When in Russia, do as the Russians do?

Putin’s system of control requires businesses constantly to negotiate challenging formal and informal rules of the game

Peter-Rodgers_100The collapse of the command economy and the gradual opening up of large and potentially fruitful markets in the Russian Federation has led to a steady influx of foreign firms seeking to operate within the business milieu of post-Soviet Russia. Twenty-five years on from the heady days of perestroika, a business environment has developed in Russia which has specifics and peculiarities best explained by taking into account the cultural and political specifics of Russia’s Tsarist and Soviet history and feeding them into an understanding of the inherent political environment in which business is engaged in today’s Russia.

The key point is that, over this past quarter of a century, the development of ‘market’ institutions, such as the development of an independent judiciary, capable of enforcing property rights and seen as crucial for Russia’s transformation from a command economy to one based on market forces, has taken place alongside the embedding of informal practices of power abuse, patronage and widespread corruption within such institutions. As such, the business environment in Russia today definitively does not operate in a political vacuum. Local Russian businesses and their international counterparts are forced per se to engage in an inherent and dynamic negotiation of different ‘rules of the game’: some formal rules, explicitly outlined in Russia’s tax and business laws, but also some others which are decidedly more informal in their nature. Within Putin’s Russia, there has in effect grown a unique network-based system of informal governance – often known as Putin’s Sistema – involving the use of incentives and control of the flow of capital stocks, operated within specific power networks.

During Russia’s Soviet experience, especially its later stages from the time of Brezhnev onwards when the ultimate societal goal of developing a ‘communist utopia’ had been supplanted by the embedding of a peculiar Soviet form of ‘developed socialism’, the use of personal networks, or blat, became highly relevant for individuals and firms alike to obtain necessary goods and services. With the collapse of the old system, Russia’s engagement with capitalism led to a re-negotiation of such informal practices. Whilst, thirty years ago, firms in Russia used personal networks to seek to improve the efficiency in resource allocation of a deeply inefficient and increasingly stale socialist system, in the new heady world of ‘chaotic capitalism’, to use David Lane’s phrase, networks today are used by Russian businesses to circumvent the maze of legal and practical barriers imposed within a business environment in which state bureaucracies have experienced no internal motivation to modernise.

For international businesses, the Russian milieu remains distinctly challenging. On the one hand, international firms are increasingly being compelled to adhere to international standards of ethical business behavior, as well as focused and stringent national regulations with regard to corruption. Within the UK, for example, the emergence of the UK Bribery Act in 2011 is one such example, explicitly stating that, irrespective of the jurisdiction in which a UK-based firm is engaging in business activities, it must act according to the rules set out in the Bribery Act. Yet, within Russia today, gaining favour with local, regional or national elites, often through the illicit payment of bribes, is critically important to operating successfully.

The establishment of property rights and their enforcement through an independent judiciary is generally considered paramount for the functioning of a fully-fledged market economy, especially one in which foreign direct investment is encouraged and, crucially, protected. Unfortunately, the continuing lack of protection of property rights in Russia has not only reduced the attraction of Russia to foreign investors but has also contributed to large levels of net outflow of private capital – ‘capital flight’ – throughout the post-Soviet period. The emergence of London, for example, as a venue for wealthy Russians to ‘park’ their capital, rather than actually engage in business in the city, demonstrates the desire of wealthy Russians to find an environment in which their private assets can be protected that is simply not available to them at home in Russia itself.

Another consequence of informal governance in Russia, involving the embedded and entwined nature of business and politics, has been the widespread illegal acquisition of businesses – reiderstvo or asset-grabbing – which again remains a key risk for Russian and international businesses. Such asset-grabbing is facilitated within business and political milieus in which a variety of state organisations – tax authorities, local judiciary and the police – are often complicit in the misuse and abuse of power in ways that enable private property to be transferred illegally. Within the Russian judicial system, the selective abuse of power by police and security forces, including notably the making of unfounded accusations against specific firms, remains as a working strategy by which to negotiate and ultimately control the nature of specific markets. Ultimately, asset-grabbing, coupled with an extremely weak formalised legal environment and embedded corrupt practices across Russian political, bureaucratic and business spaces, acts as a significant market-entry barrier for Russian and international firms alike, as well as continuing to deter existing business operations in Russia from seeking to modernise.

In sum, then, the informal nature of Putin’s sistema certainly denies Russia the democratic principles of transparency within the business environment and, by contrast, encourages the promotion of informal ‘rules of the game’, such as rent-seeking, patronage, asset-grabbing and embedded corruption, which then often trump the formal rules of the game. Nevertheless, there is an inherent logic within the sistema, as a system/structure of political organisation, which maintains a degree of order and flexibility within business and political spheres. For international firms and investors, such a business environment may seem excessively difficult and daunting. It is, without doubt, challenging.

Yet, for all this, it’s not an environment in which it is, yet, impossible to do business. Russian and foreign businesses alike need constantly to be aware of the duality of the formal and informal rules that govern the business environment. Put differently, they need to take fully into account the fact that such a system has emanated from a political centre, the Kremlin, which seeks to maintain a constant control of the business, as well as the political, environment in Russia today.