Corruption in Russia: A tale of two privatisations

The web of corruption that runs through Russia is thick, multi-layered and connects all pillars of society

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"Pelorus", belonging to Roman Abramovich, docked in St. Petersburg
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Benjamin Mueller
On 20 December 2011 12:38

To be sure, the economy was in the midst of a biting recession after a decade of stagnation. This, however, was a function first and foremost of the inherent weakness of the political economy of Communism, not of the underlying real economic base. Especially in the resource extraction sector, the Russian economy possessed tremendously valuable assets. During the early 90s, following Russia's botched privatisation programme, the size of capital outflows reached up to $20bn per annum - an indication of the wealth that the Russian economy had in store in real terms.

On a more anecdotal basis, the ostentatiously vulgar displays of wealth that the Abramoviches and Berezovskys of the world put on display in their South Kensington and the Cote d’Azure playgrounds are indicative of the raw financial wealth generated by the companies that somehow ended in the hands of those Russians lucky enough to be in the right place at the right time in the mid-90s.

Russia’s riches, far from being used to rebuild the basis of governance needed to return to a path of sustainable economic growth, were squandered. Today, the only real source of wealth for the nation and the government is the export of natural resources: duties and taxes from this sector provide half of federal income and accounting for the lion’s share of Russia’s export revenues.

What exactly went wrong? In short, there are two factors to blame.

Firstly, rapid mass privatisation in Russia was accompanied by wide-spread self-dealing among managers and shareholders. New owners tended to be no more than asset strippers. The wealth generated by such sales was partially used to corrupt the public sector and block any kind of reform, thus entrenching the moribund regulatory status quo.

Secondly, the burdensome business climate in Russia, with a stifling bureaucracy and a punitive tax regime prevented the privatisation programmes from achieving their real goal; namely, the restructuring and streamlining of business in order to make them operate more efficiently.

The crucial point is that privatisation as a concept is sound, but it needs to be properly administered. A thorough regulatory framework and institutions to oversee sales of nationalised assets are vital ingredients to prevent the programme from degenerating into a Russian-style free-for-all, where the most thuggish rather than the most efficient come out on top.

The Polish experience offers a nice example of properly administered privatisation for the benefit of the citizenry as a whole, rather than a narrow clique of crooks.

The Polish government gave itself time: small businesses were privatised first and under the guidance of Western advisers, business-friendly reforms were introduced to liberalise the corporate climate in the country whilst setting up a strong legal framework for capital market regulation.

Only then, once an environment was created in which business could thrive, were large state assets sold off. By the end of 1990, 80 percent of small and medium-sized Polish businesses had been privatised. Mass-privatisation, by contrast, only began in the summer of 1995.

In order for privatisation to be a macroeconomic success, then, it needs to be a) piecemeal and b) conducted within a stringent regulatory framework, crafted under the careful guidance and advice of outsiders who do not stand to gain financially from the sales process.

The proof of the pudding is in the eating: Polish GDP per capita increased from $1550 in 1990 to almost $4500 in 1998. In Russia, it decreased from $3900 to $2000 during the same period.

Privatisation is not flawed - kleptocracy is.

Benjamin Mueller is Director of Virtue Politics, a London-based consultancy advising clients from the public and private sectors on how to reduce levels of corruption

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