State Capture, Political Risks and International Business: Evidence from Ukraine under Yanukovych
by Hannes Meissner, Senior Researcher and Lecturer
Ideally, states provide security for doing business by a legal-institutional framework, enterprises can rely on. 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, the 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: 3). Such forms of “state capture” are associated with weak state institutions, legal uncertainty, rampant corruption and the detrimental behaviour of ruling elites, fostering their own business interests (“favouritism”) while harming independent enterprises. These are specific “political risks”, international businesses are confronted with, when operating in affected countries.
There is a lack of clarity about the term “political risk” as such. In international business studies, there is no universally accepted definition, let alone any universal concept of political risks. However, despite the heterogeneity, there is at least a common understanding. Drawing on a literature review, Leitner (2017) defines Political Risks as “any occurrence in the international business context where public actions or non-state actors that are active in the host country of the international activities interfere with private international businesses and adversely impact the performance of the international operation.” (Leitner 2017: 29) As Leitner (2017) further reveals, state capture as a source of political risks has not yet been systematically operationalised.
In the search for an approach leading to a deeper understanding of political risks associated with state capture, this paper draws on the political science concept of “neopatrimonialism”. The concept delivers insights into how specific factors of political risks are embedded in a political system. This focus has not yet gained much attention in the literature on neopatrimonialism. Research has so far dealt with political and, to a substantially lesser degree, with economic consequences of this specific mode of organisation. International business aspects, however, have been widely neglected. In international business studies, the concept of neopatrimonialism has not been considered likewise. The lack of related studies is first of all due to a general lack of interdisciplinary approaches between political science and business studies.
From the empirical point of view, this paper focuses on political risk factors to European businesses, along with coping strategies which they developed under the rule of Yanukovych. According to Fisun (2003), the characteristic features of the system Yanukovych were the ‘wide strata of neopatrimonial rent-seeking actors, acting together with/or in place of governmental institutions via clientelistic networks of patronage and pork barrel rewards’, as well as a high level of competition. Fisun therefore characterises the system as ‘oligarchic neopatrimonialism’ (Fisun 2003: 6; cf. also Franke et al. 2009: 80). However, the system was not only dominated by oligarchs, as regional politicians of networks, entrepreneurs and ‘wealthy businesspeople’ all turned out to be major players as well (cf. Pleines 2012: 128). The central broker in the whole configuration is the president. He maintains ‘a system of personal ties, (…) based first and foremost on regional (…) unity, as well as on present-day rent-seeking interests.’ He maintains power by capturing state resources and redistributing them to his own clientelistic network (Fisun 2012: 3). Menon and Rumer (2015) provide an in-depth analysis of the inner workings of this system under Yanukovych, including its large-scale corruption schemes, centred on the president’s network. As the authors highlight, such practises were treated as ‘no secret’ by president Yanukovych (Menon et al. 2015: 48). Marples (2015) describes this system as ‘a Donetsk-based regime of apparatchiks and gangsters with their own private mansions and assets abroad’ (Marples 2015: 15 f.).
In order to conceptualize political risk factors related to state capture, section two introduces the political science concept of neopatrimonialism. It derives three factors, in particular institutional ambiguity, systemic corruption and systematic favouritism. The empirical part of this chapter focuses on the impact of these three factors on European enterprises in Ukraine under Yanukovych (section four), and, finally, their coping strategies (section five). In this regard, section three gives a brief overview of the data collection process and the analysis method applied.
State Capture and Political Risks: Insights from the Concept of Neopatrimonialism
The roots of the concept of Neopatrimonialism go back to the studies of Max Weber, who drew a distinction between two “ideal types,” in particular patrimonial systems of rule and modern ones (cf. O’Neil 2007: 2). As pointed out by Erdmann (2012), neopatrimonialism refers to a system in which two forms of logic and institutional patterns exist side by side: the patrimonial system of personal rule, clientelism and patronage and the legal-rational system of modern statehood (Erdmann 2012). At the same time, the two spheres overlap. ‘The patrimonial system (of personal rule) penetrates the legal-rational system, twists its logic, functions and output (…), as formal and informal institutions and behaviour are intimately linked to each other in various ways and to varying degrees and this mixture becomes institutionalised’ (Erdmann 2012: 47 f.). In this respect, neopatrimonialism differs from ‘patrimonialism,’ under which all power relations between ruler and ruled, political as well as administrative relations, constitute personal relations (Erdmann et al. 2007: 105).
Neopatrimonialism does not stand for a particular institutional, social or economic system as such. It rather describes ‘a social and political order of conflicting modes of organisation and their legitimation’ (Robinson 2013: 137). It is a mode of organisation in which ‘the public and the private, the political and the economic, the individual and the collective, the `old´ and the `new´’ all overlap. In this context, certain groups of individuals dominate the system. Formally, they rule ‘within the framework of, and with the claim to, legal-rational bureaucracy or ‘modern stateness´.’(Erdmann et al. 2007: 105) In fact, however, they appropriate gains, privatise public resources and use them for private consumption (Sindzingre 2010: 4). In other words, formal state bureaucracies are infused with the particularistic politics of the rulers (Soest et al. 2011: 4). Regarding the relations between neopatrimonialism and regime types, it is noteworthy that authoritarian regimes provide an appropriate basis for neopatrimonial rule and vice versa. This is mainly, though not only, due to the specific structure of institutions and power relations in authoritarian states. The preservation of power due to the absence of free and fair elections, top-down processes due to vertically-organised structures in state and society, the lack of rule of law, and the dominance of the executive, altogether serve as a breeding ground for clientelism and patronage. Yet, as Soest (2010) stresses with regards to authoritarian regimes, they are not necessarily dominated by neopatrimonialism (Soest 2010: 6). However, such conclusions are merely theoretical in nature, given a lack of research in this field.
Patrimonial systems provide for security according to their own logic. The system is dominated by a patron who appoints the administrative apparatus, which is, in turn, responsible for reporting back to this strongman. The ruler delegates jurisdiction to deputies who maintain a certain degree of discretionary power. Actions taken tend to be arbitrary. They are based on subjective reasoning and follow ad hoc procedures. At the same time, operations are mostly informal or off the record. Important orders are often given orally. They draw on historical memory, based on local traditions. In official procurement and sales, verbal agreements are used. As administration is a means of clientelistic politics, benefits are the reward for personal connections with political leaders. In other words, rules are applied with partiality (Brinkerhoff et al. 2002: 6 f.) Under such conditions, security depends on and is secured best through personal connections and/or professed loyalty to the leader.
Neopatrimonial environments are not automatically associated with insecurity. ‘Within this system, people have a certain degree of choice as to which logic they wish to employ to achieve their goals and to best realise their interests’ (Erdmann 2012: 48). In other words, they can either draw on the formal legal-rational system of modern statehood or on the informal system of patrimonial rule. However, the mixture of formal and informal patterns characteristic of neopatrimonial systems is, at the same time, associated with specific factors of systemic insecurity.
One of those factors is institutional ambiguity. Ambiguity can appear both between formal and informal institutions and among formal institutions. Concerning the first case, Robinson (2013) points out that under neopatrimonialism, formal and informal rules are not mutually supportive but rather work against one another (Robinson 2013: 138). This results in insecurity about which rules are to be enforced (O’Neil 2007: 3). As Erdmann (2012) puts it, all actors are confronted with insecurity ‘about which rules or which relationships are best applied or mobilised in any particular situation in order to achieve a specific goal – either the legal-rational (formal) or the patrimonial (informal)’ one (Erdmann 2012: 48). A classic example of the insecurity inherent to institutional ambiguity is found in the practice of bribing. According to informal rules, bribing might be rational in certain situations and constellations. However, corruption may also entail legal prosecution. In the worst case, it might even provide grounds for blackmailing. In other words, under such conditions, the ‘legitimate rules of the game’ are unclear (O’Neil 2007: 3). Actions of state institutions and officials are not (fully) calculable (Erdmann et. al 2007: 19). International companies are particularly prone to this form of insecurity, since they are aliens with regards to local patrimonial systems and thus lack decisive insights into the whole logic of the process. At the same time, no general code exists which prescribes how to behave under such conditions, since each and every neopatrimonial system stands unique. In fact, praxis shows that there is a fluent transition between the two poles of legal-rational and patrimonial rule. In other words, the share of patrimonial vs. legal-rational domination invariably differs from country to country.
Ambiguity of formal institutions furthermore, entails that procedures, regulations and laws are unclear or even contradictory. In such cases, it is due to the fact that ruling elites tailor them to fit their particularistic interests. This form of arbitrariness is strongly associated with legal insecurity. While the legal/constitutional framework provides for legal certainty in theory, legal decisions in practise frequently make little or even no reference at all to abstract, general and non-retroactive laws. The result is that international companies have to deal with a lack of security and predictability, both of which in terms of the environment they are acting in. In this context, political-judicial trials are a popular strategy for harming or even getting rid of competitors. As Robinson (2013) highlights, in such constellations, foreign investment is impeded by weak property rights and high transaction costs. At the same time, property and contract rights are secured best through personal connections. However, the development of such measures proves to be highly costly to ‘outsiders’ (Robinson 2013: 138).
This leads to another political risk factor which European businesses are confronted with, and that is systematic favouritism. In the present case, it involves private actors systematically using public office to foster the business interests of the ruler himself or the ruler’s clientele, while impeding initiatives by actors who are not part of the ruler’s network. According to this understanding, systematic favouritism is a non-monetary form of corruption. In this context, rulers distribute licenses, contracts and public projects to their own business networks. As a result, political elites accumulate more and more wealth. They often control significant shares of the national economy (Robinson 2013: 138). Systematic favouritism thus poses major risks to European businesses as certain markets are freely accessible only at first sight. Businesses of the ruling elite are favoured while international companies suffer from difficulties in gaining any (sustainable) access to such networks. However, once they have succeeded in connecting with local networks, they can gain major benefits. Such relationships are most likely in such cases when the ruling elite and European businesses benefit from win-win constellations. Such relationships are, however prone to insecurity at the same time. If (international) actors tread on the logic of the respective patrimonial system, and/or if the cooperation loses attractiveness, they may well lose their position at any time. As the rule of law is weak, this this might lead in the worst case, to expropriation without compensation.
Another factor of systemic insecurity which European businesses are confronted with lies in corruption in monetary form. As Bratton and Van de Walle’s (1997: 63-68) point out, corruption constitutes an integral part of neopatrimonial orders, going hand in hand with the (informal) concentration of power and systematic clientelism (Soest et al. 2011: 7). Systemic corruption involves members of the ruling elite (both politicians and bureaucrats) utilizing their authority to sustain their status and wealth by systematically extracting bribes. A result thereof is that corruption becomes an integrated part of the public system and is therein systemic. In such environments, international companies are confronted with demands for entrance fees, kickbacks as well as payments necessary to ward off unjustified claims by tax authorities, the security service or the customs authority (etc.). In this context, corruption is always associated with a significant degree of arbitrariness and a lack of predictability, even if certain ‘going rates’ apply. In that vein, corruption stands a major risk to Western companies in particular, since such practises conflict with their compliance standards.
This section introduced three political risk factors associated with state capture, in particular, institutional ambiguity, systematic favouritism and systemic corruption. As neopatrimonialism is the prevalent form of organisation in non-OECD countries (Soest 2010: 2), the factors are universal, hence not only characteristic of post-Soviet Ukraine. The empirical focus of this chapter hones in on the case of Ukraine however, to illustrate this phenomenon. To that end, the following section introduces the process of data collection and analysis.
 In this regard, “ideal type” means the construction of abstract, hypothetical concepts for the purpose of social research.
 In fact, the concept of neopatrimonialism is of limited analytical power in this regard, as it lacks tools to measure whether, for example, Georgia is “less patrimonial” than Azerbaijan.
Data Collection and Analysis
The empirical study draws on 30 qualitative interviews in total, carried out by the three-member City of Vienna Competence Team Black Sea Region (CT BSR), of which the author of this paper is part. 21 out of 30 interviews were conducted with business representatives from companies of varying sizes, operating in different sectors, such as, chemical distribution, automotive trade, insurance services, pharmaceutics, trade of basic materials, construction, real estate, logistics, trade of paper and packaging material as well as law, business and tax consulting. All these companies were connected to the chamber of commerce in Vienna. However, not all of them were Austrian companies, as there were also European multinational companies among them. For this reason, this chapter refers to European companies. The business representatives were of Austrian, German and Ukrainian nationality. 14 of these interviews were carried out in Kyiv in February/March 2013, seven in Vienna between July 2012 and February 2013 and one in Bratislava in March 2013. In addition, nine out of 30 interviews were carried out with local academics in Kyiv in February/March 2013. These interviewees were all well-educated, of different ages and held a fundamentally critical attitude towards the political situation in their country. Among them were two journalists and at least one political scientist. They worked in local research institutes, think tanks and Non-Governmental Organisations (NGOs). One of them was a member of the State Committee for the Fight against Organised Crime and Corruption. They were tracked down by internet, based on research from local country experts.
The interviews were semi-structured, taking between 1 and 1.5 hours each. Those conducted with business representatives mainly focused on experiences and coping strategies applied in terms of institutional ambiguity, systematic favouritism and systemic corruption. In the case of the interviews with local academics, the exchanges were merely directed at gaining broader background information on the country, the specific form of state capture, along with the three factors of systemic insecurity, including its roots and changes over the course of time. The data analysis was done hermeneutically, establishing categories inductively. Moreover, most interviews were embedded in broader overall discussions on political, economic and social matters of contemporary Ukraine.
 For more details on the position and business background of the individual interviewees cf. the reference list at the end of this paper.
Political Risks in Ukraine under Yanukovych
All interview partners were well informed about the fact that Yanukovych misused his public position for private business purposes. Such issues received comparably high public attention in Ukraine under Yanukovych, not least since people were confronted with its consequences in daily live. However, in terms of the concrete constellation of state capture and its consequences, several representatives of European companies emphasised that they only learned about it after the market entry. As an international business representative put it, ‘for us from the West, the state structure of Ukraine looks strange. It is a mixture of oligopoly and clan-networks’ (Interview Partner XXI 2013). This raises the question then of how exactly were European businesses confronted with Political risks related to state capture in their daily operations?
Answers are found in an array of details. First and foremost, systematic favouritism constituted a core feature of this system of state capture. As the senior researcher of a Kyiv based research institute put it, ‘the entire economic sphere is based on interpersonal connections.’ It is a system in which ‘property and power are interconnected. Using power to obtain property is not a crime in this line of thinking. The ones who are linked to the rulers get privileges’ (Interview Partner XXVIII 2013). Similarly, the head of a local think tank stressed that ‘everybody tries to capitalise on their social contacts. Gaining political influence means you will get preferential treatment, particularly when you have access to the president’ (Interview Partner XIX 2013). As a member of the ‘State Committee for the Fight against Organized Crime and Corruption’ highlighted, the state has systematically been privatized for the purpose of generating privileges. ‘They’ developed ‘a scheme’ in order ‘to place their people inside government agencies’. Now ‘they run the system.’ They ‘influence public procurement,’ ‘develop policies’ and ‘make regulations’ (…) ‘according to their particularistic needs’ (Interview Partner XXX 2013).
The country representative of an international company for basic materials and capital goods identified (dis-)favouritism in four different fields and manners: 1) in the context of privatization of state enterprises, 2) the refund of tax paid in export business, 3), state subventions, particularly in the field of coal mining, and 4), ‘unfriendly takeovers’ of companies (Interview Partner XXI 2013). In all these areas, politically well-connected people proved to be the beneficiaries. However, other interview partners stated that favouritism was rooted in the field of public procurement (Interview Partners XVII; XIX; XXIX 2013). A Kyiv based investigative journalist reported regular cases in which members of the Yanukovych-network used state tenders to strengthen their businesses, while independent enterprises faired no chance of winning the tender (Interview Partner XV 2013).
Furthermore, systematic favouritism means that independent businesses are categorically disfavoured, insofar as they are prevented from obtaining access to the sectors dominated by oligarchs and the ruling family. As the manager of a local subsidiary of an Austrian supplier for construction components emphasized, he has ‘no friends and contacts’ in government which he would however need in order to receive a public contract. ‘In this field, the game is too complicated and allowed for a certain group of people only. This is not only a barrier, but also a border you cannot cross’ (Interview Partner XI 2013). At the same time, independent companies are often confronted with regulatory barriers (Interview Partners VI; XXX 2013). The country manager of an international pharmaceutical company complained about laws in the fields of product registration, fees and patent protection against international standards: ‘they were made because there is a very strong connection between political forces in this country and those who do business in this sector’ (Interview Partner IX 2013). Likewise, a country representative of an International Bank expressed how he felt ‘disappointed about the few illusions his institute initially had’ concerning the market entry in Ukraine. A key reason is that the state and the economy are ‘controlled by a few people’ (Interview Partner VI 2013).
State power was also strategically and deliberately applied to cause damage to competitors. According to a member of the ‘State Committee for the Fight against Organized Crime and Corruption,’ there were regular cases, where the state fiscal service, the police and the security service were used ‘to develop the business of the family’ (Interview Partner XXX 2013). Though difficult to verify, several business representatives reported second-hand stories of how the secret service SBU, the police and tax agencies (Interview Partners II; IV 2013), the national bank (Interview Partners III; VI 2013) and the judiciary (Interview Partner VII 2013) had been systematically employed to put pressure on independent businesses. A Western investor in real estate unveiled the case of an $55 million investment project in Southern Ukraine that came under serious pressure, when a unit of the ministry of interior against organised and economic crime visited the construction site in order to demand protection money in the amount of $300,000. When they refused to pay, a public prosecutor initiated inquiries against the company. The conflict was finally solved by paying local intermediaries ‘a sum less than $300,000’. (Interview Partner VII 2013) The country manager of an international car manufacturer reported a case wherein drugs were planted in his cars. He was able to solve the problem by paying a bribe of $1,000 in order to avoid the initiation of inquiries by a state prosecutor. ‘You have to stop such things in the very beginning. As soon as it proceeds by way of formal action, you are trapped. Then it will get really expensive or even, the game is over’ (Interview Partner IV 2013).
Yet, the overall view was that big international companies were still less prone to such risks than local ones (Interview Partners IV; VII; XIX; XX 2013). The situation for international companies was however sufficiently poor that the representative of an international insurance company emphasized that he had been fighting with ‘oligarchic structures’ for more than six years, as he experienced ‘extreme pressure from all sides of politics to sell his business’ (Interview Partner V 2013). The country representative of an international company from the transport sector reported, furthermore, that his company had had to struggle with the withdrawal of an important licence when they sold their shares in another company to a consortium rather than to an oligarch who was among the bidders (Interview Partner I 2013). Likewise, an international construction company was first awarded a contract by the city of Kyiv to reconstruct a historical building. However, they were later confronted with the allegation their licences were insufficient for doing business: ‘in my opinion, they tried to push us out as hard as they could.’ This took place not only by ‘verbal threats’ but also by actions aimed at undermining the company’s position as a general contractor vis-à-vis subcontractors (Interview Partner XVI 2013). The country manager of an international car manufacturer concluded that ‘in this country, it is not merely about doing and developing business’. In fact, ‘keeping the company alive, resisting the pressure of judicial and tax authorities, is already a huge success’ in and of itself (Interview Partner IV 2013).
As the aforementioned cases reveal, a strong connection is at hand between favouritism and legal insecurity. Given this backdrop, an international lawyer stated that Ukraine suffered from ‘massive problems in terms of property rights’ (Interview Partner XXVI 2012). Likewise, a company representative complained that ‘investments of foreign companies are not safe.’ The problem is that ‘profitable companies can be attacked by people in power,’ relying on ‘very well educated lawyers’, using ‘exits in Ukrainian regulations’ (Interview Partner XXIII 2012).
The latter statement indicates that ‘systematic favouritism’ and legal insecurity are in turn connected to the ambiguity attached to formal institutions. In fact, under Yanukovych, Ukraine featured a well-established system, with legislators constantly implementing new, contradictory or unclear laws. ‘There are no clear rules and people try to take advantage of that,’ commented one interviewee (Interview Partner XXIII 2012). Laws ‘are so underdetermined that they can interpret them how they need. They are full of gaps. (…) This was done on purpose’ (Interview Partner IV 2013). This phenomenon applied to all areas of trade, economic and tax law, as well as to administrative regulations. Nevertheless, the interview partners often pointed to deficient tax and fire regulations, in particular (Interview Partner XXV 2012; Interview Partners III; V; VI; VII; VIII; IX; XII 2013).
Such strategies were not only used to harm independent businesses. They were rather part of an omnipresent corruption system, affecting virtually every sphere of public life. A common strategy was to establish bureaucratic hurdles and to provoke law violations in order to extract money (Interview Partner II; VII; XII; XXII; XXX 2013): ‘the idea behind [it] is that the more bureaucratic the system, the easier it is to collect bribes. This is why the bureaucracy of this country shows incredible things’ (Interview Partner II 2013). In this context, it was particularly popular to use tax audits and fire inspections as a front for conjuring up unjustified fees and fines (Interview Partner II; IV; V; VI; VII; XI; XII; XXII 2013). Businesses not accepting this ran the risk of getting seriously impeded in their operations. In the worst case, local authorities would halt production altogether until the company paid up (Interview Partner XXIV 2012). Corruption schemes also applied in the fields of licensing and registration. The construction and real-estate sectors were particularly prone to such methods. As an international tax advisor concluded, ‘foreign investors have to fight a constant battle against the bureaucracy, tax and cartel authorities. They regard them as cash cows’ (Interview Partner XIV 2013).
At the same time, the judiciary was highly affected by corruption. ‘There is little sense going to court, because corruption prevails’ (Interview Partner I 2013). Likewise, the country representative of an international insurance company revealed that as soon as a case ends-up at court, his company writes off the disputed amount of money. ‘You cannot win. We have lost a lot of money this way’ (Interview Partner XX 2013). The general perception was that verdicts could be purchased (Interview Partners I; IV; VI; VII; IX; XVI; XVIII; XX; XXX 2013). Though difficult to verify, a company representative stated that verdicts cost between $20,000 and $40,000 (Interview Partner VII 2013). However, another interview partner noted that, despite such schemes, foreign businesses had no chance of winning when members of the ruling elite were involved in legal disputes (Interview Partner VII 2013).
Yet, under specific circumstances, there was still at least the possibility of winning public tenders if one acquiesced to paying bribes. A local anticorruption activist stated that in public procurement, ‘going rates’ of between 30 and 50 percent of the contract value applied (Interview Partner XVII 2013). The country representative of an international construction company commented, for example, that they withdrew from the contractor when they received the signal to pay between 15 and 17 percent of the project value in cash (Interview Partner XVI 2013). In other cases, foreign companies were asked to invest in social projects and infrastructure, thereby using local companies as contractors (Interview Partner XXII 2013).
Many interview partners regarded corruption as a political phenomenon, rooted in all levels of government (Interview Partner XXIII 2012; Interview Partners I; III 2013). There was also a widespread view that corruption was controlled centrally (Interview Partners III; IV; XII 2013) or even represented a part of a pyramid system with the Yanukovych family and close allies as final beneficiaries at the top (Interview Partners II; VII; X; XIII; XIX; XXII; XXX 2013). Others confirmed this, but stressed that the true picture would probably be more complex (Interview Partners X; XV 2015). In fact, the structure of the informal system is difficult to determine, as it is a black box. However, the general view on this seems to be influenced by Soviet memory and pre-Soviet memory to a large extent. This became evident in background conversations with interviewees, who regularly pointed to the fact that the system of centralised corruption and the misuse of public office for patronage and clientelism (“state capture”) dates back to Soviet and pre-Soviet times. Such practises are perceived as widespread phenomena throughout the entire post-Soviet space. Irrespective of the details, European businesses perceived corruption as a financial burden and a high risk (Interview Partner XXVII 2012; Interview Partners IV; XVI 2013).
Coping Strategies of International Businesses
European businesses responded to such political risks in different ways. Some big companies/MNCs were in the middle of preparing to leave the country or taking this step into consideration at the time of the interview. However, most companies denied having such plans in the short- and mid-term. One smaller enterprise professed to be tied to their investments and therefore was not able to leave the country (Interview VII). Still others declared to be reasonably satisfied with their business operations in Ukraine, having found ways of coping with political risks. However, in terms of additional investment, most companies proved to be reluctant (Interviews V, XXIII and XXIX). At the same time, the representative of an international consulting company specialised in Ukraine mentioned that his company would also be a beneficiary of this difficult political and economic constellation (Interview III).
One coping mechanism was found in “systematic favouritism” and all its consequences, insofar as doing business with independent “private” partners. The aim is to interfere with politics as little as possible (Interview VI). As the representative of an Austrian construction company admitted, they had decided not to take part in public tenders anymore. However, independent tenders were rare and hardly predictable. For that reason, the local office was equipped with the absolute minimum managerial staff necessary to maintain basic operations. In case the company won a tender, they sent expats and sub-contracted workers for a limited period of time (Interview XII). Nevertheless, doing business with private partners does not mean companies can entirely circumvent systemic corruption. As the company representative further stated, “you still need your building permit. They have the militia, their inspectors. They will all come to your construction site and ask for bribes” (Interview XII).
Some rosier areas could be pinpointed however. Western companies offering high-tech products needed by local companies were in a comparably good position (Interview XXXI). The same held true in case of win-win constellations: “Western investors are tolerated when they fit into the business model of the nomenklatura or when they complement their interests” (Interview XVI). However, as the country manager of an international bank pointed out, in terms of reliable business cooperations, there were also enormous differences between the individual oligarchs. While Akhmetov would be a good business partner relying on Western standards, the bank refused to do any business with Kolomoyskyi or Firtash (Interview XIII).
In light of these conditions, some companies decided to shift their business activities into such areas which are less affected by systematic favouritism. Eventually, businesses relying on high-tech and specific know-how managed to establish themselves in a comparably safe position. This held particularly true for IT-companies, as well as for the consulting industry (Interviews III and XXXII). A case to point out is a smaller enterprise tied to the Ukrainian market due to high investments done, which shifted their activities from real estate investments to consulting and facility management (Interview VII).
An approach for coping with the risk of expropriation is to make reference to property. Some companies avoided concentrating assets in the country (Interview I and IV). (cf. Leitner et al. 2014): “my office is rented, also the building for the call centre. We have not built any facility. This was a conscious decision. We do not work like this in other countries” (Interview I). Another related strategy is to set up a local branch instead of establishing a fully operating local subsidiary. Subsequently, the core processes are left with the parent company in the home country (Interviews I and IX) (Leitner et al. 2015).
Other companies preferred to outsource activities to local business partners. Such cooperations were particularly frequent in the field of sales and distribution. In this context, local business partners often act as redistributors, drawing on their local business networks (Interviews XI and XVI). In addition, they also provide for security, as they know which rules and which relationships are best applied or mobilised, particularly in case of ambiguity between formal and informal institutions (Interviews XX and XXV). At the same time, they can handle corruption claims, which keeps “your company clean from [the] inside at least” (Interview XXV). As the country manager of an international car manufacturer put it, “you need a local partner dealing with the issues you do not want to know about. (…) You know he has to do things, not compatible with your norms and values” (Interview IV). At the same time, some company representatives emphasised that establishing joint ventures with local partners is again a risky undertaking, as there is “no basis of trust” (Interview IV), and moreover, no legal system to rely on in case of conflicts or fraud (Interviews IV and VII).
There is the alternative of approaching local “consulting companies” or “lobbyists” for assistance in these matters (Interviews II, IV, V, VI, VII, XIII, XX, XXIV, XXVII and XXXI). Such “companies” are in fact one-man enterprises, operated by locals with personal contacts to high-ranked officials. They act as brokers or intermediaries. Many of them used to be state officials or managers of state enterprises themselves (Interviews II, VI, XXVII, XXXI and XXXII), some of them dating back to Soviet times. These persons can “open the door” and connect people to the highest level of the neopatrimonial order, which is, in the local context, also referred to as “Krysha” (Interviews VII, XIII and XXX). By doing so, they can provide protection. They defend attacks by officials, judges and local businessmen:“you do not have any networks. You do not know how this culture of bribing works. And you do not know where to go. So basically what you need, you need somebody, who provides you with these services” (Interview XXXII). However, such practises entail a high risk of fraud (Interview XIII). Moreover, informal networks are prone to instability (Interviews XII and XVIII). As an international company representative put it, when a new president comes into power, your informal network will break away. As a result of that, companies not only face the challenge of rebuilding their networks, but they also have to cope with hostilities and attacks by the new people in power, who regard them as a friend of their enemy (Interview II).
Such brokers are also there to handle corruption claims. In this regard, one can speak of a strategy of outsourcing corruption: “Western companies pay consulting companies for paying illegal money. By doing so, they can avoid having ‘unofficial fees’ show up in their reports. This way they keep clean” (Interview XIII). Likewise, an international company representative declared they would not pay “big sums” of bribery themselves, as this is “dangerous and criminal.” They only pay “operational money” up to 20,000 Euro, as in the case of manipulated fire inspections. One interview explained: “when things become too big, we engage our lawyer, telling him we do not want to hear and know anything about it” (Interview IV). Another case in point is found with an international construction company, having engaged a “customs broker. We do not need to worry, who will ask for money. He knows everything and he will pay. In the end, we will only get a hefty bill” (Interview XIII).
Yet despite its rampant practice in everyday business, most companies surveyed nevertheless denied paying bribes. Some of them argued it would not be possible due to their compliance laws and due to audits (Interviews XI, XXIII, XXVII and XXVIII). Others feared losing their reputation (VIII). Another argument was that there is an element of insecurity inherent to corrupt dealings. As the company representative of an international construction company put it, it is a vicious circle leading to additional claims and, as such, an incalculable financial risk (Interview XVIII, also Interviews IXXII, XXVI and XXVII). Others stressed that bribing might entail legal prosecution or might even give grounds for blackmailing (Interviews II, XXII), though you can again pay your way out of it (Interview III). Yet others argued that they are transparent and compliant with local law and, as a result of that, do not offer any basis for corruption claims (Interviews XIII and XIV). Another company representative declared that they would be the subcontractor, and as such not exposed to corruption claims, which does not however hold true for the main contractor (Interview XII). Yet others argued they could refuse paying any bribes, as they rather hold their weight through the high quality of their services and/or products (Interviews IX, XI, and XII). In contrast, others stressed that corruption is part of the system and as such impossible to avoid (Interviews II, XXI, XVIII and XXIX): “recently, a German expat from the pharmaceutical industry told me they would never bribe. I can only smile about this. The one who brings ethics into play, should not go to Ukraine” (Interview VII).
Yet another coping strategy is found in attracting as little attention as possible. This can be done by keeping operations on a smaller scale (Interview XIII), by not advertising publicly and not giving any interviews to the media (Interview II). The strategy of attracting no attention also applies vis-à-vis the tax administration. This entails neither declaring high profits, nor losses (Interviews XII and XIII). What’s more, the amount of money in Ukrainian bank accounts should not exceed day-to-day needs (Interview IV). This represents, however, no guarantee that the tax administration will not start any manipulative attack proceedings. As some company representatives expressed, in such cases, they fight against the attack with all judicial instances available. The goal is to tire out the opponent, which makes future attacks less likely (Interviews XIII, XIV and XXIV). Yet, apart from this specific case, International companies rather avoid going to court in Ukraine. Some MNCs circumvented having trials under Ukrainian law by choosing a third country as the place of jurisdiction (Interview XVIII).
Concerning systematic favouritism, institutional ambiguity and systemic corruption, Western companies not only turned to local agents, but to international agencies as well (Leitner et al. 2015). As several company representatives noted, political pressure through embassies, national chambers of commerce, European Union institutions or high level home government officials regularly turns out to be effective. Such institutions prepare lists of companies facing specific threats. They then address the problem at the highest diplomatic level (Interviews I, II, III, IV, IX, XIV, XXI, XXVII and XXXII).
Finally, the recruitment strategy plays a major role when coping with political risks (cf. Leitner et al. 2015). In Ukraine, a company’s most critical organisational departments are accounting and legal services (Interviews II, III and VII and XX): “you need a reliable accounting department; people that are well versed, as this is an area full of traps” (Interview II). Another interviewee offered: “the accounting department is in position two in terms of significance to a company” (Interview III). As the country representative of an international bank explained, for accounting purposes, he would employ three times as many people as in Austria (Interview XX).
In all these areas, international companies mostly employ locals, although they simultaneously aim at maintaining full control over organisational processes by expats (Interviews II, III and IX). In this context again, the reason is that only locals know which rules and which relationships are best applied or mobilised in any given situation (Interviews II, III, IX and XIII). As a company representative highlighted, only locals know the necessary networks and how to avoid or handle attacks by government authorities: “you need local personnel for all that. People who know how all these machinations work. Otherwise you can close down your company” (Interview XII).
This paper examined the relation between state capture and political risks. For this purpose, the chapter drew on Max Weber’s differentiation between modern and traditional forms of rule. Ideally, states provide security by a legal-institutional framework, which citizenry can rely on. Under patrimonialism, however, rules are applied informally and with partiality. Security depends on personal connections to the leader. Neopatrimonial states are, in turn, characterised by a mixture of modern and patrimonial systems, since formal institutions are seized in place by clientelistic networks. As the mixture becomes institutionalised, international businesses have a certain degree of choice. In order to gain security, they can either draw on the formal legal-rational system of modern statehood or on the informal system of patrimonial rule. At the same time, this mixture of formal and informal patterns is associated with specific risks. They are systemic corruption, systematic favouritism and institutional ambiguity.
The empirical part of this chapter first provided evidence to that effect, depicting the characteristics of these risks under the reign of Yanukovych. It also revealed that European businesses were heavily affected by these factors. It then examined their coping strategies. Coping strategies entail methods of minimising the insecurity in the business environment. In this respect, the empirical data revealed three basic options. The first possibility lies in minimising the exposure to political risk factors inherent to the local neopatrimonial system. This can be done by doing business with independent “private” partners, creating win-win constellations, shifting business activities into safer business areas, avoiding concentrating assets in the country, setting up a local branch instead of establishing a fully operating local subsidiary and/or attracting as little attention as possible. The second option is to rely on local partners who know which rules and which relationships are best applied or mobilised in the local neopatrimonial context. Related strategies aim at outsourcing activities to local business partners, employing locals and/or employing brokers or intermediaries. The latter particularly provide for security by connecting businesses to the highest level of the neopatrimonial order, which is, in the local context, also referred to as “Krysha.” The third option is to mobilise external agents in order to enforce the legal-rational system of modern states, according to international standards. In this regard, international businesses regularly rely on embassies, national chambers of commerce, European Union institutions and/or high level home government officials.
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Interview Partner I, 2013. Face-to-face interview by CT BSR with Country Representative, International Company from the Transport Sector [Interview] (25 February 2013).
Interview Partner II, 2013. Face-to-face interview by CT BSR with Country Representative, International Company in the field of chemical distribution [Interview] (February/March 2013).
Interview Partner III, 2013. Face-to-face interview by CT BSR with Country Representative, International Consulting Company [Interview] (February/March 2013).
Interview Partner IV, 2013. Face-to-face interview by CT BSR with Country Manager of an International Car Brand [Interview] (26 March 2013).
Interview Partner V, 2013. Telephone interview by CT BSR with Representative, International Insurance Company [Interview] (1 February 2013).
Interview Partner VI, 2013. Face-to-face interview by CT BSR with Country Representative of an International Bank [Interview] (February/March 2013).
Interview Partner VII, 2013. Face-to-face interview by CT BSR with Medium-sized Western Investor, Real Estate Sector [Interview] (February/March 2013).
Interview Partner VIII, 2013. Face-to-face interview by CT BSR with Director of a Think Tank [Interview] (February/March 2013).
Interview Partner IX, 2013. Face-to-face interview by CT BSR with International Pharmaceutical Company [Interview] (February/March 2013).
Interview Partner X, 2013. Face-to-face interview by CT BSR with Political Scientist, International Anti-Corruption NGO [Interview] (February/March 2013).
Interview Partner XI, 2013. Face-to-face interview by CT BSR with Manager, Daughter Company of an Austrian Medium-sized Enterprise, Supplier for Construction Components [Interview] (February/March 2013).
Interview Partner XII, 2013. Face-to-face interview by CT BSR with Country Manager, International bank for real estate and infrastructure financing [Interview] (February/March 2013).
Interview Partner XIII, 2013. Face-to-face interview by CT BSR with Journalist [Interview] (19 February 2013).
Interview Partner XIV, 2013. Face-to-face interview by CT BSR with International Tax Advisor [Interview] (1 February 2013).
Interview Partner XV, 2013. Face-to-face interview by CT BSR with Investigative Journalist [Interview] (26 February 2013).
Interview Partner XVI, 2013. Face-to-face interview by CT BSR with Country Representative, International Construction Company [Interview] (February/March 2013).
Interview Partner XVII, 2013. Face-to-face interview by CT BSR with Anti-Corruption Activist [Interview] (February/March 2013).
Interview Partner XVIII, 2013. Face-to-face interview by CT BSR with Country Representative, International Bank [Interview] (28 February 2013).
Interview Partner XIX, 2013. Face-to-face interview by CT BSR with Head of a local think tank [Interview] (20 February 2013).
Interview Partner XX, 2013. Face-to-face interview by CT BSR with Country Representative, International Insurance Group [Interview] (February/March 2013).
Interview Partner XXI, 2013. Face-to-face interview by CT BSR with Country Representative, international basic materials and capital goods company [Interview] (February/March 2013).
Interview Partner XXII, 2013. Face-to-face interview by CT BSR with Country Representative, International Manufacturer of Bricks [Interview] (19 February 2013).
Interview Partner XXIII, 2012. Face-to-face interview by CT BSR with Company Representative, Multinational Engineering Company [Interview] (29 August 2012).
Interview Partner XXIV, 2012. Face-to-face interview by CT BSR with Regional Manager, Logistics Company [Interview] (4 October 2012).
Interview Partner XXV, 2012. Face-to-face interview by CT BSR with Manager, Manufacturing Company for Chemical Products [Interview] (30 July 2012).
Interview Partner XXVI, 2012. Face-to-face interview by CT BSR with Partner, International Law Firm [Interview] (4 November 2012).
Interview Partner XXVII, 2012. Face-to-face interview by CT BSR with Manager, International Company for Paper and Packaging Material [Interview] (8 November 2012).
Interview Partner XXVIII, 2013. Face-to-face interview by CT BSR with Senior Researcher, Local Research Institute [Interview] (18 February 2013).
Interview Partner XXIX, 2013. Face-to-face interview by CT BSR with Country Representative, Multinational Engineering Company [Interview] (18 February 2013).
Interview Partner XXX, 2013. Face-to-face interview by CT BSR with Member of the State Committee for the Fight Against Organised Crime and Corruption [Interview] (February/March 2013).
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