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Business Environment in Russian Federation

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This paper aims to analyze and describe the influence and the scale of the corruption on business environment in Russia, and the consequences for the society. The paper will start by examining “The Collapse of The Soviet Union and The Rise of Russia” as the prerequisite for the escalation of the corruption among Government officials, the establishment of oligarchic structures and examining the role of domestic business and foreign investors regarding their contribution in corruption practices. Then it will discuss the historical trends of the corruption’s phenomenon, whether the traditions, mentality, and the elite played sufficient role in shaping corrupt-promoting policies, resulting in more than US$240 billion in 2006 for the Russian corruption market. Although corruption is one of the main obstacles to the country’s economic development, Russia with its rich culture, which ties its people together, is on the 154th place out of 178 in the Corruption Perceptions Index published by Transparency International. Finally, the paper will focus on some events, players and ways of corrupting the society and the measures taken by the government and the new middle class to curb this phenomenon.


Many reports, studies and TV programs are stating that corruption is a way of life for Government officials in Russia and bribe-taking is a routine practice throughout the Russian bureaucracy. There are many cases of government officials demanding bribes, also of their connections and even partnership with criminals and others covert business groups. Solving difficulties by bribing officials became some kind of natural policy for doing business for Russian businessmen and for foreign investors, even for the ordinary people too. According to a poll conducted in early 2010, 15% of Russians reported to have paid a bribe in the past 12 months.

Many students’ main goal in life after graduating is already not setting up a business, which is an example of the economic development, by establishing new workplaces, boosting the market and many other positive factors for the country, but to work for the Government, because this means a bright future, financial stability, power and respect. According to a Geert Hofstede’s research , Russia has 93%, and is among the 10% of the most power distant societies in the world . This is underlined by the fact that the largest country in the world is extremely centralized: 2/3 of all foreign investments go into Moscow where also 80% of all financial potential is concentrated. The huge discrepancy between the less and the more powerful people leads to a great importance of status symbols. Behavior has to reflect and represent the status roles in all areas of business interactions: be it visits negotiations or cooperation; the approach should be top-down and provide clear mandates for any task .

The Great Change
“From Communism to Democracy”

The year 1991 was the milestone for the whole world. It was the end of the Soviet Union and the rise of Russia. It was also the shift from socialistic ideology to capitalistic. Communism was the way of life for the country for almost a century, which main idea was to create a classless, moneyless, stateless social order structured upon common ownership of the means of production. The economic system at the end of the Soviet Union was absolutely dysfunctional. The main reason for this was the attempt of the state to control too many aspects of life. The economic bureaucracy made decisions for the whole country, which population was about 250 million people. The state constructed an economy lacking individual initiative and the most spending were for militaries. Those citizens, who tried to avoid the established system of trade and to make profit selling goods, mostly in short supply, were chased and punished as “spekulants” by the law authorities. All aspects of the individual’s life were planned and controlled by the state.

Now, when the system changed, the government had to establish absolute new for the whole country way for living. Capitalistic system states are based on the free enterprise, private property, markets, and individual choice. In 1991, the Russian language did not even have a word or term that stressed the private property in land. Property belonged to all, and therefore to no one. After the Bolshevik revolution a forceful collectivization of the land property was carried out. This way a vital link between the peasantry who were the main workforce in the country and their object of work – the land, their prime source of income and goods, was broken. The communist government vigorously was compelling the peasants to work tirelessly, for almost no profit, the salaries were the lowest in the country, so the pensions.

As a result the alienation of the citizen toward the land and the property as a whole was one of the main reasons for the fall of the communism. Huge flow of people from the countryside to the cities was taking place. As a result at the end of communist regime the base for restoration of the capitalistic economy in the villages – the development of small and middle sized farms was very weak. Rebuilding the ties between the people and the land, returning the economic initiative to the individuals and changing the state regulatory system, including the protection of the private property were immense tasks for the new post-communist government. During the reform in Russia, many analysts of all ideologies asserted the lack of “transparency” in regulation, which is essential factor for the government to establish the “rule of law,” and the need for the government to build efficient “institutions.” Without these prerequisites cannot be build efficient free enterprise system.

“The Allocation”

About 200,000 enterprises were the USSR’s economy capacity. 600 huge industries shared the responsibility for about 50% of the non-military industrial production, and an estimated 1.5 trillion state-owned acres of land for cultivation. During the soviet era real competition didn’t exist, because everywhere existed comfortable state monopoly. Therefore, management of the firms wasn’t involved in the strategic decisions normally made by a company’s executives. Instead, central planners in Moscow determined quantity and quality, chose suppliers and distributors, and decided what markets were open to industry. The management was little more than production managers. The new government had to reshape the economy in several ways- destruction of the system of state monopoly, de-collectivization of the land through quick and effective methods and privatization of the state enterprises. During the last months of USSR the control of many state enterprises was given to the local governments, which was an embarrassment for the following privatization. The local workers and managers were left in control of companies, which had different owners.

As a whole the privatization of the 1990 –ties didn’t break the inertia of about 70 years central planning and the system of inefficient producer-supplier relations. This happened because the management remained the same, but just as importantly, because the stimulus to change was missing. Despite the lack of quality and necessity most of the products still were keeping produced. The Central planning committee was disbanded, but this didn’t prosperity, because of missing competition and efficient market conditions. The process of privatization the Russian assets before creation of a market economy, left individuals and firms unable to transfer accurate supply and demand messages to each other, which in turn caused economic shrinking instead of growth.

Another reason for complicating the new economy was a lacking experience in bankruptcies. Before, in the soviets times never mind how inefficient certain enterprise was, the bankruptcy never was permitted. This built widespread feeling of security and complacency among the managers and owners of the privatized enterprises. Now in the new conditions, without state subsidies, many of the companies, exposed for the first time on real market conditions, realized that their methods, models, products and services are not suited to the demands of the clients. As a result many bankruptcies of such firms followed. “Kleptocracy ”

The opportunities that awaited Russia in 1992 were exciting, but dismantling the Soviet system of government controls and erecting in its place a free market economy based on private decision making and risk-taking was a task of monumental proportions. Another step of building a free market system was liquidating of obstacles for free foreign investments. The laws limiting export of earnings were a heavy burden on foreign firms seeking to invest in Russia. Strict rules were limiting the opportunities for the foreign companies to export earnings from the country to their stockholders. Further, government regulations discriminated many activities of foreign firms, creating unfair competition between foreign and domestic participants in the Russian market. “Privatizing” assets into a non-market economy represented similarity with the continuation of the Soviet system, with the difference that the financial benefits now accumulated to a few private individuals. It is the prerequisite to the development of a kleptocracy disguised as a free market economy.

“Corruption Practices”
From the very long list of corruption practices the “loans for share” caused the most damage to the idea of fairness of the reforms. This method belongs to the former First Deputy Prime Minister in the government of President Elcin, Vladimir Potanin . Another main promoter and the direct adopter of it was another vice Premier Anatoly Chubais . The designed “loans-for-shares” “privatization” scheme allowed the oligarchs to buy Russia’s most profitable companies for a fraction of their value. Potanin managed to acquire one of the more valuable Russian companies, Norilsk Nickel . The Russian government desperately needed cash, and was enforced to borrow money from Russian banks. As security deposits, the government offered stock in premier state-owned industries. The core of this shame was the opportunity for the banks to bring to auction these shares, which the government was unable to repay the loans for them. Usually these shares belong to strategic for the economy branches like energy, minerals and metals. Given the banks’ ability to set up such auctions, and the fact that the loans weren’t heavily secured, the failure by the Russian government to pay would yield rewards for the banks’ owners.

When the shares pledged as security deposits were eventually sold after the government failed to repay the loans they secured, the winning bid was almost always submitted by an affiliate of the bank managing the auction-and typically exceeded the minimum bid by only a nominal amount. Thus “loans for shares” program allowed chosen small number Russian bankers to acquire for a very small fraction of the real value most of the best enterprises of USSR economy. The firms included not only Norilsk Nickel, but also the massive oil companies Sibneft , Yukos and other key enterprises. In the case of Sibneft with yearly production of more than $3 billion, its controlling stakes were bought for $100.3 million, for the larger Yukos , control of the company was acquired for only $159 million. Illogically most of the funds used for these transactions probably belonged to the Russian government . Also, many those banks were among the “authorized banks”, which handled the money of government. Thus instead of strengthening the new capitalism in Russia, “loans-for-shares” consolidated the power of the “semibankirshchina”- the oligarchic “Rule of the Seven Bankers” . This way formed circle of oligarchs controlled around 50% of Russian economy and was causing ruining effect on the development of a new economy and true democracy. The oligarchs became truly new rulers of Russia and in many occasions they put themselves above the law and antagonized the ordinary citizen against goals of the reforms.

The Organized Crime
Instead of decreasing the role of government was spreading. This was the main reason for creation of the organized crime in Russia. The new businessmen were unwilling to follow the new regulations and to pay multitude of taxes and duties. On this base the mafia style groups served as intermediary between the government officials and the business. Rather than pay fees for countless licensing and permit requirements, firms choose to avoid official bureaucratic routine by paying less costly bribes. The mafia set certain rules and transmitted the fees for any kind of service. The oligarchic economy also tightened the choke of official corruption over the Russian government and the large sector of the seemingly “privatized” economy that it influenced. Wide spread relations were built between corrupted state employees, organized crime and most of the business.

This prevented the law authorities from effective work against the crime and infected other spheres of society. For example low level military were selling weapons to the mafia, custom officers were bribed by smugglers and black market dealers, the tax police officers were bribed to close their eyes for certain activities of many firms and so on and so forth. The influence that enjoyed the organized crime in Russia was immense. According to Russia’s Ministry of Internal Affairs, by the end of the 1990th, criminal groups owned and/or controlled about the half of Russia’s private businesses, more than 50% of state enterprises, and about 70% of banks . This brought a huge wave of crime and disorder in addition to growing discontent from the democracy among the ordinary people. A shameful contrast between the lavish style of life for the corrupted officials and the gangsters on one side and wide spread poverty for the casual people on the other, caused dissatisfaction and sense of insecurity among the ordinary citizen. They perceived organized crime and corrupted officials as real government of Russia, so the feeling for the morale of the rulers went very low. Public opinion polls, which understandably ranked crime among Russians’ greatest concerns, also showed the extent to which organized crime has undermined the Russian public’s support for freedom and democracy.

After the Elcin’s era, which led to almost full destruction of the Russian economy in the late 1990-ties, another wave of young bureaucrats came to power. They distinguished themselves from the former extra liberal policy of weak government. The new government of Vladimir Putin followed policy of increasing the role of the government in the economical and other spheres in the country. Considering the oligarchs as a natural enemy, they used all means, sometimes arguably lawful to destroy them and their power base- privatized earlier large mostly monopole state enterprises. Such was the situation with once the largest private company “Yukos ” and the grim fate in the prison of its owner Michail Hodorkovsky. Others left Russia in exile like the former Elcin’s cashier Boris Berezovsky and Vladimir Gusinsky. The rest who survived were forced to play with the new rules. The new Kremlin’s rulers became so called state managers conducting and benefitting from huge flows of money and resources. Of course the corruption didn’t become smaller, but somehow centrally regulated. One of the most intriguing cases was with several mandates mayor of Moscow Yuriy Luzhkov, a leading member of the governing party, who used questionable methods in his work.

For example, according to the Russian media in early 2000s, the distribution for rent of local government owned business buildings in the central Moscow, privately controlled by him and his associates, reached an absurd rent of almost 10 000 USD/ m², per year. This well suited to billions fortune of his wife, Yelena Baturina . Never the less the new economic policy of the government and the rising prices of the fuels gave positive results. According to “GDP by country statistic 1990-2011” the Russian economy enjoyed between 4.4 and 9.5 percent rise annually from 1999 to 2011, which for a decade brought the country back in the list of most developed nations. A new middle, well educated (often abroad) class emerged, that possessed the means, knowledge and desire for private enterprise. This resulted in the rise of thousands small and middle sized firms and companies, especially in the new computer and information technologies, whose owners and managers don’t support the policy of facade democracy. These people do not consider spending revenues for bribing and other unlawful practices as rational and moral, they prefer instead investing in growth and modernization in their firms and enterprises and watching their behavior in the latest elections a conclusion could be drawn, about their aspirations to achieve real democracy in the country free of corruption.


http://www.princeton.edu/~lisd/publications/wp_russiaseries_coulloudon.pdf 2.“The Role of Oligarchs in Russian Capitalism”, by Sergei Guriev and Andrei Rachinsky; http://pages.nes.ru/sguriev/papers/GurievRachinsky.pdf 3.“RUSSIAN ORGANIZED CRIME”, CSIS TASK FORCE REPORT

http://www.russianlaw.org/roc_csis.pdf; p.2
4.Appendixes 1…4 -Corruption scandals in Russia.
5.VTSIOM All-Russian Center for the Study of Public Opinion; http://wciom.com; Appendix 1
History’s Biggest Money Laundering Scandal
New York Times reported on 19.08.1999, that billions of dollars were may have been laundered from Russia using the Bank of New York. Reports from another sources suggested, that the amount was as much as $10 billion. It was written that this was possible with the cooperation of several high and middle range employees of the bank, including the vice president of the Bank Lucy Edwards, her husband Peter Berlin, and Svetlana Kudryavtsev. During the trial all three pleaded guilty. Another vice president lost his job for disloyalty regarding Russian clients. Most of the transactions included tiny Pacific island of Nauru. Also many transfers originated from a bank in Moscow, which chairman was a close financial advisor to Yelcin family. Peter Berlin, a (US) naturalized Russian, a manager of a company called Benex, together with other U.S. companies, including General Forex – all connected to Berlin – were moving hundreds of millions of dollars into accounts of Bank of New York. Berlin’s operations have been connected to Russian mafia boss Semyon Mogilevich.

Appendix 2
The scandal of Pavel Borodin
In 2001 another scandal depicting the Russian corruption took place. The State Secretary of Russia and Belarus Union, Pavel Borodin was arrested on allegations of bribery and money laundering. He supposedly received bribes of up around $25 million from Swiss companies Mabatex and Mercata for supplying them contracts of Kremlin’s renovation. Later he was released on a bond of 5 million Swiss francs, which was paid by the Russian government. Thus he wasn’t ever questioned by the Court of Geneva, because bail had guaranteed his freedom. This case was closed in 2002. But swiss investigators were saying they had evidence, that President Yeltsin and his two daughters were provided with credit cards and the bills were met by Mabetex. This case of companies having paid large kickbacks to the Russian government, was another embarrassment for the Russian President Boris Yeltsin, and was one of the reasons for his followed resignation.

Appendix 3
The scandal of Valentin Kovalev
The scandal including the former Russian Minister of Justice Valentin Kovalev took place between February 1997 and 1999. First after he was exposed in a sex scandal at a nightclub belonging to criminal gang Solntsevo. Thus the rumors for his connections to the mafia were confirmed and he resigned. In 1999 he was arrested and put on a trial for embezzling $50,000 from state funds and illegal possession of firearms. While this scandal caused a sensation in the media, later it was alleged, that he was set up by the government officials, in order to leave his job. Appendix 4

The scandal of Three Whales
In 2000 Russian media reported about the scandal involving The Three Whales furniture company and government officials of the Russian Federation. The investigators revealed that the owner of company Three Wales (Tri Kita), Sergei Zuev had avoided paying custom duties for about $5 million. His suppliers, the companies Bastion and Liga Mars were accused of illegal import of 400 tons of furniture into Moscow. Followed investigation by the Interior ministry investigators was quashed by the Prosecutor-General Vladimir Ustinov. The formal reason was the company was controlled by former FSB (Federal Security Service of the Russian Federation) agents. The information was leaked to the tabloids that up to $2 million dollars bribes were paid by the accused to silence this case. Ustinov and other officials, after subsequent investigations, were suspended of their jobs for their misconduct during the case.

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