The current situation in Russia seems to be a bit of a paradox – the economy is developing at record-breaking rates, while a serious conflict is flaring between the government and the business community, especially big business. It may seem that this conflict has subsided because it is no long the big story on the television newscasts or on the front pages of the newspaper. It may also seem that there is no problem since the random reports in the media about government pressure on business fail to cause alarm. This is not so.

The year 2003 witnessed two major events that brought the relationship between the government and business into the limelight. First, there was a whirl of developments around Russia’s oil giant YUKOS and its CEO, Mikhail Khodorkovsky, who found himself behind bars. Second, the right-wing liberal parties, the natural heralds of big business interests, failed to secure seats in the State Duma during the December parliamentary election. These events will necessarily have long-term, variegated consequences. 

The problem is rooted in the methods of, and circumstances around, the progress of Russia’s market reforms.
The circumstances have much significance, since the reforms coincided with a severe economic crisis. This occurred because the old government-planned system came to a complete halt, and the nascent market system failed to adjust itself appropriately due to the past state institutions frustrating the reform. The market demanded an intense transformation of the economy, which went by the name of “shock therapy” at the time. The complexity of this transformation was heightened by the nature of a militarized economy, which largely conditioned the structure of society and the positioning of political forces. As recipients of generous government subsidies, army personnel and representatives of the defense industry, not to mention the agricultural sector, dominated Russia’s elite.

Nevertheless, the wave of democratic reforms in 1992 to 1995 introduced the institutional foundations of a market economy.

1. At the beginning of 1992, price controls were lifted and the planned system of government handouts was dismantled;
2. The national economy was opened to the world and a market exchange rate of the ruble was introduced in 1992;
3. Amassed privatization by way of property vouchers was carried out from 1992 through to the middle of 1994;
4. Financial stability was attained in three stages, although inflation was curbed only in 1995;
5. A system of taxation was shaped;
6. A two-tier banking system emerged.

A genuine market economy had begun, although not without a hitch. Its initial stage was marked by a huge decrease of industrial output, which was primarily the result of the legacy of structural irregularities, as well as a restrictive monetary policy aimed at slashing inflation.  

It is noteworthy that no relationship between business and government could be documented at the time, since business was practically non-existent. What Russia had at the time was a group of top executives from the state-run enterprises – the so-called ‘red directors.’ Most of these individuals were pondering possible changes in the situation; they believed that the reformers’ zeal would wane and the status quo would be quickly restored.
Furthermore, in the aftermath of the 1987 Soviet law on cooperative societies, new entrepreneurs appeared. Although they began reveling in money, their influence was very small, while the government was beginning to show some benevolence toward them. It took them quite a while to gain strength.
Russian society overcame the unexpected shock of the profound change and started to repulse it. However, at the same time, it showed no willingness to revert back to the past.

The essence of the problem discussed herein is that the process of remaking the socialist planned economy into a market economy produced a peculiar adaptive model of a transitional economy.

This model has the following specifics:

1. The weakness of the state in the wake of revolutionary changes.   
The vital institutions of the state – the government machinery, the security service, the army and the police, the Court and the Office of Public Prosecutor – all had been modeled to serve a totalitarian regime. The new authorities could by no means consider them to be reliable supports. Yet they were also unable, or reluctant, to launch a profound transformation of these institutions. All of this was happening inside a large state with huge obligations, albeit somewhat devalued by inflation. The government had just enough strength to provide more freedom.

2. Poor legislation, insufficient for a market economy and state governance. In fact, the legislative system had to be built from scratch, and Western legislative patterns were taken as models. In some instances, the lawmakers disregarded the specificity of Russia’s transition period. The laws had noticeable flaws, which could not be made up for by court decisions, as the case law was non-existent. A graphic example of the situation was the MMM financial pyramid. Its founder blatantly cheated innocent people with promises of a cash bonanza over the television; the law at the time did not contain any provisions for prohibiting this sort of activity. They would go into effect some time later.

3. The limits of economic freedom were broad from the very start: anything that was not prohibited by law was considered permissible. The prohibitions, in fact, left out a multitude of things that should have been forbidden. Later, however, while the country was experiencing negative scenarios, prohibitive acts did appear, but along with absurd orders and instructions. For example, the first cooperatives were free from taxes, and in 1992 the government lifted all import duties.

4. Bureaucracy was getting stronger against the backdrop of a weakening government. As case decisions could not be supported by law, the decision-making would pass to the bureaucracy of different executive ranks. The role of bureaucracy, traditionally strong in Russia, rose to new heights, while the democratic government proved unable to control it. Furthermore, lacking experience in economic and state governance, it was compelled, more often than not, to hand the levers of governance over to others. A vivid example of this was the early resignation of Moscow’s first mayor, Gavriil Popov, and the handover of all the levers to Yuri Luzhkov.

5. Rampant corruption. This was widespread during the Soviet era as well, but at this point it grew to the extreme. The above mentioned Gavriil Popov declared that government officials should be allowed to engage in business activities because they could not receive decent salaries. So corruption did not boil down to taking bribes – striving for the success of their businesses rather than performing their duties, state officials granted privileges to their partners. The first years of the reform actually saw privatization of the state power.

6. The black economy thrived. Virtually all companies and private individuals resorted to illegal transactions to some degree. And tax evasion was not the only reason for doing so; more significant was the redistribution of financial revenues, property appropriation, etc. Even now some 20 million Russians, or roughly a third of the country’s workforce, are self-employed, that is, they do not pay taxes and nobody pays social funds for them.

The harsh transformation environment, together with the broad liberalization of the economy, forced every Russian citizen to make a choice: use the newly opened opportunities for enrichment and win a place for himself among the new elite, or strive for survival. Those who took a wait-and-see attitude – and quite naturally, many people did – lost the game. Yet both enrichment and survival strategies promoted a black economy.

7. Organized economic crime came into being as simply a racket, but later transformed into what the sociologists term “business through the use of force.” Such activities as private security services and collecting debts actually replaced the functions of government agencies. Some time later, organized crime began to decrease; some of the previous offenders received a legal status in business or in some power agency, while others were quite physically removed. Part of the services they offered were handled by the police, otherwise known as ‘werewolves in police uniforms’ [the code name of a much-advertised operation to cleanse the ranks of Moscow’s corrupt police department in mid-2003 – Ed.]. This did not appear overnight, as the raids against the business community, organized by the prosecutors, the police and tax officials have always been highly instrumental in fighting with competitors.

8. Low juridical culture, the people’s tolerance for corruption, bureaucratic arbitrariness and crime, as well as ‘legal nihilism.’ These features date from the centuries-old tradition of social hierarchy that was shaped during the czarist and Soviet rule when the will of the superiors unconditionally prevailed over law. The Russian rank-and-file do not trust either the law or the courts; they believe that the ‘mighty people’ will gain the upper hand over them anyway. Quite simply, they believe that seeking justice is a futile thing to do, and that bribes are much more efficacious. This belief among the Russians creates a lucrative environment for arbitrariness, corruption and crime. After all, the state officials are as incompetent as the citizens allow them to be.

9. Poor tax collection.  From 1992 through 1999, companies would pay as much in taxes as they would find acceptable for their businesses. Shortly before Russia’s financial default in August 1998, the tax authorities signed agreements with the biggest corporations, including Gazprom, on the rates of taxes that they were supposed to pay. The move could be explained by restrictive fiscal policies aimed at keeping inflation in check, commonly accepted barter deals and payments in kind, the proliferation of non-payments, wide use of money surrogates, as well as by legislative flaws and tax breaks. Naturally, the corporations cultivated diverse schemes for reducing their tax payments. The rule seemed to be, ‘the bigger the company, the greater its willingness to observe the law’ – and the more sophisticated its schemes of “tax optimization.”

A poor system for tax collection resulted in the government’s failure to honor its financial obligations. At the same time, it served to undermine its trustworthiness and weaken the Russian state, which at that time was being torn by separatism, the arbitrariness of the regional authorities, and standoffs between the legislative and executive branches of power.

10. Concentration of the most valuable pieces of former state property in the hands of the few is listed here as item number ten. This position stresses a fairly modest role that the shortcomings of privatization had in shaping Russia’s model of economic transition. Whatever the method of partitioning state-owned assets, the result will never be synonymous with justice. During the period of privatization, it seemed prudent to provide for a balance of interests of all social groups. Yet, it was obvious that handing out equal shares of property to everyone was equally unacceptable, as such a move might impede the emergence of effective owners and the future progress of the economy. A concentration of capital seemed to offer a more rational solution, although it had one obstacle: nobody had enough financial resources to buy out property at reasonable prices. As a result, the authorities dropped the idea of registered privatization checks and opted for privatization vouchers that were subject to sales. This choice helped make the amassed privatization process go relatively smooth. The realization that a huge part of state property had fallen into the hands of a few people who had bought up the vouchers and shares of the newly born joint-stock companies came only later. Some of those selected people had managed to build capital on soft loans from Russia’s Central Bank, as well as on the gaps between external and domestic prices for commodities in foreign trade transactions, export quotas, or financial speculations. By 1995, those people pooled into a numerically small but powerful stratum that was objectively interested in the success of market reforms, strengthening of private ownership, and in making the economic transformation irreversible. As for the rest of the social strata, including small businesses, former managers of state-run enterprises and employees, they cared little for the outcome of the reforms. Most people in Russia were overwhelmed by the struggle for survival, for which they blamed the reformers. In the meantime, the reformers needed allies.

This was the time when the so-called oligarchs (i.e. the people with the financial clout who had obtained the levers of influence on government policies) had moved to the forefront. It was a time when the notion of ‘state oligarchic capitalism’ appeared as a regime based on the merger of top-level bureaucrats with big business displaying the aforementioned traits. The rise of that sort of capitalism was crowned by bidding with securities at documentary pledge auctions. As a result, the businessmen and oligarchs who had supported Boris Yeltsin in the 1996 presidential election appropriated at low prices the industrial facilities that turned out highly competitive products – the oil companies TNK, Sibneft, YUKOS; the non-ferrous metal producer Norilsk Nickel; etc. The appropriation was carried out on the conditions they themselves had named. Also, they were given an opportunity to get control over or create major television channels.

However, that was not the only way of building large corporations. Assets in non-ferrous metallurgy and aluminum production were consolidated through the accumulation of reserves derived from tolling and other schemes. In ferrous metallurgy, powerful companies emerged on the basis of the Cherepovets, Novolipetsk and Magnitogorsk steel smelters without any competitive bidding. Two large oil producers, LUKoil and Surgutneftegaz, were also formed on different patterns. That is why President Putin is not quite correct in saying that a group of five to seven people were appointed billionaires, and they took the companies for their own in violation of the law.

11. All of the above factors, in addition to the powerful influence of big business and a corrupt bureaucracy on the economy, produced inequitable conditions for competition which aggravated the disproportion in wealth distribution and fuelled social differentiation.

12. Inequitable distribution and a glaring contrast between the wealth of the few and the poverty of the majority are boldly manifest in the gap between Russia’s 10 percent of the top rich compared with the 10 percent of the poorest people (the decile rate). According to official statistics, this index measures 14.5 times. The situation resembles that in the U.S., the only difference being that the income group representing Russia’s middle class would fall into the income bracket of the poor in the U.S. More accurate estimates indicate that the real gap is even greater. International data suggests, however, that the countries with a similar Gross Domestic Product may have far larger gaps in wealth distribution. The problem is that in Russia the decile rate reached 4.9 times back in 1990.

As a consequence, the majority of the Russian people have developed a negative attitude to the market reforms of the 1990s. They mistrust the state, hate the rich, and crave for property redistribution in order to achieve more justice. Nonetheless, the current economic growth is the direct result of the reforms and the private initiative they have awakened. Moreover, big corporations account for the greatest part of that growth. However, the economic growth also results in increase of revenues and wealth. This intensifies people’s demand for property redistribution, a situation which certain politicians are only too happy to agitate.

There can be no doubt that an economy with the characteristics detailed above has a limited potential for development. While Boris Yeltsin was still in office, attempts were made to rescue the country from the ‘institutional trap’ (a term offered by Russian academician Victor Polterovich) that the Russian adaptive model had created. As Putin took office, however, the efforts to overcome that problem acquired a new dimension. From the very start, Putin declared that all of the oligarchs would be equidistantly alienated from the Kremlin. After some time, two of the oligarchs – Vladimir Gusinsky and Boris Berezovsky (both controlling critical mass media sources) found themselves in exile. Putin then subdued the ambition of the regional authorities by building “a vertically integrated system of state power.”

When this was done, Putin was forced to confront two more serious challenges in domestic policy. Number one was economic modernization, completion of economic reforms, and removing Russia from the trap of the adaptive economic model. Number two was the consolidation of the state and bringing law and order into the economy.

The reforms and economic modernization were partly described above. As for the consolidation of the state, it was precisely in this area that the signs of a conflict between the government and the business community appeared. Its history goes back to 1997, when the broadcasting media magnates Gusinsky and Berezovsky unleashed a war of words against the boisterous reformers Anatoly Chubais and Boris Nemtsov. The two media oligarchs won the battle, while the political leaders at that time preferred to take their side. They believed that the methods used by Gusinsky and Berezovsky were unavoidable under the conditions at that time; the political situation necessitated making concessions and compromises, as well as reconciling with the political clout of big business in the agencies of power. The alliance between the politicians and businessmen in 1999 resulted in Vladimir Putin’s ascendancy to the presidency. This augmented President Yeltin’s political course for some time, while helping to secure positions for his associates.

Next, Putin had to tackle the dilemma: either consolidate the state in the evolutionary way by developing genuine democracy and conceding to big businesses’ political influence, or resort to forceful measures by putting stakes on the law-enforcement agencies, security services and bureaucracy.
Obviously, the evolutionary path takes more time and effort. It means that the state must risk introducing democracy in a country that possesses an undeveloped political culture and tough competition between the political forces. These represent the moods of different social strata, including some that may be very dangerous for the country’s modernization, such as, for example, those from the pro-Communist, pro-nationalist, traditionalist, or populist camps. Furthermore, big business in Russia acted in its own interest and would often lobby those decisions that contravened its national goals. This situation posed extra problems for the government, and heightened the level of uncertainty in the country that it could not afford to have. Yet, international experience proves that prosperity can be attained only by democratic nations with market economies, provided their governments reckon with the adopted laws of democracy and make no exemptions for themselves. This is especially true of post-industrial states.

As regards business, the evolutionary method states that the government relies on natural, spontaneously appearing trends in the economy and in society, which produce a demand for legality, commitment to obligations, transparency, and, last but not least, the protection of property rights. The number of business people who are direly interested in those institutions which support a market economy continually increases. The business community understands that it is necessary to have these institutions in order to draw loans and investments, use the advantages of a good business reputation, or scale down transaction costs. The value of credibility based on the account of mutual interests grows, too. This kind of credibility embraces relations inside the business community, between businessmen and employees, as well as between businessmen and the government.

If the government relies on these trends and pushes them delicately in the right direction, and duly treats the interests and apprehensions – or even the phantom aches – of the business community, it will have an opportunity to make use of additional reserves of business activity and the growing trust among businesspeople.

In other words, it is credibility and not high crude oil prices that creates the main resource of Russia’s economic growth. Credibility serves to increase investment in modernization, and turn the majority of Russians into investors.

Many people believe that forceful measures and an undue reliance on bureaucracy promises rapid success. These methods are consonant with Russian traditions, and most people regard them as customary tools for achieving order. Russians apparently continue to believe that normalizing the situation is impossible without indiscriminately handing out punches and kicks. The typical thinking with Russians seems to be that first law and order must set in, and then Russia can go over to establishing democracy, if need be. Yet the very use of forceful measures, even if formal democratic procedures are observed, resembles some sort of post-revolutionary chaos, because it narrows the limits to the country’s development, vests power in bureaucracy, and eventually consolidates the institutions of arbitrariness and corruption.

More importantly, the latter logic of action aggravates the conflict between business and government and turns it into a long-term factor. The adaptive transitional model of the Putin administration has embedded a special feature: all Russian businesses are illegitimate or at least have the feeling of being illegitimate. They have grown accustomed to a situation where the government may prove their illegitimacy if it so desires, and it will not even bother providing any proof of guilt. As one classic Russian fable goes, “I find you guilty anyway – because I want to eat.” That is why the businessmen are likely to perceive any moves “to straighten the situation out” through the use of force as arbitary acts which are undertaken to deprive them of money or ruin their enterprises. And excessive force makes forcible methods an accepted norm of law, undermines credibility, and ruins the prospects for developing the economy.

Following the equidistant alienation of the oligarchs which led to several of them seeking exile under the threat of criminal persecution, in addition to the attempts of the Prosecutor General’s Office in 2001 to revise the privatization of Norilsk Nickel, it seemed that the parties to the conflict reached an agreement to change over to evolutionary development. The business community agreed to treat the cases mentioned above as ‘occasional excesses’, while the government agreed to close its eyes to the dubious means surrounding the rise of Russian business. Large corporations joined the Russian Union of Industrialists and Entrepreneurs in order to voice their interests and maintain contact with top government officials.

The situation changed dramatically after Mikhail Khodorkovsky, CEO of Russia’s major oil company YUKOS and a major businessman who was partial to the modern style of management, was arrested. Most business people regarded this event as a turn to forcible methods. The case coincided with operations that were launched against corruption and criminality in law enforcement agencies. The campaign was designed to show that the government had begun putting things in order. These events occurred during an election race, and it was viewed as a move that was intended to beef up the positions of the pro-presidential forces. The persecution of YUKOS’s top managers, which involved keeping them in custody before trial under rather dubious charges, and other actions that could have otherwise been regarded as the start of a “clean hands” campaign, had a clear political taint. They illustrated the practice of selective justice and were marked by encroachments on the norms of law. No doubt, some businessmen pinned their hopes on the redistribution of property, using their high-rank connections, but in general the Russian business community viewed the authorities’ action as a threat to itself and grew adamant.

The government tried to lighten the negative impressions. Not conceding in the YUKOS case and insisting that it was an individual instance, it appointed several liberal officials to the administration after its former chief, Alexander Voloshin, had resigned. As President Putin addressed a congress of the Russian Union of Industrialists and Entrepreneurs, he reiterated that the privatization results of the 1990s would not be revised, except for overt cases concerning the violation of the law. He also made an important concession on the buyout of land that was occupied by privatized industrial facilities. Following these events the relationship between business and the government dropped off the front pages of news reports.

The conflict, however, has taken a definite shape and remains unresolved at the moment. Experts tend to interpret it as a conflict between business and bureaucracy, or between the financial and administrative resources.

However, it is now obvious that the instances of businesspeople being persecuted were no accidents, even in the situations where they had legal grounding. Russians do not believe that encroachments on the law per se are the real grounds for instituting criminal cases and would always look for “weightier” reasons. The changes in the relationship between business and the government, the achievements in establishing state control over the mass media and the methods used to manipulate the elections – all add to the picture of what is called “controlled democracy” and signify the government’s move toward more forcible methods.

The outcome of the December 2003 State Duma elections reflected the aftermath of the policy of controlled democracy, including the monopoly of the executive power (as the pro-presidential United Russia party got a constitutional majority in parliament), the strengthening of nationalistic and populist forces, and a notable weakening of both leftist and rightist opposition parties. What is more alarming, the situation will be enduring.

A graphic example was the attempt to pass a bill which practically outlawed public meetings near the buildings of government organizations. The obedient majority of MPs stopped right on the verge of grossly violating the Constitution.

A new wave of discussions occurred after Khodorkovsky had sent an article from jail. Time will show whether it was an act of repentance or a manifesto of the new liberals. However, the very fact of its publication, which contained expressions of commitment to the presidency as a state institution, as well as a criticism of liberal reformers and businessmen for their reluctance to heed the national interests and aspirations of the people testifies to the persisting conflict between business and government. Ultimately, this makes everyone a loser. It follows from Khodorkovsky’s letter that the Russian business community is promising to develop a sense of social and national responsibility. The fact that the article was published and a discussion around it began – which could not have occurred without the authorities’ initiative – is indicative of the government’s flexible stance, as if it were saying: enough with hazing the oligarchs! That is, at least for now. However, by acting this way, it has involuntarily recognized the political nature of the persecutions.

Forecasting the impact that future developments may have on the Russian economy is problematic, yet there are signs that the economy is unlikely to produce unfavorable short-term reactions to the recent changes. The waves of emotion around the YUKOS case are subsiding, and Khodorkovsky’s article was meant to whip up public interest on the situation. There will be one more wave when court hearings of the YUKOS case begin. But whatever its outcome, those events will not have a lasting effect on the Russian economy. The business community must go on living and working, thus, it will act pragmatically, while keeping in mind that the authorities are always ready to recall anyone’s sins – be they real or fictitious – in order to make business obedient.

Foreign investors will probably display an even calmer reaction to the events. Following the Moody’s international ratings agency in its footsteps, other agencies may do an upward revision of Russia’s investment ratings by the end of 2004. All the indices of the Russian economy look too good to be true, and although the ruble is growing against the U.S. dollar, this is the result of high oil prices. It is obvious that foreign investors will find Russia attractive as long as the interest rates on the Western market are low: an inevitable rates growth in the U.S.A., Japan or Europe will immediately strip Russia of that advantage. As for now, Russia may well use the favorable situation.

No long-term choice of policy line has been made. However, if it is made in favor of forcible methods, its effects on the efforts to modernize the Russian economy will obviously be harmful. But let us hope that in the next few years of Vladimir Putin’s second term in office the government will keep a nice balance between the evolutionary and forcible methods of development. Obviously, this policy line will entirely depend upon the reputation and sense of responsibility of the President – the incumbent President; but who will follow Putin?

In fact, a victory by either side in the war between business and bureaucracy would be tantamount to Russia’s failure. The most reasonable solution is to bring relations between them into the format of law and predictability. On the one hand, the law must restrict the business community’s ability to lobby decisions and impose the selfish interests of certain business groups on society. On the other hand, the government must begin moving toward democratization, genuine division of powers, freedom of the mass media, elimination of electoral manipulations and the creation of an environment for political competition. Only then will society be able to control bureaucracy, and only then will Russia have a chance of achieving success in the global post-industrial economy.