July 20, 2016

Commentary: Hybrid Business -- The Risks In

The Kremlin's Weaponization Of The
Economy
by Mark Galeotti and Anna Arutunyan
"How many divisions does the pope have?" Josef Stalin was meant to have asked contemptuously. Today the
question could as easily be posed: How many companies does the Kremlin have?
Russia's government has a pernicious habit of treating business as yet another arm of politics, and this habit goes
far beyond the notions of "kleptocracy" or "state capitalism." The recent release of the so-calledPanama
Papers has directed attention toward the complex network of offshore shell companies used to hide, launder,
move, and house funds acquired -- through whatever means -- by figures close to Putin, often through "donations"
from oligarchs and businesses seeking favors or repaying debts. This is, however, the kind of personal enrichment
familiar from kleptocracies the world over.
The case of the $2 billion in funds notionally held by Sergei Roldugin -- musician and incidentally godfather of one
of Putin's daughters -- highlights some of the more distinctive complexities of Russian practices. At least some of
the funds from Roldugin's offshores went not to fund palaces and resorts but were reinvested back into certain
strategic companies important to the Russian state. In other words, the boundaries between apparent
embezzlement and statecraft in Russia have become unclear and in some cases downright meaningless.
Russia as a state lends itself to all kinds of notions of hybridity: hybrid war, hybrid democracy, hybrid autocracy.
What, then, is hybrid business? In almost Clausewitzian terms -- and much like the concepts of hybrid
democracy and hybrid autocracy -- it reflects a process that goes both ways: Business is often politics by other
means, just as politics is frequently business by other means, interchangeably, simultaneously, and often
somewhere in between.
We can identify four ways in which this happens: when business is used, pure and simple, as an instrument of
the state; when business interests and the bottom line are sacrificed to a higher political purpose; when
companies make deals at the Kremlin's bidding; and, finally, when businesses, in a peculiar Russian reversal,
wind up actually hijacking the interests of the state. This typology is not mutually exclusive; some businesses
that fit neatly into the first category can just as easily turn into perfect examples of the last. But the general
pattern amounts to the often implicit outsourcing of government policy to business in a way that creates
vulnerability not just for the businesses themselves but for the government as a whole.
Such patterns are not new, and go hand in hand with a deeply embedded history of the government co-opting
business. Billionaire Vladimir Lisin complained in a recent interview that when state corporations control up to 60
percent of the economy, their very presence changes the rules of the game for everyone else; the motivation to
invest comes not from business itself, but from state officials.
This is not a vestige of the Soviet planning economy, but goes back at least to the times of Peter the Great, when
mining factories in the Urals were appropriated by the state when their production fell. A similar blurring of
economic and political interests is a leitmotif of Russian history, from the forced industrialization of the late 19th
century to the forced labor of the gulags.
Nonetheless, today, in an era of corruption schemes and offshore leaks, hybrid business and its weaponization by
the government have emerged as both a central feature of Russian governance and a potent risk both to itself and
the outside word.
'Marshalling' Business
The most compelling case of how certain businesses and businessmen are instrumentalized for political and even
geopolitical ends is Konstantin Malofeyev, founder of the Marshall Capital investment group. As a direct investor in
telecommunications and media, Marshall Capital was already well integrated in economic sectors of strategic
importance. But Malofeyev himself exhibited ideological leanings toward Orthodoxy and nationalism, something
that, despite persistent legal issues, placed him in direct alignment with the Kremlin's goals in 2014.

Ukraine and the European Commission have accused Malofeyev of financing pro-Russian separatist insurgents in
East Ukraine through his Basil the Great Charitable Foundation. Though he has denied these allegations, there
are more compelling factors linking the businessman to the conflict. His former employees include Aleksandr
Borodai, who led the separatist Donetsk People's Republic group until August 2014, and more importantly Igor
Strelkov, the man who claims he "pulled the trigger on the war" in the Donbas. Malofeyev himself admitted in a
November 2015 interview to Vedomosti that Borodai served as his consultant and introduced him to Strelkov
(whose real name is Girkin) in late December 2013 or early January 2014.
The nature of even more direct political links between Malofeyev and the Kremlin emerged in February 2015. The
newspaper Novaya Gazetaacquired a document drafted by people close to Malofeyev, which was then passed
on to the Presidential Administration. Even before erstwhile Ukrainian President Yanukovych had fled the country,
it outlined a game plan for the annexation of Crimea as well as the Donbas. The process outlined in the document
-- "sovereignization and the unification with Russia" -- was what rebels who captured government buildings in the
region in April 2014 would demand. Control of Ukraine's gas infrastructure was cited as the chief motive in the
report, arguing that loss of control of this infrastructure would jeopardize Gazprom's positions in central and
southern Europe.
If authentic, the document corroborates a model of lobbying practices around the Kremlin, a "marketplace" of
policies where various bidders pitch ideas to Vladimir Putin or those close to him in hopes of catching his eye or
winning his favor. The commitments made by the Kremlin in response to such overtures are usually verbal and
vague, allowing it to opt out of responsibility any time but likewise raising risks of the outsourced policy getting
out of control. In this way, the involvement of Malofeyev and his capital in the war in Ukraine suggests another
vector of hybridization: the extent to which his own ideological leanings contributed to the Kremlin's decision to
intervene further in Ukraine and thus, perhaps to some extent, even hijacked state interests.
Agents Of The State
If Malofeyev's case is one in which the precise lines and directions of influence are especially unclear, there are
certainly numerous examples of organizations technically meant to be operating on a commercial basis -- which
may include government-owned or majority owned ones such as oil giant Rosneft or the Uralvagonzavod machinebuilding corporation -- which instead become willingly or routinely used for the purposes of statecraft, regardless of
the balance of profit and loss. Mercenaries from the private military company ChVK Wagner, for example, are
fighting and dying in Syria, but this is actually a body founded at the initiative of the government, funded by the
government, and directed by the government -- and yet technically presented as a wholly independent,
commercial group. Not least, that helps keep the "official" body count down -- although reportedly casualties
suffered by Wagner's men are in the dozens, only seven Russian servicemen have been killed.
Businesses wind up co-opted into the government's domestic and geopolitical goals in other, less kinetic ways.
Yevgeny Dvoskin's Genbank has enjoyed protection from the Federal Security Service (FSB) and was reputedly
heavily involved in funneling illicit cash to state officials and state corporations. (Dvoskin himself had been
deported from the United States for tax fraud in 2001.) After Russia's annexation of Crimea, Genbank expanded to
open 175 branches there, becoming the second-biggest bank on the peninsula, which Western sanctions have
effectively cut off from the global financial infrastructure.
Despite some unsuccessful efforts by Russia's Central Bank to block Genbank's activities in Crimea over past
criminal ties, Dvoskin's outfit largely benefited from the Russian government's bid to develop the peninsula via
smaller banks with shady pasts. The question largely remains as to what extent these two developments -- the
abandonment of the Central Bank's efforts to block Genbank and the government's facilitation of such banks'
expansion in Crimea -- are owed to Genbank's FSB protection. Money laundering, FSB protection, and a share of
the action in Crimea point to a web of tradeoffs that makes all parties vulnerable and muddies the question of who,
exactly, is the client and who is the patron.
Doing Your Duty
These are, admittedly, extreme examples, not least in Wagner's case, because private military companies are
technically not even legal in Russia. This further underscores the extent to which this is a state initiative. Far more
common are the cases where business will instead become integrated peripherally and occasionally into state
operations. This might be as simple as providing a cover identity for an intelligence officer, as Vnesheconombank
did for confessed Russian spy Evgeny Buryakov in New York between 2012 and 2015. Or it could be more
complex, such as the establishment in 2004 of RosUkrEnergo as a joint venture between Gazprom and a
consortium of Ukrainian oligarchs to create not only a middleman to handle the imports of Russian gas into

Ukraine but also a way of buying influence with outgoing Ukrainian President Leonid Kuchma and then his
successor, Viktor Yushchenko. In this respect, RosUkrEnergo was at once an active economic player, a source
of corrupt profits, and an instrument of Moscow's statecraft.
More generally, there are the cases when market logic is forced to take second place to state interest and
companies have to make deals because the Kremlin wants them to happen.
Sometimes, this means the raw power politics of domestic control. This year's proposed privatizations of
government shares in a series of companies -- expected to include Alrosa, Bashneft, Rosneft, Sovkomflot, and
Vneshtorgbank -- are not only taking place in an environment of financial sanctions and market doubts but also
already being hedged about with conditions likely to deter foreign bidders. The aim is clearly neither to maximize
revenue for the state nor to create greater business efficiency so much as to reward companies and oligarchs who
have demonstrated their loyalty. This could be interpreted simply as corruption, but it is more than that. It is,
rather, an integral way in which the Kremlin manages an avaricious and ruthless elite, forcing them to rededicate
themselves to Putin and the state, with the prospect of further economic opportunities. This has, after all, been
done many times before, from the apportioning of fat contracts for everything at the Sochi Winter Olympics to
new standard school textbooks (incidentally, the key beneficiaries in both cases were Arkady and Boris
Rotenberg, coincidentally among Putin's closest friends and staunchest allies).
This is not always about elite politics and domestic calculations, though. In May 2014, for example, the Kremlin
was desperate to make sure a $400 billion energy deal with China went ahead. After all, Russia was in a new
geopolitical competition with the West following the annexation of Crimea and intervention into southeastern
Ukraine, and as sanctions were beginning to bite, Putin wanted his own pivot east. In the hope -- in hindsight, vain
-- that this would elevate Moscow's relationship with Beijing to a new level (and also teach Washington a lesson),
Moscow was willing to push Gazprom to take whatever deal the Chinese were offering. The Chinese, fully aware of
this, pushed a very hard bargain indeed, so much so that it is hard to say when Gazprom will so much as break
even on the deal. In the end, the 30-year energy agreement was likely a bad deal for Gazprom -- but a necessary
one for the Kremlin.
Who Is Client, Who Is Patron?
The hybridization of business is, though, often a two-way process in which both sides seek to win something in
exchange, whether money or favor.
A classic example is Uralvagonzavod, a public limited company whose entire stock was acquired in 2009 by the
Federal Agency for Government Property Management. Amid massive anti-Kremlin protests in December 2011, a
group of Uralvagonzavod workers delivered a televised pledge to Putin, then running for reelection, to take on the
protesters if need be. At the time, Defense Minister Anatoly Serdyukov had made it clear that he saw no need to
buy any new tanks, not least the T-90s that Uralvagonzavod had hoped to build for the Russian military. Shortly
after the workers' public display of loyalty, Putin publicly overruled Serdyukov's decision and the plant was handed
a $2 billion state order to modernize tanks for the Russian Army.
The flow of favor and politics goes both ways, though. While Uralvagonzavod was trying to use politics to win
market share, Deputy Prime Minister Dmitry Rogozin was not only lobbying on behalf of the domestic military
industrial complex -- especially seeking to reverse Serdyukov's willingness to buy foreign equipment -- but he was
also using this to try and win the industrialists' support for his ultimately unsuccessful bid to become defense
minister himself. At the time, a colonel within the Defense Ministry's legal directorate, speaking on conditions of
anonymity, referred to this as "the defense industries' attempt to take over the military again," In a hybrid
business environment, politics and business and war become deeply and incestuously intertwined.
Hybrid Business Decisions
In this way, the very culture of decision-making in both political and business spheres becomes "hybridized." In
the wake of the Panama Papers revelations, for example, many Western commentators voiced their surprise at
what is at face value a rather obvious discovery that certain decisions that might seem to be matters of policy or
ideology are in fact driven equally by the financial interests of the parties involved. Nonetheless, this is Russia's
reality. It is not simply that individuals take advantage of their positions and connections to enrich themselves.
Rather, it is that almost all decisions now are considered along the vectors of personal and factional advantage,
business sense, and political expedience.

Nobody knows where business ends in Russia and politics begins, and here is the strength but also the

very serious danger of the hybrid business model.

Russia's media policy during Putin's tenure is rife with such hybrid business decisions. The 2001 takeover of the
independent NTV station by Gazprom was not just dictated by the need to rein in a journalistic collective
vehemently opposed to being dictated to by the state. Certainly, the fraud charges against NTV owner Vladimir
Gusinsky were politically motivated, but the hundreds of millions of dollars his Media-Most company owed to
Gazprom were also important factors in the decision to take over the station.
Likewise, the sudden decision to liquidate and overhaul the state-funded RIA Novosti news agency in
December 2013 was a classic hybrid decision. The aftermath of the overhaul saw anti-Western firebrand Dmitry
Kiselyov replace Svetlana Mironyuk as the agency's chief, in a decision that Vladimir Putin himself described as
the need for a "patriot" to head a government-funded outlet. The newly remade Rossiya Segodnya became a
cornerstone in the Kremlin's propaganda around the time of the Ukraine conflict, amid clear overtures from the
English-language RT channel for closer cooperation and even hopes that the two entities could eventually merge
in the future. Yet the roots of the transformation lie more in money than politics. RT and RIA had been vying for
years over government resources; their cohabitation in the old APN news agency complex on Moscow's Zubovsky
Boulevard was a constant source of bitter rivalries over space and money. Nonetheless, political issues were
mobilized to win this economic struggle. In the two years leading up to RIA's liquidation, insiders describe efforts
by officials supporting RT to sway Putin against RIA Novosti over its supposedly pro-opposition reporting. When
the decision was finally reached, it was described by Kremlin chief of staff Sergei Ivanov as a measure of "saving
money and making state media more effective" as well as defending "national interests." As an official
characteristic, this amounts to nothing less than hybrid decision-making.
Drawing Lines
Often, it is hard to be sure exactly where the balance lies, and this is often the case with strategic projects
abroad. One of the reasons the bidding process for the Temelin nuclear power station project in the Czech
Republic was so fraught, for example (it was eventually canceled in 2014), was that there was considerable
evidence according to the Czech BIS security service that Russia's intelligence services were actively and
aggressively working in support of Rosatom's submission. The difficulty lies in knowing whether this was just a
characteristically more bare-knuckled expression of Moscow's support for a commercial venture (after all, it is not
unknown for Western countries to mobilize political and even intelligence resources behind strategic industries
and their tenders), or whether there was some strategic geopolitical purpose at work. Was this a way to make the
Czech energy infrastructure vulnerable to Russian manipulation in the future? A ruse to help infiltrate Russian
spies? It is hard to be sure.

Russia is in general losing the most educated, most active, most entrepreneurial people, says Lev
Gudkov, the director of the Levada Center
In the end, nobody knows where business ends in Russia and politics begins, and here is the strength but also
the very serious danger of the hybrid business model. In an age of relatively open economies, complex
transnational corporations and ownership structures, and voracious and, if not immoral, certainly value-agnostic
capitalism, it is relatively easy to establish enterprises, move capital, and penetrate markets.
For example, when state-owned Ruselectronics wanted to buy key components of thermal imaging systems from
the West, both to fulfill a government contract and bypass sanctions, it created an array of shell companies
through which to operate: first Cyclone then Cyclone-IR in partnership with a Cypriot company of unclear
ownership. Cyclone-IR then changed its name to Photoelectric Devices LLC to mask its origins and military role,
alike. This was not an intelligence operation but a case in which a Russian state-owned company ultimately felt it
could and should operate in ways that were disingenuous at best, downright dishonest at worst, at once to make
some money and also please their main client: the Ministry of Defense.
Bad Business
Regardless of the immediate temptations and opportunities in such a culture, there are several serious longerterm risks for Russia. First of all, politics is often bad business. It can mean that entrepreneurship and market
logic take second place to policy. At best, enterprises get fat and lazy, relying on political support rather than
efficiency and ingenuity. If spies can get you advance sight of a rival's tender, or copies of their new invention, why
bother investing in business development and R&D? If politics can clinch you orders at home and spookery win
them abroad, what need to produce the best and the cheapest? If you can use political pressure to close or take
over more efficient rivals, why get any better? Corporations such as Gazprom and Rosneft, for example, are
notoriously inefficient because they can rely on such monopolies and political support. In 2012, Gazprom was
estimated to lose up to $40 billion from corruption and inefficiency, almost equaling its net profit of $44.7 billion.

However, the Kremlin will always look after these national champions -- for a price. In return, they have to be
willing to operate from time to time as arms of the state, whether Gazprom allowing itself to be used as an
"energy weapon" against Ukraine in 2015 (which cost it almost $6 billion in fines and lost revenue) or helping
bankroll the Sochi Olympics (Rosneft stumped up $180 million).
At the same time, it all contributes to the worrying toxicity of "brand Russia." It is hard to quantify the impacts,
harder still to predict when a tipping point might be reached when the simple fact of being a Russian investor or
company starts to make you unwelcome and untrusted. One Western executive whose corporation is downsizing
its presence in Russia said, "Yes, there are objective factors such as the present economic troubles and the
worsening international situation, but at least as important is a sense on the board that Russia is going feral
again. I don't see it here on the ground, but people don't see this as a place to be for the next few years." This is
even more of a problem for new businesses. According to David Nangle, managing director of venture capital group
Vostok Emerging Finance, interviewed by the Financial Times, "it's very hard to get global capital to want to
support young companies in Russia."
Soft power, in all its many guises, has been something of a blind spot for this Kremlin. Russia's leaders
understand that it can be a powerful force, but they really don't get how it's accumulated, deployed, or
squandered. Big-ticket events such as the Sochi Winter Olympics, propaganda initiatives such as RT, and barechested Putin memes do not add up to an effective soft-power narrative, especially not when set against such
counterexamples as the annexation of Crimea, the shooting down of the MH17 airliner, the toxic outpourings of
armies of trolls and hackers, and a seemingly endless stream of sports-doping and corruption claims. Even
genuine good-news business stories become tainted and open to question. The Kaspersky Lab software security
group is an example of a genuine world leader that -- though it is registered in London -- is undeniably Russian.
Yet persistent suggestions of a connection with the FSB (most prominently by Bloomberg) are at least as much a
symptom of a generalized suspicion of Russian business as anything specific about the company, even given
founder Yevgeny Kaspersky's background in the KGB.
Hence Russia's long-term business prospects are being mortgaged for short-term and probably unproductive
political purposes. The country has tremendous natural but also human resources, and nothing trains generations
of able capitalists like 70 years of Soviet pseudo-socialism. Just as actually Russia ought, under other
circumstances, to be able to craft a compelling 'soft power' narrative based on not just historical triumphs and
virtues but also contemporary achievements and qualities, so too there will one day be a powerful economic story
the country will be able to tell, not just one based on modern pseudo-capitalism or on the desperate export of
hydrocarbons by a handful of crony businesses.
At the moment, though, just as Russians are living leaner lives in the name of the Kremlin's geopolitical
ambitions, so too their business world is shaped, deformed, and constrained by politics. Despite real
achievements in addressing corruption and red tape -- the country has after all been moving up the World Bank's
Ease of Doing Business league table -- anecdotal and survey data alike suggest young, entrepreneurial Russians
are again turning away from setting up new businesses. Not only the West but Asia too is experiencing an
unprecedented influx of smart, ambitious Russians -- and portable companies such as venture capital outfits -seeking a better environment in which to operate. It is not just the famous names such as Pavel Durov, founder
of social-networking site VKontakte. According to Lev Gudkov, director of the Levada Center public opinion
pollsters, Russia is in general "losing the most educated, most active, most entrepreneurial people."
The Kremlin may be willing to see business as simply yet another battleground and instrument of state policy.
Many businesses and businesspeople may likewise be willing to play this role in return for indulgence for their
sins and preferential treatment. But ultimately this is also proving corrosive of Russia's economic effectiveness
and public image alike, at a time when it can scarcely afford to see either damaged any further.
Mark Galeotti is a senior research fellow at the Institute of International Relations Prague and director of the consultancy Mayak
Intelligence. Anna Arutunyan is a Moscow -based j ournalist and w riter, author of The Putin Mystique.

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