The price tag

Last September, in Vladivostok, Russia hosted the annual meeting of Asia-Pacific Economic Cooperation (APEC) countries. This July, in Kazan, Russia hosts the Summer Universiade. Next February, the Winter Olympic Games will take place in Sochi. In 2018, the final tournament of the World Soccer Cup will be played in 11 cities across the country. And in 2017, Russia is planning to organize the World Festival of Youth and Students.

Why such a passion for holding hugely expensive global forums?

An answer to this question emerges when you look at the costs of the events. The total price tag for the APEC summit was $20 billion, more than twice than had been originally budgeted. Already, construction deficiencies are evident for the hallmark of the summit, the $1 billion bridge to the Russian Island (a.k.a “bridge to nowhere”). The Winter Olympiad in Sochi is promising to become the most expensive sports event in the history of mankind: the final price tag is expected at the level of $50 billion, about five times above the initial budget. Naturally, there is no one among government officials capable of explaining what happened. The opening of a soccer stadium in St. Petersburg–to be used in 2018–has been already delayed by six years. It will eventually cost about $1.5 billion, six times more than planned.

There is nothing mysterious or coincidental about these cost overruns: this is a system the Kremlin has created to maintain the loyalty of regional elites. Moscow would obtain rights to hold a global event, allocate federal money for its organization–and there is always construction involved here–and send it to the regions. In the course of “appropriation” of the money, its significant part–as it’s customary in Russia–ends up in the pockets of local authorities. The very greatness of the chosen events justifies hefty budgets, and the lack of any real oversight ensures that these budgets are constantly corrected in the upward direction. As a result, money is plentiful to steal, so not only top regional bosses benefit from the event, but the bonanza is shared by many in the region. Characteristically, Moscow chooses the events in such a way that various regions get their share: APEC in the Far East, Universiade in Tatarstan, Olympic Games in the South, Soccer Cup in many cities of the Central Russia. This allows to spread money evenly helping keep a lid on a popular in the regions sentiment that Moscow “gets it all.”

The problem with this system is that it’s going out of control. Traditionally, kickbacks (“откаты”) represented 20-30% of the size of a government contract. In the past, this allowed all necessary constructions to be at least finished–on time or with small delays. However, in recent years, the ratio of kickbacks seems to have dramatically risen and now amounts to up to 60-70%, as some anecdotal evidence suggests. Naturally, there is simply not enough money to complete any construction on schedule with reasonable quality.

It seems that Russian officials have simply gone on a stealing binge. This turn of events would appear to be a direct consequence of the current situation in the country. First, Russian economy is still dangerously dependent on export of raw materials. Should commodity prices significantly decrease, the federal center will have no more money for megaprojects in the regions. So the regional elites are trying to grab everything from what is still available. Second, Russian political system keeps revolving around one single person, president Putin, who sets the rules and ultimately decides who gets what. No one knows what will happen after 2018. Who will be setting the rules? What these rules will be? Again, this uncertainty only fuels the après nous le déluge mentality.

The budget overruns for the APEC summit, Sochi Olympics and other “megaprojects” are not simply the cost of the projects gone awry. It’s a price tag–in real money–of the political system that Putin built.

About Eugene Ivanov

Eugene Ivanov is a PMI-certified Innovation Management Consultant who helps organizations increase the efficiency of their internal and external innovation programs.
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9 Responses to The price tag

  1. AK says:

    However, in recent years, the ratio of kickbacks seems to have dramatically risen and now amounts to up to 60-70%, as some anecdotal evidence suggests.

    Anecdotal evidence as in Boris Nemtsov’s lazy back of the envelope “calculations” on his blog?

  2. Dear Eugene,

    The major reason for cost overruns on megaprojects is not kickbacks but that contractors seriously underestimate the cost and difficulties of these projects in order to land contracts. A good British example is the London Olympics, whose cost went up from an initially planned £2.3 billion to an official figure of £9.2 billion (which in reality is a serious underestimate). Bear in mind that these Olympics unlike those in Sochi were held in a major world capital with a highly developed infrastructure. The Channel Tunnel came in officially 80% above cost (again everybody knows that this is a serious underestimate) and went through most of its early existence teetering as a result on the brink of insolvency. The Millenium Dome came in officially at more than double its planned cost. In reality the cost from that misconceived project continues since the government never really worked out what it was for once it was built. It is now mainly used as a leisure and entertainment centre and has become a major rock music venue.

    Since national prestige is involved in these projects contractors know that once they land the contracts they can charge pretty much whatever they want because of the political imperative of getting the job done regardless of cost. As I well remember at the time of the Athens Olympics the contractors deliberately went on a go slow as the Olympics approached in order to extort higher prices, which of course they got. To this day there has never been a proper accounting for the cost of the Athens Olympics with estimates unofficially ranging from anywhere between 10 and 20 billion euros. Most of the facilities are now derelict and empty. I am prejudiced about this and doubtless there were other more important causes but I have always felt that the Greek crisis began with the Athens Olympics and that it has been downhill for Greece ever since.

    In my opinion (based on bitter personal experience) exploding costs are an inherent consequence of megaprojects regardless of who is in government or of what form the government takes. Perhaps totalitarian governments like those in the USSR and North Korea are able to control costs more effectively, but I doubt it. Megaprojects do sometimes serve a useful purpose to advertise the fact that a country that was once on the way down is now on the way up. That was true of the Olympics in Tokyo in 1964, in Munich in 1972 and in Beijing in 2008. They can also be an important boost to national morale. I have heard that the International Festival of Youth and Students that was held in Moscow in 1957 was a case of that. It is probably also true that they can spur the development of infrastructure in a particularly underdeveloped or neglected region (such Sochi or the Russian Far East) though inevitably this increases the cost even more and given the inherent difficulties with megaprojects is probably the least efficient and most expensive way to develop infrastructure in these places. Anyway it’s possible that the Olympics in Sochi and the forthcoming football World Cup will fulfil all these criteria. Whether that will justify the cost is another matter.

    Anyway I frankly doubt that the holding of these megaprojects in Russia has anything to do with Putin organising pay offs to regional leaders. I don’t see any evidence of that and there are any number of other reasons why Russia might want to hold megaprojects at this time. The fact that these megaprojects are being held away from Moscow is not a sign that they are intended to reward regional leaders. On the contrary they are the best single thing about these megaprojects in that they provide jobs, investment and infrastructure in places away from Moscow which need them. As for the cost overruns of these projects I don’t think it’s fair on Putin to put the blame for those on him for the reasons that I said. There doesn’t seem to be any doubt that the main work for the Sochi Olympics has been done and that all the facilities will be ready to the proper standard and in time.

    I have no doubt that Russia will put on a good show both at Sochi and in the Football World Cup and who knows it might even get some good publicity for a change (especially after the World Cup). I remember some years ago when the final in a major European football tournament happened in Moscow and involved two British teams. The British supporters of those two teams came back with glowing comments of what they found and for all too brief time we actually got some strongly positive comments about Russia in the letters columns of the British newspapers (the tabloids especially).

  3. Eugene says:

    Dear Alexander,

    Thank you for your comment. First, I’d note that you’re comparing the cost of summer Olympics (in London and Athens) with Winter Olympics in Sochi. Winter Olympics are much less expensive, and the price tag of $50 billion for Winter Games is simply beyond comprehension. Now, Russia is a northern country, and there is a lot of winter sports facilities around the country. So it begs the question why Sochi, a subtropical city, was chosen as the venue? To develop its infrastructure? Why? Why developing an infrastructure in a 350,000-resident city–peanuts by Russian standards–was worth of sinking in 2.5 federal education budgets (recently reduced, by the way)?

    Russia’s economic growth is slowing down, and there is no clear strategy with regards to how to spur it. And yet, Russia is taking up one megaproject after another. This is a distraction at best and waste of federal funds at worst.

    Sure, I’m not implying that Putin signed a special document outlining a system of buying the loyalty of regional leaders. By my hypothesis at least explains two things at once: why Russia is holding all these mega events and why there are so outrageous cost overruns. It’s obviously your right to doubt it, but I don’t feel the you offered a better explanation.

    Best,
    Eugene

    • OK says:

      “Russia’s economic growth is slowing down, and there is no clear strategy with regards to how to spur it. And yet, Russia is taking up one megaproject after another. This is a distraction at best and waste of federal funds at worst.”

      Many are blaming the growth slowdown on the central bank’s efforts to control inflation. Still, construction projects have never slowed down a country’s GDP growth. New infrastructure in Sochi and Vladivostok will also attract migration from the regions of Russia with poor infrastructure and services. Vladivostok has been losing population for years, so this “bridge to nowhere” helps solve one of the worst problems there – lack of space for new housing stock to replace the expensive housing stock that is in horrible condition.

      • Eugene says:

        Construction projects per se don’t slow a country’s GDP. Corruption–which inevitably follows any construction project in Russia–does.

        Sochi doesn’t need any migration; it’s already suffering from the lack of space. And if you can point to any sign that people began moving to Vladivostok after the summit, I’ll be very grateful.

  4. OK says:

    Don’t you live near a city with a tunnel that was supposed to cost $2 billion that will now cost at least $22 billion?

  5. Eugene says:

    You’re comparing apples to oranges. The final cost of Big Dig has been $14.5 billion. The state of MA borrowed the half of this money in bonds. When the interest is paid off in 2038, the total cost will amount to $21 billion. By the same token, if you count what the city of Vladivostok will have to pay in interest and maintenance cost for what was built for the summit, then the total amount in 2038 will be evidently much higher than $20 billion.

    Besides, as a person living near this city, I know that the city needed this tunnel and the tunnel is heavily used every single day. But who will be using all these fancy facilities when the Games are over? Ah, I know: those migrants from Chukotka you alluded to in your previous comment.

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