Russia is an emerging free-market economy, amongst some of the fastest growing in the world. The country possesses a high quality education system, demonstrated with a literacy rate of 99.4 percent, higher than most Western nations. Over the last 15 years, Russia has gone through a turbulent ride changing from a state-controlled economy to a marked-oriented economy. The changes that society had to undergo to accommodate the changing politics created a number of unforeseen consequences. At the present day Russian businesses face a number of differences from their Western counterparts. There is the well-known issue of tax evasion, something that is possibly an affect of a culture much deeper than Communism. Tax evasion also ties into Russian business ethics, which are often questioned by Westerners. Lastly there’s the question of economic stability, such as recent issues with oil giant YUKOS, and the government’s involvement in the energy industry. To sum it up, modern Russia still shares many continuities of political culture and social structure with its tsarist and Soviet past, how compatible is this with a market-oriented economy? (Wikipedia)
As stated earlier, since the fall of the Soviet Union over 15 years ago, Russian business has gone through many changes. During the last few years of the Soviet Union’s existence the country began to undergo market liberalizations enacted by Gorbachev. These changes were a step towards a marked-based economy, however they were halted by many issues, particularly excessive trade restrictions. The unforeseen consequences of the combination of market liberalization and excessive trade restrictions provided an opportunity for entrepreneurs to smuggle rare goods, such as Levis jeans or PCs, and sell them at an excessive profit. More often than not these entrepreneurs utilized connections with corrupt government officials to bypass the trade restrictions. At times these entrepreneurs were close relatives of government officials, or sometimes government officials themselves. These events have really set the stage for what Russia is today from and ethical stand point – it is very difficult to get much accomplished in business without knowing, or bribing, the right people.
Next came the privatization process, controlled by the Yeltsin government. During privatization state owned assets were sold at extremely low prices, and entire industries were quickly acquired by well connected individuals. Many Russians accumulated great amounts of wealth during this time, many of these men are now worth billions, and are referred to as oligarchs, a Russian tycoon. These oligarchs possess great influence over economic and political events in Russia, at times crossing paths with the government. (Wikipedia)
After the fall of the Soviet Union in 1991, and throughout most of the nineties, Russia struggled to complete its transition into a free-market economy – the change was anything but smooth. In addition to privatization and liberalization there were other problems. Inefficient political leadership, overcomplicated tax system, extreme inflation, and flat-out bad luck – the Asian crisis, for example, came at a bad time and further devastated the already shaky economy in 1998, were just some of the hurdles the country had to overcome. (BBC) What we will focus on here however, is where the country’s economy is now, how it differs from ours, and hopefully where it is going.
It is difficult to talk about Russian economics without mentioning the oil industry. The former Soviet Union republic is known for its vast natural resources, especially petroleum. In fact, it is the second largest oil supplier in the world behind Saudi Arabia (MoneyWeek). Regardless of its potential, it currently faces a number of issues, political instability is a major one. The case of YUKOS is still fresh on the mind of Western investors. YUKOS was the biggest oil producing company in Russia, until it ran into major problems with the government in 2003, stirring up controversy in Russia and around the world (Forbes).
In 2003 YUKOS’ chief executive, and oligarch, Mikhail Khodorkovsky was sentenced to a nine-year prison term for tax evasion and fraud. One could attempt linking this issue to Enron, but only if taking the situation entirely out of context. It is a known fact that vast majority of Russian corporations participate in extensive tax evasion, why did the government pick YUKOS? Many believe the government’s actions against YUKOS to be political; in 2003, prior to his arrest, Khodorkovsky funded a Russian political opposition party (Wikipedia). The government broke up YUKOS, selling assets at what many believe was far bellow market value. The action pounded the company’s stock and, as the Russian finance minister fretted, raised doubts about that nation’s business climate (Forbes).
The saga of ill-fated YUKOS continued when in 2004 the government confiscated YUKOS’ oil fields, believed to be valued around $40bn to cover back-tax claims of $30bn against the firm, and “auctioned” them off to a YUKOS competitor, Rosneft, for a mere $9.3bn. The following year Rosneft, backed by Moscow, was en route to its IPO in London, the fourth biggest public offering in world history (Forbes). In light of these events, YUKOS has asked the Financial Services Authority to prevent the IPO, to no avail. “If the FSA allows the Rosneft IPO to go ahead, it would be allowing the sale of stolen goods, as well as a rather convoluted process of money laundering,” YUKOS spokeswoman Claire Davidson said to Reuters (MoneyWeek).
In May this year Rosneft acquired another 37 subsidiaries of the now-bankrupt YUKOS, making it the largest oil company in Russia. The entire YUKOS issue stirred much controversy in Russia over the years. More importantly, it caused much uneasiness in Western investors as it only added onto instability of Russian economics and questionable government involvement.
The need for Western investment is seen in the case of Sibneft, another one of Russia’s major oil producers. Sibneft attributes their recent revival primarily to Western involvement. “One-and-a-half, two years ago we couldn’t imagine our production would be so high. We achieved these results because of our alliance with foreign contractors. Their specialists teach our specialists while we show them how to work in extreme conditions with temperatures below minus 50, ” says Yuri Schuliev, a manager of the company (BBC News).
So what can we make of all this? Is Russia worth investing in? The title of an article from MoneyWeek really sums it up well: “Russia: horrible politics, enticing economy”. Although most Westerners believe Russia, particularly Russian oil, to be an “enticing” investment, many are uneasy of the government’s apparent lack of respect for property rights. But it isn’t all bad, according to Valery Nesterov, an oil analyst at Troika Dialog Bank in Moscow, “The philosophy of Russia’s oil barons has changed. They used to just accumulate funds and use them for their own private purposes or even steal them. Now they are investing sums into technology that we could only dream about a few years ago and are becoming dangerous competition for international oil companies.” (BBC) We can only hope that the changing business ethics of Russia’s oil barons will eventually filter down to the average Russian businessman.
The story of YUKOS brings us into the next big topic in Russian business: tax evasion and corporate ethics. Although it does not seem to be as big of a problem as it was in the nineties, the issue of tax evasion still exists. It is difficult to find much published information about Russian tax evasion. When speaking with Russian citizens and businessmen it does not take long to come across the general consensus. Most Russians believe that the government purposefully maintains an overly-complicated tax system, deliberately making the tax burden too high. Many would say that taxes are so high, that it is plainly impossible to run any business without evasion. When it comes to paying taxes, companies typically end up bribing the tax collectors to avoid paying the “astronomical” dues to the State.
Moreover, some would say that this is deliberately set this way to guarantee direct and/or indirect bribery, since that gives the bureaucrats legal right to kill any business, unless they are paid. Another problem worth mentioning with respect to taxes is a misbalance between regional and local taxes, the former being too high at the expense of the latter, which impoverish many regions, e.g., in the north of Russia. This comes down to another typical Russian problem – excessive centralization inherited from Communism.
All that is possible, or in the very least could have been true at some point. At the present day however, Russian taxes are not that high, at least not on the surface. In the 2001 tax reform, a new flat income tax rate of 13% was introduced. Initially the flat-tax proved to be very successful, arousing interest in many Western nations, including the USA. American economist and tax expert, Daniel Mitchell, PH. D. wrote on the topic in 2003, “…every year, our tax code gets bigger and more complicated. In Russia, by contrast, the flat tax has been in place for more than two years now. This reform took place in a nation still trying to overcome the legacy of more than 70 years of communist dictatorship.” (Heritage) Three years later the government further alleviated the tax burden by reducing the corporate rate of tax from 35 percent to 24 percent.
It seems the Russians are starting to see that in practice higher taxes mean higher tax evasion, and consequently less total collected. In March Russia has declared a tax amnesty. The law allows individuals to file a simplified income tax return for revenues since 2001 on which they have not paid taxes. The amnesty program is very lenient as it lets individuals themselves determine how much tax to pay back. There is much speculation on the outcome of the new law, but hopefully the combination of lowered taxes and the amnesty law will force the country to take a step in the right direction.
The tax issue ties into the ethical issue. The problems with bribery, nepotism, corruption, and tax evasion can all be attributed to underdeveloped business ethics. In a recent study using a variety of business scenarios, Russian business managers demonstrated very low ethical values in comparison with Turkey, Slovenia, and the United States (Ludlum). We must keep in mind, however, that Russia is an emerging former socialist economy, only having private businesses in the economy since the late 1980s. For Russian business managers, there is little guidance on ethical issues and it’s become evident that Russian business owners will not simply follow Western notions of business ethics without any guidance.
Despite these grim findings, a survey of Russian business students was done in 2002 that showed some optimistic results. The students were asked questions regarding business ethics in Russia and the US. The survey results demonstrated that those students who have taken ethical classes at school had a heightened awareness of ethical issues, much like the United States. In general the results of the Russian students were quite similar to results gained from American students in the same fields. We can hope that with time the Russian businessman will come to the realization that good business ethics are in fact an indispensable component of a long-term profit-oriented business.
Lastly there is the issue with security. Contract killings are much more commonplace in Russia than in most other countries, and stories of businessmen having contracts put on their heads over business deals have made it to the news more than once. Speaking to Mark LeClair, board of directors of Imation, I inquired how big of a concern is security in Russia. I was told that American business managers are still fairly uncomfortable with the lack of security, along with low ethical values, and are worried about expanding, or even visiting, the country.
So what can a Westerner conclude from all this? Is Russia safe for investment? Does the unstable political climate outweigh the “enticing economy”? Recent events with YUKOS, as well as other oil companies, put doubt into the mind of an average Western investor. Without a doubt Russia will benefits form Western investment and involvement, likewise Western companies will benefit from formulating contracts with Russia. Although in the recent years Russia has begun to show relative stability, along with fairly steady economic growth, it is still too difficult to establish any patterns. However, if the economy continues to grow at the current rate, and providing personal security improves, Russia will be a very lucrative place to do business in within the next few years.
Resources
Johnson, David. “Tax amnesty in Russia: Getting ready to tighten regulations?.” Johnson’s Russia List. 7 March 2007. CDI.org. 8 Jul 2007 <http://www.cdi.org/russia/johnson/2007-56-31.cfm >.
Kramer, Andrew. “http://www.iht.com/articles/2007/05/03/business/YUKOS.php.” International Herald Tribute. 3 May 2002. IHT. 8 Jul 2007 <http://www.iht.com/articles/2007/05/03/business/YUKOS.php>.
Ludlum, Michael. “Russian student views on business ethics: Post-Enron.” College Student Journal 02 May 2005 1-6. 08 July 2007 <http://findarticles.com/p/articles/mi_m0FCR/is_1_39/ai_n13620072/>.
Mitchell, Daniel. “Russia’s Flat-Tax Miracle.” The Heritage Foundation. 24 March 2003. Heritage.org. 8 Jul 2007 <http://www.heritage.org/Press/Commentary/ed032403.cfm>.
“Mikhail Gorbachev.” Wikipedia, The Free Encyclopedia. 7 Jul 2007, 16:24 UTC. Wikimedia Foundation, Inc. 9 Jul 2007 <http://en.wikipedia.org/w/index.php?title=Mikhail_Gorbachev&oldid=143116707>.
Reeves, Scott. “Russian Oil Debut.” Forbes.com. 14 July 2006. Forbes USA. 8 Jul 2007 <http://www.forbes.com/business/2006/07/13/ipo-outlook-rosneft-cx_sr_0713rosneft.html>.
Schofield, James. “Russia’s oil renaissance.” BBC News. 24 June 2002. BBC. 8 Jul 2007 <http://news.bbc.co.uk/1/hi/business/2058214.stm>. Stepek, John. “Is Rosneft too risky to invest in – or just too expensive?.” MoneyWeek. 24 June 2002. MoneyWeek. 8 Jul 2007 <http://www.moneyweek.com/file/14540/is-rosneft-too-risky-to-invest-in—or-just-too-expensive.html>.
The Free Market Economy of Russia
Russia is an emerging free-market economy, amongst some of the fastest growing in the world. The country possesses a high quality education system, demonstrated with a literacy rate of 99.4 percent, higher than most Western nations. Over the last 15 years, Russia has gone through a turbulent ride changing from a state-controlled economy to a marked-oriented economy. The changes that society had to undergo to accommodate the changing politics created a number of unforeseen consequences. At the present day Russian businesses face a number of differences from their Western counterparts. There is the well-known issue of tax evasion, something that is possibly an affect of a culture much deeper than Communism. Tax evasion also ties into Russian business ethics, which are often questioned by Westerners. Lastly there’s the question of economic stability, such as recent issues with oil giant YUKOS, and the government’s involvement in the energy industry. To sum it up, modern Russia still shares many continuities of political culture and social structure with its tsarist and Soviet past, how compatible is this with a market-oriented economy? (Wikipedia)
As stated earlier, since the fall of the Soviet Union over 15 years ago, Russian business has gone through many changes. During the last few years of the Soviet Union’s existence the country began to undergo market liberalizations enacted by Gorbachev. These changes were a step towards a marked-based economy, however they were halted by many issues, particularly excessive trade restrictions. The unforeseen consequences of the combination of market liberalization and excessive trade restrictions provided an opportunity for entrepreneurs to smuggle rare goods, such as Levis jeans or PCs, and sell them at an excessive profit. More often than not these entrepreneurs utilized connections with corrupt government officials to bypass the trade restrictions. At times these entrepreneurs were close relatives of government officials, or sometimes government officials themselves. These events have really set the stage for what Russia is today from and ethical stand point – it is very difficult to get much accomplished in business without knowing, or bribing, the right people.
Next came the privatization process, controlled by the Yeltsin government. During privatization state owned assets were sold at extremely low prices, and entire industries were quickly acquired by well connected individuals. Many Russians accumulated great amounts of wealth during this time, many of these men are now worth billions, and are referred to as oligarchs, a Russian tycoon. These oligarchs possess great influence over economic and political events in Russia, at times crossing paths with the government. (Wikipedia)
After the fall of the Soviet Union in 1991, and throughout most of the nineties, Russia struggled to complete its transition into a free-market economy – the change was anything but smooth. In addition to privatization and liberalization there were other problems. Inefficient political leadership, overcomplicated tax system, extreme inflation, and flat-out bad luck – the Asian crisis, for example, came at a bad time and further devastated the already shaky economy in 1998, were just some of the hurdles the country had to overcome. (BBC) What we will focus on here however, is where the country’s economy is now, how it differs from ours, and hopefully where it is going.
It is difficult to talk about Russian economics without mentioning the oil industry. The former Soviet Union republic is known for its vast natural resources, especially petroleum. In fact, it is the second largest oil supplier in the world behind Saudi Arabia (MoneyWeek). Regardless of its potential, it currently faces a number of issues, political instability is a major one. The case of YUKOS is still fresh on the mind of Western investors. YUKOS was the biggest oil producing company in Russia, until it ran into major problems with the government in 2003, stirring up controversy in Russia and around the world (Forbes).
In 2003 YUKOS’ chief executive, and oligarch, Mikhail Khodorkovsky was sentenced to a nine-year prison term for tax evasion and fraud. One could attempt linking this issue to Enron, but only if taking the situation entirely out of context. It is a known fact that vast majority of Russian corporations participate in extensive tax evasion, why did the government pick YUKOS? Many believe the government’s actions against YUKOS to be political; in 2003, prior to his arrest, Khodorkovsky funded a Russian political opposition party (Wikipedia). The government broke up YUKOS, selling assets at what many believe was far bellow market value. The action pounded the company’s stock and, as the Russian finance minister fretted, raised doubts about that nation’s business climate (Forbes).
The saga of ill-fated YUKOS continued when in 2004 the government confiscated YUKOS’ oil fields, believed to be valued around $40bn to cover back-tax claims of $30bn against the firm, and “auctioned” them off to a YUKOS competitor, Rosneft, for a mere $9.3bn. The following year Rosneft, backed by Moscow, was en route to its IPO in London, the fourth biggest public offering in world history (Forbes). In light of these events, YUKOS has asked the Financial Services Authority to prevent the IPO, to no avail. “If the FSA allows the Rosneft IPO to go ahead, it would be allowing the sale of stolen goods, as well as a rather convoluted process of money laundering,” YUKOS spokeswoman Claire Davidson said to Reuters (MoneyWeek).
In May this year Rosneft acquired another 37 subsidiaries of the now-bankrupt YUKOS, making it the largest oil company in Russia. The entire YUKOS issue stirred much controversy in Russia over the years. More importantly, it caused much uneasiness in Western investors as it only added onto instability of Russian economics and questionable government involvement.
The need for Western investment is seen in the case of Sibneft, another one of Russia’s major oil producers. Sibneft attributes their recent revival primarily to Western involvement. “One-and-a-half, two years ago we couldn’t imagine our production would be so high. We achieved these results because of our alliance with foreign contractors. Their specialists teach our specialists while we show them how to work in extreme conditions with temperatures below minus 50, ” says Yuri Schuliev, a manager of the company (BBC News).
So what can we make of all this? Is Russia worth investing in? The title of an article from MoneyWeek really sums it up well: “Russia: horrible politics, enticing economy”. Although most Westerners believe Russia, particularly Russian oil, to be an “enticing” investment, many are uneasy of the government’s apparent lack of respect for property rights. But it isn’t all bad, according to Valery Nesterov, an oil analyst at Troika Dialog Bank in Moscow, “The philosophy of Russia’s oil barons has changed. They used to just accumulate funds and use them for their own private purposes or even steal them. Now they are investing sums into technology that we could only dream about a few years ago and are becoming dangerous competition for international oil companies.” (BBC) We can only hope that the changing business ethics of Russia’s oil barons will eventually filter down to the average Russian businessman.
The story of YUKOS brings us into the next big topic in Russian business: tax evasion and corporate ethics. Although it does not seem to be as big of a problem as it was in the nineties, the issue of tax evasion still exists. It is difficult to find much published information about Russian tax evasion. When speaking with Russian citizens and businessmen it does not take long to come across the general consensus. Most Russians believe that the government purposefully maintains an overly-complicated tax system, deliberately making the tax burden too high. Many would say that taxes are so high, that it is plainly impossible to run any business without evasion. When it comes to paying taxes, companies typically end up bribing the tax collectors to avoid paying the “astronomical” dues to the State.
Moreover, some would say that this is deliberately set this way to guarantee direct and/or indirect bribery, since that gives the bureaucrats legal right to kill any business, unless they are paid. Another problem worth mentioning with respect to taxes is a misbalance between regional and local taxes, the former being too high at the expense of the latter, which impoverish many regions, e.g., in the north of Russia. This comes down to another typical Russian problem – excessive centralization inherited from Communism.
All that is possible, or in the very least could have been true at some point. At the present day however, Russian taxes are not that high, at least not on the surface. In the 2001 tax reform, a new flat income tax rate of 13% was introduced. Initially the flat-tax proved to be very successful, arousing interest in many Western nations, including the USA. American economist and tax expert, Daniel Mitchell, PH. D. wrote on the topic in 2003, “…every year, our tax code gets bigger and more complicated. In Russia, by contrast, the flat tax has been in place for more than two years now. This reform took place in a nation still trying to overcome the legacy of more than 70 years of communist dictatorship.” (Heritage) Three years later the government further alleviated the tax burden by reducing the corporate rate of tax from 35 percent to 24 percent.
It seems the Russians are starting to see that in practice higher taxes mean higher tax evasion, and consequently less total collected. In March Russia has declared a tax amnesty. The law allows individuals to file a simplified income tax return for revenues since 2001 on which they have not paid taxes. The amnesty program is very lenient as it lets individuals themselves determine how much tax to pay back. There is much speculation on the outcome of the new law, but hopefully the combination of lowered taxes and the amnesty law will force the country to take a step in the right direction.
The tax issue ties into the ethical issue. The problems with bribery, nepotism, corruption, and tax evasion can all be attributed to underdeveloped business ethics. In a recent study using a variety of business scenarios, Russian business managers demonstrated very low ethical values in comparison with Turkey, Slovenia, and the United States (Ludlum). We must keep in mind, however, that Russia is an emerging former socialist economy, only having private businesses in the economy since the late 1980s. For Russian business managers, there is little guidance on ethical issues and it’s become evident that Russian business owners will not simply follow Western notions of business ethics without any guidance.
Despite these grim findings, a survey of Russian business students was done in 2002 that showed some optimistic results. The students were asked questions regarding business ethics in Russia and the US. The survey results demonstrated that those students who have taken ethical classes at school had a heightened awareness of ethical issues, much like the United States. In general the results of the Russian students were quite similar to results gained from American students in the same fields. We can hope that with time the Russian businessman will come to the realization that good business ethics are in fact an indispensable component of a long-term profit-oriented business.
Lastly there is the issue with security. Contract killings are much more commonplace in Russia than in most other countries, and stories of businessmen having contracts put on their heads over business deals have made it to the news more than once. Speaking to Mark LeClair, board of directors of Imation, I inquired how big of a concern is security in Russia. I was told that American business managers are still fairly uncomfortable with the lack of security, along with low ethical values, and are worried about expanding, or even visiting, the country.
So what can a Westerner conclude from all this? Is Russia safe for investment? Does the unstable political climate outweigh the “enticing economy”? Recent events with YUKOS, as well as other oil companies, put doubt into the mind of an average Western investor. Without a doubt Russia will benefits form Western investment and involvement, likewise Western companies will benefit from formulating contracts with Russia. Although in the recent years Russia has begun to show relative stability, along with fairly steady economic growth, it is still too difficult to establish any patterns. However, if the economy continues to grow at the current rate, and providing personal security improves, Russia will be a very lucrative place to do business in within the next few years.
Resources
Johnson, David. “Tax amnesty in Russia: Getting ready to tighten regulations?.” Johnson’s Russia List. 7 March 2007. CDI.org. 8 Jul 2007 <http://www.cdi.org/russia/johnson/2007-56-31.cfm >.
Kramer, Andrew. “http://www.iht.com/articles/2007/05/03/business/YUKOS.php.” International Herald Tribute. 3 May 2002. IHT. 8 Jul 2007 <http://www.iht.com/articles/2007/05/03/business/YUKOS.php>.
Ludlum, Michael. “Russian student views on business ethics: Post-Enron.” College Student Journal 02 May 2005 1-6. 08 July 2007 <http://findarticles.com/p/articles/mi_m0FCR/is_1_39/ai_n13620072/>.
Mitchell, Daniel. “Russia’s Flat-Tax Miracle.” The Heritage Foundation. 24 March 2003. Heritage.org. 8 Jul 2007 <http://www.heritage.org/Press/Commentary/ed032403.cfm>.
“Mikhail Gorbachev.” Wikipedia, The Free Encyclopedia. 7 Jul 2007, 16:24 UTC. Wikimedia Foundation, Inc. 9 Jul 2007 <http://en.wikipedia.org/w/index.php?title=Mikhail_Gorbachev&oldid=143116707>.
Price, Tim. “Russia: horrible politics, enticing economy.” MoneyWeek.com. 06 August 2007. MoneyWeek. 9 Jul 2007 <http://www.moneyweek.com/file/30612/russia-horrible-politics-enticing-economy.html>.
Reeves, Scott. “Russian Oil Debut.” Forbes.com. 14 July 2006. Forbes USA. 8 Jul 2007 <http://www.forbes.com/business/2006/07/13/ipo-outlook-rosneft-cx_sr_0713rosneft.html>.
Schofield, James. “Russia’s oil renaissance.” BBC News. 24 June 2002. BBC. 8 Jul 2007 <http://news.bbc.co.uk/1/hi/business/2058214.stm>. Stepek, John. “Is Rosneft too risky to invest in – or just too expensive?.” MoneyWeek. 24 June 2002. MoneyWeek. 8 Jul 2007 <http://www.moneyweek.com/file/14540/is-rosneft-too-risky-to-invest-in—or-just-too-expensive.html>.