, provided everyone plays by the rules of the game, defined as respect for property rights and fulfilment of contracts. In such a society, you can earn the esteem of others through the pursuit of self-interest. In that sense, it is a virtue for traders to behave honorably, but honor is not a distinct, separate virtue.

Related Article: How The Russia-China Gas Deal Hurts U.S. Liquid Natural Gas Industry

Given their different value systems, guardians and traders approach negotiations with outsiders differently. Guardians take a wary approach, maintaining an expectation that any encounter is likely to produce a clear winner and a clear loser. Furthermore, they see any commercial agreement that is reached as an ongoing contest in which deceit is a legitimate weapon, not only in negotiating the  agreement but also in carrying it out.

Traders, in contrast, approach negotiations more openly in the expectation of finding an agreement that will benefit both parties. Once they reach such an agreement, their default expectation is that it will be in the interest of both parties to honor it, and even if changing circumstances defeat that expectation, they expect the losing side to perform as promised.

Without a belief that voluntary agreements will lead to mutual benefits and that promise keeping is a virtue, the prospects for successful trading seem dim. It is not going too far to say that one who holds the opposite beliefs—the conviction that one side in any business relationship is bound to lose, combined with the view that deceit is a virtue and honesty is for chumps—does not believe in trade at all.

How do Jacobs’ categories apply to Russia? Quite possibly the guardian mindset is more prevalent there than among Americans, but the sociological distribution of value systems is beside the point. What is important is that the Russian government under Vladimir Putin is, in many respects, the very embodiment of Jacobs’ guardian mentality.

Putin and many of his closest associates came up through the KGB, an organization in which prowess, deceit, vengeance and honor are paramount virtues. Sometimes they are on display cartoonishly, as in pictures of Putin bare chested astride a horse or intently aiming a crossbow at a whale.  A more chilling example from recent events is Putin’s after-the-fact acknowledgment—not just open, but openly boastful—of the deceptive use of unmarked Russian troops (“little green men”) in the takeover of Crimea.

Was Bastiat right to think that if goods cross frontiers, soldiers will not?

Applying Jacobs’ framework to international relations suggests that we take a cautious view of the old notion that trade is an instrument of peace. Frederic Bastiat supposedly said that if goods don’t cross frontiers, soldiers will. Although the quote appears to be spurious, the idea is consistent with his thought and that of many libertarians and classical liberals today. In a recent essay in The Freeman, Julian Adorney elaborates on the theory. Free trade creates international good will, he says. It humanizes the people that you trade with and gives nations a material incentive to avoid war. He quotes empirical research by Patrick McDonald to the effect that lower barriers to trade reduce the probability to conflict between nations.

The belief in trade as an instrument of peace is institutionalized in the World Trade Organization. A WTO document lists promotion of peace as the first among ten benefits:

Crudely put, sales people are usually reluctant to fight their customers. In other words, if trade flows smoothly and both sides enjoy a healthy commercial relationship, political conflict is less likely. . . What’s more, smoothly-flowing trade also helps people all over the world become better off. People who are more prosperous and contented are also less likely to fight.

However, I think the notion that trade is necessarily conducive to peace requires an important qualification. It is valid, I think, only when the trade is between representatives of the commercial mindset on both sides. Things stand differently in the case of pseudo-commercial negotiations between traders on one side and guardians on the other, or between guardian types on both sides. As the recent Ukrainian conflict has brought home, trade agreements negotiated under those conditions are all too likely to exacerbate rather than to quell conflict. Consider three examples:

Ukrainian-Russian gas trade. For years, the gas trade between Ukraine and Russia has had guardian types at both ends. The two sides have repeatedly violated agreements and renegotiated them under duress. In these classic ???-???? dealings, the winners have been Putin’s Russia, which has gained powerful geopolitical leverage over its neighbor, and corrupt intermediaries on both sides. The losers have been ordinary Ukrainians who have awakened to see that their country has been sold down the river for the fool’s gold of (temporarily) cheap Russian gas.

Unfortunately, once Russia’s partner, former Ukrainian president Viktor Yanukovych, left the stage, Ukraine’s almost total dependency on Russian gas left it vulnerable to a classic hold-up. Gazprom, majority owned by the Russian state, announced a price increase. It justified the increase in part on the grounds that Russia was no longer bound to a previously agreed discount in lieu of rent for its Sevastopol naval base, which Russia had just swiped along with the rest of Crimea. On top of that, Gazprom has demanded immediate payment of arrears (inflated by some accounts) plus advance payment for future deliveries. To add insult to injury, Russia now claims ownership of some promising oil and gas properties offshore from Crimea–no compensation offered for those, needless to say.

Related Article: Putin Has Crimea, But Reaping Its Energy Riches May Prove Difficult

EU-Russian gas trade. The gas trade between Russia and the EU is a variant on the same story, except that this time EU commercial interests, rather than a fellow guardian autocrat, were on the other end of the deal with Gazprom. European proponents of the deal sold it as offering access to a geographically convenient source of gas at a reasonable price. Some seem to have imagined that since the price was profitable to both sides, Russia would have an economic incentive to avoid conflict.

From the start, though, the deal had built-in asymmetries. On the Russian end, a single entity, Gazprom, controlled the shut-off valve, while multiple government and private buyers on the Western end lacked the unity of purpose they would need to credibly threaten a buyers’ boycott. Furthermore, Western Europeans, who had always looked at Russian gas primarily in commercial terms, were highly sensitive to the economic costs of any supply interruption. The Russian end, in contrast, stood ready, if push came to shove, to place guardian values (national honor, revenge for perceived affronts like the admission of the Baltic states to NATO) ahead of any economic costs.

Trade in strategic goods. Gas is not the only item of East-West trade. The West has contracted both to sell strategic goods to Russia (for example, French-built warships) and buy strategic goods from Russia (for example, rocket engines used to launch US military satellites). Although the trade looks symmetrical in commercial terms, it is asymmetrical in terms of politics and geostrategy. In the West, commercial interests, including the Lockheed-Boeing rocket consortium ULA and French shipbuilders such as DCN, are lobbying furiously to see the contracts through in order to realize hoped-for profits. Western governments are reluctant to override these commercial interests. Meanwhile, the Russian side has other priorities and is willing to selectively observe or cancel such contracts in pursuit of strategic ends, absorbing commercial losses when necessary.

In short, in each of these cases, East-West trade relations give the Western side an economic incentive to avoid conflict while simultaneously giving Russia a weapon to advance its geostrategic interests. The reason is simple: The Western parties believe in trade but the Russian side does not:

•    The West views trade agreements as mutually beneficial deals that provide an inherent incentive for peaceful resolution of disputes. The Russian leadership views them in zero-sum terms, to be fulfilled or unilaterally renounced according to a perceived balance of noneconomic factors.

•    The Western partners to these deals consider fulfillment of contracts to be the norm, even if changing circumstances make them unprofitable. The Russian side considers it normal to enter into contracts in the expectation that it can renounce or unilaterally revise them if circumstances change.

•    Without denying that self-interest plays a role on both sides, it is fair to say that in the West, the ethical framework behind the self-interest assumes shared values of honesty and promise keeping. On the Russian side, in a showdown, there is a significant chance that guardian values like prowess, skill in deceit, vengeance and honor will trump economic self-interest.

The bottom line

The bottom line is that trade is a reliable instrument of peace only when commercial considerations dominate on both sides. Asymmetrical trade that has a commercially motivated party on one side and a guardian party on the other risks becoming an instrument of conflict.

In practice, as Jacobs herself pointed out, all existing societies contain a mix of guardian and commercial elements. Bastiat’s belief that increased trade will reduce chances for interstate conflict may well be valid in cases where the trade in question strengthens the hand of the commercial elements within both countries. Unfortunately that has not, at least not yet, happened in Russia. Until it does, it would be wise for governments in the West to approach trade with Russia much more cautiously than they have done to date.

By Ed Dolan




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Leave a comment
  • John jack on May 27 2014 said:
    That's a very sophisticated way of saying that the west is exceptional and the Russians are barbarians. It's not surprising that you fail to mention that direct western meddling has fomented the civil war that now has started raging on Russia's border.
  • Jackson Johns on May 27 2014 said:
    Russia has never been particularly reliable, but with Putin nothing is secure. Not all Russians are barbarians, only those in control.

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