Vladimir Putin, Transaction Cost Economist

I find the whole upstream-downstream dispute in the metals markets in Russia very fascinating.  To watch the operation of a slice of the natural state is to understand the whole.  Putin’s role in these events is particularly illuminating.

Putin held a meeting with the head of Russia’s Federal Antimonopoly Service, Igor Artemyev, at which he gave a soliloquy telling how it was going to be.  Most notably, Putin advocated the return to a system of long term contracts with fixed prices (or prices based on a formula—press accounts vary):

The largest producers and consumers of metal could return to the practice of long-term contracts with a fixed price formula, which would rule out the possibility of price hikes. He said that the government believes that the supplies of metal, iron ore and coke to the domestic market should be viewed as a priority.

But as some bank analysts point out, this doesn’t solve the problem.  Fixed prices  are almost always wrong, out of alignment with current market conditions.  Sometimes they are too low, other times they are too high.  One party of the other has a reason to squawk that current prices are out of line.  And with commodities (the role of which in the Russian economy Putin’s soliloquy emphasizes with pride, in a very revealing counterpoint to Medvedev’s embarrassment at Russia’s commodity-centric economy), since prices are very volatile, misalignments are frequently large.

The key thing is that as any good transactions cost economist knows, contracts are first and foremost a part of a mechanism to govern the relationship between the contracting parties.  They provide some structure to the relationship between the parties.  But these contracts are necessarily incomplete, and need a mechanism to respond to developments not anticipated in the contract

Putin gets this, sort of, in an intuitive way:

Disagreements over prices should not lead to the unilateral termination of deliveries or failure to pay, and commercial dispute over contracts must be resolved through talks or arbitration tribunals, without driving partners into a corner.

But crucially, Putin also outlined a state-directed governance mechanism.  As described by John Helmer:

Putin’s fourth point in the pricing formula is a vague undertaking to a new form of state supervision of input costs and state planned price benchmarks, enabling the FAS and the Ministry of the Industry to deter or control sharp price deviations.  “The relevant federal agencies will be instructed, said Putin, “to calculate the economic benchmarks for metals prices and prices for other basic goods and services.”

In brief, Putin is advocating a system in which the state plays an important role in setting and administering prices, and governing contractual relationships between big firms.

This is part of the logic of the natural state.  Competition and conflict over rents is highly destabilizing to such a state.  The state has to limit access, dampen competition, and intervene in the interactions between nominally independent firms in order to maintain stability.

The fact that the most powerful man in the country is involved in these matters intimately, and on a daily basis, also reveals the fundamental political character of these ostensibly economic issues.  The most powerful politician must use his power primarily to maintain the delicate balance between vying factions identified first and foremost by their commercial interests.  Failure to do so–the deluge.

Calvin Coolidge once said “the business of America is business.”  Things are a bit different in Russia.  Of it, it can be said that the politics of Russia is business.

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About Craig Pirrong 238 Articles

Affiliation: University of Houston

Dr Pirrong is Professor of Finance, and Energy Markets Director for the Global Energy Management Institute at the Bauer College of Business of the University of Houston. He was previously Watson Family Professor of Commodity and Financial Risk Management at Oklahoma State University, and a faculty member at the University of Michigan, the University of Chicago, and Washington University.

Professor Pirrong's research focuses on the organization of financial exchanges, derivatives clearing, competition between exchanges, commodity markets, derivatives market manipulation, the relation between market fundamentals and commodity price dynamics, and the implications of this relation for the pricing of commodity derivatives. He has published 30 articles in professional publications, is the author of three books, and has consulted widely, primarily on commodity and market manipulation-related issues.

He holds a Ph.D. in business economics from the University of Chicago.

Visit: Streetwise Professor

1 Comment on Vladimir Putin, Transaction Cost Economist

  1. Say what you will of politics, business and Russia but 30th President Calvin Coolidge never said nor believed that "The business of America is business." You may trace that misquotation to biographer, William Allen White who is the father of many errors.
    Once Coolidge was offered a choice of salad dressings and said, "I'll have whichever one isn't Red."

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