21.11.2005
The Importance of Being Normal
№4 2005 October/December
Vlad Ivanenko

PhD in Economics, Ottawa, Canada.


 

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.