What’s Wrong with Russia – Part II – Red Tape

[Note: this the second in a series of posts covering what are, in my opinion, the most significant examples of ‘what is wrong with Russia].

In my previous post on infrastructure, I identified several deficiencies in the quantity and quality of Russia’s existing infrastructure, and major problems with the construction of new or upgrade of old infrastructure.  The analysis is straightforward – if you have less roads of lower quality, and pay more to construct new roads (also of low quality), it will generally be more difficult to do stuff in the country including business.

Now we turn from Russia’s physical/organizational foundation – something the country once prided itself on – to the legal and regulatory framework – something which Russia has never done well.  Period.  The analysis here is similarly unsophisticated – if a country has onerous, vague, and contradictory regulations on business activity, there will likely be less business activity.  And if those regulations are selectively enforced for malicious or corrupt reasons, the society obtains zero benefit to offset the cost of lower business activity.  The evidence is also clear because the regulations are published and compliance costs (i.e., time, money) can be objectively measured.

Doing Business in Russia

One comprehensive source for this data is the World Bank’s annual Doing Business survey, which compiles and compares data on legally doing business throughout the world.  The current volume – Doing Business 2011 – was just released this month.  The authors review data from nine different categories:

  • Starting a Business
  • Dealing with Construction Permits
  • Registering Property
  • Getting Credit
  • Protecting Investors
  • Paying Taxes
  • Trading Across Borders
  • Enforcing Contracts
  • Closing a Business

For each category, a country’s legal/regulatory environment as analyzed, compared to other countries, and then ranked on an easy vs. difficult continuum.  The category scores are then aggregated into a composite “East of Doing Business” score.

Russia’s position in the aggregate ranking fell more than any other country between 2010 and 2011, from 116/183 to 123/183.  Despite the Duma passing new laws at a record-breaking pace, Russia’s score failed to improve in every category (though the score remained unchanged in Construction Permits, Trading Across Borders, and Enforcing Contracts).  The scores where Russia fell the most were: Closing a Business (-10), Registering Property (-6), and Starting a Business (-4).  And for all the Kremlin’s angst over improving the investment climate, Russia’s score fell by one place in the Protecting Investors category.

Parsing the Data

If you look at the data, the reality is that Russia has objectively improved its business environment in several of the covered areas – e.g., reducing time spent on construction permits (by 20%), on taxes (by 29%), on starting a business (by 32%).  The problem is that Russia has not improved as quickly or substantially as other nations.  This is the beauty of the Doing Business survey – it implicitly reflects the reality that Russia is competing with the rest of the world for the capital of foreign and domestic investors.  Indeed, Russia’s neighbor Kazakhstan was the superstar of this year’s survey, moving up 15 spots (to 59/183) by improving its regulations on Starting a Business, Paying Taxes, and Protecting Investors.

In 2009, the Doing Business folks did a subnational report on Russia, which comparatively analyzed the ease of doing business in ten Russian cities.  Doing business was easiest in Kazan, Tver, and Petrozavodsk, and most difficult in Moscow and Voronezh.  Interestingly, the governors of the regions including Kazan, Petrozavodsk, Moscow, and Voronezh have all either been fired, had their terms not renewed, or retired in the past year under Medvedev’s regional reshuffling.  And Tver Governor Dmitry Zelenin is certainly on thin ice after tweeting a picture of a worm served in his salad at a Kremlin dinner.

Opportunity Costs of Onerous Regs

Russia’s red tape is perhaps best symbolized by the nightmare involved in dealing with construction permits, each of which requires no less than 53 procedures and 540 days to obtain.  The most time-consuming procedure is requesting and obtaining the development plan for a land plot at the Moscow Architecture and City Planning Committee (180 days).  Officially, this particular procedure is free but you can imagine the unofficial costs involved in “expediting” a 180-day process.  The most costly procedure is requesting and obtaining an electricity connection with MosEnergo, the state-owned energy utility for the Moscow region, which costs approximately $336k (RUR 10.5 million).  Again, there may be unofficial costs for “minimizing” this number, which delay and degrade the process.

The practical implication of all these construction headaches is that Russia is losing out on investment, especially from newcomers wishing to start from scratch rather than make an acquisition.  The Walmart example is instructive.  Walmart has engaged in very public hand-wringing over whether and how it should enter Russia for quite some time, both before and since opening a Moscow office in 2008.  According to a company spokesman, “[W]e believe, long-term, Russia is a market where we aspire to have retail operations, and our team in Moscow continued to evaluate the most appropriate way to enter the market.”

The big question has always been – strategic acquisition with associated legacy costs/risks and potential for an unsuccessful implantation of Walmart processes/standards on an existing company; versus greenfield investment with all new stores, supply chains, marketing, etc.  If you have read about the company or watched the documentaries on CNBC every night, you know Walmart prefers the second option.  Walmart has developed a very systematic and specific approach to how every store should be run over the last several years.  And though Walmart’s entry into China was via a joint venture (with a state-owned company), this is neither necessary nor possible in Russia where the state is not involved in retail trade.  So from a broad perspective, a greenfield investment would probably be Walmart’s intuitive choice in Russia.

The problem is that Walmart has almost certainly followed the Russian drama of Swedish furniture retailer IKEA, which I have covered at length in the past.  IKEA did enter Russia through new investment – it had to construct brand new stores and deal with all of the associated headaches.  Even after a more than a decade and $4 billion invested, how did IKEA finally go down?  Over a bribe paid to facilitate obtaining an electricity connection from Lenenergo, the state-owned St. Petersburg utility.  When something as basic as getting electricity to a store still plagues the most experienced and invested foreign retailer in Russia, it serves as a huge stop sign to similarly-situated companies like Walmart.  Unlike the unlisted, Swedish IKEA, Walmart cannot afford a similar corruption scandal, which would probably result in a costly investigation and fine under the U.S. Foreign Corrupt Practices Act.  Most recently, Walmart has indicated an intent to acquire an existing Russian retailer.  Reports have suggested that Walmart is looking at either Lenta or Kopeika.  While Walmart continues to debate its options in Russia, it will open 79 stores in Brazil, 32 stores in China, and 256 stores in Mexico.

What to Do?

As with infrastructure and other problems in Russia’s business environment, overly restrictive or difficult regulations do not have one simple solution.  For example, if corruption was less rampant in Russia, many of theses regulations might run more smoothly and inexpensively (or the authorities might not see the need for them in the first place).  Also, if Russia’s civil servants were better trained, higher paid, and more professional, businesses might not dread that meeting with the chinovnik.

There are interim solutions until Russia figures out how to create Norway in Eurasia.  I attended an event last year at the U.S. Chamber of Commerce, where Trade, Finance, and Economic Ministers from Central Asia came and promoted all the reforms going on in their countries.  The presentations and progress indicators tended to match what you would expect from each country.  The Afghan minister pointed out the the mortality rate had fallen (he literally said, “less people are dying”).  The Turkmen minister discussed their recently-adopted business laws regulating private property, contracts, and other essentials of a non-socialist economy.

The Kazakh minister – the only female in the group – was by far the most impressive and talked at an impressive level of detail about areas where they had tweaked legislation in response to business concerns.  One thing she said that stuck with me: “We have found that the best way for improving the business climate is to minimize the number of transactions between private enterprises and government officials.”  This concept – sometimes implemented as the “one-window” approach – is a simple yet effective way for a country like Kazakhstan to quickly improve business conditions.  The approach recognizes that the Soviet culture and training that still plagues their bureaucracy cannot be wished or willed away.  It just takes time and until then, its best to just help businesses avoid an excessive amount of interactions with bureaucrats.

Russia should adopt a similar strategy to meet Medvedev’s goals of improving the investment climate and promoting modernization.  Of course, the civiliki who surround him promote a piecemeal strategy of crafting linguistic adjustments to Russian legislation – as if the problem can be solved with a good thesaurus.  But constant tinkering with Russian laws will only undermine their goal by undermining clarity and empowering vampire bureaucrats who judge whether a business is in technical compliance.  Instead, Medvedev and his team need to think big and approach the existing bureaucracy like a cancer, which should be isolated and cut out (Mexico’s mass firings of law enforcement and customs officials is an example worth emulating).  Then they can start from scratch and build a legal/regulatory system that reflects their post-Soviet ideas, rather than grafting those ideas onto the legislative corpse of the USSR.

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1 Response to What’s Wrong with Russia – Part II – Red Tape

  1. marknesop says:

    The biggest obstacle to reform, at least as I see it, is the lingering persistence of the Soviet way of doing business, which suggested that – since there was no real competition – it was not only safe, but necessary to add gratuitous levels of bureaucracy to every procedure, so that everybody got a chance to make a little money. The trouble is, as you’ve eloquently pointed out, Russia is struggling to transition to a market-based economy. An instructive post which somewhat mirrors your own can be found here:

    I don’t know if Wal-Mart is the best example, though, as many western sources have remarked on their predatory policies, such as sealing a deal with a local manufacturer to be their exclusive supplier and agreeing to buy all his output, then progressively shaving his profit margin to the bone.

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