Rumors of Oligarchs' Demise Greatly Exaggerated

A December 1998 update to How Russia Is Ruled - -1998

Much has been written since Russia's August economic collapse about the demise of the business oligarchs -- the small circle of influential entrepreneurs who grew rich in the past decade through close ties to the government, currency speculation, and -- some say -- criminal activity. Indeed, the business empires heavily dependent on the financial sector, such as Vladimir Gusinskii's Most Group and Vladimir Potanin's Oneksimbank, have been seriously damaged by the crash and two, Aleksandr Smolensky's SBS-Agro and Vladimir Vinogradov's Inkombank, are ruined. Though weakened, however, entrepreneurs with extensive interests in natural resources extraction -- Viakhirev of Gazprom, and Alekperov of Lukoil -- or in industry -- Khodorkovskii of Menatep and Berezovskii of LOGOVAZ -- remain influential.

The oligarchs came to the notice of many people in the West in October 1996 when Berezovskii boasted in an interview that he and six other tycoons had ensured Yeltsin's reelection by bankrolling his campaign. Moreover, he bragged that he and six cronies controlled much of the Russian economy. In fact, though the Big Seven, as the oligarchs came to be called, controlled a large chunk of the Russian economy and had the decisive say on some key issues, their influence was less than Berezovskii suggested. There were many issues such as START ratification and military reform, where they played virtually no role at all. There were also many influential interest groups at the time that Berezovskii did not mention: Lukoil, Gazprom, holdover Soviet lobbies such as the collective farmers and regional leaders such as Moscow Mayor Luzhkov.

Since the meltdown, Moscow's Alfa Bank, with longstanding ties to the Yeltsin administration and whose relatively small holdings in the now defunct short-term securities market enabled it to escape the worst of the downturn, has been able to gain competitive advantage over its more exposed rivals. In the absence of a strong treasury, Alfa has been "authorized" to service the St. Petersburg City budget, a task fraught with possibilities for corruption. The regional banks and banks that service oil, gas, and precious metals exporters also remain important.

Elsewhere in the regions, the economic collapse has also accelerated the formation of oligarchic structures. In Saint Petersburg and Yekaterinburg, local governments have taken over regional banks to ensure ready access to revenue streams. The Nizhnii Tagil Metallurgy Combine has given a 25 percent stake to the government of the Sverdlovsk region in exchange for a restructuring of its tax debts and the cancellation of the firm's wage arrears.

Still other oligarchs are regrouping. The strategic alliance recently announced by Lukoil and Gazprom may actually strengthen their economic and political clout. Gazprom already pays a quarter of all Russia's taxes, while Lukoil, is also a major contributor to tax coffers. Even if they do not unite, the firms will almost certainly remain two of the few effective Russian foreign policy levers, especially toward Europe and Russia's neighbors.

Indeed, the Primakov government, far from trying to end crony capitalism, appears to be favoring cronies of its own. Favored banks participated in several debt swaps orchestrated by the Central Bank in September and the Central Bank has sharply cut reserve requirements to increase banks' liquidity. Most of the "socially important" large banks the government intends to save have ties to the new government, Gerashchenko or the administration of Moscow Mayor Yury Luzhkov. SBS-Agro, for example, was one of the first banks to be bailed out. Depositors and creditors received little money. It went instead to pay off a loan SBS-Agro owed the International Moscow Bank, which Central Bank Chairman Gerashchenko headed until September. The authorities, meanwhile, have allowed Inkombank to fail, even though it had the second largest retail base in the country.

The government has also announced it intends to save, among others, Menatep and Most -- Menatep has strong supporters in power, though few depositors and no regional network. Most's extensive media holdings make it invaluable as the legislative and presidential elections approach. Meanwhile, Oneksimbank, widely considered to have been close to ousted "reformers" Sergey Kirienko, Anatoliy Chubais, and Boris Nemtsov, has so far been left in the cold. In the non-banking sector, the government's highly publicized battle with Gazprom over the taxes it owes appears to be resolved in the firm's favor. Gazprom will provide food aid to needy Russians instead of paying money to the cash-starved federal government. A shakeup in the leadership of Rosvooruzhenie, the state arms export agency now under the control of a reported Primakov protege, suggests that the Russian arms industry may well experience a resurgence by more aggressively seeking clients for high tech weaponry abroad.

This is not to say that Russia's business interests win every battle. The government has warned six major oil companies that their access to highly profitable export pipelines will be cut off if they do not draft a plan to sell more crude on the domestic market. There are serious policy and economic interests dividing the oligarchs, such as over economic protectionism. Since these differences are often over who is to receive increasingly scarce government favors, however, they are unlikely to benefit the long-suffering Russian public and may well become fiercer as total default looms.

What has survived the August collapse, however, are the rules by which Russian politics is played. Much of politics is informal, authority personalized, institutions are weak, the distinction between public and private is blurred, and money is the currency of political power.
That some people will financially profit by these rules is certain; that the rules will advance economic reform and democratic development is not. It was this absence of the rule of law underlying economic reform that the 1998 EBRD Transition Report recentlycited as part of the explanation why Russia's transition has been so difficult.

The Importance of Political Culture

There is much that is new in Russian politics. Public opinion polls show, for example, that people display more political tolerance and support for civil liberties than ever before. (4) The Russian constitution borrows heavily from the West. However, continuities with Russia's political culture and the Soviet past are everywhere evident: (5) in the stronger overall support for a strong leader than elsewhere, for example, and the more widespread preference for order. (6) Three elements of that culture have special importance today because of their implications for the institutionalization of a democratic regime:

An underdeveloped state. The state has traditionally been weak in Russia. The few institutions that did exist were cumbersome and inefficient. Their authority was poorly defined and they had trouble implementing their decisions. Laws guaranteeing property or power once obtained were nonexistent or poorly enforced. Instead, authority was personal and informal. The idea of civil society - the recognition by the state of the right of nonofficial social groups to legal status and a legitimate sphere of free action -- was poorly developed. Indeed, the distinction between private and official action itself was often blurred. (7)

Today's Russia's institutions also have vague, often overlapping authority -- the boundaries between federal and regional authority, for example, are poorly defined, as is the separation of powers at the federal level. The boundary between "official" action and the private activity of its citizens is hazy. Laws are inconsistently enforced. Despite a large official bureaucracy, the government cannot implement many of its decisions, even "normal" functions such as tax collection. Thus, the state cannot easily act as a catalyst for social development by taking resources and devoting it to the "public interest" -- if, indeed, the concept were widely shared and understood in the West.

Patrimonialism. Political authority was viewed by traditional Russian elites as closely related to property ownership. The czar - who identified the state with himself -- "owned" the nation, its vast resources, and its citizens. He concentrated in his hands the most profitable branches of commerce and industry and granted favored nobles economic privileges in exchange for their support. The civil ervice practiced a byproduct of patrimonialism -- "kormlenie," or feeding -- which meant that it administered the czar's lands, collected taxes and kept a portion of what it collected for itself.

Today, patrimonial attitudes characterize many Russians, especially the elites. Especially influential entrepreneurs have gotten rich, with government support, by stripping Russia of oil, natural gas, and other resources and salting profits abroad rather than reinvesting it in the country's development. Corruption -- the modern equivalent of kormlenie -- is widespread. The government also holds large chunks of stock in key industries, often in natural resource extraction.

The culture of the imperial court. (8) The culture of the Russian ruling elite traditionally centered on the "czar," who refereed and balanced the competition among princely clans for his favor as well as political, coercive, and economic advantage. Decision making was collective and reflected a workable consensus among members of an inner circle whose dynamics were controlled by tradition, a balance of interests, and the regulating "fiction" of the czar's unlimited power as a source and justification for the clans' authority. (9)

Political competition today centers on Yeltsin's "court." He avoids identifying with any single faction, and instead balances ministers, business tycoons and security chiefs, who, in the absence of selected political rules of political competition, are in perpetual competition with one another for his favor. Ties between members of the "court" with the society at large, as before 1917, are minimal. Yeltsin's divide and rule strategy fosters oligarchic infighting, and inconsistent policy, but enhances his authority.

II. Crime Integral to System

These trends have contributed to the criminalization of the political system. Today the normal business of the state, of law enforcement, and of the courts, cannot be conducted without reference to what in many Western democracies would be considered official illegality and corrupt and criminal interests.

Crime and illegality are not a threat to the system. They are a part of it:

• Since the state is weak and authority informal and personal, commitment to the rule of law is feeble. Hundreds of Yeltsin's decrees, for example, have violated the constitution or decisions of the legislature and the courts. Law enforcement is ineffective andinconsistent, so much so that the government is unable to monopolize punishment for violations of accepted norms of behavior. Thousands of private security firms -- sometimes resembling private armies -- exist.
• Patrimonialism fosters corruption, the use of public resources for private gain. With few institutional or legal restrictions on their activity, the country is seen by many public officials as providing an unlimited scope for "kormlenie." Since the line separating ownership from sovereignty is poorly defined, or nonexistent, the Russian state facilitates insider trading, the granting of preferential licenses and the illegal banking of state funds. Moreover, the widespread illegal or underground markets growing out of the state's inability and unwillingness to creating the preconditions for legal economic activity have blurred any moral difference between illegally generated capital and income earned through legitimate means.
• The highly fluid, personalized nature of Kremlin politics encourages a reliance on favors from the "czar" -- today the Russian president -- rather than the rule of law. The system also fosters the use of compromising material -- "kompromat" -- as a tool in the leadership struggle, with contending leaders seek Yeltsin's favor by trying to discredit their rivals by selectively publicizing corruption allegations.

Corruption widespread. Government officials conduct business in an atmosphere in which state service is routinely used -- and indeed expected -- to advance personal material interests, often in the name of "reformist" economic goals or revenue raising. What would be denounced in Western societies as a conflict of interest appears to the elite as a natural and agreeable state of affairs.(10) In 1998 surveys by the European Bank of Reconstruction and Development and the Control Risks Group, Russian ranked among the top three in the world in corruption. In the past two years dozens of corruption cases have been uncovered in the Prosecutor General's office, the Federal Agency for Government Liaison and Information (FAPSI), the Interior Ministry, State Customs Committee, State Tax Service, Central Bank of Russia, Foreign Economic Relations Ministry the former Committee on Precious Metals, and the Health and Medical Industry Ministry.(11)

The Audit Chamber, the nonpartisan, independent state auditor analogous to the U.S. General Accounting Office, has extensively chronicled the pervasiveness of the problem. The Chamber recently found that at least one-sixth of Russia's budget in 1997 was misspent due to mismanagement and corruption -- a loss of more than $10 billion. The Chamber's head, Venyamin Sokolov, a Chamber member, surmised that the real amount may have been twice that sum. In 1995 and 1996, he added, "not a single article of the federal budget law was observed."(12) In other recent reports the Audit Chamber determined in 1995-96, the government conducted $160 million in gold sales without the required approval by the legislature. Two government agencies illegally retained almost $100 million in commissions on foreign sale and one-third of the cash generated by unauthorized gold sales was spent on perquisites for high officials. In July 1997 the
Audit Chamber found illegal the government's auction of Norilsk Nickel shares to ONEKSIMBANK, controlled by Vladimir Potanin, an ally of then First Deputy Prime Minister Chubays. Of $3 billion earmarked for reconstruction of the Chechnya economy after the war ended, the Chamber found documentation for only $2 billion. Less than $150 actually reached Chechnya. Also in 1998 the Audit
Chamber reported numerous financial irregularities in the management of the state owned Russian Television Network (RTR), largely from 1990-96. The State Property Committee, according to the Chamber, failed to monitor the finances of RTR, leading to the misappropriation of property, precious metals, and funds.

Organized crime. It is the centrality of official crime and illegality to normal political activity, not organized crime, which is the major threat to democratic development, but Russian organized crime is nevertheless a major problem. The MVD estimates that in 1996 there were 8,000 criminal gangs in the former Soviet Union, 300 operating internationally. The Ministry of Internal Affairs (MVD) has estimated that 40 percent of private business, 60 percent of state-owned enterprises, and more than half of the country's banks are controlled by organized crime. Russian organized crime groups have in many ways supplanted the state in paying protection, employment, and social services, activities that the state can no longer provide.(13)The majority of private enterprises are compelled, by force if necessary; to pay protection of up to 30 percent of their profits to organized crime.

The criminal groups built themselves up on the foundations laid in Soviet times -- on the networks of "thieves in law," or "vory v zakone" who ran underground criminal networks from the penal system and specialized in activities such as robbery and prostitution. During the Brezhnev era, some of the thieves in law made common cause with members of the Communist Party, who grew rich through bribes, payoffs and underground barter economy, which provided the goodswhich the socialist system either banned or could not supply.(14) Today organized crime includes these thieves in law, officials and entrepreneurs who got their start illegally during Soviet times, as well as groups sharing experiences (such as service in the Afghan war), membership in sports clubs, or loyalty to a particular leader. Ethnic groups composed of Chechens, Armenians, Azeris, Dagestanis, Georgians and Ingush join them.(15)

The weakness of the state requires that businessmen have a krysha -- protection -- to be able to operate. Linking criminal and legal economies, this protection can come in the form of a criminal overlord protecting members of his organization or the protection a criminal group offers to a businessman in exchange for paying extortion money. Often the krysha provided by a crime group includes other services such as protection of property, debt collection, customs assistance, legal and business advice, and banking privileges at crime-controlled banks. A krysha also can include forms of corrupt government protection involving the militia, tax, police, military, customs, and border guards.(16)

In a developed democracy, these abuses would be mitigated by the workings of a democratic government or protests from an aware and active civil society. In Russia, however, the pervasiveness of crime has undermined Russia's already weak political institutions and civil society, contributed to the fraying of the social fabric.(17) Crime is also the main reason why, seven years after President Yeltsin launched economic reforms, the economy still shows only the faintest signs of improvement. The standard of living, the health and the prospects of the majority of citizens are deteriorating, while the wealth made by its business elites is siphoned off abroad, often illegally.(18) The fact that crime is imbedded in Russia's system of governance does not necessarily mean that it cannot be reduced through a combination of sound public policies and effective leadership. Its deep roots, however, suggests that it cannot be effectively combated without fundamentally changing the way the regime itself works.(19)

Endnotes:
4. V.A. Kolosov and R.F. Turovskiii, "The Electoral Map of Contemporary Russia," Russian Social Science Review, vol., 39, no. 1, January-February 1998, pp. 67-9. See also, Trud, March 18, 1998, pp.1-2.

5. Wilson, p.81.

6. For a more detailed discussion of political culture and these concepts see, E.L. Keenan, "Muscovite Political Folkways," The Russian Review, vol. 45, 1986, pp. 46, 156-57.

7. R. Pipes, Russia under the Old Regime, New York: Collier, 1974, pp.

8. Keenan, p.132.

9. Keenan, pp.156-710

10. V. Coulloudon, "The Criminalization of Russia's Political Elite," East European Constitutional Review, Fall 1997, p.74.

11. CSIS, "Russian Organized Crime," p. 34.

12. Financial Times, June 9, 1998.

13. Louise I. Shelley, "Transnational Organzied Crime: An Imminent Threat to the Nation State," Journal of International Affairs, Winter 1995, 48, no.2. p. 484.

14. Lloyd, "Red Alert," The Times Magazine, January 31, 1998.

15. CSIS, "Russian Organized Crime.," p. 28.

16. CSIS, "Russian Organized Crime," pp.29-31.

17. CSIS, "Russian Organized Crime," p.33

18. Lloyd.

19. Center for Strategic and International Studies, CSIS Task Force Report, "Russian Organized Crime," 1997, p. 2.