How Russia really works

Alena V Ledeneva
16 January 2002

For Russia to achieve long-term success in the global economy, it will need transparent “rules of the game” to replace the dominance of “unwritten rules”. But to get from here to there, we must first understand how Russia works today.It’s becoming a commonplace to say that “in Russia, nothing is as strong as it seems, nor as weak”. Just as the August 1998 crisis overturned expectations of a Russian boom, so the speed at which the Russian economy recovered post-1998 came as a surprise (GDP surged, from 3.2 per cent in 1999 to 7.7 per cent in 2000 and to around 5 per cent in 2001).

The need to understand how the Russian economy really works is urgent. Globalisation reveals the distinction between transparent and non-transparent economies. In her interview with openDemocracy, Maria Livanos Cattaui of the International Chamber of Commerce rightly stressed the importance of rules and transparency to development. Global financial capital avoids non-transparent economies, which also do not comply with international standards in accounting or corporate governance. Russia is one of the least transparent economies in the world.

Non-transparent economies are not only unpredictable. They are often regarded as a threat to the world’s financial stability. Russia appears on the IMF’s blacklist on money laundering, the CIA’s blacklist on nuclear proliferation and near the top of Transparency International’s corruption index. Its nationals, like Cubans, Iraqis, Libyans and Iranians, are subject to more stringent processing by US and many European embassies.

Transparency may be vitally significant for the global economy. Yet it is not enough to say, with Cattaui, that we need rules and laws. We still know very little about how non-transparent economies work. We know even less about how to encourage policy-making that would create motivation for transparency at the grassroots level, rather than simply imposing control and punitive sanctions.

We need to understand Russia’s economy on its own terms. Rather than looking only at what does not work, I want to concentrate on what does work and how. The ineffectiveness of the rule of law in Russia is one of the main obstacles to economic and political development. This not only deters much-needed foreign investment, it undermines efforts to curb capital flight, tax evasion, and corporate governance abuses. But if the rule of law does not work in Russia, then what does?

Popular wisdom offers one tentative answer: “Russia is a country of unread laws and unwritten rules”. Or, as they say, “the imperfection of our laws is compensated for by their non-observance” (nesovershenstvo nashikh zakonov kompensiruetsya ikh nevypolneniem).

It’s not that the components of the rule of law are absent in Russia. Rather, the ability of the rule of law to function coherently has been diverted by a powerful set of practices that evolved organically in the post-Soviet milieu. Understanding how these unwritten rules work will help to make the rules of the game more transparent, and thereby subject to positive reform.

The rules of the game

Given the scale of the informal economy in Russia, there is no shortage of examples that illustrate how unwritten rules operate. Tax evasion and tax bargaining alone are an excellent introduction to the informal order of things. In the corporate sector, the practices most damaging to transparency are those based on the so-called corporate identity split and false reporting.

Firms insulate themselves with at least two front companies, and create various shell-firms or scam-firms, organized in sophisticated financial networks. Offshore companies are set up to channel profits for the insiders’ club of shareholders or managers. Unwritten rules also prevail, to regulate non-monetary exchanges and help fight business and political wars.

The focus of unwritten rules is not on constraints per se, but on the enabling aspects of those constraints. The unwritten rules are the know-how needed to navigate between formal and informal sets of constraints, and to manipulate their enforcement to one’s own advantage.

Reliance upon unwritten rules is one outcome of the loopholes in legislation. The other is a lack of respect for formal rules, and the impossibility of their enforcement. Attitudes to the law are traditionally distant and sceptical. As long as such attitudes prevail, there is a limit to the extent to which the institutional framework essential for a market economy can operate.

Overcoming Russia’s dependency on unwritten rules means breaking free from the following chain reaction:

Unfortunately, these attributes of the system seem not to have changed much during Russia’s transition. Just as the planned economy was not really planned, but was actually run with help of tolkachi (pushers), blat(the informal exchange of favours) and other informal arrangements, the market economy today is not really a market economy. It relies on unwritten rules.

Unwritten rules: an invisible hand

Western aid programmes have funded ambitious macroeconomic reforms aimed at shocking Russia into a functioning market economy. Foreign investors have attempted to introduce and apply Western business practices.

But despite these external efforts and internal political will, changing the foundations of the system has turned out to be no easy task. Unwritten rules have long been a powerful invisible hand within Russian political culture: their presence is unlikely to melt away.

In the 1990s, these unwritten rules surfaced in the opportunistic manipulation of formal corporate constraints. To fulfil routine business tasks, companies are often compelled to secure a krysha (roof): to employ fixers and private security services companies skilled at navigating Russia’s complex financial and legal spheres.

These private security service providers combine professional expertise in formal codes (the tax code, licensing requirements, insolvency law, accounting and banking procedures) with the know-how to manipulate these codes to advantage.

They also employ informal negotiating techniques, which include sophisticated intelligence-gathering capacities and the manipulative use of blackmail files (kompromat). Such files include copies of bank statements, currency transfers, business and real estate transactions, and other official documents; as well as general correspondence, personal information and unofficial transcripts of telephone conversations.

Rather than restricting their activities to traditional tasks such as physical protection and informational security, private security services in Russia have become the de facto administrative force of the economy. Their extra-legal activities lubricate Russia’s imperfect institutional framework. ‘Krysha’ agencies facilitate interactions with state bodies and other economic agents, including business competitors, organized crime groups, and protection agencies.

The transaction costs created by private security services, pervasive corruption and the high-risk environment undermine the solvency of small firms in competitive markets. They serve to maintain the unwritten rules, which benefit the entrenched informal order.

Will Russia be able to break free from its dependency on unwritten rules? There is no need to be pessimistic. But changing the formal constraints will not be enough to weaken the hold of unwritten rules on the economy, or to make it more responsive to market stimuli. The system of informal constraints will have to change. The ways in which they divert, redefine and enforce formal constraints must be targeted. Otherwise further attempts at reforms will be endlessly frustrated.

Step by step across the tightrope

If the functioning of the economy depends on unwritten rules, how can their significance be reduced without cutting off the branch on which one is sitting?

Some practical steps should be taken:

Formal constraints notoriously associated with extra-legal practices must be identified and revised (as was done with the tax code). Legislation which does not work must be abolished. Then, Russia needs a long-term commitment to impartial enforcement of the revised codes.

A public debate should begin on the role of informal constraints, which are tied up with the legacies of the command system and traditional patterns such as patronage. It needs to become clear to people that the rule of law is a more advanced form of social contract. Susan Richards has suggested that Russians are beginning to understand the value of more formal civil society infrastructures.

A framework which encourages motivation, professionalism and good management will bring a spontaneous change in unwritten rules. People in Russia are enormously ingenious, and this can be a source of positive change if synchronized with the interests of the economy as a whole.

Personal networks, which perform dozens of functions in Russia, including those of redistribution, survival (food, money, mutual help), security, business, rent-seeking and technology, must be modernized. Crucially, they need to change, to become open and inclusive.

Outside influences and organizations can play a substantial role in transforming the setting for the unwritten rules. On a company level, investors, lawyers and consultants can act as role models by introducing new practices and norms into the Russian economy.

In Russia, as in other economies, it is vital that we become aware of the unwritten rules. For the development of an effective, transparent market economy depends on our being able to transform them.

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