The debate about “Who lost Russia?” has been proceeding in the West since the Russian sovereign default of 1998. It flared under a new heading when Andrei Shleifer and Daniel Treisman wrote, “Russia has become a typical middle-income capitalist democracy” in Foreign Affairs in February 2004. Many Western observers have expressed reservations about this conclusion. For example, in the European Journal of Comparative Economics, 2005, Steven Rosefielde claims: “Russia is an abnormal political economy unlikely to democratize, westernize or embrace free enterprise any time soon.”

One of the reasons for this ongoing controversy is obvious. Participants in the debate define ‘normalcy’ differently. For example, Shleifer and Treisman argue that while Russia has similar political and economic institutions as the young democracies of Brazil or India, Rosefielde describes ‘normalcy’ as a regime where the ‘median voter’ determines government spending. As the result of this obscurity with definitions, both authors arrive at contrasting conclusions while debating supposedly the same topic.

It is a grave mistake to dismiss the debate on Russian ‘normalcy’ as a purely linguistic task. Western policymakers develop their stance toward Russia while making gross assumptions: “Does Russia continue its current policies? Do we have confidence in the integrity of its leadership?” One repeatedly hears such things. Academic debate, however, should provide the necessary background that bureaucrats need to answer these questions. Explaining the concept of Russian ‘normalcy’ affects Western public attitudes because it contributes to a better understanding of Russian processes.

A clearer definition of normalcy is necessary for making a comparative judgment of Russian strengths and weaknesses, while such a comparison helps to understand what position this country assumes in the world. In addition, it reveals potential benefits that Russia sees advancing on different fronts. For example, the compatibility of its market infrastructure is an important factor that affects the level of foreign direct investments (FDI). Russia would attract comparably more FDI if its utilities provide better services, for example, and its transportation network is more developed, than, say, in China. The commonality of corporate practices – accounting standards, attitude to property rights and labor training – raises the chances of Russian firms forming international alliances. This may also help increase Russia’s chances in economic diversification since global integration benefits high-tech industries first.

From a political point of view, Russian adherence to democratic principles facilitates the defense of its national interests through the Group of Seven or the OECD. Furthermore, the EU set conditions for Russia’s access to its markets on the compatibility of Russian institutional norms with EU standards. These and other considerations suggest that progress toward ‘normalcy’ is beneficial to Russia. Finally, determining Russia’s relative strengths and weakness helps to understand current political processes that take place in this country and to evaluate its current policies.

WHAT IS ‘NORMALCY’?

The word ‘normalcy’ has two different meanings. The first definition is pragmatic and describes normalcy as the recurrence of particular situations. Facing repetitive tasks, people develop habits or ‘norms,’ which have practical importance in the realm of commerce and politics because they simplify social interactions. The second meaning of ‘normalcy’ is cultural and defines commonalities within certain boundaries. When used in public debate, the two meanings are often indistinguishable. The pragmatic interpretation has apparent advantages in our case. First, it avoids conflating debate on Russian ‘normalcy’ with meaningless discussion on whether this country is ‘civilized.’ Second, the pragmatic interpretation limits the set of features to consider. From our perspective, ‘normalcy’ is the ease of interaction in commerce and politics. Defining who interacts and for what purpose suffices to make a clear judgment about ‘normalcy.’

This paper defines three categories of ‘normalcy’ that correspond closely to the criteria that the OECD uses to invite new members. The OECD strategy for enlargement and outreach, designed in 2004, mentions two fundamental parameters that its members share – free-market economies and democratic

principles.

Free-market economy. The basic idea of a free market economy, shared universally by the OECD countries, is that private agents are free to produce and to trade while the state guarantees their property rights. Among its basic tenets are the requirements that citizens command productive facilities and financial funds; that they have the right to own assets privately or to rent from other agents; and that they are able to accumulate resources through long-term investments. The government’s role is limited. It protects property and arbitrates conflicts between private agents.

In reality, this idealized account of a free market economy is uncommon. There are several reasons for expanding the role of the state. First, unfettered markets ignore social conventions that embody values whose significance goes beyond economics. For example, using reductio ad absurdum argumentation, James Arnt Aune points out in his Selling the Free Market: the Rhetoric of Economic Correctness (2001) that the logic of unfettered markets justifies an organ donor’s right to sell his or her body parts, while permitting parents to actually sell their children. Second, unregulated markets ignore externalities such as the social costs of environmental degradation or health hazards. In both cases, the OECD countries maintain that it is ‘normal’ for the state to intervene. However, to limit the abuse of power, the state should follow certain procedures, namely, the popular vote and the respect of certain inalienable rights. The last observation is important because it suggests that the West values democratic principles as much as or more than free-market standards.

Democratic values. The previous discussion indicates that democratic ‘normalcy’ should complement its economic analog. Certainly, democratic values are widely recognized as important in the modern world. Amartya Sen – reflecting on the major events that took place in the twentieth century – concludes in the Journal of Democracy (1999) that the focus has clearly shifted in the twentieth century from the discussion of “whether one country or another was ‘fit for democracy’” to whether “it has to become fit through democracy” (italics in original). While the causes for the growing importance of democracy are numerous, historical reasons explain why the West attaches high value to democratic traditions. The twentieth century witnessed horrible instances of human suffering. In the aftermath of the last world war, the Western countries have become convinced that democracy safeguards against destructive conflict resolutions. In this respect, the creation of the OECD itself has served the objective “to permit the emergence of political and social conditions in which free institutions can exist” (speech given by George C. Marshall at Harvard University on 5 June 1947).

Democracy, in its modern liberal variant, is a system of governance where “The majority rules and minorities have rights.” It comprises periodic change of leadership, defined and legitimized by elections, and incorporates the protection of certain individual rights. These two features – regular elections and the protection of human rights – are essential. The first stipulates that citizens choose their candidates and elect leaders using transparent procedures. The second feature says that the elected authority is not free to adopt rules that are unnecessarily unfair or justifiably intolerable to the minority who opposes them. For example, even if sacrificing one life may save many more lives, it is inappropriate to vote on a list of candidates using the majority rule in a liberal democracy. The right to live belongs to the set of inalienable rights, upon which the majority cannot vote.

RUSSIA’S INSTITUTIONAL STRENGTHS AND WEAKNESSES

The concept of normalcy implies the absence of considerable deviations in all categories rather than in total ranking. This consideration justifies investigating individual parameters, which determines a country’s adherence to free market principles and democracy, rather than simply their aggregates. This study uses mostly data derived from two closely related studies: the index of business competitiveness developed by the World Economic Forum (WEF) and the World Bank (WB) economic surveys. Because the goals of both projects are rather narrow, they underestimate the importance of democratic institutions. We complement these data with democratic indicators constructed by Polity IV, Amnesty International and other organizations that monitor democratic institutions worldwide. The WEF and WB reliance on survey information is potentially troubling due to its biased findings that stem from the ‘halo effect.’ Later, we will show that Russian respondents show unwarranted pessimism, a finding that supports our inference about the high incidence of mistrust in this country.

We omit direct comparison of Russia with the G7 group countries, which seems obvious because Russia still struggles to establish its reputation as a full member of this prestigious club. The contrast between Russia and the G7 institutions is so stark as to be uninformative. On the other hand, a comparison with the B5 (or “Big Five”) group of middle-income large countries – Brazil, China, India, Indonesia and South Africa – is more instructive. The choice of countries follows the OECD list of “strategic non-members” whose importance the organization expects to grow in the near future. A “horse race” between Russia and the B5 group allows a prediction as to who among large non-OECD members is likely to increase its political weight and who will lag behind. To avoid excessive statistics, we present the comparative results with a single indicator – the ratio of Russia’s estimate to the average value shown by the B5 group. The lower the ratio, the comparably worse is the situation in Russia relative to the reference group. The range between about 0.95 and 1.05 does not reveal any distinction because it is statistically insignificant. We divide the concept of free-market economy into two parts for expositional purposes.

Free-market economy 1: infrastructure. Economists agree that a healthy physical infrastructure, an efficient labor market and the absence of monopolies are important public conditions that create a favorable economic environment.

Modern firms rely heavily on transportation facilities, communication networks, water supplies and electric utilities. Russian managers appraise the physical infrastructure in this country as similar to the standards of the B5 countries. Russian roads and the water supplies received the lowest mark of 0.87, while the railroad system received 1.16.

The availability of a well-educated and healthy workforce is another condition indispensable for the operation of many economic sectors. Well-educated and professionally trained workers are able to produce sophisticated goods that have high value-added content. In addition, the international division of labor benefits those countries that are capable of innovative research and development. Russia performs relatively well in this category, with the ratio ranging from 1.09 for the availability of engineers to 1.32 for the quality of public education. Other surveys corroborate the claim that the situation on the labor market is positive. For example, WB reports that finding qualified personnel is less a problem in Russia than in the B5 states. In the category of health, the situation is a bit worse as there is a disparity in medical treatment available between the rich and the poor. Here, the ratio of Russia’s estimator to the B5 average is 0.83.

Robust competition among suppliers and consumer dominance is the third parameter that determines a favorable market environment. The Russians consider the price and market power environment to be slightly worse here. Monopolies are the main problem (0.80), while the adverse effect of state subsidization is equal with the B5 group (0.98).

In general, the evidence suggests that the quality of the Russian market infrastructure is about equal with the B5 average. This implies that Russia has decent prospects for FDI, especially in technologically advanced areas where it has the advantage of a better-developed labor market.

Free-market economy 2: corporate practices. Good business practices are important in a free market economy. Companies develop conventions that govern inter-firm relationships and shape their attitude to suppliers, customers and public agencies. Here, we will consider how Russian firms protect ownership rights, train workers, design incentive schemes for managers, organize technological chains, compete in markets and retain customers in comparison with firms in the B5 group.

Data indicate that Russian firms are more secretive in comparison with their peers in the B5 group. Because of greater informational uncertainty (0.65), it is unsurprising to find that minority shareholders and banks are reluctant to invest and to provide credits. Consequently, Russian firms rely more on internal sources of funds than do firms in other countries. However, it is premature to conclude that companies hide information deliberately to cheat hapless investors or creditors. Secrecy is imperative in Russia where property rights lack protection. For example, the risk of falling prey to hostile takeovers is more common with Russian firms than with companies from the B5 group (1.14).

The estimation of corporate labor practices reveals two paradoxes. First, Russian managers are less trustful of their workers than are managers from other countries. They avoid delegating authority to workers (0.78). This finding does not square well with the high grade that Russian labor receives on education (1.32); one would expect that more qualified workers require less supervision. A closer look indicates that labor relationships are more controversial in Russia than elsewhere, where firms spend less on cultivating employee’s loyalty. For example, Russian companies pay less attention to training and retraining employees (0.73). They are quicker to lay off employees in times of trouble because the expected cost of firing an employee in Russia is only a fraction of costs in the B5 group. The adversity in manager-worker relations provides an answer to the second paradox. According to the FOM survey conducted in 2002 (1,500 respondents), Russian managers believe that workers get what they deserve (the ratio of pay and productivity index is 1.14), while the workers argue that they do not. The latter opinion sounds more plausible since managers argue that their pay is unrelated to productivity. Management compensation includes less significant bonuses and stock options in Russia than in the B5 group (0.92).

Data indicate that Russian companies fare about the same in competitive practices and cooperation. Their attitude to customer retention (1.01) and cooperation with suppliers (0.90) are about on the same level with the B5 average. Paradoxically, this result contrasts with low opinion that corporate ethics receives in this country (0.84). Apparently, the Russians are more pessimistic about their business partners and expect worse treatment than they receive. They exhibit the same pessimistic attitude toward public agencies as we see below.

The previous indicators show that Russia has strong positions in labor and research, while retaining a decent physical infrastructure. Yet these factors do not help Russia’s attempts to penetrate global markets (0.86). Given the caution with which companies in this country approach partners, they are slow to develop long-term connections. Such sluggishness does not only limit Russian participation in the global division of labor. It has detrimental effects at home because suppliers are overly confident in customers’ loyalty (0.91) and are slow to adapt new technologies (0.91).

In general, statistics show that corporate practices in Russia are below average. The situation is particularly stark in the area of control over assets. We argue below that this feature is a consequence of a general level of mistrust.

Democratic values. The Polity IV Project – administered by the Center for International Development and Conflict Management (U.S.A.) – evaluates democracy as the process of power change and political innovation. It has three elements. The evidence of formal procedures to choose leaders and to express public preferences is the first feature of democratic process. The second category comprises constraints that a particular society exercises in order to limit executive power. The third feature combines mechanisms that guarantee civil liberties.

Elections are considered to be democratic if the process follows well-established rules and any citizen can compete for the top position. A composite of these factors comprises executive recruitment processes. By this standard, Russia outperforms the total average of the B5 group (1.20). Yet this indicator does not capture one important aspect in the selection of executive authority, and that is how top candidates appear on the ballot sheets. This is the area where Polity IV detects a problem. Its analysis suggests that Russian candidates get their endorsements from groups organized around regional as opposed to national interests. Such a situation is conducive to political fragmentation and discontinuity of the political power elite. In its turn, fragmentation creates favorable conditions for corruption while discontinuity raises apathy among the citizens. Facts support the latter inference. Corporate support of volunteerism, which is indicative of political activism in this country, is weak (0.73). Leadership in informal organizations is the first step to a public career in the democratic countries, but Russian companies fail to see it this way.

The second set of democratic elements deals with the abuse of power that democratic countries control through a regular audit by legislative authority. The Russian parliament (the State Duma) has less supervisory powers than the legislatures of the B5 countries (0.86). The power of the judiciary to check the observance of laws is an alternative method. Here, the situation is worse. To impose effective constraint, courts should be independent from political interference. However, Russian courts are highly dependent on powerful interests, both public and private, compared with the B5 countries (0.50). In addition, courts have the reputation of being less fair (0.72), reliable (0.68) and lacking authority (0.77).

The public’s perception of the integrity of its politicians is a measure of moral constraint, which a society believes its authorities should have. Data show that the Russians are more cynical about their leaders compared with citizens of the B5 group (0.58). Many think that the abuse of status for financial gains is rampant in this country, while evidence suggests that politicians gain predominantly for serving private interests. For example, the state practice of granting contracts and amending regulations in response to requests of well-connected companies is more common in Russia than in other countries (0.68). It is also noteworthy that the dynamics are stable, which suggests that powerful private interests have captured public agencies in this country.

Overall, evidence indicates that Russia performs significantly worse than the average B5 country by democratic standards. Furthermore, it is particularly backward in controlling abuses of power by the executive office. The performance of alternative centers of control – judiciary and legislature – offers little comfort in this respect. A recent poll by the Levada Center (May 13-17, 2005) supports this pessimistic assessment. It finds that 83 percent of respondents think that a small group of individuals, whom voters cannot control, maintains power in this country. Interestingly, many Russians believe that big business wields power but politicians and public agencies are simply corrupt.

Summing up. Russian institutional development cannot be described as normal by the standards of the B5 states. On a brighter side, Russia provides relatively good opportunities for FDI, particularly in the least advanced industries where cooperation with suppliers is unimportant. The situation is less favorable for Russia’s attempts to integrate into the global economy and to diversify economically because poor corporate practices limit the development of stable partnerships. Symptomatically, OECD researchers Rudiger Ahrend and William Tompson find that the current institutional situation in this country is conducive to continuing Russian dependence on the export of natural resources. Russia performs particularly badly by democratic standards. The combination of unconstrained bureaucrats and widespread violations creates the impression of an authoritarian state. Such an impression certainly tarnishes Russia’s image abroad.

THE GREAT RUSSIAN CHALLENGE: DEALING WITH CORRUPTION AND MISTRUST

The collected evidence has provided a rather somber assessment of Russia’s current institutional development. Particularly troubling is the duo of unethical businesses and uncontrollable executive powers. Such a combination appears to nurture one of the most severe institutional challenges that Russia faces, and that is the spread of corruption. To understand how to confront this problem, it is important to understand its driving forces.

Private interests of public agencies. In the light of this assessment thus far, it should come as no surprise that public agencies operate poorly in Russia. Efficiency is particularly low for the federal government (0.65), the State Duma (0.78) and the tax agency (0.80). Arguably, the pattern of state inefficiency fits well the argument of weak democratic oversights; operating with impunity, bureaucrats neglect the concerns of private residents. This line of reasoning provides a natural explanation for corruption. If the authorities are omnipotent, they can pressure businesses to pay bribes. It follows that in order to contain corruption, the Russian government must curb discretionary power that bureaucrats exercise over companies today. Is this true?

Corruption is a common phenomenon in Russia and, as the recent study by InDem Fund indicates, it is predominantly concentrated within the executive branch of power (77 percent). However, three facts contradict the hypothesis that omnipotent bureaucracy harasses businesses in Russia. First, statistics show that businesses view regulatory costs to be relatively low in this country as compared with the B5 group: for example, compliance costs with labor regulations are 1.57. If businesses are harassed systematically, we expect compliance costs to be high. Second, recent data shows that corruption actually decreases compliance costs. For example, the customs agency is most corrupt in Russia (0.76), yet companies claim that it is easy to deal with it (1.20). Interestingly, the situation is just the opposite in the case of the least corrupt tax agency. This observation suggests that Russian firms are willing victims of corruption. Data on the effectiveness of corruption confirms this inference. Russian companies are more assertive in claiming what they have received from bribes (1.31). Recalling that corporate ethics is low in this country, many firms are likely to see corruption as a convenient tool to get around regulations. Third, in spite of common complaints about the unpredictability of state regulatory innovations (0.59), Russian firms claim that public agencies are less intrusive in business affairs than agencies from other countries. For example, government interference in mergers and acquisitions is 1.49 of the average for the B5 countries. Moreover, businesses claim that the consequences of political donations are profound in this country (0.72), implying that “to buy a favor” is not difficult. These observations suggest that Russian bureaucrats are not as powerful as many believe. In fact, it proves just the reverse: private interests capture public agencies and not vice versa.

Coalition building and breaking. There are several reasons to claim that big business dominates the bureaucrats. Three are obvious. First, following the collapse of collectivist ideals, many Russians embraced capitalism as a system where one is free to extract profit at any cost. Business managers, entrepreneurs and bureaucrats have uncritically equated capitalism with the “get-rich-quick” formula, implying that reneging on contracts or cheating customers and partners is appropriate as long as it pays. Clearly, making money is easier through business operations, which gives an upper hand to businesses dealing with bureaucrats. Second, the diminishing authority of vertical administration corrupted the institutions of power. Bureaucrats realized that serving the state was less advantageous than working for private interests. Many switched sides and continued to be “servants of the state” in name only. Finally, the method of Russian privatization provided substance to the “get-rich-quick” formula. It entailed a massive redistribution of state property that private groups captured through their alliances with supposedly public servants. These groups continue competing lobbying for regulatory changes with the entailing regulatory chaos.

The above reasoning suggests that coalitions of private interests and public agencies hinder Russia’s institutional development. The dynamics of corporate indicators shows that corporate practices are improving over time and no intervention is necessary on this front. Existing private-public alliances are naturally unstable because they have outlived their short-term objective of dividing state property. Today, businesses and former public servants turned private entrepreneurs do not need to share with acting bureaucrats. However, the stability of the corruption indicators suggests that Russia has settled for a sub-optimal equilibrium in bureaucratic preferences. Businesses cannot sever their link with bureaucrats now. Bureaucracy are on the losing side, of course, but they may initiate a destructive process of re-nationalization that voters will support. The next logical step that the Putin administration should take is to provide incentives for bureaucracy to leave businesses alone, but without initiating massive re-nationalization.

Russian policy options. The Putin administration appears to be re-establishing its control over bureaucracy with a two-prong strategy. The first dimension is to put local administrations under central oversight. The center has already succeeded in reestablishing control through governors’ appointment. By making regional bureaucracy accountable, the Putin administration has made it costlier for local bureaucrats to serve private interests with impunity. The second dimension is to initiate a limited re-nationalization of corporations. In perspective, the last move is crucial in winning bureaucratic loyalty to the state. A greater public control of currently private funds secures the financial position of public servants and, consequently, they are less likely to risk their good positions for a bribe.

However, there is a serious danger that the current process of centralization and re-nationalization will not lead to the demise of private-public coalitions but only change their ranking. Many observers already treat the oncoming presidential election of 2008 as the “succession game.” Central bureaucracy will strengthen its position but its power is virtually unchecked. Currently, the legislature and judiciary exercise only token control over the executive branch. Another consideration is that an attempt to win bureaucratic loyalty through re-nationalization does not have a natural limit. Politicians have various private incentives to expand the roll of enterprises slated for increased state control. Symptomatically, the State Duma has not agreed on the list of “strategic sectors,” which is just a euphemism for re-nationalization. In addition, greater state power raises the specter of authoritarianism. The incumbent leader who risks the greater cost of losing his position is more interested in twisting the voting process to his liking.

To avoid the danger of incessant infighting among various “Kremlin clans,” the appeal of the top governmental job should be restricted. The most obvious solution is to ensure the inevitable rotation of power within the political elite, while keeping top bureaucracy out of competition for direct state control – as it is in the G7 countries. However, to become operational, this approach requires a stable political elite, the appearance of which depends on a national consensus about the country’s political future. This brings up another serious problem: the low level of trust that Russians express in their political system, elite and government.

Public mistrust. A median Russian voter has little faith that any candidate for the top government position will uphold his or her interests. In this respect, Russia is “normal.” Politicians lack credibility in young democracies because even if they promise to “work for the people,” the incentive to renege after the election is high. To substantiate the pledge, politicians need to establish a reputation, for example through party membership. Such a membership provides a certain level of commitment because a party policy serves as a “trademark” assuring continuity.

Apparently, the Putin administration understands this argument because it pays attention to raising the profile of the political parties. It has introduced a new system of proportional representation in the State Duma that favors party membership. Importantly, the reform envisages public sponsorship of successful parties. Currently, party funds come mostly in the form of corporate donations, which erodes party credibility, as businesses are quick to solicit political favors. The change in the source of financing frees parties from obligations to corporate sponsors.

However, the Putin administration runs a political gamble that may do more harm in the end. The concentration of power is dangerous because it is conducive to authoritarianism. The current initiatives do not increase popular oversight over the central power. This does not seem to be a significant problem as the Kremlin enjoys popular trust, however, the situation may change after 2008. New initiatives, such as the creation of a Public Chamber, are not enough. Yet in spite of the threat that the Putin administration abuses political technologies, devising non-elected forms of public oversight, it may have no better option today than to experiment.