10.08.2004
A Battle Between Business and Bureaucracy
№3 2004 July/September

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.