A Normal Country

Andrei Shleifer and Daniel Treisman

From Foreign Affairs, March/April 2004

Summary:  Conventional wisdom in the West says that post-Cold War Russia has been a disastrous failure. The facts say otherwise. Aspects of Russia's performance over the last decade may have been disappointing, but the notion that the country has gone through an economic cataclysm and political relapse is wrong--more a comment on overblown expectations than on Russia's actual experience. Compared to other countries at a similar level of economic and political development, Russia looks more the norm than the exception.

Andrei Shleifer is Whipple V.N. Jones Professor of Economics at Harvard University. Daniel Treisman is Associate Professor of Political Science at the University of California, Los Angeles. For full references and data sources see http://papers.nber.org/papers/w10057.

Russia's big business is certainly dominated by a few tycoons. But in this respect, Russia is typical of almost all developing capitalist economies -- from Mexico, Brazil, and Israel to South Korea, Malaysia, and South Africa. Even in developed countries such as Italy and Sweden, the largest firms are generally either state- or family-run, with a few families often controlling a large share of national production through financial and industrial groups. Big businessmen are invariably politically connected, receive loans and subsidies from the government (as in South Korea and Italy), participate in privatization (as in Mexico and Brazil), or hold high-level government offices while retaining connections with their firms (as in Italy and Malaysia). Oligarchical patterns of ownership have also emerged in other transition economies, such as Latvia's and those of various Central Asian states.

Following the Asian financial crisis, this system of politicized ownership has been pejoratively labeled "crony capitalism," even though it accompanied some of the most rapid growth ever seen and underlay remarkable recoveries in Malaysia and South Korea. In the case of Russia, the country's sharp decline in measured output (as already noted) came before, not after, the oligarchs emerged on the scene in 1995. A few years of stagnation followed, and then rapid growth began.

Oligarch-controlled companies have, in fact, performed extremely well -- far better than many comparable companies that remained under the control of the state or Soviet-era managers. Consider three of the most notorious cases. In Yeltsin's loans for shares scheme, Khodorkovsky (now in jail) obtained a major stake in the oil company Yukos; Boris Berezovsky (now in exile) won control of another oil firm, Sibneft, along with his then-partner Roman Abramovich; and Vladimir Potanin acquired the nickel producer Norilsk Nickel. Since 1996, profits and productivity at these three companies have increased dramatically along with their share prices. Between 1996 and 2001, the audited pre-tax profits of Yukos, Sibneft, and Norilsk Nickel rose (in real terms) 36, 10, and 5 times respectively. Their stock market valuations also soared, those of Yukos and Sibneft multiplying by more than 30 times in real terms. This performance is markedly better than that of the gas monopoly Gazprom or the electricity utility UES, which remained under state ownership, or of major private companies, such as Lukoil, which remained controlled by pre-privatization management.

Have the oligarchs stripped assets from the companies they acquired in privatization, rather than investing in them? The audited financial statements of these companies suggest that their assets have grown dramatically, especially since 1998. Yukos' assets were worth $4.7 billion shortly after privatization. By 2001, their value had risen to $11.4 billion. Norilsk Nickel's assets also increased during the period for which figures are available. Sibneft's assets did decline initially, but they have risen each year since 1999. And the major oligarchs have been investing hundreds of millions of dollars annually in their companies. In 2001, for example, Yukos invested $945 million in property, plant, and equipment, and Sibneft made capital expenditures of $619 million. In contrast, the greatest asset-stripping scandals occurred in companies that remained under state control. Gazprom's former management has been accused of stealing assets via complicated networks of trading companies. Aeroflot, the state-owned airline, also reported a drop in its assets between 1998 and 2001.

None of this is to say the oligarchs are public-spirited, politically innocent, or protective of their minority shareholders. They benefited from sweetheart deals with the government, and they massively diluted the value of minority shares in order to consolidate control over their companies. Investor protection and corporate governance in Russia remain weak. But here, again, Russia is typical of middle-income developing countries, where expropriation of minority shareholders is a nearly universal practice. Legal reforms eventually alleviate such problems, but such measures typically occur at higher levels of economic development than Russia currently enjoys.

The claim that the oligarchs privatized companies in order to strip their assets gets the logic backwards. In reality, the oligarchs stripped assets from state-controlled companies in order to buy more companies when they came up for sale. They sought to minimize the price they paid for state property and pursued various legal (and sometimes illegal) strategies to consolidate their stakes. But once they became full owners, they acted as any other owner would, investing in order to improve their companies' performance. In doing this, they followed the example of oligarchs everywhere -- from J. P. Morgan and John D. Rockefeller in the United States to Silvio Berlusconi in Italy.

In sum, Russia started the 1990s as a disintegrating, centrally planned economy and ended the decade as a market system in a burst of rapid growth. Its economy is not a textbook model of capitalism. In common with other middle-income countries, Russia suffers from inequality, financial crises, a large unofficial sector, and intertwined economic and political power. But the claim that Russia's economy is a unique monstrosity is a vast -- and ignorant -- exaggeration.

GRADING GRAFT

In the late 1990s, House banking committee chairman Leach wrote that he had made a study of the world's most corrupt regimes, including the Philippines under Ferdinand Marcos, Zaire under Mobutu, and Indonesia under Suharto. Bad as these countries were, he argued, each was outdone by the "pervasiveness of politically tolerated corruption" in postcommunist Russia. Other characterizations of corruption in Russia have been equally grim. In annual ratings by the World Bank and the advocacy group Transparency International (TI), which assess countries' "perceived corruption" based on a range of business surveys, Russia scored toward the bottom. In the World Bank's 2001 index, Russia came in 142nd out of 160 countries. In TI's 2002 corruption perceptions index, Russia came in 71st out of 102.