Red Tape, and Black Knights. Political Risk in Russia.
Russia is trailing comparable emerging markets when it comes to attracting foreign businesses. Notwithstanding its current economic downturn, over the past decade the country has shown enormous acceleration of its economy and still is the most powerful market in the region. However, state capture, red tape and black knights prevent enterprises from increased engagement in Russia. International Business Associations help foster transparency and facilitate information exchange to protect against political risk.
by Johannes Leitner
Russia’s economy is suffering from a deep recession, the roots of which can be attributed to low commodity prices, the sanctions, and – to a large degree – the economy’s structural shortcomings accompanied by a hostile business environment. On the other hand, Russia still is a major economic power, ranking among the top 15 economies worldwide in 2015, with enormous political influence on a global scale. Nevertheless, in contrast to other emerging markets such as Brazil, India or China, Russia’s outward FDI stock surpasses the country’s inward FDI stock. Considering Russia’s market size, its population of more than 143m, and its economic growth over the past decade, the question remains why Russia has not been able to attract more international companies to settle between Kaliningrad and Vladivostok. A major factor is political risk, discouraging international businesses from entering the country and also repressing entrepreneurial initiatives in Russia itself. Political risk comprises any occurrence in the international business context through which public or non-state actors active in the host country of the international activities interfere with private international businesses and adversely impact the performance of the international operation.
Considering state capture and political risk
State institutions work in a legal-rational, predictable and effective manner. Relations between officials and private actors are formal and impersonal. In the OECD area, this is a constellation often taken for granted. In many countries worldwide, however, reality looks different. Private actors seize public institutions and processes to realize their particularistic interests of accumulating power and private wealth. For this purpose, they systematically “abuse, side-step, ignore or even tailor” formal institutions to their own needs in order to accumulate power and ever more wealth (Amundsen, 1999). Such forms of state capture are associated with weak state institutions, legal uncertainty, rampant corruption and detrimental behavior by the ruling elites, fostering their own business interests (“favoritism”) while harming independent enterprises. The existence of an influential informal decision-making network parallel to weak and distorted formal governing institutions causes severe political risk for international companies that are not aware of these networks or do not have access to them. This is what might lead to political risk factors that we describe as institutional ambiguity, systemic favoritism and systemic corruption in our latest book, ‘State Capture, Political Risks and International Business. Cases from the Black Sea Region’, available from December 2016.
Unfinished business when it comes to institutional reforms
Among the representatives of international companies active in Russia there seems to be no consensus on the political risks involved. Those who have been doing business with Russian national companies in strategic sectors such as oil and mining say, ‘it is very risky, but it is very profitable, especially if the Kremlin likes you’ (The Economist, 2008). It would be wrong, however, to believe that joint ventures between Western and Russian partners enjoying the Kremlin’s patronage would be fully protected. Analysis of the lagging development of Russia’s economy and its poor business environment leads to the conclusion that due to insufficient institutional transformation and incomplete implementation the reforms triggered under Putin’s administration since the early 2000s have not shown the expected positive effects (Kusznir, 2016). They have gotten stuck in the red tape of a captured state.
The risk of raider attacks
Under such circumstances, raider attacks against international companies are frequently reported (Rochlitz et al., 2016), with figures oscillating between 166,000 (Putin in December 2015) and 700,000 (Rossiskaja Gazeta, July 2015) cases per year, whereas independent NGOs supporting raided entrepreneurs counted not more than 1,000 attempts between 2011 and 2014. Despite the inconsistent figures, the existence of such raider attacks is not questioned. These raider attacks, locally referred to as rejderstvo, show the coordinated interplay of corruption, favoritism and institutional ambiguity. Private business interests collude with formal institutions such as tax authorities, the police and courts to put pressure on the targeted company until it goes bankrupt. Subsequently, it gets taken over by installing new management and hiring a new, loyal security agency to prevent the previous owner from reclaiming his or her stakes.
The rise of International Business Associations as a counterstrategy
Considering the blurry and opaque networks collaborating in such rejderstvo, foreign business associations seem a promising counterstrategy for international businesses. An increasing number of such associations from China, the U.S., India, Canada, Japan, Korea, etc. can be observed in Russia, and their presence provides more effective lobbying, improved information exchange and political backup from the respective country (e.g. the Association of European Businesses) to protect international business endeavors (Rochlitz, 2016).
Bibliography:
Amundsen, I., 1999. Political Corruption: An Introduction to the Issues. Available at: http://www.cmi.no/publications/file/1040-political-corruption.pdf
Kusznir, Julia (2016): Doing Business in Russia. The Main Political Risks and Challenges for International Companies. In: Leitner, Johannes; Hannes Meissner (eds): State Capture, Political Risks and International Business. Cases from Black Sea Region Countries. Routledge.
Leitner, Johannes; Hannes Meissner (2016): State Capture, Political Risks and International Business. Cases from Black Sea Region Countries. Routledge.
Rochlitz, Michael (2016): Collective Action Abroad: How Foreign Investors Organize. Evidence from Foreign Business Associations in the Russian Federation. Working Paper Series at National Research University, Higher School of Economics: Political Science. WP BRP 32/PS/2016. Available at: https://www.hse.ru/en/org/hse/wp/prepfr_PS
Rochlitz, Michael; Anton Kazun, Andrei Yakovlev (2016): Unter Räubern. Russland: Investitionsrisiko Unternehmensplünderungen. In: OSTEUROPA. 66, 5. S. 95-110.
The Economist, 2008. Special reports: Globalization, oil, politics and corruption. Available at: http://www.economist.com/node/12080765
