April 9th, 2015
Quarter of a century on from the heady days of perestroika and the Russia Federation still presents an intriguing and tough-to-navigate world for businesses. The collapse of the command economy and the gradual opening up of large and potentially fruitful markets has led to a steady influx of foreign firms keen to operate in the post-Soviet world. The peculiarities of the business environment they face can be explained by examining the political environment for business in a Russia dominated by its president, Vladimir Putin.
Over the past 25 years we have seen two developments in parallel. Efforts have been made to create formal “market” institutions such as an independent judiciary which is capable of enforcing property rights. This is seen as crucial for Russia’s transformation from a command-based economy to one based on market forces. But this evolution has taken place simultaneously with the embedding of informal practices of power abuse, patronage and widespread corruption within such institutions.
As such, today’s business environment in Russia is one in which companies certainly do not operate in a political vacuum. Local Russian businesses and their international counterparts are, as a matter of course, forced to engage in a dynamic negotiation of different sets of “rules of the game”. There are some formal rules, of course – explicitly outlined in Russia’s tax and business laws – and then there are some rules which are decidedly more informal in their nature.
Within Putin’s Russia, there has grown a unique network-based system of informal governance – Putin’s “sistema” – involving the use of informal incentives, control and the flow of capital stocks, operated within specific power networks.
For international businesses, Russia remains challenging. International firms are increasingly being compelled to adhere to international standards of ethical business behaviour or subject to focused and stringent national regulations around corruption.
The UK’s Bribery Act is one such example. It explicitly states that, irrespective the jurisdiction in which a UK-based firm operates, it must act according to the rules set out in the legislation. But in Russia today, in order to successfully negotiate the bureaucratic machine and operate successfully, the ability to gain favour with local, regional or national elites often depends on the illicit payment of bribes.
For evidence that the environment is still flawed, let’s look at that idea of the establishment of property rights again. The enforcement of this through a truly independent judiciary is paramount for the functioning of a fully-fledged market economy. This is the kind of environment which would encourage and crucially, protect, foreign direct investment.
Unfortunately, we are still waiting for the necessary protections – and that has meant Russia remains less attractive than it would otherwise be for foreign investors. It has also contributed to large levels of net outflow of private capital, “capital flight”, throughout the post-Soviet period. An easy example lies in the emergence of London as a venue for wealthy Russians to “park” their capital, rather than actually engage in business in the city. This demonstrates the desire of wealthy Russians to find an environment in which their private assets can be protected when this is not the case at home.
Another consequence of informal governance in Russia, involving the embedded and entwined nature of business and political elites, has been the widespread illegal acquisition of companies – reiderstvo or asset-grabbing. This is clearly a key risk for Russian and international businesses alike.
Asset-grabbing like this can only happen when a variety of state organisations – tax authorities, local judiciary and the police – are complicit in the misuse and abuse of power enabling private property to be transferred illegally. Within the Russian judicial system the selective abuse of power by police and security forces – typically making unfounded accusations against specific firms – remains a strategy to negotiate and ultimately control the nature of certain markets.
The singling out and imprisonment of Mikhail Khordokhovsky by the Putin regime and the systematic dismantling of his “Yukkos” empire, whose assets were transferred to state-controlled entities, is one such high-profile example. Similar cases, occur regularly at much smaller levels.
Dodging the duality
Ultimately, asset-grabbing, coupled with an extremely weak formalised rule of law environment and embedded corrupt practices across Russian political, bureaucratic and business spaces act as significant market-entry barriers for firms. It’s important to remember too, that this also acts as a key deterrent for existing business operations in Russia to seek to modernise. There is little incentive to strive towards efficient and transparent business solutions when, at any given juncture, either the state or other private firms – in cahoots often with state agencies – can either seek to extract bribes or shift the property rights of a given company.
As outlined above, the informal nature of Putin’s sistema certainly lacks the democratic principles of transparency within the business environment. Instead, it encourages the promotion of informal “rules of the game” such as rent-seeking, patronage, asset-grabbing and embedded corruption which often trump formal rules of the game. For international firms and investors, such a business environment may seem foreign, daunting and, without doubt, challenging.
In order to successfully do business in Russia then, company executives are obliged to acknowledge the duality of the formal and informal spheres of business and the importance attached to them by a variety of different state and non-state actors in Russia. Putin has designed the system – and that means there is little option but to engage or keep away.
“When in Rome, do as the Romans” – this, you have to presume, would be a popular adage echoing from the Kremlin.