Tech Report October 2011

The Next Russian Revolution

Outside Moscow, the Kremlin is laying plans to turn a forlorn patch of farmland into a new Silicon Valley, and Russia into a major technological power. Cisco, Nokia, and MIT are eager partners. Russia’s people, by and large, are less enthusiastic. A report on Russia’s peculiar version of capitalism today, as that country gathers itself for its next leap forward.
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Above: Field of dreams? A scale model of the technology center to be built at Skolkovo

If you start at the Kremlin—as almost everything still does in Russia—and drive down Novy Arbat, the first landmark you’ll pass, just before crossing the Moskva River, will be the White House, site of the famous confrontation with the hard-liners that ended the Soviet Union. Soon after, on your left, as you travel along Kutuzovsky Prospekt, is the post-Soviet Victory Park, home to a grandiose architectural monstrosity. Just down the road on your right, you’ll see a shiny white mall, featuring Chanel and Cartier, which is, perhaps, a truer monument to the spirit of post-Communist Russia. Eventually, after turning left off the main highway and driving about half a mile down a dirt road, you’ll come to a 900-acre patch of farmland, some 15 miles from the center of Moscow.

I went there on a hot, dry day last fall. The land looked unremarkable, and there were no passersby, but entry to it was blocked by two uniformed government guards, a border-style barrier, and concrete blocks. After a 20-minute negotiation and an appeal to higher authorities, the guards let me and my official escort through. Most of the cultivated fields beyond them had already been harvested, with only yellow-green stubble left from the year’s crop. In one corner, two men in undershirts dug potatoes.

To the south, the fields looked out at the vast, pink Three Whales shopping mall, whose billboard claimed it was “the biggest furniture center in Europe.” To the northwest, the site abutted a cluster of houses—ramshackle, white-washed cottages in the traditional village style, side by side with newer faux-French châteaus and multistory brick fortresses, their roofs sprouting satellite dishes. The only distinguishing natural feature was a pond in one corner of the site, surrounded by a birch copse littered with beer bottles, cigarette butts, potato-chip bags, and bonfire ashes left by local picnickers. A herd of cattle grazed nearby.

If all goes according to the Kremlin’s plan, by 2015 those cows will be replaced by 15,000 scientists and entrepreneurs. From these fields will rise a new “Silikonnovaya Dolina,” Russia’s version of Silicon Valley. Over the next few years, the government plans to spend some $6.6 billion on the new city, colloquially known as Skolkovo, after the existing village. It is to be the centerpiece of the Kremlin’s plan to turn Russia into a major technological power.

Skolkovo is partly a construction project—the idea is to create a modern and luxurious mini-city that can serve as an incubator for technology entrepreneurs. It is also meant to be a legal and economic oasis: Russia’s restrictions on visas and imports are to be relaxed, and tax breaks created, for the city’s resident companies; as to most business matters, the city will sit outside the purview of Russia’s normal government bureaucracy, with its vast capacity for graft, red tape, and delay. Finally, Skolkovo is an effort to bring together in a single place all of the elements that are essential for commercially viable innovation. To that end, the community will include the Skolkovo Institute of Science and Technology, to be created in partnership with MIT. But to transform a smart new technology into a business, you also need project managers, marketers, lawyers, and accountants. In Silicon Valley, once you have a good idea, you can pull together a solid team of these pros in a week, as easily as a good musician can bring together a band in college. The hope is to make the same variety of human capital available at Skolkovo.

The project represents Russia’s latest effort to grapple with one of the recurring, central questions of its history—how to keep pace with the world’s leading countries. Peter the Great dragged a resistant Russia out of the Middle Ages into a socioeconomic order that was at least conversant with Enlightenment Europe. Alexander II began to pull Russia into the industrial age. Stalin brutally completed the job, allowing his successor, Khrushchev, to send the Soviets into space. By the time Gorbachev came to power, it was clear even to the Kremlin that Russia had again fallen behind. And so, over the past 20 years, the country has struggled to catch up with Western capitalism.

Skolkovo is the pet project of President Dmitry Medvedev, a short, bespectacled, technophilic lawyer who is sometimes described—with equal measures of affection and sarcasm—as “Blogger Medvedev,” thanks to his heavily promoted Kremlin blog, occasional tweets, and enthusiasm for Facebook. One senior Russian journalist told me that Skolkovo was Medvedev’s “Great Pyramid,” the shining legacy he hopes will endure long after his presidency ends. A businessman described Skolkovo as Medvedev’s application for the job of prime minister, a post that may be vacated in 2012 when Vladimir Putin reassumes the presidency, as many Russians expect he will. Last year, shortly after the Skolkovo project was announced, Medvedev visited Silicon Valley for inspiration, just as Peter the Great had once traveled to the shipyards of Zaandam.

National politics and national pride have doubtless helped propel the project forward, but it has also been greeted enthusiastically by the leaders of many Western blue-chip companies. Intel’s Craig Barrett is on the Skolkovo Foundation Council, as is Eric Schmidt, Google’s executive chairman. Last year Schmidt told me, “We are big supporters of the Skolkovo project, simply because the Russian history of math and science, the innovation, the craziness that is the modern culture of Russia, should enable the creation of a whole bunch of new industries.” Cisco and Nokia have pledged to house significant research teams within the new city. If all goes well, the Skolkovo project will begin to redress one of Russia’s biggest problems—and one of its worst-kept secrets: despite massive privatization in the 1990s, and strong growth in the Aughts, the particular version of capitalism that the country has built is ill-suited to an increasingly high-tech world.

Moscow certainly now has capitalists. Last year, 101 Russians made it onto the Forbes “World’s Billionaires” list, giving Russia the highest number of billionaires per trillion dollars of GDP of any country in the world; and lower down the income-distribution scale, a growing middle class is emerging, especially in the capital and in St. Petersburg. The European Union officially recognized Russia as a market economy in 2002. And Russia’s abundant natural resources, particularly in energy, have given its leaders and oligarchs clout beyond the country’s borders.

Yet many critics claim that the past decade’s high energy prices are the main reason for Russia’s resurgence, and have been papering over severe problems that are likely to come to the fore as oil and gas reserves decline (or sooner, if the price of oil falls). Per capita income is roughly $15,900, below that of Lithuania, Croatia, and Puerto Rico, and male life expectancy is 59 years. On a 2011 World Bank ranking of nations based on ease of doing business, Russia sat at 123, below Bangladesh, Yemen, and Pakistan.

Vladislav Inozemtsev, a leading Russian economist, says Russia’s system is not so much true capitalism, or even classic authoritarianism, but rather “neo-feudalism.” Government corruption, he argued in an essay published this spring, is the system’s central trait—bribes aren’t an exception, they determine how the economy operates and how the country is ruled. Inozemtsev wrote:

What Westerners would call corruption is not a scourge of the system but the basic principle of its normal functioning. Corruption in Russia is a form of transactional grease in the absence of any generally accepted and legally codified alternative.

The main function of the state is to divide the country’s natural-resource wealth among an interconnected group of oligarchs and apparatchiks.

According to the Russian think tank Indem, bribes accounted for 20 percent of the country’s GDP as of 2005. To put that number in perspective: in 2010, United States federal tax revenues were about 15 percent of U.S. GDP. Georgyi Satarov, a Russian sociologist who is one of the country’s leading experts on corruption, estimates that the value of bribes paid annually in Russia rose from $33 billion when Putin came to power at the turn of the millennium, to more than $400 billion at the end of his presidency in 2008. Thanks to WikiLeaks, we know that in private, American diplomats agree that government predation is a defining feature of Russian life. One leaked cable, for example, explains that in Moscow, the Ministry of Internal Affairs and the federal intelligence service have crowded out the private mafia as a source of “protection” for private business, “since they not only have more guns, resources, and power than criminal groups, but they are also protected by the law.”

Many Russians, even within the elite, now look back upon the past 20 years with ambivalence—or at least the sense that Russia’s transition from a planned economy remains incomplete. Anatoly Chubais was the architect of Russia’s privatization program and market reforms in the 1990s, when the big national project was the wrenching shift from central planning to capitalism. I met with him in his Moscow office just past 9 o’clock on a Friday night last fall, after a busy day that included a visit from Prime Minister Putin (“He sat right where you are now!,” I was informed). Reflecting on Russia’s recent history, and his own role in it, Chubais said, “I am not judging whether we did it well, or we did it badly, but the fact is that the mission was accomplished—a market was built.”

The chief problem facing the country, he told me, is that while Russia was creating its rough-and-ready version of a market economy, many others took the next step: “I can name you a dozen countries which, during that precise period, built what is called an innovation economy.” Chubais now runs Rusnano, a state-controlled investment fund founded four years ago to finance companies pursuing innovation in nanotechnology and other high-tech realms. It is one of the key sponsors of the Skolkovo project, and Chubais sits on the Skolkovo Foundation Council. In his view, Russia today is at another difficult crossroads: “Innovate, or degenerate.” Turning Russia’s economy into an engine of innovation, he believes, is as important to the country’s future as privatization was—and will be harder to achieve.

Po Bronson, one of the most eloquent chroniclers of Silicon Valley’s great burst of creativity in the 1990s, titled his classic 1999 book The Nudist on the Late Shift. The naked programmer of his title was a guy who happened to prefer working without any clothes on, and his insistence on exercising that harmless personal choice—on the late shift, when few others were around—struck Bronson as characteristic of the Valley’s famously libertarian and individualistic ethos.

Some of Russia’s most engaged foreign observers find that Valley spirit rather hard to square with control by the Kremlin—an institution not normally associated with letting your freak flag fly. At an international conference last fall at which Russian representatives were pitching Skolkovo, Carl Bildt, Sweden’s foreign minister, asked: “Do you really think you can build Silicon Valley by ukaz,” or presidential decree?

Bildt’s question gets at the most compelling reason to doubt that Skolkovo will work. After all, one of the most important—and, if you happen to be a democrat, inspiring—lessons of the past two millennia of human history is that open societies are better at innovation than closed ones. That is why the spark of the industrial revolution didn’t catch in 15th-century China, despite the technical brilliance of its mandarins, while it did take off in poorer, more chaotic, but freer Europe 300 years later. And it is also why Stalin’s Soviet Union, after beating America into space, had to watch, over the next three decades, as the United States not only got to the moon, but invented most of the modern technologies that matter.

The anarchic culture and power of the Internet has given that argument fresh power. Tahrir Square is a pretty persuasive demonstration that new media and old dictators don’t mix. If you are unconvinced, ask the Chinese functionaries, whose fear of Tunisian contagion prompted them not merely to block online references to the Jasmine Revolution, but to ban the sale of the flower itself. Those repressive reflexes have prompted many of the technorati to question, at least in private, whether authoritarian regimes can ever permit the free-spirited, open-ended, often frankly rebellious style of thinking and working that breakthrough innovation requires. Authoritarian countries might be good at manufacturing iPads, but can they invent them?

A lot of Russians share this skepticism. Many believe Skolkovo is a pipe dream—this is, after all, the country that gave the world the term Potemkin Village—or yet another cynical scheme by state apparatchiks and their businessmen friends to funnel money into their own pockets.

I visited the Moscow headquarters of Ekho Moskvy, a liberal radio station and the freest media outlet in the country, to get a sense of the spirit with which the intelligentsia has greeted the Skolkovo plan. The station was airing a call-in program about the project, and the first hint about Russian attitudes toward it was provided by the title: “Skolkovo: Better Than Nothing?” It never got more cheerful than that. A co-host asked, “What happens [to Skolkovo] if one day Putin says the U.S. is our class enemy and you can’t bring their experts here?” A caller said private investment would be better than a government-sponsored project like Skolkovo: not only would private investors make better decisions, but “the government will only steal, anyway.”

The most biting criticism came in from Sergei Aleksashenko, a brilliant former deputy head of the central bank and deputy finance minister, who now works in Moscow at a liberal, Western-sponsored think tank. Skolkovo’s boosters hope it will offer a refuge from some of the country’s more onerous laws: restrictions on travel by foreign workers, difficulties importing outside technology, the hassle and kickbacks required to register new businesses. “Instead of having special rules for Skolkovo, let’s have the Skolkovo rules apply to the whole country,” argued Aleksashenko. “Those who want to live by the current, idiotic rules, they can go live in Skolkovo. We will build a wall, and they can live behind it.”

At the end of the hour-long show, listeners voted. Twenty-five percent agreed that Skolkovo is better than doing nothing; 75 percent said doing nothing is better than Skolkovo.

Ample reasons for pessimism aside, the Skolkovo project is not without theoretical basis. Even some independent outside reformers are starting to argue that it is easier to create an honest, transparent economic infrastructure on a green-field site than it is to change an entire country. That is the theory of Paul Romer, an economist profiled last year in these pages (“The Politically Incorrect Guide to Ending Poverty,” July/August 2010), who is hoping Honduras will try out such a scheme next year.

And while many efforts to create high-tech clusters, at a stroke, have failed (Malaysia’s attempt to create a Silicon Valley for biosciences is now sometimes referred to as the “Valley of the Bio-Ghosts”), some have succeeded. China’s science-and-technology park in Zhongguancun, in Beijing, for instance, is home to the computer manufacturer Lenovo, and to Baidu, the Chinese-language search engine.

The man in charge of proving Skolkovo’s doubters wrong is one of the biggest winners in the messy creation of Russian capitalism so far: Viktor Vekselberg, a 54-year-old Ukrainian-born billionaire, whose empire includes major holdings in Russia’s oil and aluminum industries. If you have heard of Vekselberg, it is probably because of his splashy 2004 purchase of the Forbes family’s Fabergé eggs, which he then ceremoniously exhibited at the Kremlin. He made a similar gesture in 2006, when he paid $1 million to return the bells from Harvard’s Lowell House to their native Danilov monastery in Moscow (Harvard received replicas).

Up close, though, Vekselberg doesn’t fit the testosterone-pumped stereotype of the Russian billionaire class. He has a fireplace in his Moscow office, and a statuesque receptionist on guard just outside it, but the wall behind his desk is lined with books: some typical examples are a scientific guide to metallurgy and Master of the Senate, the third volume of Robert Caro’s biography of Lyndon Baines Johnson. (The latter book is in its original English, a language Vekselberg speaks competently.)

Vekselberg is short and stocky, with a graying beard, blue eyes, and unusually long eyelashes. The four times I saw him over the past year, he was wearing a soft-colored suit, typically gray and sometimes without a tie. He speaks quietly, makes a point of courtesy, and smiles often. In a country of vivid tsars—where, as the old Russia hand and Peterson Institute scholar Anders Aslund puts it, the rule in politics is “Always escalate”—Vekselberg’s public persona is self-deprecating, patient, and mild. His life, he tells me, is “as boring as that of a gray mouse: meeting, meeting, meeting, meeting, official meeting, meeting, meeting, meeting, meeting. Sleep—just a little bit. Another meeting.”

Since March 23, 2010, when he was appointed by Medvedev to lead the Skolkovo project, Vekselberg has divided his time between establishing the legal underpinnings for the techno-park back home and traveling the world on his private jet to sell the project abroad. His itinerary has included the Shanghai Expo; a couple of trips to Silicon Valley; a visit to Washington, D.C., as part of Medvedev’s delegation; Davos; and Yalta, where a friend of his, the Ukrainian oligarch Victor Pinchuk, hosts an annual gathering of business and political leaders.

Like everyone I spoke with, Vekselberg thinks the Skolkovo project is a gamble with forbidding odds. “Having studied the international experience, we see that at least half of these projects … don’t work,” he said. “Strong countries that have tremendous financial resources built fabulous buildings, which are half empty, and streets which have no one on them.” Building is not the problem, Vekselberg told me. “Early, or a little late, more beautiful, or a little less beautiful, we will build a city.” The hard part is “what comes after that.”

Vekselberg is adamant that the heavy initial involvement of the government is not antithetical to the creation of a free-thinking, innovative local culture—but, rather, essential to it. “When it comes to innovation, Silicon Valley appeared thanks to the government,” Vekselberg insisted. “Let’s not have illusions about this. It appeared in the first instance thanks to serious contracts from the military-industrial complex. And to this day, Silicon Valley—don’t try to twist things around—still relies heavily on state contracts … Wherever you look, if we take other examples, the state always plays a dominant role. Singapore: the state plays a dominant role in an analogous project. India: huge involvement of the state.”

When it comes to Russia, Vekselberg argued, the role of the state is even more critical. “Especially in Russia, you can’t get by without the state—I don’t believe it,” he told me. “The role of the state is absolutely essential. For example, the laws about Skolkovo will be passed. Who does that? The state. Without the law, there will be nothing. Who gave the start-up capital? Well, the state gave it.”

To Vekselberg, the question on which Skolkovo’s success turns is whether the park can attract Russia’s best and brightest—and whether Russia’s best and brightest have what it takes to build a new, high-tech economy. “The key to success is people. We need people who want, and who believe and who will struggle, to think of something new and then make it a reality in the Russian economy. Do we have such people? That is a big question.”

Vekselberg’s question is common in Russia today. In fact, it has been common every time Russia’s leaders tried to modernize their country. Yeltsin and his reformers worried that the Russian people weren’t ready for a market economy. Lenin and the Bolsheviks worried that the Russian people weren’t ready for Communism. Peter the Great worried that the Russian people weren’t ready to leave the Middle Ages.

But just as it is a little disingenuous to blame the failure of Communism on the inadequate enthusiasm of the Russian proletariat, describing the Russian people as the chief barrier to the creation of an innovation economy seems misguided today. While the Russian economy isn’t leading the world in innovation, plenty of individual Russians are among the world’s top innovators. The Nobel Prize in physics last year went to two Russian expats. In Silicon Valley and on Wall Street, Russian mathematicians and programmers are prized.

Two of Europe’s biggest Internet IPOs in the past 12 months were of Russian companies—Yandex, the Russian search engine whose founders boast their technology is better than Google’s; and Mail.ru, Russia’s Facebook-and-Yahoo copycat. Today, these companies are among the top Internet ventures in Europe, as measured by market capitalization, despite the seeming handicaps of the Russian economy. Moscow, meanwhile, is home to what may be the world’s smartest and most aggressive IT investment fund—DST Global, which made a pioneering $200 million investment in Facebook in 2009 and has a stake in Zynga, the flourishing gaming company. DST’s founder and a major Mail.ru shareholder, Yuri Milner, made it onto the Forbes rich list earlier this year, with a net worth estimated at $1 billion, and bought a $100 million estate in Los Altos Hills.

The reason these stories remain scattered—at least inside Russia itself—involves incentives, as is so often the case in business. And for all the Kremlin’s current, Skolkovo-inspired enthusiasm for the technology sector, the unwelcome truth is that at least until recently in Russia, high-tech entrepreneurs have been, at best, second-tier successes—people who lacked the savvy or the chutzpah to follow more-lucrative commercial opportunities. That is how Serguei Beloussov, a 40-year-old entrepreneur who employs more than 1,000 Russian programmers at three international tech companies, explains his country’s dearth of high-tech industry.

“In Russia, all the property belonged to the state and the most money was made by people who were involved in privatization,” Beloussov, wearing dark jeans and a long-sleeved red shirt, told me. “Then, 10 years ago, the big scarcity in Russia was brick-and-mortar businesses, and many of my engineers would come to me and say, ‘I want to open a chain of drug stores’ or ‘I want to build homes.’ Then, five years ago, many businessmen decided to work for the government.” Only now, he thinks, is it starting to make real sense to work in technology.

Beloussov, an international businessman who travels on a Singaporean passport, has no illusions about his own decision to focus on building computers and then computer software at the start of his career, nearly 20 years ago. “I was young and stupid,” he said, sipping an espresso one night in a crowded Starbucks in downtown Moscow. “If I had invested my first money in privatization, that would have been much more profitable.”

For the most part, since the fall of Communism, Russia’s smartest and most daring mathematicians and physicists—the cohort that in the U.S. would have gone to Silicon Valley or Wall Street—have focused their energies on a different sort of enterprise. Consider one math Ph.D. who earned his investment capital by selling computer programs, but then quickly turned to privatization: Viktor Vekselberg.

Vekselberg made his initial small fortune in 1988—when Gorbachev’s U.S.S.R. took its first tentative step into capitalism with the cooperative movement—by writing and selling his own computer software. Within three months he had earned enough, he told me, “to buy an apartment, a car, and a dacha.”

He and his five partners next devised a more complicated operation, involving salvaging copper wire from scrap heaps in western Siberia, then exporting the copper and using the revenue to import IBM computers, which his group loaded with its own software and sold to Russian companies. The business was lucrative—Vekselberg said he and his partners made $100 for every single dollar invested—and within a year, they had made $1 million. “That sounds funny today, but in those days it was huge money.”

If this were a Silicon Valley story, Vekselberg and his partners would probably have gone on to become serial software entrepreneurs. If this were a story about India, they would probably have moved on to technology outsourcing. If they were Chinese, they might have used that first million to build a factory. But this was Russia, and Vekselberg was turning out to be one of the country’s most adept businessmen. “People didn’t know what to do with privatization vouchers, so we bought up vouchers and used them to participate in privatization auctions. That is how we bought our first real assets, beginning with aluminum factories, and from there on, we built our real business.”

Those early landgrabs are now gone, of course. Perhaps Skolkovo will appeal to the next generation of Russia’s most highly skilled, most intelligent people. But then again, maybe not. Ironically, the greatest barrier to Skolkovo’s success may be precisely what the Kremlin and the oligarchs pray for—continued high commodity prices, especially for oil and gas. “Too high a price for oil is bad for an innovation economy,” Serguei Beloussov told me. “If the price is too high”—he later said he thought the critical threshold was about $100 a barrel—“all the engineers will want to work at the banks and at Gazprom.”

Or in the government, which continues to siphon off so much of the country’s oil-based wealth. One consequence of Russia’s klepto-capitalist model is the growing appeal of government jobs, with their lucrative opportunities for payoffs. Over the past decade, the federal bureaucracy has grown by two-thirds, from 527,000 bureaucrats to 878,000. Vladislav Inozemtsev says that of the 109 students he taught in 2008 at the Higher School of Economics, one of the country’s most prestigious universities, 88 aspired to work for the government.

Skolkovo, if it works, will offer these and other students a different path—although that path will entail many risks, ranging from the ones inherent in any high-tech job to those involving the strength of the government’s commitment to a hands-off environment. The question is, how many people will take that path, when more-certain opportunities exist elsewhere—not least within the bosom of the state itself?

Chrystia Freeland is the editor of Thomson Reuters Digital. She is writing a book on the super-elite.
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Chrystia Freeland is the managing director and editor of consumer news at Thomson Reuters.

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