Economy Expands in 3rd Quarter, First Time in a Year - NYTimes.com

Image by Ed Yourdon via Flickr

By CATHERINE RAMPELL

Ending the longest contraction since World War II, the United States economy finally grew in the third quarter of this year, the Commerce Department said on Thursday.

The nation’s gross domestic product expanded at an annual rate of 3.5 percent in the three months ending in September, matching the economy’s average annual growth rate from the last 80 years. But the end of government programs to encourage spending on things like cars and houses, alongside employers’ continued reluctance to hire more workers, means the recovery may not last, economists say.

“The big picture perspective is that things have improved,” said Jan Hatzius, chief United States economist at Goldman Sachs. “The question is, how sustainable is this growth going forward?”

Job-seekers, he says, probably will not see the benefits of a recovery for months to come.

The spike in G.D.P. came from a somewhat shrunken base. The economy had been falling for four straight quarters, bottoming with a 6.4 percent decline in the first three months of this year, the steepest quarterly fall since 1982.

Much of the growth in Thursday’s report can be attributed to the billions in federal aid devoted to economic renewal, economists say.

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“That alters the dynamic of a recession and a recovery, and what you’re left with, to some degree, is an artificial recovery,” said Dan Greenhaus, chief economic strategist at Miller Tabak, an investment research firm. “Over the next several quarters, the support for the economy on the part of the government wanes and the economy has to find its own footing.”

The cash-for-clunkers program helped increase consumer spending on durable goods, which grew by an annual rate of 22.3 percent in the third quarter compared to a decline of 5.6 percent in the previous quarter. Similarly, economists say the $8,000 federal tax credit for first-time homebuyers helped revive spending on housing, which increased 23.4 percent in the third quarter, in contrast to a decrease of 23.3 percent in the second quarter.

The economic growthcame without a major surge in inflation. The price index for gross domestic purchases, a broad measure of prices that Americans pay for goods and services, increased at an annual rate of 1.6 percent in the third quarter, compared with an increase of 0.5 percent in the second, the department said. Excluding food and energy prices, the inflation index rose 0.5 percent in the third quarter, compared with an increase of 0.8 percent in the second.

The stock market surged in reaction to the news, with major indexes up over 1 percent in early afternoon trading.

Thursday’s report will probably provide ammunition to both advocates and opponents of additional federal spending to stimulate certain parts of the economy, as mutually reinforcing pessimism among consumers and employers continues to fester.

On the one hand, the poor job market, along with wealth losses from housing and the stock market, is discouraging Americans from increasing their spending by too much. Consumer spending on nondurable goods like food and clothing, for example, increased 2 percent in the third quarter, compared with a decline of 1.9 percent in the second quarter.

Likewise, stagnant consumer demand and withering consumer confidence have left companies wary of hiring more employees — or, for that matter, taking any expensive risks. The jobless rate reached 9.8 percent in September, its highest rate in 26 years. According to Thursday’s report, business investment in buildings and other structures fell at an annual rate of 9 percent in the third quarter.

“At some point firms will have to begin to bring some of their workers back, but it may not be anytime soon,” said Joseph Brusuelas, director of Moody’s Economy.com. “That means 2010 may be a year of growth in the economy, but it’s likely to be characterized as jobless growth.” Initial jobless claims fell 1,000 in the week ending Oct. 24 to 530,000, according to a Labor Department report also released Thursday. The number has been trending downward, but is still well above claim levels historically associated with job creation, according to John Ryding, chief economist at RDQ Economics.

Such forces may pressure Washington to look for selective interventions in the labor market, in addition to last winter’s broader $787 billion stimulus package, much of which will be distributed next year. Proposals on the table include another extension in unemployment benefits and various job creation programs.

A slower drawdown in inventories was one bright spot in Thursday’s report, as it indicated that businesses have largely sold out their current stock and may rev up orders in the coming months to replenish supplies.

“Everybody had been dealing with a just-in-time status quo,” said Sandra Westlund-Deenihan, president and design engineer for Quality Float Works, a plant in Schaumburg, Ill., that manufactures metal float balls and valve assemblies. “They were living off inventories they’d built up over the last several years. Now they’ve drawn that down and reached a point where they may have to have it ready and back on the shelf again.”

Like many American manufacturers, Ms. Westlund-Deenihan says that international business has helped keep her company afloat. United States exports over all grew at an annual rate of 14.7 percent in the third quarter, while imports grew 16.4 percent.

“We’re seeing a strong rebound in trade simply because global trade had collapsed before,” said Robert Barbera, the chief economist at ITG.

Javier C. Hernandez contributed reporting.

Obama seeks Afghanistan data to determine U.S. troop levels

Image by The U.S. Army via Flickr

AFGHAN PROVINCES TO BE ANALYZED
Details should help president determine need

By Scott Wilson and Greg Jaffe
Washington Post Staff Writers
Thursday, October 29, 2009

President Obama has asked senior officials for a province-by-province analysis of Afghanistan to determine which regions are being managed effectively by local leaders and which require international help, information that his advisers say will guide his decision on how many additional U.S. troops to send to the battle.

Obama made the request in a meeting Monday with Vice President Biden and a small group of senior advisers helping him decide whether to expand the war. The detail he is now seeking also reflects the administration's turn toward Afghanistan's provincial governors, tribal leaders and local militias as potentially more effective partners in the effort than a historically weak central government that is confronting questions of legitimacy after the flawed Aug. 20 presidential election.

"This is obviously a complicated security environment in Afghanistan, and the president wants the clearest possible understanding of what the challenges are to our forces and what is required to meet that challenge," said a senior administration official who has participated in the Afghanistan policy review and spoke on the condition of anonymity to discuss it. "Any successful and sustainable strategy must clearly align the resources we provide with the goals we are trying to achieve."

As U.S. forces in Afghanistan endure the deadliest month of the eight-year-old conflict, Obama is weighing a request by Gen. Stanley A. McChrystal, the top U.S. and NATO commander in Afghanistan, for a quick jump in forces to blunt the Taliban's momentum against concerns that too many new troops could help the insurgency's recruiting efforts.

Administration officials say that Defense Secretary Robert M. Gates and national security adviser James L. Jones, a retired four-star general, support Obama's request for a more detailed status report on each province that could identify potential U.S. allies among Afghanistan's local leaders, some with less-than-sterling human rights records.

Gates and Jones have pushed McChrystal to justify as specifically as possible his request for 44,000 additional troops, the figure now at the center of White House deliberations. The review group once included intelligence officials, generals and ambassadors, but it has recently narrowed to a far smaller number of senior civilian advisers, including Biden, Gates, Jones, Secretary of State Hillary Rodham Clinton and White House Chief of Staff Rahm Emanuel. Administration officials said the province-by-province analysis will be ready for Obama before his scheduled Friday meeting with the Joint Chiefs of Staff at the White House.

"There are a lot of questions about why McChrystal has identified the areas that he has identified as needing more forces," said a senior military official familiar with the review, who spoke on the condition of anonymity to discuss the deliberations candidly. "Some see it as an attempt by the White House to do due diligence on the commander's troop request. A less charitable view is that it is a 5,000-mile screwdriver tinkering from Washington."

A range of options

The weeks-long White House review has been shaped by a central tension between the broad counterinsurgency strategy endorsed by the military and a narrower counterterrorism campaign against al-Qaeda that some senior administration officials favor.

McChrystal, who took command of the 100,000 U.S. and NATO forces in Afghanistan in May, is promoting a plan that calls for concentrating forces around urban areas to better protect the Afghan population and pulling back from remote regions. His idea calls for speeding the training of Afghan forces, expanding civilian efforts to improve Afghan governance and starting other long-term programs to win the support of the population that the insurgency draws from.

About half the 44,000 troops McChrystal requested would be sent to take back Taliban sanctuaries in southern Afghanistan. The others would push into western Afghanistan, where the U.S. military has only a slight presence, and reinforce operations in the mountainous east. One brigade would train Afghan army and police forces.

Even after weeks of review, administration officials say a range of options is still under consideration, including whether additional U.S. forces could be deployed in phases. Although Obama had been expected to announce his decision before leaving Nov. 11 on a 10-day trip to Asia, administration officials say he may wait until he returns.

"I think it's important to hear and to get this right," White House press secretary Robert Gibbs told reporters Wednesday.

In reviewing McChrystal's bracing assessment of the war, the president and his senior advisers have concluded that the Taliban cannot be eliminated as a military and political force, regardless of how many more troops are deployed.

The acknowledgment is behind Obama's request for an analysis of which of Afghanistan's 34 provinces can be left to local leaders, perhaps including elements of the Taliban unaligned with al-Qaeda. Administration officials have said that under any strategy, the Taliban would not be allowed to threaten the Kabul government or provide sanctuary for al-Qaeda, whose leaders operate largely from the tribal areas across the border in Pakistan.

"How much of the country can we just leave to be run by the locals?" said one U.S. official involved in Afghanistan policy, who discussed the White House request on the condition of anonymity. "How do you separate those who have taken up arms because they oppose the presence of foreigners in their area, because they're getting paid to fight us because we're there, from those who want to restore a Taliban government? How many of the people who we're fighting actually share al-Qaeda's ideology?"

Obama's interest in provincial allies also reflects the administration's growing disenchantment with President Hamid Karzai and his inability to extend his government's authority beyond Kabul during his nearly eight years in office. Provincial governments and tribal structures have long exerted more power than the central government, which many Afghans view as remote, corrupt and ineffective. Another U.S. official involved in Afghanistan policy said, "Most of Afghanistan that's stable is under local control."

"The question is: Can you get benign local control in more places?" the official said. "And will that be easier to achieve, and more effective, than trying to establish more central government control?"

Refining a strategy

Critics of ceding authority to local power brokers point to Kandahar, Afghanistan's second-largest city, where Karzai's brother Ahmed Wali Karzai has been given wide latitude to run the municipality and the surrounding province. Security in the area has deteriorated over the past year, while the cultivation of opium-producing poppies has soared.

Some U.S. and Afghan officials contend that Ahmed Wali, who heads the Kandahar provincial council, has been reluctant to crack down on drug traffickers -- and the Taliban fighters who protect them -- because he is involved in narcotics smuggling, an accusation he has repeatedly denied. The New York Times reported Wednesday that Ahmed Wali has been on the CIA's payroll for much of the past eight years.

"Ahmed Wali illustrates the challenge we face across the country," a senior U.S. official involved in Afghanistan policy said Wednesday. "Do we pay him off to help us -- whatever help that may be -- or is our goal of improving the government more important than doing these kinds of deals?"

Obama is refining his strategy from several options outlined during more than 15 hours of meetings in the White House, administration officials say.

Some White House officials, including Biden, have advocated a strategy that would focus primarily on counterterrorism efforts against al-Qaeda. The vice president has argued for preserving the current U.S. troop level of 68,000, expediting the training of Afghan forces, intensifying Predator drone strikes against al-Qaeda operatives and supporting the Pakistani government against the Taliban within its borders.

But the deepening conflict is complicating those plans. For example, administration officials say that sending additional U.S. training brigades to accelerate preparation of the Afghan security forces may not accomplish as much as hoped because recruitment -- and retention -- has gone poorly as the war intensifies.

"It's all part of the endemic problems of illiteracy and security that plague many countries, but particularly this one," said a senior administration official familiar with the review process, who spoke on the condition of anonymity to discuss it. "You want to increase the number of people engaged in training, but at some point bringing in more and more Americans won't produce quicker results. There's a ceiling."

McChrystal has advocated something far closer to a nation-building project. Some Republican supporters of the general's plan in Congress have compared his strategy to the 2007 "surge" of U.S. troops in Iraq, a shorter-term effort that helped pull the country back from sectarian civil war.

But administration officials reject the comparison, pointing out that McChrystal's troop request would require a far longer deployment of U.S. forces and that Afghanistan is in a less dire position than Iraq was at the time of the surge.

Most important, administration officials say, the violence in Afghanistan is directed against U.S. forces rather than among Afghans. In Iraq, much of the pre-surge violence involved Iraqi Sunnis and Shiites fighting for control of the state, which gave the U.S. military a clearer role in protecting Iraqi civilians.

"There are some areas of the country that will fight us and fight the Taliban just because we are there," Sen. Jack Reed (D-R.I.), a member of the Armed Services Committee, told reporters Wednesday.

Debt Watch in Dubai - BusinessWeek

Image by Åndrey via Flickr

The flashy city-state's companies owe 126% of GDP, and the main hope for salvation is Abu Dhabi

By Stanley Reed

On a sultry fall evening in Dubai, Mohamed Ali Alabbar proudly shows visitors the artificial lake surrounding the nearly completed Burj Dubai, at more than 2,600 feet the world's tallest building. As an Andrea Bocelli recording plays Time to Say Goodbye over the sound system, water sprays high in the air. Alabbar, chairman of Emaar Properties, Dubai's top real estate developer, explains how the fountains were designed to outclass similar waterworks at Las Vegas' Bellagio hotel and casino and cost more than $250 million. "I said to make it 20% better" than the Vegas version, he recalls.

Bigger. Faster. Taller. Better. For the last decade Dubai thrived on this I-want-it-now credo as the Gulf emirate turned itself into a premier business hub. Today construction crews still labor on Dubai's skyscrapers and malls, and the bars at swank hotels like the Fairmont and the Emirates Towers are packed. Yet Dubai Inc.—that collection of state agencies and state-backed companies that has powered the city forward—now faces a debt crisis as scary as anything that threatened the banks of the U.S. and Europe. It has to pay back or refinance almost $50 billion in four short years. Dubai's ability to pull that off now depends very much on outside bankers—and especially on the largesse of Abu Dhabi, the nearby oil-rich emirate that has long looked on Dubai with a mix of admiration, disapproval, and envy.

The key cluster of Dubai companies owes as much as $90 billion, or 126% of gross domestic product, much of it in short-term bonds and loans from the world's top banks. Dubai could get away with so much borrowing as long as real estate and other asset prices kept rising. But they crashed. Its residential real estate prices have fallen over the past year by a world-leading 47.5%, while office rates are also way off except in the choicest areas. Office and hotel space keeps piling up as the government of hereditary ruler Sheikh Mohammed bin Rashid al Maktoum presses developers to finish their projects. Dubai officials would not comment for this story.

Dubai's debt workout is reaching a pivotal moment. The most immediate concern is a $3.5 billion sukuk, or Islamic bond, issued by Nakheel, a branch of investment company Dubai World. Nakheel, which is building the spectacular palm-shaped artificial islands off the emirate's coast, must pay bondholders back or refinance by yearend. Further out, Standard & Poor's (MHP) figures that Dubai must pay off or refinance a total of $47.4 billion by mid-2013. Regional investment bank EFG-Hermes estimates key Dubai companies have $13.1 billion in debt due in 2010 alone.

Farouk Soussa, an S&P analyst in Dubai, figures the emirate has only $3 billion to $4 billion left of a $10 billion loan it obtained from the United Arab Emirates central bank earlier this year. Meeting the payments "is not going to be easy or comfortable," he says. The $10 billion Dubai borrowed earlier this year was supposed to be just the first half of a $20 billion financing program, a mix of central bank loans and publicly issued bonds. While spreads on Dubai debt are narrowing, bankers say there is little appetite in the debt markets for more Dubai paper. What gives investors pause is that they have not yet heard a clear plan from Dubai on how it is going to clear out the debt. "It is likely that Dubai will be unable to access fresh funding for quite some time," says Simon Williams, chief Middle East economist for HSBC in Dubai. The most likely source of the next $10 billion is up the road in Abu Dhabi, the largest and wealthiest emirate in the U.A.E., about an hour's drive southwest of Dubai. A major oil producer, Abu Dhabi has several hundred billion in cash and investments and no debt problem at the moment.

Abu Dhabi may prove a tough lender. Financial sources say its leadership, which in effect underwrote the $10 billion Dubai borrowed earlier this year, is not thrilled by the prospect of writing big checks to its profligate cousins in Dubai. Abu Dhabi has a corps of financial professionals at a web of funds that invest the bulk of the emirate's surpluses. Sources say these pros are pushing Abu Dhabi's leaders to insist on hard terms in exchange for fresh funding. One idea is for Abu Dhabi to take stakes in Dubai's crown jewel companies, such as Emirates Airlines, ports operator DP World, and Dubai Aluminum. Such deals could consolidate these companies with their Abu Dhabi counterparts, such as Etihad Airways.

So far, Dubai's Sheikh Mohammed has shrewdly fended off any grab of Dubai's equity. This summer he even pulled the plug on a sale of about 20% of DP World for some $2 billion to Abraaj Capital, the Dubai private equity firm, and China Investment Corp., Beijing's sovereign wealth fund.

FAMILY TIES

Dubai's leader has other cards to play. A debacle in Dubai would shake investor confidence in the entire U.A.E., Abu Dhabi included. The other emirates cannot let that happen. Moreover, the Abu Dhabi potentates have close ties to Dubai through everything from hotel investments to marriage. Sheikh Mansour bin Zayed Al Nahyan, for instance, who recently made $2 billion selling his stake in Britain's Barclays (BCS) bank and is considered the third most influential member of Abu Dhabi's royal family, is married to the Dubai sheikh's favorite daughter. "You can be sure Sheikh Mansour hears about this every weekend when he visits the palace," says a banker. A possible compromise: a mortgage held by Abu Dhabi on Dubai assets that would let the emirate regain equity if and when it pays off its obligations.

The debt overhang, meanwhile, is putting a damper on the economy. Credit may get even tighter for local businesses: As Dubai Inc. pays off foreign creditors, it will probably lean on local banks to shoulder larger shares of the debt burden. And despite his political skills, Sheikh Mohammed has lost stature in the U.A.E., especially with the Abu Dhabi elite. Both Abu Dhabi and gas-rich Qatar are following Dubai's example in building financial hubs and are poised to exploit its stumbles. If Abu Dhabi, which is more conservative than Dubai, ends up calling more of the shots on U.A.E. policy, it could force Dubai to tighten rules on the immigrants who bring in money and do much of the work. It could also push Dubai to crack down on the bars and clubs that offer a competitive edge for the freewheeling emirate. Abu Dhabi officials declined to comment.

The best thing Dubai can do now is recover its fast pace of growth. Recently a visitor, stuck in traffic in the financial district, phoned a banker's secretary to say he would be late. "That's great," she said. "Things must be getting better." More seriously, lower office rents help companies, and hotel rooms that once fetched $600 a night can be had for a third of that, making Dubai an affordable destination once more. It's still the place to discuss any business having to do with Iran or Saudi Arabia, which sport few amenities. "As long as conditions in Saudi Arabia remain hard, Dubai will thrive," says Khaled Al-Muhairy, CEO of Dubai fund management firm Evolvence Capital.

Can Dubai change? Many see the forced slowdown as a chance to plot a more restrained course. "This is an opportunity to do things differently," says Tarik Yousef, dean of the Dubai School of Government. That means, first of all, whittling down that debt.

Demystifying Dubai

Visitors to Dubai can nowadays dine out on lobster and champagne, but during a famine in the 1940s residents of the emirate subsisted on locusts and leaves. In City of Gold, published this fall, journalist Jim Krane chronicles Dubai's journey from backwater to boomtown in rich and fascinating detail.

To read a review of the book, go to http://bx.businessweek.com/dubai-business/reference/

Reed is London bureau chief for BusinessWeek.

Inside the App Economy - BusinessWeek

Image via CrunchBase

Beyond the goofy games is a world of useful programs that's making fortunes and changing the rules of business

By Douglas MacMillan, Peter Burrows and Spencer E. Ante

It's easy to shrug off the kooky world of apps. The bite-size software programs people load onto their mobile phones or tap into on the Web seem mostly to be silly games and pointless novelties. But look past the beer-drinking apps and flatulence programs and you'll see something significant taking shape: a bustling app economy that's creating new fortunes for entrepreneurs and changing the way business gets done.

It's happening with dizzying speed. Just two years ago, almost none of this existed. Apple's (AAPL) App Store, the most popular destination for mobile-phone programs, was launched last summer. Now there are more than a dozen rival stores, and at least 100,000 apps have been created. Some startups that staked their claim in the app economy have become large, lucrative businesses in just a few months. Two-year-old Zynga, which makes popular game apps, is already profitable, with more than $100 million in revenues. By comparison, Google (GOOG) didn't start making money until its third year—and still had less revenue.

There are serious business tools among the thousands of new apps. Salesforce.com's (CRM) programs let executives manage customer relationships from an iPhone or BlackBerry. Oracle (ORCL) apps let managers check inventory or get a snapshot of a business unit's performance. The computing that people used to do at their desks increasingly can be done on devices they can carry anywhere.

Early Days
Apps will help determine technology's next big winners. The success of Apple's iPhone is due in large part to the fact that the company can offer customers more software choices than any rival. Research In Motion (RIMM), maker of the business-oriented BlackBerry, has scrambled to catch up and has made progress. But established giants such as Nokia (NOK) and Microsoft (MSFT) are struggling to get traction, raising questions about their prospects.

These are such early days, no one knows exactly how big the app economy is. Companies make money from selling apps, from ads within apps, and from selling digital goods used in apps. Add it up and analysts figure it's at least a $1 billion market today, headed for $4 billion by 2012. Not bad for a brand-new business.

True, much of the money these days comes from goofy games. One popular app is I Am T-Pain, named after the performer, born Faheem Najm. Fans can download software to their iPhone and mimic his robot-like voice. But it's time to heed the opportunities in this fast-evolving world. The $2.99 T-Pain app has put its creator, a year-old startup called Smule, on track to pull in $3 million this year. "Apps have moved into the mainstream. The world's changed," says Jeff Smith, Smule's chief executive.

Zynga's Zing

Revenues are soaring on the success of 'Social Game' Apps like FarmVille

Early this year, Mark Pincus, founder of the tech startup Zynga, huddled with staffers in his company's San Francisco offices to brainstorm new product ideas. Zynga develops game apps that can be played on social networks such as Facebook or mobile phones like the iPhone, and Pincus needed a follow-up to a popular poker app. One employee suggested a farming game, where players could grow digital crops and sell them to make virtual money. Pincus liked the idea and gave it the green light. Four months after its launch, FarmVille is one of the most popular apps in the world, with 60 million people playing it in the last month. "It just exploded," says Pincus.

Such is the nature of business in the burgeoning app economy. Success—and a flood of money—can arrive practically overnight. Zynga doesn't charge users to play FarmVille, but it does sell digital crops, cattle, and farmland. Corn seed, for instance, goes for the equivalent of 10 cents; cows run 20 cents each. All those digital goods add up. Zynga pulls in its nine-figure annual revenues from FarmVille and 20 other games.

The company may be just getting started. U.S. revenues from so-called social games have surged over the past two years to $720 million, and analysts project they will grow to $2 billion by 2012. "We are seeing very strong success with these companies," says Atul Bagga, an analyst with investment bank ThinkEquity. "They are basically letting customers choose [how much money] they want to [spend] in a particular game or application."

Zynga has the vibe of a young Google (GOOG). Just like the search giant in its early days, the company has a masseuse on staff and chefs who serve up two meals a day to keep employees from wasting time going out for food. It has weekly keg parties, like the ones Google's founders once hosted. And Pincus has tried to maintain a light atmosphere, even as the company has grown to 468 employees. The winner of a monthly poker tournament gets treated to a one-day Lamborghini rental. Pincus calls the atmosphere "ghetto Google."

Seeds of Success
The company's offices are in the industrial Potrero Hill neighborhood of San Francisco. On a recent October day the 43-year-old Pincus, clad in jeans and an untucked oxford shirt, drew three intersecting circles on a whiteboard. He says the next great opportunity on the Web lies at the intersection of three trends—apps, Web services, and small online payments from consumers. Pincus sees apps not as products but as ongoing services that users tap into from Facebook or the iPhone and pay for in small increments. "Our story has been about finding games people could play forever and giving them a reason to do it," he says.

The strategy is in full swing in the FarmVille studio at Zynga, where a 30-person crew manages the company's biggest hit to date. The game is an odd success for the digital world: Users get a virtual plot of land to farm as they see fit. As they grow crops and earn currency, they can use the money to buy more seeds, animals, and tools like tractors. Since all players are logged in to Facebook, they can work with friends or co-workers, or they can compete against them for farmer bragging rights. There are roughly 20 times more people playing FarmVille these days than there are actual farms in the U.S.

For a hit like FarmVille, the work is never done. A wall-size chart in the FarmVille studio lists the various virtual items up for consideration in the next round of improvements to the game, culled from staff ideas and requests from users. The ability to get feedback and act on it quickly is a break from past models, says Mark Skaggs, who runs the FarmVille group. At large companies such as Electronic Arts (ERTS), where Skaggs used to work, "You might design a feature and not know until two years later whether it was good or people liked it," he says. "Here, you can design a feature in a day and put it in the game the next day."

As Zynga's games have grown, they've become giant test labs for new ideas. "Every single click is being recorded," says Vish Makhijani, Zynga's chief operating officer. That means Zynga can quickly find out the impact of small adjustments—such as changing the size of a cabbage patch in FarmVille or the cost of a new gun in the game Mafia Wars—on retaining users and increasing revenue. One recent success: digital sweet potato seeds that cost $5 a packet. The seeds, which of course cost nothing to duplicate, pulled in more than $400,000 in three days.

The rich opportunity has fueled aggressive competition. Zynga's primary rivals are London's Playfish and Mountain View (Calif.)-based Playdom. Playfish is known for a game called Pet Society, which lets people adopt online creatures and then dress them up in designer clothes, while Playdom's hit game is Mobsters, in which people try to gain skills, alliances, and wealth. All three companies are private and don't disclose financial information.

The game makers compete for users across all sorts of technology platforms. The big targets are Facebook, with more than 300 million members, and Apple's App Store, with more than 50 million iPhone and iPod touch users.

Lately, Playdom and Zynga have also been dueling in court. A lawsuit filed by Zynga in September alleges that several former employees recruited by Playdom supplied the competitor with the Zynga Playbook, a proprietary document the complaint describes as "the recipe book that contains Zynga's 'secret sauce,'" referring to its game-making techniques.

The rapid growth and sharp rivalries have drawn comparisons to the early days of Web pioneers such as Amazon.com (AMZN) and eBay (EBAY). One significant difference is that the apps business has virtually no barriers to entry, meaning it is hard for any company to maintain a lead. Today there are thousands of small developers who crank out apps that don't make a dime.

The perk-heavy culture at Zynga is certainly reminiscent of the dot-com days. Inside its office for human resources, 160 small paper bulldogs are tacked on the wall, one for every new hire in the past quarter. There's a cooking staff of 17, and most game studios have their own kitchen. Several rooms are equipped with Xboxes and board games, and are designated "meeting-free areas."

New Staffers and a Couch
With employees grouped into a series of discrete loft offices, Zynga's operation looks more like 11 small startups glued together than one large one. It's a reflection of how the company is run: Studio heads set goals and are given freedom to achieve them any way they can. Those who succeed are rewarded with cash and stock bonuses and are granted extra resources such as new hires. When a new game called Café World recently set a company record for growth, signing up 16 million users in its first two weeks, its head, Roy Sehgal, was rewarded with a bevy of new employees and the leather couch he had been requesting for his office for weeks.

Pincus calls this style of management "true meritocracy" and says it's modeled partly after the approach at Amazon. It applies to regular staffers as much as managers. In his first three months in the poker group, Harsimran "Sim" Singh moved up the company ladder three times for helping to bring growth back into the company's longest-running game, Texas Hold'em. A year after landing at Zynga with no direct reports, the 25-year-old runs the entire poker unit, a team of 45.

The Amazon influence affects how Pincus conducts his board meetings. Each time he meets with his directors, he begins by recounting whatever issue kept him awake the night before. It's a tip he learned from Amazon CEO Jeff Bezos, an acquaintance and role model who shares a director with Zynga.

One matter getting airtime at board meetings of late: When should the company consider going public? Zynga doesn't need cash. It raised $39 million in venture capital in 2008 and hasn't touched the money since. But a publicly traded stock would give Pincus the currency to make deals or dole out employee options. Still, Pincus wants to protect the culture he has created. "We all make so many compromises in order to build our businesses that we wake up one day and we've created a company that we don't want to work at," he says. "I wanted to create a long-term home."

The Man Behind Apple's Apps

How Eddy Cue and his team keep the App Store ahead of the competition

If you had to choose one person who makes the world of apps go around, Eddy Cue might well be it. Apple (AAPL)'s vice-president for Internet services is the architect and overseer of Apple's App Store. Millions of iPhone owners have downloaded the 85,000 apps available from the App Store. That's light years ahead of rival offerings from Google (GOOG), Microsoft (MSFT), or Research In Motion (RIMM).

Cue and his team seem on track to ensure that those mobile Internet wannabes don't close the gap anytime soon. While no rival has even 15,000 apps, his team keeps tweaking Apple's offerings to make them more attractive to consumers and useful to developers. On Oct. 14, for example, Apple told developers that for the first time they could give away apps on a trial basis and then ask consumers to pay later. "Apple has done a ridiculously good job, and now they're taking it to the next level," says Jeff Holden, chief executive of Pelago, which makes apps for the iPhone and other devices.

Cue, 45, joined Apple as a lowly staffer in the IT department in time to witness the company's darkest days during the mid-1990s. He not only survived a major housecleaning after Steve Jobs returned to the company as chief executive in 1997 but emerged as one of the CEO's most trusted lieutenants. When Apple found itself playing catch-up in digital music early this decade, Jobs put Cue in charge of creating the iTunes Music Store. While far less ambitious efforts floundered, Apple's site was doling out millions of songs within weeks, with nary a hitch.

Hollywood Connection
Over time, Cue's role expanded from running the iTunes store to cutting deals to fill it. While Jobs often finalizes agreements, Cue does most of the heavy negotiations with record labels and Hollywood studios. "Eddy doesn't have attitude. That's part of his success," says one former Apple insider. "In an industry with lots of big egos, he can hold his own without saying, 'I'm the inventor of iTunes, bow before me.' One favorite approach is for Cue to "play good cop to Steve's bad cop," says the ex-employee. Apple declined to comment for this story.

Cue stands out within Apple's hard-core culture for his friendly, let's-get-a-beer manner. A rabid Duke University basketball fan, he's described by insiders as an "East Coast guy's guy." But he's one of a tight-knit group that makes sure that Apple devices, software, and services work smoothly together. Many app developers don't know the role he plays or even his name.

No doubt Cue has his hands full with the fast-growing App Store. When Apple rushed plans for the store into place in 2008, it was overwhelmed by the customer interest. The company had to invent the business on the fly, including how to approve and promote applications. Now Apple's back-end infrastructure may be as indispensable a competitive advantage as the iPhone's design. Developers have flocked to Apple because they see how the App Store can make huge successes of programs like Shazam and Tap Tap Revenge.

Apple's success has led to controversy. Some developers gripe about delays in getting into the App Store, and the Federal Communications Commission is investigating Apple's refusal to approve an application from Google. Analysts say Apple needs to develop better ways for customers to find just the right app among the thousands of options—and thereby make the business more profitable for more developers.

Still, most developers give Apple and Cue high marks. They not only established the App Store but also are building on its success. "Apple is really listening to the marketplace," says Shervin Pishevar, CEO of app developer Social Gaming Network.

Enter Yahoo

The company is out to become the go-to place for applications

Yahoo! (YHOO) has big plans for apps. While Apple may have started the app phenomenon by letting developers create programs for the iPhone, Yahoo wants to be the company that brings apps to the wider world.

In the company's most ambitious app effort to date, Yahoo is redesigning its home page to include applications from outside developers. As the changes roll out through November, the apps will be listed along the left-hand side of the Yahoo.com page, used by more than 300 million people each month. Visitors can customize their own home pages, selecting the apps they want. Then they can check the day's headlines from USA Today or bid for an item on eBay (EBAY) without leaving the Yahoo site.

Yahoo will make money from advertising embedded within the apps. It's also considering launching its own app store, similar to Apple's, in which case it could charge for applications and split revenues with developers.

This is only one of the app frontiers Yahoo is exploring. The company has developed software for televisions that lets people launch applications such as Twitter and Facebook on the TV screen while watching their favorite shows. Another new technology allows people to tap into apps directly as they use Yahoo! Mail. Wherever people are, Yahoo wants to "summon up a gallery of all the possible things you could do," says Prabhakar Raghavan, head of Yahoo's research division. "Here are 50 million things you could do—book a ticket, upload a picture. Everything's an app."

Yahoo's home page strategy is getting some traction. Dozens of software developers have signed up and landed their programs in the "App Gallery," a menu from which users can pick and choose their favorite free programs. Carrie Cronkey, the director of business development at personal finance site Mint.com, says people are more likely to join Mint if they're referred by Yahoo because it implies a level of security. "The fact that [your app] is on Yahoo makes you more credible," she says.

For Yahoo, the real payoff from sprinkling apps into TVs and its home page comes in the form of data. By tracking which apps people use and how they interact with them, the company is building on its ability to serve targeted ads. That may help the company compete for ad revenues against rivals such as Google (GOOG). "Apps can play a big role in understanding user behavior," says Raghavan.

Gold Rush?

Money is flowing into apps as smartphones reshape the tech world

When Bart Decrem went looking for office space in the spring of 2008 for his startup, Tapulous, Jeff Clavier opened his door. Clavier, the founder of venture capital firm SoftTech VC, saw enormous potential in the Tapulous software that would run on Apple's iPhone. So he let Decrem use some space in the firm's Palo Alto (Calif.) digs and made an investment in his company.

Eighteen months later, Clavier's support of Tapulous looks like it may be one of his best investments ever. The company's Tap Tap Revenge app, in which players tap on-screen balls in sync to the beats of a song, has become a breakout hit. The game and its multiple spin-offs have been downloaded more than 15 million times. Tapulous, which makes money from game sales, advertising in the game, and the sale of in-game avatars, has been profitable since this summer, a speedy accomplishment for a tech startup.

The investment has convinced Clavier there is loads of potential for venture capital investments in mobile applications. At last count, consumers had downloaded 2 billion programs from Apple's App Store, and that's just one place among several where people get apps. Clavier believes app startups could become billion-dollar outfits that rival traditional game and software companies. "The revenues of these companies will become substantial," he says. "There will be publishers that become large brand names."

"We See Huge Markets"
The torrid growth has attracted money from other high-profile investors. Last March, Kleiner, Perkins, Caufield & Byers, one of the Valley's marquee venture capitalists, launched a $100 million investment fund specifically to back startups creating software applications for the iPhone. Last October, Research In Motion (RIMM) unveiled a $150 million venture fund, with investments from Thomson Reuters (TRI) and RBC Venture Partners, to develop apps and services for its BlackBerry and other phones. And this October, U.S. mobile operator Verizon Wireless (VZ) announced an initiative to invest up to $1.3 billion in wireless applications and related technologies. "We see huge markets and game-changing opportunities," says Kevin Talbot, co-managing partner of the BlackBerry Partners Fund.

Of course, investors don't need a dedicated fund to participate. Firms such as Union Square Ventures, O'Reilly AlphaTech Ventures, and XG Ventures are devoting an increasing amount of time and money to financing wireless apps. "Most of the deals we see are in the mobile arena," says Andrea Zurek, co-founder of XG Ventures, a new VC firm of former Google (GOOG) executives.

The money flowing into apps is inspired by the belief that smartphones and other portable devices are transforming the tech world. The growth of mobile computing is sparking a renaissance in software development. Gaming apps are the most popular programs right now, but mobile shopping, content, social media, communications, and productivity tools are attracting increasing amounts of capital. "We don't think this is slowing down anytime soon," says Matt Murphy, the partner at Kleiner Perkins running the fund dedicated to Apple-related investments. (View an interview with Murphy here).

Douglas MacMillan is a staff writer for BusinessWeek in New York. Burrows is a senior writer for BusinessWeek, based in Silicon Valley. Ante is an associate editor for BusinessWeek.

Treasury's Geithner on the State of the Economy - BusinessWeek

Image via Wikipedia

Maria Bartiromo talks to Treasury Secretary Timothy Geithner

By Maria Bartiromo

MARIA BARTIROMO

Is there enough capital in the system?

SECRETARY TIMOTHY GEITHNER

You're seeing a really dramatic improvement in access to credit. But parts of the system are still very damaged, access to credit for small business remains constrained, and there are markets, such as mortgages, where progress is enormously reliant on the government.

Right. Look at the cash-for-clunkers deal. Car sales went from horrible to great to horrible again. What happens when the stimulus is gone?
A recovery that's going to work requires a recovery led by private demand. But you still have to make sure there's enough support to reinforce that process of recovery. That's a difficult balance to get right. We're not going to make the mistake many countries made in the past of putting the brakes on too early and creating the risk of a weaker recovery with even higher levels of unemployment.

Do we need a second stimulus?
No. But Congress is looking at unemployment insurance and other programs critical to recovery. And there's a good case for extending them.

People are nervous about 2010 and new taxes. Are you going to allow the Bush tax cuts to expire if the economy remains flat and unemployment is still high?
The overwhelming responsibility of people in government today is to make sure we have an economy that's growing, unemployment coming down, factories going back to work. That is the critical imperative. That's why we cut taxes for 95% of working Americans and for businesses across the country. It does not make sense to raise taxes in a recession.

How worried are you about the deficits?
When we have an economy that's growing again and we get unemployment down, we're going to have to bring those deficits down. And we need to make sure people understand we will do that. Because if they're not confident in that, the recovery will be weaker, interest rates will be higher, investment will be constrained, and you'll have higher unemployment. Deficits can be very damaging to growth.

When do you expect growth in jobs?
I'm not an economist, and I don't forecast, but if you look at what business economists say now, you're going to see the economy growing at a significant rate for the rest of this year. Then positive growth in 2010 at a level that will begin to gradually bring down the unemployment rate.

World Bank President Robert Zoellick recently said that the U.S. should not take for granted the dollar's preeminence. Would you expect, at some point, that the dollar will not be the world reserve currency?
I wouldn't. But I think the dollar's role in the system requires us to do everything possible to keep inflation low and make sure we're getting our fiscal house in order. That's really important to confidence [in the dollar]. We take that very seriously—nobody more than me.

Here we are at Dow 10,000, and JPMorgan (JPM) and Goldman Sachs (GS) are once again reporting great numbers and paying record bonuses. And yet 10% of the country is unemployed. Some people out there are saying: "Did we get snookered again? Have we learned anything?"
We're not going to let this financial system go back to where it was, and we're not going to let the practices reemerge that caused this crisis. That's very, very important, and the financial community has a huge interest in a more stable framework with better protections for the industry. The best-run firms were disadvantaged by the worst-run.

But we're still dealing today with too big to fail, aren't we?
At the center of any reform process is making sure institutions are not living with the expectation the taxpayer is going to save them from their mistakes. The object of reform—apart from what we're trying to do on the consumer side—is to make sure we have a system in which we can let firms fail without taxpayers being on the hook. And we're going to do that.

Won't a consumer protection agency just be one more bureaucracy?
This basic balance between [financial] innovation and protection is really important to get right. But we got it wrong. There's no way to look at our system the way it was run and say we did an adequate job of protecting consumers and investors. Of course we want to make sure there's innovation and choice, but I think we found that balance in the proposals we made to Congress.

Some people feel there's real class warfare going on, and when you look at some Administration policies—whether it's cap and trade or higher taxes, or in some cases higher health-care costs—it feels a little anti-business. Is this Administration anti-business?
Absolutely not. And the President and the people around him understand deeply that for our economy to be more productive in the future, it requires an atmosphere in which businesses are willing to innovate, invest, and take risk. There's no path to growth, no path to lower unemployment, no path to broad-based gains in income that doesn't come from and rely on an atmosphere in which investors are confident and companies are confident.

Maria Bartiromo is the anchor of CNBC's Closing Bell and writes the blog Maria Bartiromo's Investor Agenda at investoragenda.cnbc.com

High-Speed Trains Are Making China Smaller - Newsweek.com

Image by Getty Images via Daylife

By Duncan Hewitt | NEWSWEEK

Published Oct 24, 2009

From the magazine issue dated Nov 2, 2009

For decades, rail travel in China meant an arduous overnighter in a crowded East German–designed train, riding along a rickety old track. Now China is undergoing a rail revolution. Over the next three years, the government will pour some $300 billion into its railways, expanding its network by 20,000 kilometers, including 13,000 kilometers of track designed for high-speed trains capable of traveling up to 350kph. Result: China, a nation long defined by the vastness of its geography, is getting, much, much smaller.

Already, the journey from Beijing to Taiyuan, the capital of Shanxi province, has been slashed from eight hours to three. Shortly before the Olympics last year, the 120km trip from Beijing to Tianjin was cut from almost an hour to just 27 minutes. In the next few years, a train journey from Wuhan to Guangzhou, halfway across the country, will shrink from 10 to three hours. The trip from Shanghai to Beijing, which currently clocks in at 10 grueling hours—and twice that, not so long ago—will be cut to just four, making train travel between China's two most important cities a viable competitor to air for the first time. Similarly, a trip from the capital to the southern manufacturing powerhouse of Guangzhou—more or less the entire length of the nation—will take just eight hours, compared with 20 before and more than a day and a half by bus.

In many ways, China's rail revolution is comparable to the building and opening of America's transcontinental railway in the 19th century or, more recently, to the opening of the U.S. interstate highway system in the 1950s and 1960s. In their own ways, each of those infrastructure projects opened up the United States for development, exploration, and trade. By making travel available to ever-larger numbers of people, they changed not only distances, but individuals' perceptions of their own limitations, shifting "people's mental maps of the land mass in which they lived," says Colin Divall, a professor of railway history at University of York in the U.K.

The advent of high-speed trains is likely to have even greater implications for China, given its larger territory, population, and history of regional unrest. By improving connections, they may help spread economic development more evenly around the country, helping Beijing to bind the nation together and strengthen its hold over the provinces, and decreasing the likelihood that China's internal divisions might one day lead it to fragmenting into "warring states," as some worst-case forecasts have predicted. In particular, the leadership hopes that its call for the nation's talents and industry to "go west" to China's poorer provinces may become easier once western regions become less remote, thanks to rail. Thus the gaps in wealth, status—even dialect—that now divide countryside and city, the more urbanized east and the mostly rural west may be narrowed, advancing Beijing's vision of a more "harmonious society."

Bullet trains are already expanding the definition of a day trip and could help transform isolated backwaters like the inland city of Xian into booming heartland hubs. With traffic already clogging China's expanding network of highways, bullet trains could ease the snarls while opening up travel to the millions of Chinese still unable to afford a car, or a plane ticket. In general, high-speed rail is likely to be just as fast as air travel, at half the price. By shrinking people's sense of the scale of the nation, fast trains may also help stimulate the creativity and new thinking that China needs for the next stage of its economic development. Xie Weida, a professor at the Institute of Railways and Urban Mass Transport at Shanghai's Tongji University, argues that "transport will have a big impact on every aspect of the entire life of our society," stimulating development "not just in the field of economics, but in politics and culture too."

Already, government investment has created something of an economic miniboom. At the railway station in Suzhou—the old Yangtze delta city north of Shanghai famous for its canals and ornamental gardens—teams of construction workers now spend their days suspended precariously from a latticework of girders high above the track. Soon, a brand-new glass-and-steel terminal will rise here, and the crumbling old 1950s station, with its few platforms, will be consigned to history. Guangzhou, Shanghai, and other cities are following suit, building shiny new stations to service the fast new trains. Authorities are so confident about the market that they've invested tens of millions of dollars in localizing production of bullet trains, with 85 percent of the parts for trains in the new Beijing-Shanghai line expected to be manufactured domestically.

Far bigger economic effects are down the line. The train tracks are helping to spur consumer spending, with Beijing residents traveling as far as 120 kilometers to shop in places like Tianjin, where prices are lower. The $8.50 one-way trip takes less than 30 minutes, attracting many middle-class passengers who see the bus—which takes three times as long—as a nonstarter. Beijing's campaign to promote development across regions—like the Yangtse River Delta around Shanghai, or the Pearl River Delta from Guangzhou to Hong Kong—gets a huge boost from the fact that it will soon be possible to traverse these regions in minutes. High-speed rail will cut the trip from Shanghai to Nanjing from what was originally four hours to just 75 minutes. The city of Wenzhou in southeastern Zhejiang—home to many of China's biggest private enterprises, including fashion brands like Meters Bonwe and shoemakers like Aokang—has long been hindered by its relative isolation in a mountainous coastal area. This month it opened high-speed rail tracks connecting it for the first time to Ningbo, a major port, and to the neighboring province of Fujian, an important hub for Taiwanese investment. The link, which will ultimately extend south to Hong Kong, is expected to further stimulate Wenzhou's legendary entrepreneurial spirit, which has seen it move rapidly from small family workshops to major textile and electronics manufacturing, as well as becoming the source of much of the real-estate investment around China.

The high-speed lines will also help eliminate trade bottlenecks by freeing up space on existing tracks. Paul French, head of the Shanghai retail and logistics consultancy Access Asia, says many foreign businesses are frustrated by the lack of space for transporting goods on China's railways, with freight trains monopolized by shipments of coal and grain. "There's too much investment in passenger rail now and not enough in cargo," he says, noting that this forces companies to add to the number of "overloaded trucks plowing along China's death expressways." But the investment in passenger tracks will allow the old lines to be used for cargo, aiding the Chinese economy by allowing for a more efficient freight-train network. Xie says the government also plans to bolster freight rail with a $40 billion investment on new rolling stock by the end of 2010.

That could put Beijing's policy of opening up the west in high gear. Introduced in 2000 with the aim of binding some of China's poorer western regions to the economic growth of the east coast, thus reducing dangerous social and economic imbalances, the initiative has been hampered by slow and expensive transport connections and the unwillingness of qualified talent to work in remote western regions. The fast-train links may help reduce all of these problems. The ancient capital of Xian has struggled to attract cutting-edge industries to its isolated location, 1,200 kilometers and 10 hours by train from Beijing, but soon that ride will fall to just four hours.

China's effort to develop medium-size cities across the country, in order to reduce the pressure of massive internal migration on big coastal cities, will also get a boost. The fast-rail links include rapidly expanding light-rail connections around major cities, encouraging moves from central cities to smaller satellite towns, or even commutes from one city to another. Retired people seeking a better environment are beginning to do the same.

Still, there is also the possibility that the unifying aim of the high-speed-rail project could create unexpected challenges for Beijing. Some of the fast-train routes are so popular that many passengers can be forced to stand throughout their journey. Outrage over this has led some media outlets to demand that the state-controlled railway system be opened to competition. "Only when monopoly is replaced by free competition," said an article in the Chengdu Business Daily, "can we expect real quality train services." What's more, improvements in mobility could begin to undermine the Chinese government's highly restrictive residency regulations, which even today tie people's right to welfare, health care, and education to the place where they were born or have worked during their adult life. Now, according to Mingzheng Shi, head of New York University's teaching center in Shanghai and a specialist in China's urban development, more and more people are moving across old administrative boundaries. "Their concepts of cities and distance are changing," he says. "People from Shanghai see no problem now in living in cities in southern Jiangsu province, where apartments are cheaper, and then taking the fast train to Shanghai in 20 to 40 minutes." Large numbers of urban residents moving away from the cities where their welfare entitlements have traditionally been located may prove too much for the household registration system, and could lead to its "eventual complete collapse," says Shi, removing a vital plank of the state's traditional mechanism of social control.

Over the longer term, easier travel could be the driving force behind a new understanding of what China can one day become. Chinese officials have long argued that the nation's vast area and population make it too unwieldy to be suited to multiparty democracy—and this idea has been deeply lodged in the Chinese psyche for generations. This may have been unsurprising in a country where a couple of decades ago it would often take half a day to get to the next town, and where it could easily take four hours to make a phone call from one city to another. Yet once people begin to sense that their country is getting smaller, those obstacles are likely to seem smaller, too. In fact, the effect of the high-speed trains could be that they do bring China together—just not in the way Beijing might have planned.

Find this article at http://www.newsweek.com/id/219416

The Dissident Who Came In From the Cold - Newsweek.com

Image by Getty Images via Daylife

Nikita Belykh is radically remaking Russia's vast Kirov region. The country's democratic future may depend on his success.

By Owen Matthews and Anna Nemtsova | NEWSWEEK

Published Oct 22, 2009

From the magazine issue dated Nov 2, 2009

Dozens of villagers are lined up at the gates of the decrepit local boatyard on a breezy Saturday morning to witness an unheard-of event. They gaze in wonder as the visitor arrives: never in living memory has a regional governor paid a call to the backwater town of Arkul, on the Vyatka River, roughly 500 miles northeast of Moscow. Climbing out of his battered Land Cruiser in scuffed jeans and a New York Yankees cap, Nikita Belykh makes a startling contrast to Russia's standard-issue provincial bureaucrats.

Looks are the least of the differences: Belykh made his name opposing those entrenched post-Soviet apparatchiks as one of the most determined pro-democracy activists in the country. Old friends were shocked and angry when he abruptly abandoned their street protests and took a Kremlin appointment as governor of Kirov oblast, deep in Russia's neglected heartland. But Belykh is tackling his new job with all the energy he used to radiate as an opposition leader. He immediately begins peppering the boatyard's director with questions—especially about what needs fixing. "Tell me what you do!" Belykh says briskly. "Tell me everything!"

The shipyard is one small piece of an experiment he hopes will transform Russia—and so far, at least, he has the blessing of no less than Russia's president, Dmitry Medvedev. It was Medvedev who appointed Belykh to the job late last year, essentially granting him a socioeconomic laboratory slightly larger than England. Kirov is a microcosm of Russia and its problems—chronic unemployment, decaying Soviet infrastructure and wretched public-health conditions, to name only three. Medvedev has made it clear that Kirov is his personal project and Belykh his protégé. If Belykh can raise Kirov up from its knees, there will be a clear precedent for applying the same management style across Russia. "Maybe some people would like to see us liberals fail," says Belykh. "My job is to prove the opposite."

And fast. Medvedev publicly deplores Russia's economic plight and has called for massive changes, but he may not have much longer to do anything about it. Former president Vladimir Putin, the KGB veteran who chose him as successor, recently dropped broad hints that he intends to take the presidency back at the next election, in 2012. Worse yet for both Medvedev and Belykh, hostility toward the Kirov project is growing, even within Medvedev's (and Putin's) own United Russia party. Two weeks ago the party's youth wing, the Young Guards, marched against Belykh's plan to hold a conference on regional development in Kirov. Whipped up by false rumors that the conference was sponsored by the U.S. International Republican Institute, the protesters carried professionally made banners with slogans like GET OUT WASHINGTON ORGANIZERS! and YANKEE GO HOME! They displayed no qualms about publicly attacking Medvedev's protégé—a sign of bigger challenges ahead.

But Belykh seems undeterred. Even by the standards of Russian democratic activists, he has a mind of his own. He grew up in a well-educated family near the Urals city of Perm. His parents expected him to study at one of the top schools in Moscow, but when he was 16 his father died of a heart attack, and Belykh stayed in Perm to look after his mother. That was the year Boris Yeltsin stood atop a tank and defied an attempted coup by hardliners trying to roll back democratic reforms. To this day, Russia's first post-Soviet president remains Belykh's hero. "I come from a generation of Yeltsin democrats," he says. "Nobody else but Yeltsin dared to give people freedom in the conditions Russia lived in the 1990s. Unfortunately we did not manage to keep that hard-won freedom." Belykh adds, "Now our job is to rehabilitate democracy."

A high flier from the start, Belykh majored in law and economics simultaneously at Perm State. At 23 he was made vice president of a local investment house, and at 28 he was appointed the region's vice governor. The next year—2003—he ran for Parliament on the reformist Union of Right Forces ticket, but the tide had turned against the progressives: the party won no seats at all. Belykh stuck with the party anyway and moved to Moscow to become its leader, but times grew even tougher, and members began talking about making peace with Putin. Belykh opposed any such idea. "I did not see myself as a part of the Kremlin's project," he recalls. He quit the party in protest.

Putin's strong-arm tactics had effectively neutered Russia's liberal opposition. And yet Belykh couldn't just stand by while the country deteriorated. While Putin has won heavy domestic support with his loud, aggressive foreign policy, Russia is hollowing out inside. Reform at the local level gets no attention, but it's essential if the country is ever to thrive.

That's where Belykh decided to focus his efforts. He passed a message to Medvedev that he wanted to work in regional government. He knew his old associates would accuse him of selling out, but he saw no other way he could make a difference. He was still struggling with himself when Medvedev suggested making him governor of Kirov. The Kremlin wasn't taking chances. Belykh's first interview was with Vladislav Surkov, the Kremlin's chief ideologist, who warned him to keep his mouth shut in public about national issues like the war with Georgia. Belykh would be permitted to do a weekly radio show called A Governor's Diary on the liberal Moscow-based Radio Echo network—but only if the program stayed away from "provocative" questions.

The new governor arrived in Kirov in January. One of the first things he did was hang a portrait of Boris Yeltsin on his office wall. Then he auctioned off his predecessor's official car, a Lexus. He allowed all street protests to go ahead, including a thinly attended gay pride parade, and announced he was ready to meet with any group that had a beef with the government. He's been working 12-hour days ever since, mainly talking with people about their grievances.

Kirov has no shortage of complaints. Unemployment is set to reach 20 percent by the end of the year. The oblast's sole gasoline distributor, Lukoil, uses its monopoly to demand the highest prices in the entire Volga federal region. Infrastructure and public utilities are a constant source of outrage. And as almost everywhere in Russia, the demographics are a disaster: between January and August 2008 (the most recent statistics available) Kirov recorded 10,474 births and 16,204 deaths in a total population of 1.5 million. On top of that, an estimated 15,000 people left last year to seek better lives elsewhere.

But what seems even more baffling to Belykh is that Kirov's people seem stuck in the old ways of dealing with a hostile bureaucracy. "For the first time in my life I find myself on the same side of the barricades as the government," he says in frustration. At one recent meeting, he struck a deal with local labor chiefs on job security and keeping factories open—and the next day, they published an open letter excoriating him for trying to cut teachers' salaries. In another instance, a group of local NGOs organized street protests against high utility rates only a day after Belykh gathered their leaders in his office to find a solution to exactly that problem. "I want to say to them: 'People, I am much more experienced with protests than all of you. Here I am, your governor, come in and find solutions together with me!' "

But the single biggest challenge may be the region's law-enforcement system. Local NGOs have documented dozens of police-brutality charges, including numerous alleged cases of anal rape in police custody. At least four alleged victims have registered complaints with prosecutors. Nevertheless, victims who were interviewed by NEWSWEEK insisted on closing their curtains and speaking in whispers for fear of retribution. Few have much hope that Belykh will prevail over the local security forces. "There are areas which neither Belykh nor even President Medvedev can change," says one of the victims' lawyers, asking not to be named criticizing the police. "I have lived a long life in the Russian law-enforcement system and can assure you, it lives by its own rules."

Belykh has asked all his old activist friends to join his team in Kirov, but few are willing to relocate so far from the social and cultural mainstream. Even his wife and their three children remain in Moscow, where she manages a travel agency. (Their eldest son, 6-year-old Yuri, started school there in September because Belykh didn't want the boy tagged by Kirov classmates as "the governor's son.") One activist friend who has accepted the invitation is Maria Gaidar, 27, the daughter of Yeltsin's acting prime minister back in 1992, YegorGaidar. She once rappelled down the side of the Great Stone Bridge just outside the Kremlin, to unfurl a banner declaring NO TO KGB POWER. When Belykh accepted the Kirov job, she excoriated him for "selling his soul to the devil" but then relented. Another old friend from the opposition, Konstantin Arzamastsev, had to think hard before joining the team. "Only my respect for Belykh made me take this job," he says. "Kirov is far from being an easy place to liberalize."

After months of wrangling, Belykh has managed to appoint eight deputies, but almost every other member of his government is a holdover from the old regime. Kirov's legislature has blocked other appointments. By law the governor is also entitled to nominate a senator to represent Kirov in the Federation Council, but Belykh's pick was vetoed by Medvedev himself. "They made Belykh governor without letting him put together a team of his own," says an aide to Nikolai Shaklein, the senator who was named instead, requesting anonymity when discussing his bosses.

Nevertheless, Belykh insists on running the place his way—as democratically as possible. He keeps his advisers working practically nonstop and has them debate all sides of any issue before he makes a decision on it. "We plan to turn this region into the most transparent, corruption-free, and business-friendly region in Russia," says Gaidar. "But that is a long way off. We face a wall of Soviet mentality that has not changed in 20 years." Sometimes it seems nearly impossible. "On my worst days I think it is easier to rule like an Asian despot than to become a Russian Obama," Belykh says. "But look, to me this job is a chance to change people's attitudes about democratic values."

Changing those attitudes in Kirov alone will take "a social revolution," Belykh says. First, people need to see tangible benefits in their lives. "The level of trust for liberals in Putin's Russia has shrunk to almost zero," says Belykh. Even so, Medvedev has shown plenty of trust in him. This May the president became the first Russian leader to visit the oblast since Tsar Alexander I in 1824. Medvedev didn't merely put in an appearance; with Belykh at his side, he announced a crowd-pleasing new plan to pay newly unemployed Russians a full year's benefits to help them launch new businesses. "I am Medvedev's man," says Belykh. "I am his appointee, on his team. And not anybody else's." The question is how far the leader of that team can go to make Belykh's experiment a success.

Find this article at http://www.newsweek.com/id/219008