Russia: Down, Down, Down in a Burning Ring of Fire

Aug. 8.10 | About: VanEck Vectors (RSX)

Russia continues to choke on the smoke from the ring of fire that is consuming the country.

I mentioned that one likely contributor to the seriousness of the outbreak was a change in Russia’s laws, under Putin’s direction, that dismantled Russia’s fire protection service. This explanation is getting wider play as the fires continue to burn.

In brief, the law privatized anti-forest fire activities. Russian state-employed fire rangers were eliminated on state land. Instead, those leasing the properties–Russian forest product companies–were “responsible” for detecting and fighting fires.

But Russia being Russia, such “responsibility” is wholly theoretical. After all, to work, responsibility must be balanced by accountability, and Russia is notorious for lacking reliable and regular mechanisms for holding malfeasors accountable for their conduct. Even in the US, with a highly developed court system that can impose harsh punishments on tortfeasors, one can witness disastrous failures to take efficient measures to reduce environmental damage: just witness the BP fiasco in the Gulf. In Russia, such mechanisms are completely unreliable, so they have very little deterrent effect.

At best, the threat of ad hoc sanctions imposed by the power structures has the potential to deter. But these sanctions are employed in a highly corrupt and skewed way: those without juice may pay a price for screwing up, those with juice, not so much.

And it must be emphasized that the pulp and paper sector has juice in Russia. Not so much as energy, but enough (pace the Putin decision to reactivate the Lake Baikal paper mill owned by Deripaska).

Most notably, Medvedev came out of that sector. He is reported to have been (it is unclear whether he still is) a 50 percent owner of a forest products company, Fincell. He worked as legal director of Ilum Pulp from 1993-1999. He was a director of Bratskiy LPK, a paper mill. A recent taxonomy of the Russian oligarchic clans places Medvedev as a member of the pulp and paper oligarchy (h/t S/O). No doubt that Medvedev and his cronies–and yes, the elfin Medvedev does have cronies–benefited from the changed law, and I would not be surprised to learn that he was a supporter and advocate.

Which means that the likelihood that any major decision maker in the forest product sector will pay a serious price for the fires, and any failure to take adequate precautions, is virtually nil. Oh yes, there will probably be the usual ritualistic scapegoating, if only to present a facade of doing something; and perhaps, to punish someone who is out of favor for some other reason.

The lack of state capacity and a weak and corrupt legal system is only one reason why the privatization of this service was ill-advised. Other economic considerations suggest the same thing. The theory of privatization (based on property rights economics concepts) states that privatization is inefficient when it is very costly to verify that the supplier of the privatized service has undertaken agreed upon measures. It would be likely very costly to verify whether Russian forest product firms have undertaken the appropriate fire-prevention measures, and fire fighting preparations, either ex ante, or ex post. Knowing that the government doesn’t have the way to determine compliance with fire prevention/fighting standards is sufficient to make it inefficient, according to these theories, to put them in the control of firms subject to high powered incentives. They have every incentive to chisel on these costs in order to enhance profits, knowing that there is no commercial or legal penalty for doing so.

Given the immensity of the costs of the fires, moreover, it is likely that most Russian firms would be judgment proof. Another reason not to rely on ex post deterrence to achieve this objective.

So, it is likely that Russia has neither the will nor the way to provide forest products firms with the incentive to take efficient, or even barely adequate, fire prevention and fighting measures.

The change in law therefore increased the likelihood and severity of the catastrophe currently being experienced. Yes, given the dry conditions and intense heat, it is likely that many fires would have broken out this year. But things are almost certainly worse as a result of the law. It placed fire prevention and firefighting in the hands of people with no incentive, positive or negative, to invest resources into the task. In a country with corrupt courts, a politically connected industry pays no price for making such investments. So why do it?

And now the country is paying the price. Again.

A part of the Russian Academy of Sciences predicted this immediately upon passage of the law. They were very prescient.

It will be interesting to see whether those ultimately responsible, Putin and Medvedev, pay any political price. I doubt it. That would be as telling as anything, and make it clear that that yet more catastrophes await.